Banks gain funding boost from FCNR deposits, but margins face near-term pressure

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Mumbai: A surge in foreign-currency deposits is giving Indian banks ample liquidity to sustain strong credit growth but the surplus is set to squeeze net interest margins (NIMs) this quarter, particularly at private lenders, analysts said.
Motilal Oswal Financial Services expects private-bank NIMs to decline by 8-20 basis points in the September quarter, while Nomura Global Markets Research expects margins to remain under pressure as banks carry surplus FCNR(B)-linked liquidity in lower-yielding assets. The pressure arises because banks have mobilised the funds faster than they can deploy them into loans at normal lending spreads, temporarily diluting margins.
The trade-off highlights how the Reserve Bank of India's push to attract dollar inflows has eased funding constraints for banks, even as it creates a near-term drag on profitability.
Strong credit demand means lenders can keep expanding loan books with the extra liquidity, but until those funds are deployed into higher-yielding assets, the surplus will likely weigh on margins.
“Banks have to park the surplus liquidity in the short-term money market and other instruments, where the yields are much lower than the cost of deposits,” said Sanjay Agarwal, director at Care Ratings.
“This creates a negative carry for some period, which will weigh on margins. It will take some time for banks to deploy these funds into the lending market and start earning higher returns, so margins could remain under pressure during this transition.”
The Reserve Bank of India (RBI) on 5 June opened subsidised windows to attract dollars and bolster the rupee. As of 18 September, the three windows had attracted $143.6 billion, with 93% through FCNR(B) deposits, some of which flowed back to banks, adding to surplus liquidity.
Public-sector banks, on the other hand, are expected to report more resilient and range-bound NIMs because FCNR(B) deposits account for a smaller share of their overall deposit base and they remain focused on retiring high-cost liabilities, according to Motilal Oswal.
Strong credit growth
The September quarter is likely to show continued strong loan-growth momentum across the banking system, with higher-than-expected foreign currency non-resident bank (FCNR(B)) inflows giving lenders additional funds to deploy.
As of 15 September, system credit grew over 18% on year, while deposits rose more than 17%, latest RBI data showed. The gap between credit and deposit growth has consequently narrowed sharply, pushing the system credit-to-deposit ratio down to 81% from 82% in August.
FCNR(B) flows have significantly boosted bank deposits. Motilal Oswal estimates that system deposit growth has accelerated to 17% from 11-12% earlier, with FCNR(B) deposits accounting for about 4.5% of system deposits.
The brokerage expects bank credit growth to remain strong, supported by retail demand, higher utilisation by micro, small and medium enterprises (MSMEs), corporate borrowing and FCNR(B) flows. It has pegged FY27 credit growth at around 15.5%.
The banking system's liquidity surplus, driven by heavy FCNR(B) mobilisation, peaked at  ₹9.85 trillion on 15 September before easing to  ₹4.7 trillion by 30 September, Nomura said in a report on 2 October. The RBI has been draining some of the surplus through its different operations.
"The funding constraint has eased," Motilal Oswal said in a report on 5 October. "But the flip side is that banks are temporarily holding more liquidity than they can immediately deploy into loans," creating pressure on margins.
Nomura expects banks to report high-teens loan growth in the second quarter, while margins remain under pressure as lenders hold surplus FCNR(B)-linked liquidity in lower-yielding assets.
Among mid-sized private banks, RBL Bank is expected to see NIM expansion from the full-quarter impact of Emirates NBD Bank's capital infusion, while IDFC First Bank is expected to report a sharper sequential decline, the brokerage said.
To be sure, a likely repo-rate hike, expected later this week, should also support NIMs, benefiting banks with a higher share of floating-rate loans, Nomura said.
Investors would continue to watch out for loan growth, NIM trajectory, CASA mobilisation, credit costs and asset quality. So far, asset quality remains benign, with analysts expecting slippages and credit costs to stay under control, although the uncertain macroeconomic environment and below-normal monsoon remain risks.
For now, analysts expect the strong loan growth to translate into healthy earnings. Motilal Oswal estimates private-bank profit will rise 24% year-on-year in the September quarter, compared with 27% growth for PSU banks. Across its banking coverage, it expects profit to rise 25% year-on-year and 9.5% sequentially.

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