Hi everyone,

Welcome to the 157th edition of The Pattern, weekly where we dive into the latest from the world of economy, finance and technology. Let’s get started.

Where banks go missing

If something happens for the first time in 20 years, it deserves attention. And this isn’t about RCB lifting the trophy. It’s a matter of grave concern. IndusInd Bank reported a net loss of Rs 2,328 crore in the January – March period. This is the first time it has reported quarterly net loss since 2006!

It happens. One might be tempted to think of it as a one-off, but the devil, as always, is in the details. First, the bank is struggling with accounting issues that now look more like a case of fraud . A derivative portfolio misreporting hit the bank by Rs 1,979 crore – according to pwc. This is not all; auditors found separate instances of interest amounts wrongly recorded in its microfinance portfolio. Damages? Rs 674 crore across three quarters. Oh! There is also “unsubstantiated balance” of Rs 595 crore in the “other income” section of its balance sheet. The subpar financial performance of the bank thus can be explained. But that would be missing the woods for the trees.

Turns out, the bank’s cost-to-income ratio dipped to 52% from 47% - a concerning dip which suggests that the bank is now spending an additional 4 cents to earn the same rupee. This directly hurts their profit margins. Additionally, the bank’s interest income fell 13 percent in the quarter compared to the previous quarter. Enough with the bad news. The bank is working with the Reserve Bank of India – the regulator and authorities to clean up the mess. Indeed, the RBI Governor himself suggested today that the bank is “doing well”.

"The IndusInd Bank issue should settle very soon. We will keep monitoring it. The bank has taken enough steps to improve the accounting issues and, on the whole, it is doing well,” RBI Governor Sanjay Malhotra said , adding that there is no systemic impact arising from it. The bank’s stock price finally jumped after weeks of struggling against the spooky news cycles.

The deadly trinity The above is not a story of one bank having a bad quarter. It’s a story of the entire banking sector fighting a multi-front war against common and unique enemies.

Indeed, many other banks are fighting margin compression – a situation when their profit from interest income reduces due to either rate cuts or expensive deposits. Bandhan Bank, Yes Bank, IDFC First Bank and South Indian Bank are also in the list.

The problem of margin compression started when the RBI started to cut interest rates. Between February and May this year – repo rate dipped by 50 basis points. On the first Friday of June, the regulator decided to bring out its big axe and slashed the repo rate further by another 50 basis points. A third rate cut in a row and a total of 100 bps reduction since February.

This is even larger than the emergency 75 bps rate cut the regulator implemented in March 2020 when the Indian economy was struggling with the COVID pandemic.

Rate of decline So, what happens next?

The impact of rate cuts will be two-fold for banks – one, they will earn less interest income from new advances and thus, margin pressures will worsen. Secondly, the lower interest rates will also prompt new credit offtake and there are chances that the increase in disbursals would take care of lower margins. However, even before the latest slashing – research agencies were predicting a worsening financial situation for the banks.

“As of 16th May’25, systemic credit growth declined to ~9.8% amid higher CD ratio and stress in the system. Our checks suggest that banks are currently following a conservative path with a keen focus on asset quality vs disbursement velocity. We expect banks’ NIMs to experience a downward bias in the near term, with growth likely to be slower in FY26 amid a slowdown in retail and corporate lending,” wrote Motilal Oswal two days before the latest rate cuts.

The situation on the financial performance front is likely to get a lot worse before it gets better.

Digital chaos But the rate environment is just one scary corner of the Bermuda Triangle. The second threat comes from the digitisation. In the race to digitise, banks are losing ground to their nimbler FinTech counterparts and digital-first natives, a report by BCG says.

“Financial services revenues are growing – but banks are not capturing their fair share,” BCG said . It added that digital-first contenders are stealing the share of pie away from traditional institutions and it looks like a tiresome tangle in the making. “Maturing digital assets appear to be on pace to cause significant disruption, with most banks currently on the outside looking in,” it added.

This is in line with our thesis at FinBox that the bank of the future will not resemble the banks as we know them today. Indeed, “digital attackers” - banks, non-banks and fintechs that are rapidly adopting technology-driven digitisation are likely to see outsized returns, BCG predicts.

“Non-traditional bank competitors are generating new revenue pools. The best attackers are positioned for rapid growth, thanks to modern technology stacks and front-to-back digitised operating models.”

While the report is a study of the financial institutions across the world, there is evidence to suggest that Indian lenders aren’t faring much better.

First, most banks are seeing a profitability dip because of increased expenditure on digitisation – a lot of this is for the medium or long term and these benefits might take some time to materialize.

Second, the laggards – both banks and NBFCs – are seeing revenue erosion as their customer base moves towards digital contenders which promise a cleaner experience and faster processing. Be it payments or loan approvals – customers demand the speed of quick commerce and the reliability of institutions.

The ecosystem will still take a while to mature, but there’s no alternative to investing in digitisation and doing it fast.

The distress of stressed loans

While the overall asset quality across the banking ecosystem continues to be healthy, there are certain warning signs. For instance, the retail unsecured loan books experienced severe stress over the past year which prompted even the RBI to increase risk weights and put certain brakes on the reckless lending being observed across the sector.

As a result, lenders are now focussing more on secured loans – be it gold, home or vehicle loans. These loans tend to be more stable by nature because of an asset backing but even gold loans have had their share of discrepancies while two-wheeler loans could be the next to come under stress , according to rating agency Moody’s.

"Delinquencies have increased for two-wheeler loans, which are more vulnerable than those for passenger or commercial four-wheeled vehicles, as younger borrowers with lower income and nascent credit habits account for a large proportion for the former type," the ratings agency said.

Indeed, the RBI has also suggested that there’s a lot more stress on the microfinance side of the portfolios which are also a part of many banks’ and NBFCs’ balance sheet and hence, increased provisioning could further impact profitability.

The broken compass The above issues aren’t disparate problems. They’re acting in tandem – at the same time – and hence, making it incredibly difficult for banks to navigate effectively.

For instance, the rate environment will pressurize banks' margins – forcing them to lend more, which could lead to worsening asset quality. This can be a dangerous cycle that, if left unchecked, could mark the return of rough weather that the banking industry worked so hard to sail past.

The case is similar for digital competition too as traditional lenders might see resource depletion due to investments in digital and decreased margins as competition heats up. That is, until they get their digital strategy right and start to reap outsized returns for the effort.

The current chaos could take quarters and years to resolve, but the current instability calls for urgent action. Not just in terms of strategic direction but also in terms of deploying additional resources to cut costs, invest in digital, keep underwriting in check – all this while fighting competitors and managing compliance.

There are banks across public and private sectors who are doing well and can serve as spiritual guides for this journey. However, playbooks don’t work when you’re in the eye of an unprecedented storm. What works is head-down execution and rapid iteration till something works. The only way out, unfortunately, is through.

That’s all for me this week. I will see you next week. As always, leaving some reading recommendations below.

Reading list

1. Private banks more quicker in passing on rate revisions

2. Share of high cost deposits double in two years

3. No collateral damage: Finance ministry wants relief for small gold loans

4. Metros fill bank vaults, but credit now fuels India’s heartland

5. Introducing FinBox Prism – a cutting-edge partnership lending stack

Thank you for reading. If you liked this edition, forward it to your friends, peers, and colleagues. You can also connect with me on X here and follow FinBox on LinkedIn to always get all updates.

Cheers,

Mayank