NPAs Likely To Surge In Next Quarters, Says ICRA

The banking sector will witness a surge in non-performing assets (NPAs) in the next quarters, consequential to the rise in credit growth, which is anticipated to grow by 10.8 per cent, according to a report by credit rating agency ICRA.

ICRA expects banks to between Rs 19 trillion and Rs 20.5 trillion in FY2026—higher than Rs 18.0 trillion in FY2025. This credit impulse is underpinned by recent measures such as the cut in repo rate by the Reserve Bank of India (RBI) and reversal of increased risk weights on unsecured loans and exposure to non-banking financial companies (NBFCs). The RBI has also provided liquidity to the banking system through open market operations and forex swaps.

However, in spite of these encouraging developments, there is growing concern regarding the quality of loans being distributed, especially in the unsecured retail and small business segments.

ICRA has said that the gross NPA (GNPA) ratio will remain range-bound until March 2025, but is expected to go up in FY2026. The reason primarily lies in an upsurge in slippages—fresh accounts becoming NPAs—and decline in recoveries and upgrades. The increasing credit cost, or amount of money which banks are required to reserve against bad loans, will presumably continue to affect the bottom line.

Adding to the worry is the rise in defaults on unsecured items. Credit card NPAs, for example, have increased more than 500 per cent—from Rs 1,108 crore in December 2020 to Rs 6,742 crore in December 2024, according to an RTI response quoted by The Indian Express. This indicates an increasing trend of distress in short-term personal credit, a segment banks had pushed aggressively in recent past.

Incidentally, even as lending growth improves, banks are struggling to garner deposits—particularly at affordable rates. The flight of savers to higher-yielding investment channels and fixed deposits has lowered the proportion of low-cost current account and savings account (CASA) deposits. This is encouraging banks to draw more on wholesale deposits, which are more expensive and also hit liquidity buffers.

As a result, the average liquidity coverage ratio (LCR) of the banking sector, though still above regulatory limits, is steadily falling. With a high credit-deposit (CD) ratio, banks are also under pressure to grow deposits quickly, often by offering higher rates. This not only impacts their margins, but also makes it difficult to transmit RBI’s policy rate cuts to customers.

ICRA said that the net interest margins (NIMs) of banks is also likely to contract by 15–17 basis points (bps) in FY2026. As lending rates face downward pressure on account of declining external benchmarks as the competitive pressure of the debt market, the same may not fall easily in case of deposit rates on account of cut-throat competition for funds.

Sachin Sachdeva, vice president and sector head, ICRA, said that despite a projected 75 bps cut in repo rates since February 2025, transmission to decreasing borrowing costs can be lagging, as banks are finding it difficult to cut their cost of funds.

“As credit expenses increase and margins contract, banks’ overall profitability is likely to decline. ICRA anticipates return on assets (RoA) to stabilise at 1.1 to 1.2 per cent and return on equity (RoE) at 12.1 to 13.4 per cent in FY2026—both lower than in the past few years. Yet the agency observes that banks are adequately capitalised and won't require new equity in the near future. Their lower net NPAs and internal generation of capital will sustain solvency,” he said.

ICRA has maintained a ‘stable’ outlook for the banking industry in spite of these stresses. The positivity is due to factors, such as regulatory drive, robust capital levels, and the resilience displayed by banks over the last couple of years.

It, however, said that the next few months will challenge their capacity to sustain growth while managing asset quality, particularly as riskier segments start to exhibit initial signs of distress.

“With increasing retail defaults and shrinking margins, FY2026 could prove to be a tightrope walk for Indian banks—between the temptation of credit growth and the caution required to contain a new cycle of NPAs,” it added.