Indian Banks Face Asset Quality Moderation, Says Moody’s

India’s banking sector may see a moderate deterioration in asset quality in the coming months, global rating agency Moody’s said, citing moderation of economic growth, the impact of past hikes in interest rates and the aging of unsecured retail loans.

The systemwide non-performing loan ratio had declined sharply from 7.3% in March 2021 to 2.6% by September 2024, the rating agency said, maintaining a “stable” outlook on the India’s banking sector as it expects strong capital buffers and steady profitability to ensure resilience.

NPAs projected to increase to 2-3% over the next 12-18 months, it said.

At the same time, loan growth is projected to slow to 11-13% in 2025-26, down from an average of 17% in 2022-24, as banks look to align lending expansion with deposit growth. This moderation also reflects a cautious lending approach, particularly in riskier segments such as unsecured retail loans and small business financing.  

The global rating agency Moody’s has maintained “stable” outlook on the India’s banking sector, but see some emerging challenges, like moderate asset quality deterioration, softer loan growth, and narrowing net interest margins (NIMs).

The rise is attributed to aging unsecured retail loans, higher borrowing costs, and slower economic growth, though corporate loans remain strong due to deleveraging and stable earnings.

Banks' net interest margins are expected to decline marginally as policy rate cuts impact lending rates before deposit re-pricing. While NIMs stood at 3.4% in 2023-24, they are expected to come under slight pressure in the coming year. However, banks will offset this impact through higher non-interest income, including wealth management, insurance, and opportunistic bond gains.

Despite the expected rise in bad loans, Indian banks maintain strong capital buffers, ensuring they can absorb potential losses. The Tier-1 capital ratio stood at 14.8% in March 2024, and capital generation remains steady. With easy access to India's deep equity markets, banks are well-positioned to raise additional capital if required, Moody’s said.

Although loan-loss provisions will rise slightly, banks are expected to maintain adequate profitability. The return on assets is projected at 1.25-1.4% for 2025-26, supported by strong non-interest income and disciplined lending. While credit costs will increase slightly, the overall profitability outlook remains stable.

Rate cuts
After lowering its policy rate by 25 basis points to 6.25% in February, RBI is likely to implement only a modest interest rate cuts, despite easing inflation and a rebound in economic growth, Moody’s said.

The central bank is expected to remain cautious due to global uncertainties, US trade policies, and exchange rate volatility, it said.

Moody’s projects India’s inflation rate to ease to 4.5% in 2025-26 from 4.8% in the previous year, while GDP growth is expected to exceed 6.5%, aided by government capital expenditure, tax cuts for middle-income groups, and monetary easing.