Lending yields set to shrink in FY26 as banks play it safe

Synopsis

Mumbai banks anticipate lower lending yields this fiscal year. Caution in unsecured loans and slower retail growth contribute. Policy rate cuts also play a role. Analysts predict a yield drop to 8.6%. Net interest margins may contract. Repricing of loans linked to external benchmarks will impact private banks. Deposit repricing lags will further squeeze margins.

Mumbai: Banks are expected to face downward pressure on lending yields in the current fiscal year amid growing caution in the unsecured lending space, a slowdown in high-yield retail loan growth, and lower policy rates. Analysts forecast that the yield on advances could drop by around 50 basis points year on year to 8.6% in the coming months-against a peak of 9.48% in FY24-as banks increasingly shift focus to lower-risk, lower-return assets in response to evolving credit conditions.

Banks' net interest margins (NIMs) are also projected to contract by 20-25 basis points year on year in FY26, they said. "The yield on advances will drop in FY26, as loans linked to the repo rate will be re-priced downward immediately, while those linked to EBLR (external benchmark lending rate) will adjust over the medium term," said Sanjay Agarwal, senior director at CareEdge Ratings.

"Banks remain cautious about lending to unsecured, high-yielding asset classes. There could be some competition with the slowing credit growth resulting in softening yield on advances," he added.

Agencies

According to data from CareEdge Ratings, private sector banks saw their yield on advances fall from 10.95% in FY24 to 10% by the end of FY25. The rating agency expects this figure to decline further to 9.64% in FY26, highlighting the sector-wide impact of monetary easing.

The Reserve Bank of India (RBI) had raised the repo rate by 250 basis points through FY23, which was held steady at 6.50% until February 2025. This tightening phase had enabled banks to pass on higher borrowing costs, boosting lending yields. However, with a 100-basis point cut in repo rate in five months, the trend is reversing.

The re-pricing of EBLR-linked loans, especially prevalent in private sector banks, where 86% of the loan book is tied to EBLR, will further weigh on yields. These banks, which also have higher credit-to-deposit (C/D) ratios, are likely to face greater margin pressure compared to their public sector counterparts.

As rates fall, a structural lag in deposit repricing is expected to put additional pressure on net interest margins. In a falling interest rate environment, lending rates tend to adjust more quickly than deposit costs, particularly fixed-term deposits, which are typically repriced with a delay of two to four quarters.

"The steep cut in repo rate is expected to sharply impact the net interest margins of the banks and Q2FY26 is expected to be the weakest," said Sachin Sachdeva, sector head, financial sector ratings at ICRA.

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