Indian Banks' Gross NPA Expected to Deteriorate in FY26

The banking sector in India is expected to experience a slight decline in asset quality in the financial year 2025-26 (FY26) with the main cause being the rising stress levels in the unsecured personal loans, as per a recent report by CareEdge Ratings. The gross non-performing assets (GNPA) ratio of scheduled commercial banks is expected to increase marginally by 0.1 percentage point to 2.3-2.4 percent by FY26, indicating some weaknesses in some loan categories despite the general improvement over the past few years.

Increasing Slippages in Unsecured Personal Loans

The most important factor that is likely to increase NPAs is the increasing pressure on the unsecured personal loan segment. Sanjay Agarwal, Senior Director at CareEdge Ratings, pointed out that new slippages will grow since the personal loans segment will be under pressure. This is combined with a slowdown in recoveries and upgrades, which had in the past assisted banks in sustaining asset quality.

Unsecured loans, such as personal loans and microfinance, are more prone to defaults since they are not secured by collateral. The report observes that although the overall asset quality has improved on account of recoveries, increased bank write-offs and reduced slippages among bank groups, the unsecured segment is a matter of grave concern. This segment is likely to counteract some of the improvements in other loan types.

Broader Risks to Asset Quality

In addition to the unsecured loan segment, other factors pose a downside risk to the asset quality of the banking sector. High interest rates are raising the cost of borrowing which may affect the repayment ability of borrowers. The uncertainty is also compounded by regulatory changes and global headwinds, including tariff increases. All these combine to give a pessimistic view of asset quality in FY26.

History and Trends

The GNPA ratio has been on a downward trend since March 2019, even in the pandemic years FY20 and FY21, partly because of the regulatory forbearance measures in the form of moratoriums and delayed NPA recognition. At the close of the FY25 Q4, the GNPA ratio had improved to 2.3 percent due to recoveries and write-offs. Nevertheless, the existing prospects indicate that this decline might stabilize or even turn in the opposite direction because of new tensions.

Banks have also been writing off bad loans to clean up their books. Indian banks have written off non-performing assets to the tune of about Rs 16.35 lakh crore in the past ten years and Rs 1.70 lakh crore in FY24 alone. These write-offs assist in enhancing the reported quality of assets but do not release the borrowers of their debts as banks proceed with recovery processes via legal and regulatory means.

Increase in Credit Cost Marginal

The report also predicts a marginal rise in credit expenses of banks in FY26. The credit cost of the private banks is likely to increase to 0.47 percent in FY25 compared to 0.46 percent in the current year and it is likely to increase to 0.43 percent in the state-owned banks compared to 0.38 percent in the current year. Although this has increased, it is estimated that the banks have adequate provision coverage ratios that can cushion against possible losses without necessarily putting their capital adequacy to the test.

Retail Loan Growth and Sectoral Implications

There has been a sharp increase in retail lending, particularly unsecured personal lending, as corporate credit demand has remained low. This change has exposed banks to more risky segments. CareEdge estimates that the slippages will be higher in the case of private banks as they have a greater proportion of unsecured lending. The microfinance section which is classified under unsecured loans is also susceptible to increased defaults.

Conclusion

Although Indian banks have been able to achieve significant improvements in asset quality in the past few years, the FY26 forecasts spell out caution. The increasing pressure on unsecured personal lending, macroeconomic and regulatory issues are likely to lead to a minor worsening of gross NPAs. To overcome these headwinds, banks will have to ensure that their credit risk management and provisioning are vigilant to ensure that they remain financially stable.

This trend highlights the significance of paying close attention to retail loan books and controlling risk factors of unsecured lending which has emerged as a key credit growth factor in the Indian banking industry.