On paper, 2022 was the best year for banks in more than a decade, with many financial institutions posting outstanding performance and bank profitability reaching a 14-year high, with an approximate 12 percent return on equity. In 2023, however, global banking is facing testing times. In the past six months, the sector has experienced significant turmoil, precipitated by the pace and quantum of interest rate movements. Many small and mid-size banks in North America, as well as long-standing institutions across America and Europe, have faced material stress, with some having gone into liquidation. Given the muted economic growth outlook and continuing geopolitical situation, the growth of global banking and profitability levels will likely continue to be challenged.
Indian banks, in contrast, have so far held ground. Having withstood the global macroeconomic and interest rate volatility, they are poised to deliver strong financial returns. However, it is becoming increasingly evident that those returns alone cannot guarantee outperformance in shareholder returns. Indian bankers have been tested across operational, reputational, competition, and technology risks and outcomes have been mixed.
McKinsey research shows that it is no longer sufficient for corporations to measure performance through the lens of financials and profitability alone; taking a broader view on impact is highly relevant for sustained success, with 50 percent faster growth observed in sustainability-focused institutions and increasing investor requirements and workforce expectations around holistic impact. They may now also need to assess performance more holistically to ensure continuous and enduring value creation through operations, customers, employees, and environment and social aspects—any material slippage or weakness in these can devolve into significant profit-and-loss (P&L) and value-creation risks.
In this article, we explore how banks in India can strengthen their defenses, as well as engage with a broader gamut of stakeholders, and suggest essential actions across five broad themes that banks could take to build resilience in the uncertain times ahead.
Indian banks: Financially strong, with opportunities to drive holistic impact
Over the past five years, and even more so through the recent global banking turmoil, Indian banks have remained strong and outperformed their global peers on growth and profitability. A large portion of the banking system remains profitable, primarily driven by strong growth in the retail and micro, small, and medium enterprises (MSME) lending segments. Consolidation across public sector banks (PSBs) has also yielded larger, healthier institutions.
However, while financial returns have been strong, Indian banks are faced with many challenges across their operating models that could threaten their long-term, value-creation potential. In light of that, we believe it is time that a more comprehensive view of the maturing Indian banking sector is taken, and have devised a “holistic impact” scorecard for Indian banking that suggests five dimensions of improvement for banks to strengthen their positions and mitigate business model risks (Exhibit 1).
Financial performance: Indian banks have led with a healthy credit growth of 10 to 11 percent over the past decade, with higher ROAs than global peers that have resulted in a valuation premium. Despite having conservative investment portfolios, granular deposit bases, and diversified asset bases compared to other countries’ banks, they have shown greater resilience to market risks and portfolio concentration, with increasing deployment toward retail credit and deeper geographies over the past few years.
Industry health: This has been driven by the consolidation of PSBs, whose numbers have reduced from 27 to 12 over the past five to six years. Consolidation, along with recapitalization, has resulted in stronger and bigger banks, leading to greater competition. In addition, specialized banking players and dynamic fintechs are innovating in areas like payments and microlending, prompting larger incumbent banks to innovate in customer acquisition and servicing.
Customer experience: Customer experience and customer-centricity has improved but could be strengthened by ongoing investments. While progress has been made with digital journeys and banking super apps, Indian banks have yet to create frictionless processes across onboarding, underwriting, and servicing touch points. India’s emerging public digital infrastructure, however, is likely to have a multiplier effect on customer services and efficiency as open infrastructure solutions like Account Aggregators (AA) and Open Network Digital Commerce (ONDC) scale up.
Societal and environmental responsibilities: Banks in India have played a crucial role in driving financial inclusion, particularly with business-correspondent (BC) coverage and microfinance—though there is still some distance to cover on incremental penetration. Environmentally, while most banks have started committing to net zero on climate change, they have yet to lay down comprehensive strategies and KPIs to track their performance. Both regulators and bankers may need to work toward creating viable institutions, supportive policies, and frameworks for climate finance. Financing the transition economy will likely require annual investments of around INR 12 to 13 lakh crore ($145 billion to $160 billion) over the next decade and around INR 35 lakh crore ($430 billion) on average for the next 25 years—India currently is servicing only a fourth of the demand.
Operational resilience: Indian banks urgently need to address this, focusing on tech infrastructure, cybersecurity, data management, and talent-management practices to deliver a very different scale and operating environment. While banks have undertaken significant investments across digital banking, data management practices and privacy, along with modernizing core tech platforms, still need attention.
