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The Indian banking sector is currently navigating a challenging landscape characterized by margin pressure and slowing loan growth, as highlighted by a recent report from S&P Global Market Intelligence. This slowdown, a significant departure from the robust 22.5% growth observed in the previous fiscal year, is projected to reach 12.3% by March 31, 2025, for six of India's largest banks. This contraction is primarily attributed to the interplay of high interest rates implemented by the Reserve Bank of India (RBI) and the subsequent rise in deposit rates. As deposit rates rise to match prevailing market interest rates, banks' net interest margins (NIMs) – the difference between the interest earned on loans and the interest paid on deposits – are expected to decrease. This fundamental pressure point directly impacts profitability, forcing banks to re-evaluate their lending strategies and explore alternative methods to maintain financial health.
The RBI's monetary policy, designed to curb inflation, has played a critical role in shaping this environment. While central banks in the US and Europe have begun easing their interest rates in 2024, the RBI has maintained higher benchmark rates. This decision, although aimed at stabilizing the Indian Rupee and containing inflationary pressures, has inadvertently contributed to the challenging conditions for banks. Furthermore, the RBI's decision to allow rupee depreciation as a de-facto easing measure, leading to a 2.8% drop in value since November 2024, adds another layer of complexity to the equation. This currency fluctuation can impact the profitability of banks with foreign exchange exposure and further complicate their lending decisions.
In response to these pressures, many Indian banks have adjusted their lending practices. There has been a notable reduction in the disbursal of consumer and personal loans, as banks prioritize mitigating risks associated with unsecured lending. To bolster their balance sheets, these institutions have also focused on mobilizing retail deposits. This strategic shift reflects a cautious approach to lending in the current climate, prioritizing capital preservation over aggressive loan expansion. The RBI's own actions have further reinforced this cautious approach; in an effort to control unsecured lending to riskier customers, risk weights on unsecured lending have been raised by 25 percentage points. This has significant implications for credit cards, personal loans, and credit extended to non-banking financial institutions, further tightening the lending environment.
Despite the slowdown in loan growth and the pressure on NIMs, Indian banks continue to report higher net profits, albeit at a slower rate. Leading public sector banks like the State Bank of India, projected to report a 5.6% increase in net profit, illustrate this trend. However, the trajectory suggests a potential deceleration in profit growth in the coming years. Private sector giants such as HDFC Bank, despite exhibiting strong deposit growth (16% year-over-year), show significantly slower growth in gross advances (only 3% year-over-year), underscoring the sector-wide challenges in loan expansion. This discrepancy between deposit growth and advance growth highlights the current conservative lending strategies adopted by many banks.
The report also notes a positive development: the bad loan ratio in Indian banks has improved considerably, reaching multi-year lows. This improvement is a direct result of the RBI's focus on asset quality improvements across the banking sector. While this positive trend offers some relief, it doesn't negate the overarching challenges presented by margin pressure and slowing loan growth. The future trajectory of the Indian banking sector will depend significantly on the RBI’s continued monetary policy decisions, the evolving inflation rate, and the banks’ ability to adapt to a slower-growth, risk-averse lending environment. The balance between maintaining financial stability and stimulating economic growth through credit availability will be a key determinant of the sector’s performance in the coming years. Further analysis will be needed to determine whether these recent trends are a cyclical downturn or a sign of a more fundamental shift in the Indian banking landscape.
Source: Banks struggle with margin pressure as loan growth slows amid high interest rates: S&P Global