Indian banks are currently grappling with significant margin pressures as loan growth decelerates amid persistently high interest rates. According to a recent report by S&P Global Market Intelligence, the aggregate loan growth for six of India’s largest banks—encompassing both private and state-owned institutions—is projected to decline to 12.3% in the fiscal year ending March 31, 2025. This marks a substantial decrease from the 22.5% growth recorded in the previous fiscal year.

Factors Contributing to Margin Pressure

The slowdown in loan growth is attributed to several key factors:

• Elevated Interest Rates: The Reserve Bank of India’s (RBI) policy stance has maintained higher interest rates to combat inflation, leading to increased borrowing costs. This environment has dampened credit demand across various sectors.
• Regulatory Measures: In late 2023, the RBI imposed higher capital requirements on personal loans and credit cards to mitigate the risk of bad loans. These measures have contributed to a slowdown in retail lending growth.
• Intensifying Competition for Deposits: Banks are engaged in a competitive battle to attract deposits, often offering higher interest rates to secure funds. This scenario has led to increased costs for banks, further squeezing their net interest margins (NIMs).

Impact on Net Interest Margins

Net interest margins, a critical indicator of a bank’s profitability, are anticipated to decline as deposit rates rise to keep pace with lending rates. S&P Global’s report indicates that NIMs at most lenders are expected to edge lower, with weaker margins anticipated as deposit rates catch up and potential monetary easing looms.

Asset Quality and Profitability Concerns

Despite the challenges, Indian banks have reported higher net profits, albeit at a slower pace. The gross non-performing assets (GNPA) ratio has improved, falling to 2.6%, reflecting better management of bad loans.

However, concerns persist regarding asset quality, particularly in unsecured lending segments. For instance, HDFC Bank reported a decline in asset quality due to an increase in non-performing agricultural loans, leading to a rise in its GNPA ratio to 1.42% from 1.36% in the previous quarter. The bank also increased its provisions for bad loans by 17%, totaling ₹31.54 billion.

Outlook and Strategic Responses

Analysts predict that the profitability of Indian banks may moderate in the coming fiscal years. India Ratings has revised its credit growth forecast for 2024-25 to around 13.5% from an earlier estimate of 15%, citing the impact of regulatory changes and heightened competition for deposits.

In response to these challenges, banks are focusing on bolstering their retail deposit base and enhancing risk management practices to maintain financial stability. The sector is also witnessing increased competition from global lenders, such as Japanese banks, which are expanding their lending operations in India, thereby driving down loan prices.

In conclusion, Indian banks are navigating a complex landscape characterized by slowing loan growth, high interest rates, and competitive pressures. While efforts to manage asset quality and attract deposits are underway, the sector must remain vigilant and adaptive to sustain profitability in this challenging environment.