Attracting and retaining talent is another pressing issue—the Indian banking sector sees annualized attrition increasing to 30 to 40 percent at frontline levels and high attrition in specialized roles such as analytics and product management. The talent space is extremely competitive—globally and regionally—however, there are ways of addressing the challenge: Banks could take another look at their organizational culture, decision-making processes, and employee value propositions.
Multiple forces challenge banking economics in India
While banking ROAs have been healthy, multiple trends could exert downward pressure on banking profitability over the next three to five years and, left unmitigated, banks are likely to see considerable compression on margins. Key drivers include:
Net interest margins (NIMs): With increasing penetration, new-to-credit (NTC) pools will likely get credit tested (the NTC mix across products is beginning to plateau), and will limit yield expansion opportunities. Growth of deposits will likely remain constrained as India undergoes a structural shift in household financial-product-allocation levels, resulting in a prolonged upward bias on interest rates.
Fee income: The Indian banking sector has experienced a secular decline in fee income, and the disintermediation of financial services, rising customer awareness, and regulatory push toward transparency of charges and schedules may lead to a further downward bias. Moreover, the growing prevalence of partnerships has led to a division of fee-income pools among banks, non-banking financial companies (NBFCs), and fintechs.
Operating expenses: Intensifying competition and a shift in talent profile are expected to lead to higher-per-unit personnel costs. This could be mitigated by a technology-led transformation in sourcing, underwriting, operations, and support functions (which could reflect as increased productivity over a few years). As a result, a large variance in operating expenses across banks may emerge, depending on their strategies around talent, digital transformation, and technology capital expenditure (capex).
The way forward: Building resilient leadership
While the going has been good on financial metrics for Indian banks, they may need to consider material actions to make sure they continue outperforming. At the same time, they could also constantly improve various non-financial metrics to ensure consistent value creation. We propose nine priority actions across five broad parameters that Indian banks could adopt to achieve this (Exhibit 2).
McKinsey analysis shows that banks could further improve financial performance by finding new engines of growth and building capabilities to drive customer experience and improve efficiency.
1. Win the next set of new money pools
We see three areas that could drive a significant proportion of net new money flows; banks may wish to think more strategically about them:
- Build capabilities for digital commerce and open digital infrastructure: AA is the first step toward the future of consumer and merchant finance. Combined with protocols like ONDC, end-to-end digital sourcing in conventionally challenging segments (like NTC pools and microenterprises) may become a near-term possibility. Banks will need to think like digital-first players to capture this opportunity. To develop an integration layer across platforms in a modular, scalable fashion, they could consider establishing cross-functional product, risk, and operations teams, and partnership management capabilities.
- Participate in financing a resurgent capex cycle: Driven by higher capex spending in both public and private sectors, corporate lending is expected to grow at 8 to 10 percent over the next few years. Incremental investments are likely to be concentrated in select sectors, supported by enabling policies and infrastructure (for example, agriculture and food processing, healthcare, logistics, and auto equipment). And, with new opportunities in sectors like clean energy and defense, banks could think strategically around exposure mix at a granular level. Banks could create strong knowledge and product propositions—build or reinforce product propositions and build underwriting capabilities. Simultaneously, corporate banking processes would need to be reviewed, leveraging analytical techniques and digital workflow platforms that could enhance insights across corporate clients and improve productivity.
- Mid-affluent and mass-affluent segments are still underserved from a wealth management perspective: These segments will be the largest contributors to wealth creation in India over the next decade. Given the size of this segment (around 14 to 15 percent of the population), executing at scale will require banks to invest in digital capabilities and self-serve wealth platforms that simplify and organize portfolio allocations for seamless investing. Banks need not build all these capabilities organically—they could collaborate with wealth-tech companies.
2. Build horizontal capabilities to optimize efficiency and experience
AI (generative or otherwise) is at the cusp of creating a new revolution in banking; multiple use cases are being experimented upon and scaled up for production. Further, a zero-ops and generative-AI (gen-AI) driven reimagining of operations can help reduce human intervention in several areas, especially with repeatable, rules-based processes such as “know your customer” (KYC), anti-money laundering (AML), routine customer service requests, and even some credit decisioning activities.
- Full-stack AI capabilities with a focus on adoption: While many banks have recognized the inherent value of incorporating AI and machine learning (ML) into their decisions, several challenges have prevented them from fully leveraging AI—a fragmented data landscape, limited data-governance practices, underinvested analytics talent, limited-use analytics platforms, and a lack of automated pipelines into downstream consumption systems. Extracting value from generative AI (gen AI) requires much more than the underlying foundational models; rather, banks need to leverage a full business system approach supported by a culture of experimentation. To successfully scale gen AI, banks could consider building cross-functional ownership; providing rapid feedback cycles between business, product, and analytics; and creating explainable models (where generative AI could play a significant role). The co-ownership of analytics strategy and investments between analytics, technology, and business teams is a vital component of this action.
