Bank credit growth in India is expected to moderate to 14% in fiscal 2025 from the existing 16% if the deposit growth is unable to keep pace with loan demand, a global rating agency said in a report. 

"Deposit tightness will remain a system overhang. Our base case is for loan growth to slightly moderate, leading to manageable competition for deposits. Indian banks will have to strike a fine balance between maintaining strong loan growth and paying more for deposits to fund that growth," S&P Global Ratings said.

If the clash for deposits gets fiercer, Indian banks will take a hit, either with slimmer margins or slower growth, it said.

"Credit demand is strong. The economic backdrop is highly conducive to growth. Asset quality is improving, buoyed by a confluence of supportive structural and cyclical factors. All that India's banks are missing is a boom in deposits," it said.

Funding conditions will determine loan growth for many banks. As per the report, system-level credit growth is expected to moderate to 14% in fiscal 2025, from about 16% year-on-year growth in the first three quarters of FY24. 

Margins are also expected to fall. "If credit and deposit growth rates remain steady, a period of deposit competition looms, squeezing bank margins to 2.9% from 3%. Private-sector banks are likely to bear the brunt of the situation, as they are already operating at much higher loan-to-deposit ratio (LDR)," said S&P Global Ratings credit analyst Deepali V Seth Chhabria.

Adding to the stress on the private-sector banks, the lenders are growing at a much faster pace than public sector banks, she added.

Deposit competition could get fiercer than what the base case assumes, if lenders don't pull back on credit growth, it said. “Private banks' LDR could cross 97% by March 2026 in our alternate scenario of 18% credit growth,” the report added.

A surge in credit growth has pushed Indian banks' ratio of loans to deposits to a two-decade high; growth beyond this level will either come more slowly or be more expensive, it said.

With regard to capital adequacy ratio, the report said, most of India's banks can support loan growth as high as 15-20% for the next three years without need for large capital raising.

Banks have bolstered their capitalisation in the past few years following several stints of fund raising and government infusions into the public sector banks (PSBs).

Improved profitability has also supported banks' capital formation.