Indian Banking Sector: A New Phase of Loan Stress?
Just when Indian banks seemed to be regaining their footing after the pandemic, data suggests things may be changing again. A recent report has indicated that stress in lending is expected to increase in FY26 (Financial Year 2026) in India. Neither public sector banks nor private sector banks are at the greatest risk, but private sector banks appear to be standing on the weakest ground.
Let’s break down what this means, why it’s happening, and how it relates to India’s broader financial stability.
A Closer Look at FY26 Forecasts
A new report by CareEdge Ratings has sparked concern across the financial industry, especially with private lenders. The key takeaway is that in FY26, banks may struggle more with unpaid loans and rising costs because many people have taken loans without providing collateral, especially in small-scale lending, such as microfinance.
For banks, this means preparing for potential NPAs (non-performing assets) (loans whose EMIs are not paid periodically), provisioning buffers (to take care of loans that are getting defaulted), and possibly tightening lending standards. For borrowers, it could mean stricter procedures and fewer easy loans.
Key Findings from the CareEdge Ratings Report
The report points to some red flags:
- Increasing dependence on unsecured loans NPAs, especially from NBFCs (Non-Banking Financial Companies) and private sector banks.
- Slower repayment cycles in microfinancing and rural spaces.
- Potential spike in credit costs due to deteriorating quality of loans.
- Sharp contrast between private lending and risk appetite versus PSBs (Public Sector Banks).
Of course, the growth-focused lending in the last several years could mean the consequences are delayed.
The Source of Strain: Unsecured Loans & Microfinance
Over the past couple of years, private banks and NBFCs have aggressively pushed into unsecured lending, like personal loans, small business credit, and microfinance. The aim is to capture market share and grow rapidly in the post-COVID era.
However, with high interest rates and inflation eroding household budgets, repayment has become a significant challenge, particularly for low-income segments. As a result, the NPA risk of unsecured loans has escalated.
Rising Credit Costs: What to Expect in FY26
Here’s where it hits the banks directly: credit costs.
Private lenders may need to provision more for defaults, which could raise their operational costs. According to projections, FY26 might see a noticeable uptick in the credit costs banks will incur. That could directly impact profitability, investor sentiment, and even stock valuations.
On the other hand, PSBs may fare better, thanks to their conservative loan books and focus on secured retail and corporate lending.
Private Banks vs. Public Sector Banks: Who is More Exposed?
One thing is clear from the report: private banks have a greater exposure to credit risk than public sector banks. Their more aggressive lending activities, particularly in the retail and microfinance space, have made them more susceptible.
Having undergone cleanups in their asset quality with the fallouts of IL&FS (Infrastructure Leasing & Financial Services) and DHFL (Dewan Housing Finance Corporation), public sector banks have a relatively stronger PSB loan buffer post these interventions, with better coverage ratios.
Understanding the Gross NPA Outlook
The non-performing assets in India have improved in recent years. Gross NPAs as a percentage of total advances have been steadily declining since FY20.
But that might change.
CareEdge expects a mild increase in NPAs across the board, particularly in segments like consumer loans, small-ticket business lending, and microfinance. Banks will need to brace for this, possibly by increasing their PSB loan buffer or tightening loan approval standards.
Offsetting Factors and Resilience in the Sector
It’s not all negatives. The report also points to a few positives:
- Better capital adequacy across major banks.
- Digital credit monitoring and early warning systems.
- Stronger macroeconomic indicators compared to global peers.
- Government support in rural credit schemes.
These factors could act as a cushion, softening the blow of increased loan stress. Many large lenders also continue to purchase their corporate books, helping limit risk.
What This Means for India’s Financial Landscape
If you’re wondering how this impacts the broader banking sector outlook, here’s a simple way to look at it: this is more of a recalibration than a crisis.
Yes, FY26 may bring bumps like higher credit costs for banks, a few more non-performing assets, and slightly more cautious private lenders. But Indian banks are entering this phase stronger than before, having dealt with twin balance sheet problems not too long ago.
Still, this report serves as a timely reminder. Growth must come with wisdom, especially when dealing with unsecured loans NPAs.
Final Thoughts: Watch, Prepare, Adapt
The key point for investors is to pay attention to how individual banks will manage provisioning. Look at the mix of their retail loan portfolio and their stance on microfinance.
For the policy watchers, it’s about ensuring the financial stability that India continues to strengthen, while credit access remains inclusive.
For the rest of us, it’s in our interest to understand how macroeconomic shifts like these affect interest rates, loan availability, and even our personal finances.