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India’s banking sector has witnessed a significant reduction in policy rates, with the Reserve Bank of India (RBI) cutting the repo rate by a cumulative 0.75%—first in April and then again in June 2025. The objective behind this move was to reduce the cost of capital and stimulate private investment in the economy. Finance Minister Nirmala Sitharaman and other government officials have repeatedly urged domestic investors to increase investments, citing various government initiatives—from tax reductions to easing business regulations and lowering capital costs.

However, private investment has not picked up as expected. Even in the last quarter of this financial year (FY), despite the lower policy rates, investment activity remained below projections. Economic growth continues to rely heavily on agriculture, services, and government-led capital expenditure.

Sluggish Credit Growth in the Last Quarter

According to The Economic Times (9th July 2025), credit growth in the banking sector slowed during the first quarter. Public Sector Banks (PSBs) reportedly outperformed their private counterparts, although their loan pricing remained competitive (a comparative chart was sent to the Additional Director).

Further data from ET (3rd July) reveals that loan growth rose by only 9.6% year-on-year up to mid-June, compared to a robust 19.1% growth in the same period last year. This deceleration is visible across sectors. Credit to corporations grew by just 1% in May 2025, down sharply from 7.1% a year earlier. Similarly, home loan growth stood at 9%, a dramatic fall from 38.7% the previous year. These two segments alone account for 31% of the total non-food credit portfolio, which stood at ₹183 lakh crore as of May 2025.

Credit to Non-Banking Financial Companies (NBFCs) has been particularly hard hit, contracting by 0.3% compared to a 16% growth during the same period last year.

Factors Behind Slowing Credit Demand

One key reason for this muted credit growth is the trend among companies to prepay high-cost loans by raising cheaper funds through bonds and commercial papers. Anil Gupta, Senior Vice President and Co-Head of Financial Sector Ratings at ICRA, noted: “Many large firms have prepaid high-cost debt by raising funds from the market through bonds and commercial papers.” Gupta added that some investors are holding back, anticipating another policy rate cut, which may eventually drive up credit demand.

Banking Sector Performance in Q1 FY26

Despite sluggish credit growth, the financial performance of major Indian banks for the quarter ending June 2025 has been broadly positive. While not all banks had announced their results by 25th July, early trends show several banks benefitting from higher treasury gains and increased net interest income (NII). Additionally, asset quality has improved and term deposits have shown healthy growth trends.

However, net interest margins (NIMs) remained under pressure for many banks. NIM—defined as the difference between the interest income earned on loans and investments and the interest paid to depositors—serves as a key indicator of banking profitability.

A key contributor to Q1 profits was the surprise double repo rate cut by the RBI. This move created trading opportunities, enabling banks to earn significant returns from the sale of investments. When interest rates fall, bond prices rise, leading to gains in the bond portfolios held by banks. Aswini Kumar, Managing Director of UCO Bank, highlighted that the 50 basis point cut in June created substantial trading gains, helping banks book higher treasury income.

However, experts caution that such gains may not recur in the coming quarters unless the RBI opts for further rate cuts.