Credit growth slows as banks turn cautious over asset quality

Banks are tightening the taps on riskier borrowers such as non-banking financial companies (NBFCs) and unsecured retail customers, resulting in a credit growth slowdown even as the economy stays stable, reveals data from the Reserve Bank of India (RBI). Overall, credit growth has nearly halved, from nearly 16% in FY24 to about 8-9% this fiscal. As a result, personal loans for vehicles, education, and credit cards have also slowed.

Sectors worst affected include NBFCs, housing finance companies, SMEs, and unorganised businesses, said Apoorva Javadekar of Muthoot FinCorp. “Petroleum, mining, telecom, sugar, ports, and beverages are among industries seeing weaker credit growth,” Javadekar added.

According to the RBI, as of May 30, the total non-food credit outstanding of commercial banks is worth ₹182 lakh crore. Credit growth slowed sharply from 15.8% in FY24 to 8.8% in FY25, with all major segments, including agriculture, personal, industry, and services, showing subdued credit pick-up. In the latest data for Q1 of FY26, consumer durables, housing, large industrial credit, and bank credit to NBFCs continue to witness slow credit growth. On the other hand, vehicle loans and micro/small industrial credit are showing signs of revival.

“While banks are reluctant to lend to low-credit-score retail customers, the slow credit growth for large industries is on account of a lack of demand as larger companies are adopting a ‘wait-and-see’ approach amidst global uncertainties,” added Javadekar.

As defaults are rising and regulators are circling, lenders are recalibrating risk and rethinking who deserves their money. However, the drivers differ across sectors. 

The credit growth data for the first quarter of FY26 reveals divergent trends among major banks, based on pro forma numbers released by the banks. HDFC Bank saw a sharp deceleration, with credit growth dropping to 6.7% from 14.9% in Q1 FY25, reflecting post-merger consolidation and a cautious retail lending stance. YES Bank reported a similar decline, with growth falling to 5.1% from 14.8%, pointing to continued stress in its lending portfolio. In contrast, Bank of India posted relatively strong growth of 11.9%, though lower than last year's 15.8%, indicating it is still drawing borrowers effectively amid the broader credit slowdown.

One key reason is the surge in unsecured personal loans over the past few years, which triggered regulatory alarm. “Banks have reduced exposure to NBFCs as they remain selective, favouring higher-rated NBFCs due to stress in microfinance and unsecured portfolios,” said Sanjay Agarwal, Senior Director, CareEdge Ratings.

Digital lending has also added to the stress, especially from fintechs and instant-loan platforms. “Many loans were underwritten with limited data, leading to overleveraged borrowers and rising defaults,” said Siddarth Jain, CFO, MinEMI.

“Given the macroeconomic uncertainty and continued asset quality pressure in unsecured loans, banks remain in risk-off mode,” said Anand Dama, head–BFSI, Emkay Global.

Adhil Shetty, CEO of BankBazaar.com, said, “Banks are now under pressure to monitor delinquencies and repayment behaviour more closely.”

This regulatory push, coupled with concerns over household over-leverage and rising early wrongdoings, has led banks to favour safer lending segments, such as salaried individuals or businesses with strong balance sheets.

Pressure on margins and earnings

According to a report by Motilal Oswal Financial Services, banks are earning slightly less on new loans, but the impact isn’t the same across the sector. “In May 2025, the average interest rate on new loans, known as the Weighted Average Lending Rate (WALR), fell for the overall banking sector. However, private sector banks (PVBs) managed to increase their WALR by 7 basis points (bps), which means they raised their interest margins even as the broader rates were falling. In contrast, public sector banks (PSBs) saw their WALR on new loans fall by 8bps, indicating they are earning less. This shows that PVBs have been more successful in protecting their earnings by adjusting their loan pricing strategies.”

On outstanding loans, the interest earned also declined slightly by 1 basis point across the sector in May. But private banks showed more strength yet again. They saw a 2-bps increase in the rate they earned, while public banks experienced a 2-bps drop, the report stated. “Over the past three months, private and public banks have seen a 10-bps decline in the rates earned on outstanding loans, but private banks appear to be managing the trend better in the short term.”

On the deposit side, rates are also inching down. The interest paid by banks on fixed deposits, measured by the Weighted Average Term Deposit Rate (WATDR), declined marginally to 7.07% in May. Between February and May, this rate dropped by 3 bps, revealing that banks are gradually lowering the returns they offer to depositors, likely to balance the pressure from falling loan yields, the report noted.

According to JM Financial’s July report, SBI’s outstanding personal loans stood at ₹4.1 lakh crore in FY25, marking a marginal 2% year-on-year growth, while HDFC Bank’s personal loan book reached ₹1.99 lakh crore, growing by 8% in the same period. SBI’s share in the personal loan market declined to 28% from 30% a year ago, with gross NPAs rising to 1.07%. In contrast, HDFC maintained a stable 14% market share. The report highlighted a broader slowdown in unsecured lending, with banks reducing disbursements by 9% and shifting towards higher-ticket loans, while NBFCs gained market share by focusing on small-ticket personal loans. Delinquencies have worsened in unsecured segments such as personal loans, consumer durables, and credit cards, especially among NBFC-originated loans. For example, HDFC’s consumer durable gross non-performing assets rose to 0.95% in FY25. The report notes an increase in Portfolio at Risk (PAR 360+) to over 4%, reflecting growing stress in the unsecured loan segment.

Banks recalibrate lending risks

PSBs have long been viewed as cautious lenders, but recent data suggests they are adapting. From FY20 to FY25, PSBs’ advances hit a CAGR of 13.9%, while private banks expanded faster at 15.7%. However, the momentum is shifting.

“Private banks now hold about 54% of credit, down from 59% in FY20, partly due to their higher credit-deposit ratios and selective lending,” said Agarwal. This gain in market share reflects how PSBs are stepping up, particularly as private banks deal with asset quality concerns. They are also exploring newer lending models.

“This indicates they are moving beyond their traditionally risk-averse stance,” said Javadekar. “Higher delinquencies in private banks reflect their larger exposure to retail loans.”

Meanwhile, PSBs are using pricing as a tool to drive growth. “They have been aggressively pricing high-ticket loans, helping grow loan books faster, even if volume growth is modest,” noted Shetty.

Their approach remains measured, though, with risk control at the core. “PSBs avoid risky lending not out of fear but because it often doesn’t make financial sense,” said Jain. 

“PSBs haven’t been hit by recent unsecured loan stress; they are simply more focused on profitability,” said Dama. 

Will policy moves unlock lending?

The RBI has already taken significant steps to support credit growth. Since January 2025, it has infused ₹9.5 lakh crore into the banking system and recently announced a 100-bps cut in the Cash Reserve Ratio (CRR), effective September, unlocking an additional ₹2.5 lakh crore. “The CRR cut, along with a 50-bps reduction in the policy repo rate, lowers banks’ cost of funds and gives them headroom to expand lending,” said Shetty.

However, easing liquidity alone may not immediately translate into higher lending. Many banks are still concerned about margin pressure and asset quality risks, particularly in the retail segment. “Growth will pick up once funding costs ease further and asset stress reduces,” said Dama. “We expect a gradual recovery in credit growth from the second half of FY26.”

Policymakers also need to address structural gaps in lending practices. “A big step would be real-time, unified borrower records to accurately assess repayment capacity,” said Jain. Promoting secured alternatives such as loans against mutual funds or home loan top-ups could be one way for bankers to shift demand away from risky personal loans. But that will be a wait-and-watch, say experts.