Credit market in for a tough time in FY26, liquidity is key

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ET BureauLast Updated: Jan 10, 2025, 12:04:00 AM IST

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The credit market will face volatile financial conditions in FY26 due to challenges in retail lending, banking system liquidity, and growth-inflation issues. This will increase volatility and spreads for entities with weak credit outlooks. The easing of banking system liquidity and availability of risk capital will become critical to improve lending rates and financing.

The credit market is likely to face volatile and tough financial conditions in FY26, according to an analysis by India Ratings. It faces challenges around indebtedness in the retail lending segment, volatile banking system liquidity and domestic growth-inflation conundrums, the rating agency said in a report.

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"In the milieu of external headwinds and weakening domestic credit conditions, the overall credit market is expected to see higher volatility and elevated spreads especially for the entities with a weak credit outlook," said Soumyajit Niyogi, director, core analytical group, India Ratings. "Given the limited tailwinds from the monetary and fiscal space and cautious financing conditions, easing of banking system liquidity on a sustained basis and timely availability of risk capital have become critical."

As per the report, due to weak macro and micro conditions, a sustained easing of the banking system liquidity has become necessary. Stable surplus liquidity will not only ease the pressure on banks' lending rates but also ensure ease of financing, it said.

The rating agency said that the large and frequent volatility in the banking system liquidity does not augur well for the financing conditions, especially when the overall environment is not so favourable. The high volatility in the banking system liquidity also acts as a deterrent for commercial banks in terms of addressing adverse loan-to-deposit ratios and asset liability pricing, it said.

India Ratings also forecast that while deposit rates in the banking system have peaked out, the structural shift in the system will keep the downward rigidity intact. As a result, it said, banks' lending rate is expected to elevate in FY26, though it could soften from the September quarter.