Indian banks could face renewed pressure on margins as the Reserve Bank of India’s ability to inject local-currency liquidity narrows amid efforts to stabilise the rupee, Fitch Ratings has said. It added that the sector margins may fall by 20 basis points to 30 basis points below its current 3.1 per cent forecast for the financial year ending 31 March 2027 (FY27) if higher funding costs linked to tensions in the Middle East persist.
That, in turn, could reduce operating profit to risk-weighted assets, Fitch’s core earnings metric, by around 30 basis points to 40 basis points from its 2.5 per cent forecast for FY27. It stated that banks’ earnings buffers remain adequate to absorb the pressure without affecting their overall assessment of their profitability. However, it flagged that treasury gains could also come in moderately below earlier expectations.
The agency’s base case had assumed deposit costs would ease in FY27 as accommodative liquidity helped transmit the Reserve Bank of India’s cumulative 125 basis points of policy rate cuts since December 2024. As of January 2026, only 44 basis points had been passed on to deposit rates. To ease pressures, the RBI had increased durable liquidity in the system through government bond buybacks and open market purchases since the second half of FY25.
However, Fitch noted that surplus banking-system liquidity fell to around 0.5 per cent of deposits as of 29 March 2026, down from 0.8 per cent in late February before the onset of the Middle East conflict. This coincided with sustained pressure on the rupee, which depreciated by 4.5 per cent over the period.
Fitch said if currency pressures persist, the RBI’s room to ease liquidity could be constrained, as measures to support the rupee also withdraw local-currency liquidity from the banking system. Despite this, the agency said Indian banks’ direct foreign-currency risks remain limited. Overseas loans account for less than 10 per cent of sector loans, and the net open foreign-currency position stood at only 2.5 per cent of equity at nine months of FY25.
Fitch added that currency weakness alone is unlikely to affect asset quality materially, as corporate borrowers typically hedge foreign-currency exposures. However, it cautioned that sustained rupee weakness combined with higher energy and raw material costs could fuel inflation and weaken repayment capacity among small and medium enterprises.
The RBI’s recent directive requiring banks to unwind foreign exchange positions above USD 100 million was also cited as evidence of the central bank’s focus on containing currency volatility. Fitch estimated income from exchange transactions at less than about 0.1 per cent of risk-weighted assets, limiting any profit impact from such measures.
On ratings, Fitch said upside to banks’ viability ratings remains possible if key drivers improve in line with expectations and the operating environment score is raised to ‘bbb-’, supported by continued reform momentum and strong economic growth prospects. Conversely, downside risks could emerge if a prolonged Middle East conflict materially affects India’s growth outlook, for instance, through sustained energy price pressures.
Even in such a downside scenario, Fitch said Indian banks’ issuer default ratings are likely to remain intact, as they are supported by sovereign backing and India’s ‘BBB-’ stable rating provides moderate headroom to absorb shocks. However, outlooks on private banks’ ‘BB+’ positive ratings could be revised to stable if the operating environment outlook weakens. |
