Why India’s Next Banking Crisis Won’t Start With Bad Loans

For decades, deposit mobilisation was the quiet strength of Indian banking, predictable, stable and largely uncontested. That era is decisively over and the Indian banking system today stands at a critical inflection point where the next stress is unlikely to emerge from asset quality, but from the liability side of the balance sheet.

Deposits have become the most fiercely contested part of banking. Banks are no longer competing only with each other for household savings, they are competing with fintech platforms, capital markets, alternative investment products and a retail investor who now prioritises returns, liquidity and optionality over inertia. Household financial savings have fallen sharply from 7.1% of GDP in FY22 to 5.3% in FY25, while mutual fund AUM has surged to nearly Rs70 lakh crore, diverting Rs2–3 lakh crore annually away from traditional bank deposits. This shift is structural, not cyclical and it marks a regime change where balance- sheet stress will originate not from bad loans, but from shrinking and volatile funding.

The recent experience of HDFC Bank, the country’s largest private sector lender and a market leader in execution and balance-sheet discipline, illustrates that this is not a peripheral issue but a systemic one. Over the past two years, HDFC Bank has reported advances growth consistently outpacing deposit accretion, pushing its Credit–Deposit (CD) ratio to 98.5% by Q3 FY26. Markets had earlier responded positively when management articulated a medium-term intent to moderate the CD ratio to 85–90%. The subsequent reversal despite no visible asset quality stress triggered renewed market concern. The signal was clear:

• Even the deepest CASA franchise and strongest brand equity cannot insulate banks from changing saver behaviour.

• Sustained credit growth without commensurate deposit traction is now interpreted as a structural risk, not a growth virtue.

• Elevated CD ratios revive concerns around funding costs and margin sustainability, with NIM compressing 25 bps QoQ to 3.85%.

This is instructive because the vulnerability is not credit-led, it is liability-driven.

Regional banks tell a similar story. Institutions with strong local roots and historical depositor loyalty are seeing advances grow faster than deposits, quietly rebuilding pressure on funding costs. J&K Bank, a regional powerhouse, improved its CD ratio to 72.85% in Q3 FY26 (advances Rs1,16,248 crore, deposits Rs1,55,861 crore), yet advances still outpaced deposits (17.3% vs 10.6% YoY). This divergence signals early-stage liability stress, long before asset quality becomes a concern.

Thus, deposits are no longer a passive outcome of economic expansion as they must now be actively competed for, defended,and priced with discipline. Banks, once barometers of the economy, are no longer its sole financial anchors. Households today face a widening menu of alternatives-mutual funds, equities, bonds, small savings schemes and fintech-led

Instruments like digital gold or UPI-linked yield products offering convenience, liquidity and perceived superior returns. This structural shift has transformed deposits into a “contested liability” rather than a captive one. As per National Payments Corporation of India data, fintechs now hold nearly 15% of household liquid savings, eroding banks’ share by 10–12% since 2023.

The problem is compounded by limited pricing headroom. Deposit repricing beyond a point directly erodes Net Interest Margins, already compressed by operating costs, CRR/SLR impoundment, regulatory capital requirements and competition-driven product feature costs embedded in MOU deposits. Since FY24, term deposit rates have risen sharply, yet deposit growth continues to trail credit expansion industry pl-wide. This is why the next crisis, if it emerges, will not be about NPAs , it will be about margins, liquidity and funding sustainability.

Banks are now trapped in a narrow operating corridor. On one side lies the risk of deposit attrition while on the other, the certainty of margin compression. As CD ratios climb toward 95–100%, reliance on higher-cost market borrowings increases, raising rollover and liquidity risks. What was once a balance-sheet strength is quietly becoming a structural fragility.

The looming risk is a deposit rate war. Large banks, armed with deep capital buffers, can absorb short-term margin pain ,something smaller banks simply cannot afford. For institutions with modest Tier-1 capital and already elevated CD ratios, matching aggressive rate hikes could be existential. Not matching them could be equally fatal. Matching such hikes would push NIMs below 3% and strain capital buffers, while inaction risks erosion of wholesale deposits.

