Key facts
- Public sector banks' (PSBs) outperformance advantage is diminishing due to reduced liquidity and rising credit costs.
- PSBs have drawn down investments in high-quality liquid assets (HQLA) to fund loan growth, lowering their liquidity coverage ratios (LCR).
- The implementation of the expected credit loss (ECL) framework will increase credit costs for PSBs.
- Analysts predict private sector banks will regain market share and potentially grow faster than PSBs.
- A special FCNR (B) deposit scheme from the RBI is expected to boost liquidity for both PSB and private banks.
Public sector banks (PSBs) in India may be losing their competitive edge over private sector peers as the liquidity and credit cost advantages they previously enjoyed are diminishing, according to analysts. PSBs have significantly reduced their holdings of high-quality liquid assets (HQLA) to support loan growth, leading to a sharp decline in their liquidity coverage ratios (LCR).
Analysts from Bernstein noted that PSBs' LCR has fallen to 123% as of March 2026 from 137% a year prior, indicating a substantial drawdown of reserves. This reduced liquidity is expected to constrain future loan growth, making it increasingly dependent on deposit accretion.
Furthermore, the upcoming implementation of the expected credit loss (ECL) framework from the first quarter of the next fiscal year will likely increase credit costs for PSBs. This framework requires banks to set aside provisions based on the probability of loan defaults.
Analysts anticipate that private sector lenders, such as HDFC Bank, which were previously hampered by merger-related issues, will re-enter the market more aggressively. This increased competition is expected to lead to a convergence in credit growth between PSBs and private banks, with private sector lenders potentially growing faster and regaining market share from next fiscal year onwards.
However, both PSBs and private banks are expected to benefit from a special FCNR (B) deposit scheme introduced by the Reserve Bank of India (RBI). This scheme absorbs the entire hedging cost for these deposits, which could lead to a significant increase in domestic liquidity.