Core Income Slowdown in Indian Banks: A Tale of Twin Structural Shocks

India's banking sector is currently navigating multi-layered challenge to its bottomline. On one front, banks are losing ground to fintechs and neobanks, which are rapidly displacing traditional lending channels and income from core sources with greater competition. On the other, banks are contending with multiple structural macroeconomic constraints: slowing wage growth, consumption weariness, and rising economic inequality. This dual pressure—technological disruption coupled with demand-side sluggishness—has driven a sharper and more immediate contraction in Indian banks' core income than in other major economies.

A main structural change is the growing influence of digital financial platforms. Indian fintechs that dominate a significant share of unsecured credit and micro-loans, particularly among digitally native consumers and underserved MSMEs. Neobanks and digital lending platforms offer faster onboarding, lower transaction costs, and personalized products—rendering traditional banking models comparatively rigid and expensive. Indian banks, while responding with digitization initiatives of their own, have increasingly pivoted toward fee-based revenue streams such as treasury operations, transaction services, and supply chain finance. This mirrors trends observed in other markets, where declining net interest margins (NIMs) over the past two decades pushed banks toward non-interest income and transactional banking services. Yet the shift is appearing sharper and therefore worrying from a strategic and policy perspective.

This contraction is starkly visible in financial disclosures from Q4 FY25. For instance, Bank of Baroda reported a 6.6 percent year-on-year decline in net interest income, with its NIM sliding from 3.27 percent to 2.86 percent. Public sector banks more broadly are showing similar pressures. According to Economic Times estimates, banking sector earnings growth is expected to fall to 6.5 percent in FY26—down sharply from 39.3 percent in FY23. This sharp drop underscores that core income is not merely growing more slowly, but aggressively deteriorating in nominal and real terms.

The underlying structural factor is even more concerning: a macroeconomic environment that severely limits credit demand. Despite India’s projected 8 percent GDP growth, household consumption remains tepid due to stagnating wages, declining real incomes, and an extraordinary rise in inequality. A recent report by the World Inequality Lab, covered by TIME magazine, reveals that India's top 1 percent now controls 22.6 percent of national income and a staggering 40.1 percent of national wealth—worse than during British colonial rule. This wealth concentration has coincided with rising numbers of billionaires; India added 94 new billionaires in 2023 alone, bringing the total to 271. This surge in wealth at the top has not translated into mass prosperity or robust credit demand. In fact, constrained consumption is now one of the primary factors behind the deceleration in loan growth, especially in discretionary and unsecured retail segments.

The inequality study go further, describing India as entering a “Billionaire Raj” that has displaced the egalitarian promise of the post-colonial era. They warn that without serious investment in health, education, and wage support, the country risks sliding into plutocracy. From a banking perspective, this erosion of middle-class economic power means fewer mortgage applications, declining SME borrowing, and higher default risks in retail lending. The result is a structurally weaker pipeline of profitable, secure lending opportunities—leading banks to double down on non-interest income streams, often more volatile and less predictable.

Globally, banks have adapted to similar pressures by becoming “financial supermarkets”—offering wealth management, insurance, and digital advisory services. Yet these adaptations occurred over decades, and were supported by robust social safety nets and inclusive fiscal policy. In India, the sudden convergence of financial disintermediation and economic polarization presents unique regulatory and strategic challenges. RBI’s recent policy moves—including a front-loaded 50 basis point rate cut and CRR reduction—acknowledge the urgency, but may be insufficient to revive core lending income unless accompanied by broader fiscal and structural reforms.

Strategic Imperatives for Banking Sector

In developing a sound strategy for banks—particularly in emerging markets—it is essential to understand the nuanced relationship between diversification and financial performance. While conventional wisdom has long supported the idea that diversifying income streams can reduce risk and enhance returns, empirical evidence from emerging markets suggests that the reality is more complex. The shift toward non-interest income, especially in activities like trading and investment banking, has not consistently translated into improved risk-adjusted performance. Instead, banks often face increased earnings volatility and a heightened risk of financial distress. This suggests that indiscriminate diversification may do more harm than good, especially when banks expand into unfamiliar or volatile sectors without adequate preparation.

A more effective approach is to pursue selective and strategic diversification, focusing on stable, low-risk non-interest activities such as fee-based services, including asset management, payments, and advisory services. These income streams tend to be less volatile and more sustainable over time. However, even such diversification must be undertaken with careful consideration of a bank’s specific risk profile. The research highlights a non-linear relationship between risk and diversification benefits, indicating that banks with moderate risk exposure are best positioned to benefit. Banks already operating at high risk levels may find diversification exacerbates their exposure, while very conservative banks may not gain much advantage either.

Furthermore, any diversification strategy should be aligned with the bank’s internal capabilities, size, and capital strength. Larger banks with more developed infrastructure and skilled personnel are generally better equipped to manage the complexities of non-traditional banking activities. Smaller institutions, on the other hand, may find it more prudent to focus on core competencies and carve out specialized market niches where they can build deep expertise and client relationships. In all cases, strong internal risk management systems and regulatory oversight are critical. Without these supports, banks risk venturing into areas that may undermine financial stability rather than enhance it.

Ultimately, banking strategies must be tailored, data-informed, and risk-sensitive. Diversification is not inherently beneficial or harmful; its value depends on how well it aligns with the institution’s strengths, risk tolerance, and the regulatory and economic context in which it operates. A deliberate, well-executed strategy that emphasizes quality over breadth will position banks for sustainable growth in a rapidly evolving financial landscape.

The demand side is also important and requires appropriate policy measures . It must be recognized that  India’s core income slowdown in banking is not just a sectoral anomaly; it is a symptom of broader structural fault lines. The combination of digital disruption and extreme inequality is squeezing banks from both supply and demand sides.  This demands policy shifts towards economic inclusion, job creation and social safety nets. Ignoring social welfare and pursuing growth alone cannit be a sustainable government policy.

References

.Income and Wealth Inequality in India, 1922–2023. World Inequality Lab Working Paper, March 2024. https://wid.world/www-site/uploads/2024/03/WorldInequalityLab_WP2024_09_Income-and-Wealth-Inequality-in-India-1922-2023_Final.pdf

“India’s Income Inequality Is Now Worse Than Under British Rule, New Report Says.” TIME, https://time.com/6961171/india-british-rule-income-inequality/

 “Indian Banks’ Earnings Growth Forecast Halved Amid Economic Caution.” The Economic Times, June 20, 2025. https://economictimes.indiatimes.com/markets/stocks/earnings/indian-banks-earnings-growth-forecast-halved-amid-economic-caution-and-high-deposit-costs/articleshow/121963715.cms

Ben Gamra, Saoussen, and Dominique Plihon. “Revenue Diversification in Emerging Market Banks.” arXiv Preprint, July 1, 2011. https://arxiv.org/pdf/1107.0170