Banks set to reap deregulation dividend as RBI easing frees capital

India’s banking system is set to get a “deregulation dividend” as easier financial conditions and a raft of RBI relaxations free up capital and cut funding costs, Goldman Sachs said in a note dated Wednesday, 15 October.

The bank estimates recent and proposed rule changes could lower system-wide capital requirements by about 2 percentage points of total bank credit, with credit growth expected to pick up from the second half of FY26 as transmission from 2025’s rapid rate cuts filters through.

Goldman said the macro drag from tight liquidity and curbs on risky retail lending has eased this year after 100 basis points (bps) of policy rate cuts, liquidity injections and fresh regulatory leniency. One basis point is one-hundredth of a percentage point.

The RBI lowered the repo rate in three straight moves earlier this year: by 25 bps in February, 25 bps in April and 50 bps in June, taking it to 5.50%. It then held in August and again in October with a neutral stance.

The central bank also announced a phased 100 bps reduction in the cash reserve ratio effective in four tranches starting 6 September through late November, with an intended liquidity release of about ₹2.5 trillion.

Analysts said the boost has been partially offset by FX operations and other drains, but the direction of policy remains supportive of credit.

Headline retail inflation fell to an eight-year low of 1.54% in September, helped by softer food prices, giving the central bank more room to ease if needed.

The government’s official release put food inflation in negative territory for the fourth month and the RBI has trimmed its FY26 inflation projection to about 2.6%, while keeping growth near 6.8%.

Some of the biggest capital reliefs take effect in 2027. The RBI has proposed Basel III-aligned credit-risk rules, effective 1 April 2027, that would lower standardized risk weights on segments such as MSME and individual housing loans and reduce risk weights for highly rated corporate exposures.

By shrinking risk-weighted assets, these changes raise effective capital ratios and expand lending headroom, amplifying the benefits of easier rates and liquidity.

Goldman Sachs expects analysts to look past a soft September quarter. Consensus now sees banks’ earnings growth rebounding to about 15% in 2026 from 8% in 2025 as asset quality stabilizes and loan growth recovers.

Positioning could add fuel, with domestic mutual funds underweight and roughly $9 billion of foreign selling in the sector since last year after one of the steepest downgrade cycles in five years.

It also expects the Nifty Bank index to outperform near term, arguing valuations sit below five-year averages and at a discount to MSCI India.

A key risk is demand. While supply-side credit conditions are improving, corporate borrowing appetite could stay cautious amid external headwinds, including higher US tariffs on Indian goods and rising visa costs that affect the IT sector.

Even so, Goldman’s baseline assumes an improving external backdrop in 2026, one more repo cut this year, and that regulatory easing plus offshore borrowing relaxations will support total private-sector credit over the next two years.