Credit costs expected to rise in FY26 amid unsecured loan, microfinance strain: Report

The stress in short-term unsecured loans and microfinance segments could push credit costs of the banks upward in the Financial Year (FY) 2026, according to a report by CareEdge Ratings.

However, the report added that since banks already have strong provision buffers or high provision coverage ratios, they are well-positioned to absorb these potential losses.

The Public Sector Banks (PSBs), over the last one and a half to 2 years, have built up strong financial cushions (called provisions) to cover any future loan losses.

The report added that since fewer loans have been turning bad recently, the PSBs don't need to set aside much new money for bad loans. This led to lower credit costs--the money banks spend to deal with unpaid loans.

PSBs now have a high Provision Coverage Ratio (PCR) of about 75 per cent to 80 per cent, meaning they've already saved up enough to handle most of their bad loans.

This reduces the need for further provisions and could even lead to extra profits if some bad loans are recovered.

On the other hand, Private banks have fewer bad loans but also a slightly lower PCR of about 74 per cent.

Because most loans are being repaid on time, banks have seen fewer losses and better profits.

For example, credit costs dropped from 0.86 per cent in FY22 to 0.47 per cent in FY24, and further to 0.41 per cent in FY25.

However, the report added that this downward trend in credit costs is likely to stop soon.

Since banks already have a good safety cushion, credit costs are expected to go back to normal levels. Also, stress is starting to appear in unsecured loans (like personal loans without collateral) and in microfinance loans (small loans to low-income borrowers).

Because of this, credit costs may slightly increase in FY26, though banks still have enough buffer to manage the impact, the report added.

According to Sanjay Agarwal, Senior Director, CareEdge Ratings, "Net additions to NPAs have remained broadly low, enabling the sector to witness a steady reduction in headline asset quality numbers. However, with the personal loans segment facing stress, the overall fresh slippages are expected to rise, and recoveries/upgrades are likely to taper gradually."

"The SCB GNPA ratio is projected to marginally deteriorate, albeit remain in the same broad range from 2.3% by FY25 end to 2.3%-2.4% by FY26 end due to an increase in slippage in select pockets and stress in unsecured personal loans, which would be offset by corporate deleveraging and a declining trend in the stock of GNPAs. Key downside risks include deteriorating asset quality from elevated interest rates, regulatory changes, and global headwinds such as tariff increases," he added.