India’s banking sector continues to consolidate

India's banking sector has shown stable health and robust performance across key financial and operational metrics in recent years. Public Sector Banks (PSBs), in particular, have achieved a turnaround, supported by the Reserve Bank of India's (RBI) 4R strategy: Recognition, Resolution, Recapitalization, and Reform. This strategy has helped PSBs grow their incremental credit market share from 49% in FY20 to 53% in FY24, buoyed by surplus liquidity and proactive growth initiatives.

FY24 highlighted the sector's resilience, marked by strong capital levels, high NPA coverage, stable asset quality, consistent loan growth (15–16% YoY), and healthy net interest margins. Credit growth was broad-based, spanning multiple segments. A key shift was the regulatory transition from rule-based to principles-based frameworks, emphasizing robust technological infrastructure to address data security, customer privacy, and digital lending. Despite growth, the sector remains exposed to the following challenges:

1. The rising share of unsecured loans: Growing at a CAGR of 18% (2017–2024), now constitutes 36% of incremental retail loan growth despite the associated increase in risk-weighted assets (RWAs).
2. Elevated operating expenses: In FY24, digital transformation and IT upgrades led to a 50-basis point increase in the cost-to-asset ratio. Large private banks' operating expenses grew at an 18% CAGR over five years, while PSBs faced rising employee costs due to IBA-linked pension and wage provisions.
3. The rigorous regulatory stance to improve accountability and reduce risks have raised compliance costs, impacting margins and profitability, especially in microfinance book.

Sector FY 24 performance and key themes:

Regulator more engaging than ever.

The Indian banking sector is undergoing a regulatory transition from rule-based to principles-based frameworks, fostering innovation and risk-calibrated growth. Governance and compliance have emerged as central themes, with the RBI addressing concerns such as data security, customer privacy, and digital lending practices. In FY24, the RBI took proactive measures against some banks and NBFCs for non-compliance, emphasizing the need for robust technological and risk management frameworks. Persistent concerns regarding lending practices in smaller NBFCs, MFIs, and fintechs highlight issues like inadequate risk assessment, high loan-to-value ratios, non-compliance in cash disbursals, and poor KYC adherence. The RBI advocates disciplined growth and robust risk management.

Supported by strong fundamentals such as profitability, capital adequacy, and asset quality, alongside proactive regulatory oversight, the banking sector is well-positioned to anchor India's economic aspirations. Banks and NBFCs are encouraged to innovate using digital infrastructure and emerging technologies like Generative AI. However, the RBI's increased vigilance may raise compliance costs for the sector.

Deposit flight, a key boardroom agenda for banks as customers chase alpha.

Majority of the large banks (Both public and private) have witnessed a slowdown in the deposit growth. Credit growth for SCBs have consistently outpaced deposit growth in the last three years (CAGR credit growth of 15.1% vs Deposit growth of 11.2%). Credit to Deposit (CD) ratio for the sector has also peaked at 80% in FY24 compared to 72% in FY21.

The rise of alternative investments and India's shifting household behaviour towards financialization are key challenges for bank deposit mobilization. Savings are moving from physical assets to financial instruments, leading bank deposits toward higher-yielding capital market options like equities, mutual funds, AIFs, and private credit. Notably, 47% of term deposits are now held by senior citizens, indicating that the younger demographic is moving away from traditional deposits. Consequently, households have become net borrowers from the banking system, with household financial borrowing as a percentage of GDP rising to 5.8% in FY23, up from 3.3% in FY13. This shift is exerting pressure on banks' NIMs and liquidity.

The battle for a larger share of CASA deposits will continue, as macroeconomic factors pose challenges to deposit growth, with the RBI likely to cut benchmark rates in near future. Banks must adopt multifaceted strategies targeting both existing-to-bank (ETB) and new-to-bank (NTB) customers across segments to succeed. Key focus areas for building robust CASA franchise include:

A) Digital SA onboardings:

• Analytics driven hyper-personalized products for GenZ customers.
• Segment focused services like Cash-backs/ Rewards for instant activation.
• Empower branches through digital onboarding journeys.
• Leverage DIY and AI chat bot for certain customer service.
• Strategic partnerships and integrations with FinTech companies to build synergies in acquisition, onboarding, and servicing.

B)?Segment specific offering:

• Doorstep banking to senior citizens.
• Complimentary air accidental insurance to defence salary accounts.
• Education loan at preferential rates to student savings accounts.
• Preferential rates on remittances to mariners’ salary accounts.
• On demand salary with interest free advances and instant disbursement including differentiated rewards and exclusive offers to corporate salary accounts.

C) NRI saving accounts:

• Enhanced remittance offerings including status tracking and rates analyzer.
• Beyond banking offerings such as expert tax & legal advisory, Retirement & estate planning, premium invitations from exclusive partners.
• Assistance with investments in India including investments in GIFT IFSC

D) Strategic approach for CA mobilization:

• Differentiated product offerings to target customer segment. -- Offer cash management service to build CA.
• Bundle high variant products with features such as MB/IB, POS, etc.
• Focus on micro-market segmentation to onboard retailers in existing geographies.

