New Delhi [India], April 2 (ANI): Indian banks could face increased margin pressure as liquidity conditions tighten, according to a report by Fitch Ratings, which highlighted constraints on the Reserve Bank of India's (RBI) ability to inject liquidity amid currency volatility concerns.

Fitch said that 'margin pressure for Indian banks could increase, as the Reserve Bank of India's (RBI) flexibility to inject local-currency liquidity into the banking system has narrowed amid efforts to contain rupee volatility.'

The report warned that sector margins may decline further if global risks persist. It noted that 'sector margins could decline by 20bp-30bp below our current 3.1% forecast for the financial year ending 31 March 2027 (FY27) if higher funding costs linked to Middle East tensions persist.'

Such pressure could also weigh on banks' core earnings, with Fitch estimating that it 'could reduce operating profit/risk-weighted assets (RWAs)... by around 30bp-40bp, from our 2.5% forecast for FY27.'

Despite the challenges, the agency maintained that Indian banks remain resilient, stating that 'Fitch-rated banks have sufficient earnings buffers to absorb such pressure without affecting our assessment of their earnings and profitability.'

On liquidity conditions, Fitch observed a decline in surplus liquidity in the banking system, noting that 'the banking-system liquidity surplus has declined to about 0.5% of deposits as of 29 March 2026... amid sustained currency pressures, with the rupee having depreciated by 4.5%.'

The report added that continued pressure on the rupee could constrain the RBI's policy flexibility, as 'measures to support the rupee also drain local-currency liquidity from the banking system.'

However, Fitch emphasised that direct foreign currency risks remain limited. It stated that 'rupee volatility is unlikely to have a material direct effect on Indian banks, as the system is denominated predominantly in local currency.'

Looking ahead, the agency flagged both upside and downside risks. It said that 'upside to Viability Ratings (VRs) remains if key rating drivers improve,' while warning that 'downside pressure could emerge... from a prolonged conflict in the Middle East.'

Even in a downside scenario, Fitch expects stability in overall ratings, noting that 'Indian banks' Issuer Default Ratings (IDRs) would be likely to remain intact... as they are underpinned by sovereign support.' (ANI)