For instance, HDFC Bank, responding to market imperatives to restore deposit growth and supported by Tier-1 capital exceeding Rs 3 lakh crore, possesses the balance-sheet capacity to pursue aggressive deposit rate repricing. While such actions may be rational at the institution level, they carry the potential to amplify industry-wide competition for deposits. Smaller banks, however, operate under tighter structural constraints, with Tier-1 capital typically below Rs 20,000 crore and credit–deposit ratios already elevated in the range of 85–100%.

Meanwhile, credit demand particularly retail (home loans up 15% YoY) and corporate credit continues to exert pressure on balance sheets. The system is operating with elevated CD ratios (industry average around 91% in FY26), constrained liquidity buffers (LCR around 125%) and growing dependence on market borrowings like CDs and CPs, which are structurally more expensive than retail deposits. In this context, a prolonged phase of aggressive deposit competition could transmit stress through funding channels, exacerbate margin compression and heighten vulnerabilities in segments of the banking system with limited capital and liquidity buffers, thereby raising macro-prudential concerns. Thus, as funding stress deepens, liability-side fragility not asset deterioration becomes the dominant systemic risk.

In this environment, chasing short-term credit growth via aggressive loan pricing is strategic paralysis. Offering low lending rates may temporarily expand the balance sheet, but it embeds repricing risk, maturity mismatches and sustained margin compression especially when liabilities reprice faster than assets (deposit beta around 70% vs loan beta around 40%). With operating costs, CRR/SLR impoundment and capital requirements already constraining spreads, this path accelerates vulnerability.

The danger is most acute for banks operating at lower CD ratios that feel compelled to “catch up” with aggressive peers. In this cycle, restraint is not weakness but a strategic resilience.

Repricing and maturity mismatches are emerging as the true fault lines of the current banking cycle. Liabilities especially deposits and market borrowings are repricing rapidly, while asset yields adjust with a lag due to longer reset cycles and legacy fixed-rate books. This asymmetry compresses NIMs precisely when liquidity is tight. The stress is amplified when short-tenor deposits fund long-duration assets such as housing and corporate term loans, increasing rollover and liquidity risk.

Historically, Indian banks operated comfortably with CD ratios in the high-80s. The drift toward 90–100% is not merely statistical, it reflects thinner liquidity buffers and higher wholesale dependence. If incremental credit growth is increasingly funded through market borrowings rather than core deposits, NIM expansion becomes structurally difficult, as reflected in CRISIL estimates projecting industry NIMs to decline toward 3.2% by FY27.

Unlike large banks, smaller institutions cannot endure prolonged capital burn. A few quarters of margin stress can quickly translate into existential pressure. This makes the challenge disproportionately severe for small and regional banks especially those dominant in narrow geographies or niche segments operating with limited capital, narrow deposit franchises and restricted diversification.

At this juncture, regulatory flexibility becomes not a concession but a necessity. The current deposit framework is binary, fixed-return, zero-risk, places banks at a structural disadvantage relative to market-linked instruments. Regulators must allow banks greater freedom to design innovative hybrid deposit products that reflect contemporary saver preferences while extending maturities and easing provisioning pressures.

Hybrid products offering a base assured return with a limited, transparent risk-linked upside anchored to long-tenor housing or mortgage-backed portfolios with historically low default rates can realign incentives without converting deposits into pure market instruments. Such innovation would extend tenor, reduce rate competition, align depositor interests with asset performance and reinforce banks relevance in a financialised economy.

If banks are denied this innovation space, the implications extend beyond banking. Shrinking deposit capacity will constrain credit creation, pushing households away from ownership toward lease-based consumption models — EVs, housing and durable assets increasingly controlled by large capital owners. The economy risks drifting from a bank-financed ownership model to a capital-controlled access economy, concentrating financial power and weakening distributive equity.

Banks have historically been the most democratic allocators of capital, enabling asset ownership and economic mobility. If they lose this role, not because of bad loans, but because of liability-side rigidity the consequences will be structural, not cyclical.

India’s next banking crisis, if it comes, will not begin with NPAs, it will begin quietly with deposits.

(The author is a risk professional and trade unionist. Views are personal.)