Banks' profitability to moderate in FY26 on narrowing margins, higher credit costs: Ind Ra

New Delhi: Banks' profitability is set to moderate slightly in the ongoing financial year as lenders set aside higher sums of money for covering potential loan losses and a narrowing in net interest margins due to the rate cuts, a domestic rating agency said on Tuesday.

India Ratings and Research expects credit growth to climb up to 13 percent in FY26, but added that higher tariffs, if they indeed come about, may impact the number.

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The rating agency expects the return on assets for the banking system to come down to 1.33 percent in FY26 from 1.38 percent in FY'25.

Karan Gupta, the head and director for financial institutions at the agency, said the profitability will be down due to the NIMs, which have already been impacted by the 1 percentage point rate cut and the ensuing passing of the benefits to the borrowings linked to external benchmarks, and also the higher credit costs.

Private sector lenders are set to see a sharper impact on the NIMs than their state-run peers because nearly 87 percent of their loans are external benchmark lending rate-linked, the agency said, adding that the NIMs will be declining at a system-level.

On the tariffs aspect, Gupta explained that the overall impact from an asset quality perspective will be very limited as the banking system's exposure to the gems and jewellery and textile sectors is very limited but added that in a scenario where higher tariffs become a reality, it may impact credit growth.

Contrary to some fears, it said the asset quality pressures due to unsecured retail exposures will be limited.

"Stress in unsecured retail credit, especially among private banks, remains evident, particularly in personal loans, credit cards and microfinance," it said, noting that unsecured retail lending has slowed down following the RBI's November 2023 action and asset quality stress is elevated.

On the microfinance front, it expects a 10 percent increase in assets under management for NBFC-MFIs and also hinted that issues plaguing the sector will ease as the fiscal year progresses.

However, a bulk 60 percent of the retail credit (housing and vehicle loans) remains stable, it said.

The agency has maintained its ratings and outlooks on all the verticals but for personal loans, where it has revised the outlook to neutral from deteriorating, Gupta said.

On the loan growth front, it expects corporate lending to improve to about 10 percent as demand revives during the remainder of FY26.

For NBFCs, it expects a moderation in overall assets under management to 18 percent in FY26 from 24 percent in FY25 primarily on a slowdown in bank lending to such entities and also some conservativeness by them.

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