Budget Snapshot: Although India's banks appear sound, the true danger is hidden beneath the balance sheet.

The finance ministry appears to have little reason to be concerned about the state of the financial system, even though the Union Budget is just one month away. Profitability is still substantially above long-term norms, asset quality is the best in decades, and capital buffers are robust. Return on equity is still strong, credit costs are low, and gross non-performing assets (NPAs) are at all-time lows. Indian banks are doing well by traditional measures. However, budgets are designed for more than just balance sheets. They focus on identifying stressors before they manifest as issues. Beneath the comforting headline figures, there is a subtle change occurring in the banking system that warrants government attention. The difference on the liability side is the most noticeable. The conventional anchor of bank balance sheets, deposits, are no longer expanding quickly enough to keep up with credit. Banks have been raising equity capital to close this gap more and more over the past year. Because balance sheets are being supported by capital rather than household savings, the credit-to-deposit ratio has therefore slightly increased rather than due to careless lending. India’s banking sector continues to show strong financial health, with profitability remaining well above historical averages and asset quality at its best level in decades. Gross non-performing assets are at record lows, credit costs are subdued, and capital adequacy ratios remain robust. These indicators suggest that, on the surface, the financial system is well prepared ahead of the upcoming Union Budget. Despite this apparent strength, policymakers are expected to look beyond headline numbers to identify emerging vulnerabilities. Budgets are not only about acknowledging current stability but also about addressing early signs of stress before they evolve into larger problems. In this context, subtle changes in the structure of bank balance sheets are beginning to draw attention. A key concern is the growing mismatch between credit growth and deposit mobilisation. Deposit growth has slowed as households increasingly prefer market-linked investments, while credit demand has remained strong. To support lending activity, banks have increasingly relied on equity capital and other funding sources, leading to a gradual rise in the credit-to-deposit ratio. While this shift does not indicate reckless lending, it does point to a changing funding dynamic that could carry risks during periods of market volatility. Experts believe this trend may influence budgetary priorities, encouraging measures that boost deposit growth and strengthen long-term funding stability, ensuring the resilience of the banking system over the medium term.