Indian banks’ profitability is expected to moderate in FY26 after reaching an inflection point in FY25, due to rising delinquencies from over-leveraging of unsecured assets and an increase in unsecured credit costs, analysts at India Ratings said on Tuesday.
Since FY22, deposits in the banking system have continued to lag behind the system’s credit growth, with an average gap of 416 basis points (bps). This has led to the loan-to-deposit ratio (LDR) rising to 80.4% in the first half of the current financial year, up from 70.1% in FY21. India Ratings believes that the elevated LDR may constrain loan growth for banks in the medium term.
“We see LDR (loan-to-deposit ratio) normalising to around 70% levels in FY27,” Karan Gupta, head and director of financial institutions at India Ratings said.
Banks’ credit growth has slowed, primarily due to the base effect and regulatory changes, India Ratings said, revising its credit growth forecast for 2024-25 down to 13.5% from 15% earlier. The agency expects loan growth to be in the range of 13-13.5% and deposit growth to be between 12-13% in 2025-26, amid heightened competition.
Besides elevated LDR norms, draft guidelines on liquidity coverage ratio (LCR) norms, higher provisioning for the infrastructure sector, and the introduction of expected credit loss are likely to pose further challenges to the banking sector. With the LCR norms kicking in from April, the rating agency expects an impact of around 5-15 bps on banks’ net interest margins, but at the same time added “if there is any time to implement ECL norms, this is the right time” as banks are adequately capitalised.
While sharing the outlook on the banking sector’s profitability, the rating agency sees that profitability is at an inflexion point in FY25 and may moderate in FY26 as gross slippages and recoveries are expected to rise 2024-25 and 2025-26 to 58 bps and 66 bps, respectively.
On the non-banking financial institutions and microfinance institutions, India Ratings said that funding will remain a challenge for the sector as banks lending to NBFCs has come down. Consequently, they will continue to diversify their source of funding by tapping other avenues, such as external commercial borrowings, the bond market, and short-term money market instruments. Due to NBFCs high reliance on the unsecured loan segment amid increased regulatory scrutiny, the rating agency has cut the sector’s credit growth outlook to 18.5% in the year 2025-26 from 20% in 2024-25.
For microfinance institutions, the stress of borrower deleveraging to play out until the next two to three quarters and expect the situation to stabilise only in the second half of FY26.