Margin pressure for Indian banks could increase as RBI’s flexibility to inject Rupee liquidity narrows: Fitch
April 02, 2026
Margins may fall 20–30 bps below its current 3.1% forecast in FY27
Margin pressure for Indian banks could increase as the Reserve Bank of India’s (RBI) flexibility to inject local-currency liquidity into the banking system has narrowed amid efforts to contain rupee volatility, cautioned Fitch Ratings. However, the credit rating agency believes banks’ direct foreign-currency risks remain limited.
The agency assessed that sector margins could decline by 20-30 basis points (bps) below its current 3.1 per cent forecast for the financial year ending 31 March 2027 (FY27), if higher funding costs linked to Middle East tensions persist.
This could reduce operating profit/risk-weighted assets (RWAs) — Fitch Ratings’ core earnings metric — by around 30-40 bps, from the earlier 2.5 per cent forecast for FY27.
Treasury gains could also be moderately below its previous expectations. But the agency believes that Fitch-rated banks have sufficient earnings buffers to absorb such pressure without affecting its assessment of their earnings and profitability.
Fitch Ratings’ base case assumed deposit costs would decline in FY27 as accommodative liquidity would enable further transmission of the RBI’s 125bp of policy rate cuts since December 2024; only 44bp has been passed through to deposit rates as of January 2026, due to intensified competition for deposits with loan growth exceeding deposit growth.
Liquidity surplus declines
“In response, the RBI increased the supply of durable liquidity to the banking system since second half (2HFY25) through government bond buybacks and open-market purchases. It also indicated that it would remain proactive in maintaining adequate system liquidity,” the agency said in a statement.
However, the banking-system liquidity surplus has declined to about 0.5 per cent of deposits as of 29 March 2026 — from 0.8 per cent in late February before the onset of the Middle East conflict — amid sustained currency pressures, with the rupee having depreciated by 4.5 per cent.
If sustained, currency pressures could limit the RBI’s ability to ease banking system liquidity, as measures to support the rupee also drain local-currency liquidity from the banking system, cautioned the agency.
Rupee volatility
Fitch said Rupee volatility is unlikely to have a material direct effect on Indian banks, as the system is denominated predominantly in local currency: overseas loans were under 10% of sector loans, and the net open foreign-currency position was not significant at 2.5 per cent of equity at 9MFY25 (nine months).
The agency is not expecting currency weakness alone to affect asset quality significantly, as corporate borrowers typically hedge foreign-currency borrowings. Still, sustained currency weakness coupled with higher energy and raw material costs could raise inflation and weaken SME repayment capacity.
Fitch observed that the RBI’s recent directive for banks to unwind FX positions above USD100 million also highlights its focus on limiting currency volatility. However, the impact on banks’ profit should be limited, as income from exchange transactions is estimated at less than about 0.1% of RWAs.
The agency emphasised that upside to Viability Ratings (VRs) remains if key rating drivers improve in line with its expectations, and the operating environment (OE) score is revised upward to ‘bbb-‘. This could occur if it assesses that the RBI remains committed to reforms implemented over the past decade, and that India’s economic growth prospects remain intact.
Conversely, downside pressure could emerge if Fitch were to expect a significant and lasting adverse effect on India’s economic growth from a prolonged conflict in the Middle East, for example through sustained pressure on energy prices and availability.
Fitch said Indian banks’ Issuer Default Ratings (IDRs) would be likely to remain intact even in a downside scenario, as they are underpinned by sovereign support - and India’s ‘BBB-‘/Stable sovereign rating has moderate headroom to absorb downside risks. However, Fitch’s Outlooks on the private banks’ ‘BB+’/Positive IDRs could be revised to Stable if the OE Outlook is revised to Stable.
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Published on April 2, 2026
The agency assessed that sector margins could decline by 20-30 basis points (bps) below its current 3.1 per cent forecast for the financial year ending 31 March 2027 (FY27), if higher funding costs linked to Middle East tensions persist.
This could reduce operating profit/risk-weighted assets (RWAs) — Fitch Ratings’ core earnings metric — by around 30-40 bps, from the earlier 2.5 per cent forecast for FY27.
Treasury gains could also be moderately below its previous expectations. But the agency believes that Fitch-rated banks have sufficient earnings buffers to absorb such pressure without affecting its assessment of their earnings and profitability.
Fitch Ratings’ base case assumed deposit costs would decline in FY27 as accommodative liquidity would enable further transmission of the RBI’s 125bp of policy rate cuts since December 2024; only 44bp has been passed through to deposit rates as of January 2026, due to intensified competition for deposits with loan growth exceeding deposit growth.
Liquidity surplus declines
“In response, the RBI increased the supply of durable liquidity to the banking system since second half (2HFY25) through government bond buybacks and open-market purchases. It also indicated that it would remain proactive in maintaining adequate system liquidity,” the agency said in a statement.
However, the banking-system liquidity surplus has declined to about 0.5 per cent of deposits as of 29 March 2026 — from 0.8 per cent in late February before the onset of the Middle East conflict — amid sustained currency pressures, with the rupee having depreciated by 4.5 per cent.
If sustained, currency pressures could limit the RBI’s ability to ease banking system liquidity, as measures to support the rupee also drain local-currency liquidity from the banking system, cautioned the agency.
Rupee volatility
Fitch said Rupee volatility is unlikely to have a material direct effect on Indian banks, as the system is denominated predominantly in local currency: overseas loans were under 10% of sector loans, and the net open foreign-currency position was not significant at 2.5 per cent of equity at 9MFY25 (nine months).
The agency is not expecting currency weakness alone to affect asset quality significantly, as corporate borrowers typically hedge foreign-currency borrowings. Still, sustained currency weakness coupled with higher energy and raw material costs could raise inflation and weaken SME repayment capacity.
Fitch observed that the RBI’s recent directive for banks to unwind FX positions above USD100 million also highlights its focus on limiting currency volatility. However, the impact on banks’ profit should be limited, as income from exchange transactions is estimated at less than about 0.1% of RWAs.
The agency emphasised that upside to Viability Ratings (VRs) remains if key rating drivers improve in line with its expectations, and the operating environment (OE) score is revised upward to ‘bbb-‘. This could occur if it assesses that the RBI remains committed to reforms implemented over the past decade, and that India’s economic growth prospects remain intact.
Conversely, downside pressure could emerge if Fitch were to expect a significant and lasting adverse effect on India’s economic growth from a prolonged conflict in the Middle East, for example through sustained pressure on energy prices and availability.
Fitch said Indian banks’ Issuer Default Ratings (IDRs) would be likely to remain intact even in a downside scenario, as they are underpinned by sovereign support - and India’s ‘BBB-‘/Stable sovereign rating has moderate headroom to absorb downside risks. However, Fitch’s Outlooks on the private banks’ ‘BB+’/Positive IDRs could be revised to Stable if the OE Outlook is revised to Stable.
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Published on April 2, 2026