Loan growth has hit an eight-quarter high, but the money to fund it is not keeping up.

Every banker knows this basic rule: you can lend only what you can fund. In the April-June quarter, Indian banks tested that rule. Credit grew 16.5 percent, an eight-quarter high, while deposits grew just 11.3 percent, according to CareEdge Ratings. Loans outstanding reached ₹213.6 lakh crore on June 30, against deposits of ₹256.5 lakh crore.

The 512-basis-point gap between credit and deposit growth was the widest in eight quarters, and it pushed the system's loan-to-deposit ratio to a record 83.3 percent. CareEdge says this points to a real funding gap, not a seasonal blip. In simple words, it’s an issue that we can expect to persist.

That single figure explains much of what bankers are feeling today: higher funding costs, aggressive deposit campaigns, and margins that refuse to recover. It also raises a harder question for the second half of the year. Where will the money come from?

Who is lending, and to whom

The growth is broad. But, there’s something interesting when you double click to look who’s lending, and to whom. Bank funding to NBFCs rose 22.4 percent to ₹25.3 lakh crore. Motilal Oswal says MSME and gold loans also kept their momentum. Public sector banks are stretching the most, though. They grew loans 16.4 percent against 15.9 percent for private banks, but their deposits rose only 10.7 percent, compared with 14.3 percent at private lenders. The average loan-to-deposit ratio for PSBs has climbed to 81 percent from 77 percent.

Among private lenders, Axis Bank led with 19 percent credit growth, ahead of HDFC Bank at 15 percent and Kotak Mahindra Bank at 12 percent. IDBI Bank's advances rose 22 percent while its deposits grew 10 percent. For years, PSBs had a comfortable deposit cushion. Most had average loan-to-deposit ratios near 65 percent during FY22-23, well below private banks at 82 to 83 percent. That cushion is thinning.

Why margins are the casualty

When deposits lag, banks have two choices. They can pay more to attract term deposits, or they can borrow in the wholesale market. A rising credit-deposit ratio increases reliance on wholesale funding, which is generally more expensive than customer deposits. Either way, the cost of money goes up before the yield on loans does.

The results are visible. HDFC Bank's net interest margin narrowed to 3.26 percent in Q1 FY27 from 3.38 percent in March, its lowest level on record. Kotak Mahindra Bank's margin slipped to 4.53 percent from 4.67 percent. A review of the quarter's results found the same dynamic across the sector: deposit repricing is not keeping pace with asset repricing. Brokerages say a margin recovery remains elusive, even though funding costs have eased.

RBI's Financial Stability Report adds a warning. It flags intense competition for deposits, and says a shift toward term deposits could pressure bank margins. Cheap savings and current account money is being replaced by costlier term money. The RBI also notes that banks that leaned into retail and MSME lending protected their margins better as cheap deposits dried up. That helps explain why the loan books keep growing in those segments.

The optimists' case

Not everyone is worried. Bernstein argues that the spread between fresh loan yields and term deposit rates is wider than the spread embedded in the existing book, so new lending is still margin-accretive. It expects FY27 loan growth of 13 to 15 percent, broadly stable margins and benign asset quality. Lower certificate of deposit rates and issuance have also eased some funding pressure. Motilal Oswal expects credit growth to moderate to around 14 percent during FY27.

The optimistic reading is that the gap is wide now but will narrow as growth cools. The cautious reading is that the funding problem is structural and will return whenever growth picks up.

A forecast that missed

The history here is instructive. In March 2025, India Ratings expected the gap between credit and deposit growth to shrink sharply to about 80 basis points in FY26, from an average of 386 basis points over FY22 to Q3 FY25. Nine months earlier, then-Governor Shaktikanta Das had urged banks to rework their business plans because of the persistent gap.

The gap did not close. It widened again. The lesson for planning is simple: do not assume deposit growth will catch up on its own.

The dollar lifeline, and its limits

Foreign currency deposits helped. One report says the gap narrowed to about 360 basis points by August 31, from about 500, as banks mobilised dollar deposits. But this was a special measure. The RBI closed its special FCNR(B) swap window on August 31. Regular FCNR(B) deposits continue, but without the special concessional cover. Banks should not treat dollar money as a permanent substitute for rupee deposits.

Policy adds a twist. If the RBI raises the repo rate this week, depositors will expect higher returns. Surplus system liquidity, at about 1.8 percent of net demand and time liabilities, has offered some relief. A tighter RBI could reduce that relief.

What bankers can do

Watch the incremental loan-to-deposit ratio, not just the stock figure. It shows how much of each new rupee of lending is being funded by new deposits. Price term deposits by tenor, rather than raising rates across the board. Push salary accounts, business current accounts and transaction banking, which bring stickier low-cost money. Reduce dependence on certificates of deposit and other wholesale borrowing. Link loan growth targets to a deposit plan, and review them quarterly. Public sector banks, in particular, should look at branch productivity and digital onboarding.

For years, Indian banks competed on loan growth. The next phase may reward the lender that wins on deposits.