India Ratings forecasts moderate profits for banks in FY26

India Ratings has predicted that Indian banks’ profitability will slow down in FY26, following a peak in FY25. This is mainly due to rising loan defaults caused by excessive lending in unsecured credit, which is increasing credit costs. Analysts have highlighted that since FY22, deposits have been lagging behind credit growth, creating a gap of around 416 basis points (bps), resulting in a higher loan-to-deposit ratio (LDR) of 80.4% in the first half of this year, compared to 70.1% in FY21. India Ratings believes this high LDR could limit loan growth for banks in the medium term and expects it to normalize to around 70% by FY27.

The agency has also revised its credit growth forecast for 2024-25, lowering it to 13.5% from an earlier estimate of 15%. They expect loan growth to be between 13-13.5% and deposit growth to be 12-13% in FY26, amid strong competition in the banking sector. Further challenges to the sector include draft liquidity coverage ratio (LCR) guidelines, higher provisioning for the infrastructure sector, and the introduction of expected credit loss (ECL) norms. The LCR guidelines, which will take effect in April, could reduce banks' net interest margins by 5-15 basis points. However, the agency believes this is the right time to implement ECL norms, as banks are sufficiently capitalized.

Regarding the non-banking financial sector, India Ratings noted that funding will continue to be a challenge, as banks have reduced lending to non-banking financial companies (NBFCs). To compensate, NBFCs will look for funding from external commercial borrowings, the bond market, and short-term money market instruments. Due to their reliance on unsecured loans and increased regulation, the outlook for the sector's credit growth has been lowered to 18.5% in 2025-26, down from 20% in 2024-25.

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