RBI Policy: Domestic growth takes priority amid global uncertainties

Further, with a reduction in the MPC's FY2026 forecasts for both CPI inflation and GDP growth by 20 bps, and clarity that the policy stance signals future rate direction and not liquidity conditions, we now expect an additional 50 bps of rate cuts in this rate cut cycle.

Decline in yields could spur bond issuances

With 50 bps cut in repo since February 2025 and sizeable infusion of durable liquidity by RBI, the yields on short-term as well as long-term borrowings have declined by 30-70 bps since January 2025. The decline in yields for short-term instruments like treasury bills, commercial paper and certificate of deposits has been sharper, supported by liquidity infusion. 

This shall benefit larger corporations that have access to the debt capital market, and is reflected in all-time high corporate bond issuances of over ₹11.0 trillion during FY2025. With yields likely to continue to soften in the coming months, we estimate the bond issuances to scale new heights in the current year as well.

Margins could be a pain point for banks

With an elevated systemic credit-to-deposit ratio, the ability of banks to quickly transmit policy action through cuts in deposit rates remains monitorable. Even with softer deposit rates, the deposit base will reprice downward with a lag, whereas the transmission is expected to be faster on loans linked to external benchmarks, which account for a sizeable portion of the bank credit, and on loans taken by highly rated borrowers. As the policy rate cuts and deposit rate cuts may continue over the next few quarters, the pressure on interest margins is expected to persist during FY2026 and may spill over to next year.

The pressure on margins coupled with Icra's expectations of banking sector credit growth of 10.4-11.2% for FY2026 (similar to FY2025) could translate into a muted earning growth for banks. A likely higher treasury profits on bond portfolio coupled with ability to work around the product mix will be key supporting factor for the growth of earnings.

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Credit flow through NBFCs could improve

The co-lending regulations allow banks to jointly lend with NBFCs to capitalise on the credit delivery and collection strengths of a NBFC. While these existing regulations clearly articulate this arrangement for priority sector loans (PSL), there are prevailing arrangements between NBFCs for non-PSL loans, which are not spelt out clearly in existing regulations. 

With the proposal to harmonise the regulations for players, we expect that this shall favorably support the growth in assets under management for NBFCs and aid in enhancing formal credit penetration. Mid and small sized NBFCs, which may be constrained in access to competitive and scalable funding sources, can use this avenue to augment their loan books with non-PSL loans also becoming eligible. Larger NBFCs could use this route to diversify their product profile and expand their borrower segments.

Further, given the sharp growth in gold loans driven by upwards movement in gold prices and favourable demand dynamics, amid slowdown in unsecured and personal credit, RBI has proposed to harmonise gold loan practices across lenders. The elevated gold prices and liquid nature of the collateral could help absorb any near-term impact on account of regulatory tightening. However, competitive pressures for NBFC could increase going forward, which remains monitorable.

Also Read: Banks seek more measures to support lending rate cuts

Efforts to revive the partial credit enhancement structures

Lastly, the partial credit enhancement (PCE) of corporate bonds saw limited traction since the guidelines on the same were announced almost a decade ago. To improve the credit flow to infrastructure projects through debt capital markets, RBI is revisiting the PCE guidelines to provide a fillip to the infrastructure financing in the country. Given some of the restrictions such as capping of the PCE to only 20% of bond issue size and high capital requirements on the guarantee provider coupled with limited / back-ended amortization of credit enhancement resulted in guarantee fees costs outweighing the benefits of cost reduction upon rating enhancement. 

With the government's strong focus on infrastructure investments, improved access to capital markets for infrastructure projects could support the sizeable investment requirements in this sector.

Karthik Srinivasan is senior vice president and group head, financial sector ratings, Icra Ltd. Views are personal