How can Indian lenders balance loan growth and risk?

Reforms could help improve efficiency, especially of state banks.

Indian banks have high margins and low credit penetration, creating significant growth opportunities, but bad loans and inefficiencies in state-owned lenders continue to weigh on the sector.

The country, projected to become the world’s third-largest economy by 2028, already has banks that match US peers in profitability.

Return on assets for Indian banks stands at 1.3%, on par with US banks and higher than major Asian and European economies, CARE Ratings Ltd. (CareEdge) said in a January report. Noninterest income streams and efficient capital use also support performance.

“Despite digitalisation, [state banks] are inefficient not just in comparison with private sector banks but also compared with other regional banks in South and Southeast Asia,” Deepali V Seth Chhabria, associate director and a credit analyst at S&P Global Ratings, said in a February report.

Sprawling branch networks, high staff costs, and large pension obligations reduce efficiency. Many branches are underused and low yielding, which drags on profitability, she pointed out.

State-owned banks are also constrained by union rules that make staff reductions difficult. By contrast, banks in Thailand and the Philippines have paired digital adoption with branch closures, voluntary retirement programmes, and mergers to improve efficiency.

India’s credit penetration is relatively shallow. The country’s credit-to-gross domestic product ratio is 53%, below peers, despite high margins. Gross nonperforming assets remain elevated at 2.23%, among the highest in major economies.

Analysts say India’s untapped credit markets and high margins make it a promising place to grow profitably.

Foreign banks are targeting the market. Sumitomo Mitsui Banking Corp. has received Reserve Bank of India approval to set up a unit, whilst Mizuho Financial Group, Inc. and Mitsubishi UFJ Financial Group, Inc. (MUFG) recently invested in Shriram Finance and Avendus Capital, respectively.

Japanese banks are seeking to capture long-term credit growth, particularly in retail and micro, small, and medium enterprise (MSME) lending.

Despite the growth potential, India’s banking system remains modest in scale. Total assets are about $3.45t, about 57% of Japan’s banking assets, and well below China, Europe, and the US.

CareEdge said there’s a need for deeper financial intermediation, stronger underwriting, and improved recovery frameworks to sustain growth.

“The comparative analysis clearly indicates that the Indian banking sector still has a long way to go,” it added.

Reforms could help improve efficiency. Finance Minister Nirmala Sitharaman has proposed a banking committee to review the sector and align it with India’s next phase of growth.

Potential measures include mergers, restructuring, and digital acceleration for state-owned lenders.

Banks are expected to benefit from rising credit demand, continued digital adoption, and gradual improvements in asset quality.

“However, sustaining this trajectory will require disciplined risk management, prudent capital allocation, and continued focus on efficiency and governance,” CareEdge said.

Questions to ponder:

• How are banks balancing pressure to boost market share with regulatory expectations on risk management?
• What lessons from past credit cycles are shaping lending strategies?