Indian banking sector faces 'structural profitability squeeze' amid rising costs and credit risks: McKinsey
May 05, 2026
New Delhi [India], May 5 : India's banking sector, after a period of strong profitability and balance sheet improvement, is entering a more complex phase marked by emerging structural pressures, according to a report by McKinsey & Company.
The report, titled "Indian Banks: Navigating through the turbulence," highlights that while banks have benefited from robust macroeconomic growth and improved asset quality, headwinds such as margin compression, rising costs, and evolving credit risks are beginning to surface.
"Indian banks have been outperforming global peers, but they are still facing headwinds," the report noted, pointing to growing challenges that could test the sustainability of recent gains. It added that profitability has reached a peak, with return on assets (ROA) touching 1.4 per cent in FY2025, but further upside may be limited due to declining net interest margins (NIMs) and rising operating expenses.
The findings indicate that banks are navigating a "structural profitability squeeze" as credit growth continues to outpace deposit growth, leading to tighter liquidity and higher funding costs. At the same time, fee income has remained under pressure amid increasing competition from fintech players and the shift towards low-cost digital transactions.
The report also flagged emerging stress in asset quality, particularly in unsecured retail lending. While gross non-performing assets (GNPAs) have declined to a 13-year low, rising write-offs and higher slippages suggest underlying vulnerabilities that could impact future earnings.
The sector is witnessing shifts in credit dynamics, with non-banking financial companies (NBFCs) outpacing banks in credit growth and retail lending gaining a larger share of overall portfolios. Additionally, the credit-deposit ratio has reached a decade high, forcing banks to rely more on higher-cost deposits.
Beyond financial metrics, the report underscores the importance of a broader approach to evaluating bank performance. It introduces a holistic impact scorecard that assesses banks across five dimensions financial performance, industry health, customer experience, societal impact, and operational resilience.
"To stay ahead, banks would need to strengthen their financial and operational foundations, embrace innovation to enhance customer value, and align their growth with broader social and environmental goals," the report said.
Technology and digital transformation are emerging as key priorities, with banks accelerating investments in artificial intelligence and data-driven capabilities. However, legacy infrastructure and uneven adoption remain significant challenges. The report also warns of rising cybersecurity risks as digital adoption increases, necessitating stronger risk management frameworks.
In addition, the sector faces evolving customer expectations, with a shift toward hyper-personalised services and digital engagement models. While public sector banks are closing the gap in digital capabilities, private lenders continue to lead in customer experience and technology investments.
Overall, the report concludes that Indian banks stand at an inflection point, balancing strong growth momentum with increasing operational and financial pressures. Sustained success, it suggests, will depend on the sector's ability to adapt quickly, manage risks effectively, and build resilience in an increasingly competitive and technology-driven landscape.