Banks will have to reimagine its value proposition of deposits with technology and innovation at the core. Digital customer acquisition & ecosystem partnerships coupled with innovation of legacy deposit products will be critical.

Focus on increasing share of fee income.

Deposit re-pricing has largely materialized, but CASA degradation continues to weigh on NIMs in the near term. However, banks have tools to mitigate this impact at the ROA level. With mounting pressure on margins due to challenges in deposit growth, banks are shifting focus toward fee income to enhance operating leverage. In FY24, other income, including fees, grew 36.2% YoY for large PSBs and private banks. Since FY19, non-interest income for private banks has risen at a 15% CAGR, outperforming public sector banks’ 7% CAGR. As interest rates are expected to decline, fee income will become critical to offset moderating lending yields. With rising credit costs, particularly in unsecured lending, and slowing deposit growth, banks face margin pressure. To maintain competitiveness, banks must prioritize fee-based income, supported by a favourable capital market environment and increasing savings financialization. Key areas of focus include distribution-based fees, transaction banking, and cash management services. Some of the key focus areas for banks to gain competitive advantage while increasing the share of fee income:

• Insurance distribution: Cross sell third party LI and GI products to existing customer base having bank finance assets.
• Wealth management: Increasing finalization will also open-up more advisory and distribution opportunities for banks. Aim for greater share of equity broking, SIP distribution and portfolio management tailored to clients’ financial needs.
• Cash management and bill discounting: Develop unified digital platforms for real-time visibility of cash, payments, and receivables across accounts, utilizing blockchain for faster, secure payment settlements and reconciliation.
• Extend supply chain finance beyond Tier I suppliers and expand client base by becoming strategic partner across the supply chain.
• Significant potential to increase share of fee income by improving branch activation and best-fit partnership models.

Stress in retail unsecured loans exert pressure on profitability of smaller players…

In the post-COVID era, banks and NBFCs have experienced significant growth in unsecured lending, with inquiry volumes rising across product categories. Personal loans, a key driver, nearly tripled since FY21 and contributed approximately 28% of incremental retail loan growth by FY24. Among new-to-credit (NTC) borrowers, younger individuals show higher leverage, particularly in small-ticket loans. A TransUnion CIBIL report highlights that middle-class youth under 35, with credit scores of 620-720, are leading this surge, accounting for 51% of unsecured loan originations by FY24, up from ~45% in March 2020. However, concerns persist about higher delinquencies, particularly for personal loans below INR 50,000, with delinquency rates reaching 5% by March 2024. In response, RBI increased capital requirements and risk weights on unsecured retail loans and mandated detailed loan book disclosures from select NBFCs.

Despite increased scrutiny, this segment remains vital to India's goal of becoming Viksit Bharat by 2047. Unsecured lending penetration is just 9% in India, compared to ~250% in the US, 173% in the UK, and 65% in Germany. There is significant unmet credit demand, especially in the small-ticket segment. Banks and NBFCs should prioritize disciplined growth by developing a distinct 'small ticket' lending journey using data and digital tools.

…gradual shift of stress towards secured credit

While unsecured retail lending has emerged as the key contributor to the stress in the last three years, there are early signs of stress moving towards secured credit. TransUnion CIBIL reports that 25% of multi-loan borrowers default first on secured loans. Stress is acute in small-ticket secured microfinance loans, particularly among older borrowers in non-metropolitan areas. CRISIL highlights a drop in collection efficiency to 94% in Q2 FY25, with secured assets like home and gold loans dominating MFI exposure.

India's banking sector is at a pivotal point, balancing robust growth with emerging challenges. PSBs have shown resilience through reforms and steady market share, but rising costs, regulatory demands, and shifting consumer preferences towards alternative investments add pressure. Deposit outflows, especially low-cost CASA accounts, and a focus on unsecured retail lending further strain profitability. However, banks are leveraging technology, digital platforms, and fee-based income to drive growth

The regulatory landscape, led by the RBI, is adapting to support innovation while maintaining stability. The increased vigilance surrounding lending practices, especially in unsecured loans, emphasizes the need for disciplined growth and sound risk management frameworks. As India advances towards Viksit Bharat 2047, banks and NBFCs will play a critical role in fostering inclusive financial growth.

Our outlook for key metrics in 2025 include:

• Credit growth momentum is expected to be sustained. Moderation in CD ratio will be the primary determinant of loan growth for most banks in FY25
• Earnings drivers to shift towards asset growth and operating leverage now, as asset quality has normalized, and liability spreads have peaked
• CASA mobilization will continue to be a challenge.
• With cyclical tailwinds (higher NIM+ higher credit growth) fading, banks with higher core profitability (superior NIM profile and PPOP margins) are likely to outperform. ?

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