India's banks are earning more than ever and carrying the fewest bad loans in decades, just as falling interest rates begin to squeeze the margins behind the boom.

That combination of peak profitability and an easing cycle is what makes the moment awkward. Lenders rarely look better than they do at the turn, and India's are posting their strongest numbers since before the bad-loan crisis of the last decade. Public sector banks alone booked a record INR1.98 trillion ($20.7bn) in net profit in the year to March 2026, with gross bad loans down to a historic 1.9%.

The Reserve Bank of India (RBI) described asset quality across the system as a 'multi-decadal low' in its latest Financial Stability Report, putting the gross non-performing asset ratio at 1.8%, the best reading in more than a decade. Fitch, keeping India at 'BBB-' with a stable outlook, pointed to the same clean-up as a support for the sovereign.

The cleanest books in a generation

The turnaround has been years in the making. Recovery rates on soured loans have nearly doubled to 26.2% from 13.2% seven years earlier, helped by resolutions under the Insolvency and Bankruptcy Code, where creditors have realised 94% of fair value. Capital buffers are thick, with the capital-to-risk-weighted-assets ratio at 17.2% last September.

The scale of the expansion is striking. Over the decade to FY2025 the system's deposits roughly tripled to about INR241.5 trillion ($2.5 trillion), loans rose faster still, and banking assets climbed to around 94% of GDP from 77%. Loan growth has outpaced deposits, pushing the credit-deposit ratio up towards 79% and leaving lenders scrapping for funding.

The clean-up came after the bad-loan crisis of the last decade forced a state recapitalisation of the public banks, and it has run alongside a push into the unbanked. The Pradhan Mantri Jan Dhan Yojana had opened more than 550mn no-frills accounts by early 2025, and public lenders have sanctioned trillions of rupees of digitally assessed credit to small firms, deepening the deposit base even as competition for it intensifies.

The margin squeeze

That funding fight is where the cycle starts to bite. After two cuts the RBI has held its repo rate at 5.25%, keeping a neutral stance and lifting its growth forecast to 6.7% at its August meeting, but the lower rates have already thinned margins. Net interest margins at HDFC Bank slipped to 3.38%, still short of the 4% it managed before its 2023 merger, while Punjab National Bank is guiding to a slender 2.6%-2.7%.

Deposits are the pinch point. State lenders reported double-digit loan growth into the June quarter but deposit mobilisation trailed badly — Bank of Baroda's advances rose 17.4% against 13.8% for deposits, and Union Bank of India's deposits crawled up just 3.5%. With system credit still running near 18.6% year on year, the gap keeps upward pressure on funding costs.

The other soft edge is the retail engine itself. After years of breakneck growth in unsecured lending, the RBI has leaned on banks to cool personal loans and credit cards, and the strain is showing: credit-card defaults have climbed to 7.6%. Lenders are provisioning harder and leaning back towards secured mortgages and gold loans, a mix that is safer but thinner on yield.

Private heavyweights

HDFC Bank (NSE: HDFCBANK), the country's biggest private-sector lender, sits at the centre of the story with a balance sheet of about INR52.6 trillion and full-year profit near INR704.8bn, its bad-loan ratio pared to 1.15%. Its nearest rival, ICICI Bank (NSE: ICICIBANK), turned in a standalone profit of INR501.47bn on assets of INR23.7 trillion, among the richest returns in the sector.

Axis Bank (NSE: AXISBANK) and Kotak Mahindra Bank (NSE: KOTAKBANK) round out the private pack, both leaning on retail and fee income. Beyond the banks, the financial complex that has led the equity market — NBFC Bajaj Finance (NSE: BAJFINANCE), state insurer Life Insurance Corporation of India and exchange operator BSE — has ridden the same wave of household money moving out of savings and into markets.

The state giants

Among the public banks, State Bank of India (NSE: SBIN), the system's dominant lender, lifted full-year profit 13% to INR800.32bn; its chairman told Business Standard the bank would keep return on assets above 1% despite the margin pressure. SBI has stayed active abroad, recently closing a $500mn five-year dollar bond.

Punjab National Bank (NSE: PNB) is reworking its loan book, letting lower-yielding assets run off while holding 12%-13% growth guidance, and Bank of Baroda and Canara Bank both logged double-digit advances. Between them the state banks carry the bulk of India's deposits and remain the truest gauge of the economy's health.

Cracks in the shine

Not every ledger is spotless. IndusInd Bank (NSE: INDUSINDBK) is still digging out of a derivatives-accounting lapse that cost it about INR19.8bn in net worth and triggered senior resignations; the RBI has since cleared HDFC group entities to lift their stake to 9.5%. Yes Bank (NSE: YESBANK), rebuilt after its 2020 rescue and now anchored by Japan's Sumitomo Mitsui, grew first-quarter profit 34% to INR10.7bn, with bad loans at 1.3%, as its new owner weighs a deeper tie-up.

The softest spot is microfinance. The sector has shrunk from a INR4.3 trillion peak to about INR3.14 trillion ($36bn) amid over-indebtedness and patchy recoveries, prompting a INR200bn ($2.3bn) government credit-guarantee scheme. Underpinning it all, the digital rails keep widening: the Unified Payments Interface handled 23.2bn transactions worth INR29.9 trillion in May alone, cheap plumbing that has helped banks push credit deeper into the retail base.

For now the picture is one of strength bought with years of clean-up: recoveries up, capital thick, profits at records. The test is whether India's banks can defend those margins as the easing works through, deposits stay scarce and the unsecured and microfinance books that powered the last leg of growth are worked out. The cycle has rarely looked this good — which, for bankers who remember the last one, is reason enough to watch the descent.