Banking sector in 2025: Key growth drivers and potential challenges

As the 2024 year comes to an end, the banks gave a nominal 6.5% return on a YTD basis as of December 23. The banking sector is one of the major sectors and remains a cornerstone of the economy. Let us look at what lies ahead for the sector in the new year.

Key tailwinds driving growth:

Rate cycle reversal

The RBI (Reserve Bank of India) will likely start cutting rates in early 2025, which means the funding costs for the banks go down. If you ask how this will benefit, the major beneficiary of this rate cut cycle will be the banks whose tenures for fixed-rate assets are shorter (both are liabilities) and can be repriced swiftly at lower interest rates. This will act as a cushion to their margins.

Credit growth revival

Credit growth, which refers to an increase in the total amount of loans (provided by banks to individuals, businesses, and governments) over a specific period, is expected to moderate to a low double-digit pace. Although it might pick up in the second half as discussed in the first point (lower interest rates stimulate borrowing).

Digital transformation

The operational efficiency is expected to improve due to the expansion of the customer base (particularly in underserved areas). This is expected to be achieved through investments in technology and fintech partnerships.

Strong retail demand

The retail lending space, mainly home loans and personal loans, supported by government schemes and urbanization trends, remains a bright spot in the coming year.

Key headwinds for the sector:

Margin pressures

As interest rates fall, it reduces the income from repo-linked loans for private banks faster than they lower the deposit cost (discussed in the first point in tailwinds for deposits), which leads to NIM (net interest margin) going down. So, a higher exposure to repo-linked loans will have a pronounced effect as they are dependent on such loans.

Rising credit costs

Credit cost, an expense which a bank incurs to cover potential loan losses, includes provisions for bad debts and NPAs (non-performing assets). Stress in loan portfolios, especially the unsecured loan portfolio, might lead to higher provisions, which ultimately impact profitability. PSBs (public sector banks) may face challenges due to their higher exposure to risky segments.

Regulatory challenges

Any change in digital security requirements or stringent capital adequacy norms could increase operational costs.

Economic uncertainty

If inflation cools slower than expected, the GDP growth might dampen due to higher interest rates. Along with it, consumer and corporate sentiment might suffer too, which will delay recovery in certain sectors.

Q3FY25 result outlook

For the third quarter of FY25, banks are expected to report moderate growth in their earnings. Whereas retail loans and lower deposit costs could support revenues, the pressure from margins and higher provisioning might cap profitability.

As banks need a steady inflow of deposits to fund loans and maintain liquidity, deposit mobilization is crucial—tracking the credit-deposit ratio is one of the important metrics to look at.

Conclusion

So, at last, it’s all about adaptability, as the banking sector for 2025 is expected to be mixed. Banks that efficiently manage their liabilities, leverage technology, and maintain strong asset quality are poised to outperform.

You, as an investor, shall focus on leading names with diversified portfolios and sound fundamentals as the sector goes through a year of transition.