- Zero-ops capabilities to lower operational complexity: Back-end operations consist of multiple repeatable, rules-based tasks that are complex and data intensive. While efforts have been made to plug in robotic process automation (RPA), for example, the approach has been largely piecemeal, leading to only partial realization of gains. Near-term optimization is important, however, a simultaneous effort could be made toward creating a zero-ops road map. This would require a bank to reconsider its end-to-end operations and look at interventions beyond the operations function (such as front-end demand management and hygiene practices). We estimate that a zero-ops transformation could enable a 30 to 50 percent improvement in efficiency and internal and external net promoter score (NPS) across the organization.
Scaling up co-lending and fintech partnerships can help banks extend beyond traditional channels, deepen engagement, and reduce operating costs.
3. Leverage co-lending and digital partnerships to drive scale
The Indian co-lending model is a unique framework devised to enable lending to the smallest MSMEs and to segments where entities have limited expertise. However, while there has been traction in the last few quarters (approximately INR 25,000 crore or $3 billion), a lack of common product norms, policy templates, and API protocols has restricted the growth of point-to-point integrations. Here, banks and intermediaries could come together to create an industry-wide unlock to drive accelerated outcomes on co-lending. Fintechs present a large partnership opportunity with their capabilities around digital lending, understanding of surrogate data points, and tech-forward operating models. In addition, integrating with large-scale B2B and B2C consumer platforms also presents a considerable opportunity for banks to improve digital sourcing penetration and operating costs.
The entry of fintechs and big-tech into retail banking and allied sectors has led to banks increasingly focusing on improving customer experience to maintain their leadership positions. We see two opportunities for banks: leveraging personalization, and digital and analytics-led collections to drive customer experience.
4. Drive improved customer experience through personalization
While personalization is customary across most banks, its extent and maturity can significantly differ. Most Indian banks use segment- or rule-based engagement strategies that target similar cohorts of customers with similar messages. Given the static approach to defining next-best action strategies, past interaction feedback as well as most recent signals are often not accounted for. The maturity of the digital marketing and analytics landscape has now made it possible to tailor engagement strategy and content at a one-to-one level. This can lead to a three to five times improvement in conversion rates and retention rates. Banks could create a clear road map (regarding digital capabilities, analytics infrastructure, and organization structure) to take them to this dynamic hyper-personalization level.
5. Use digital and analytics-led collections to improve customer experience
Customers are becoming digitally savvy and expect a uniform experience across their loan journey. To retain customers, banks need to focus on their loan-servicing activities, shifting from a collections-oriented view to a customer-service mindset. This entails a cultural shift, as well as building the necessary technology infrastructure and analytics model to tailor strategies to customer-specific behaviors. Our analysis shows that this shift could unlock significant value—reducing collections costs by up to 15 percent and increasing engagement by as much as five.
Societal and environmental impact
Indian banks have taken significant strides in promoting financial inclusion, with around 78 percent penetration of bank accounts. Nonetheless, banks have the potential to drive further financial inclusion in access to formal credit by focusing on the NTC, rural, and agriculture segments. On the environmental side, Indian financial institutions have a long way to go on providing Indian banks the opportunity to finance green transition and decarbonization.
6. Drive financial inclusion with a focus on rural and agricultural markets
Rural credit demand has grown by more than 10 percent over the past few years, signifying the large, latent potential in these segments. While this has been traditionally driven by public sector entities and inclusion players (such as microfinance institutions [MFIs] and rural NBFCs), there is a clear opportunity here to drive profitable, sizeable growth. While the rural segment may appear fragmented, the selection of the right markets, based on a combination of crop types, specialty produce, allied activities, and investment credit could enable banks to go deep into profitable clusters. This would allow them to create a curated go-to-market by leveraging value chains, BCs, self-help groups (SHGs) and other intermediaries. At the same time, given the emphasis on land-record digitization, geospatial advances in land zoning, and the penetration of credit bureaus due to MFIs, banks have the opportunity to disrupt by straight-through lending to certain segments. This would require building the correct enablers and collaboration across multiple bank teams (for example, agri-lending stack and micro-market-based, go-to-market strategies).
7. Financing India’s green transition and decarbonization
A significant gap of around 70 to 75 percent exists between India’s need for climate finance and its current supply. While the Reserve Bank of India’s draft regulations on climate finance are being discussed, banks have the chance to become first movers in key areas of the climate finance agenda. Similar to banks in other countries, Indian banks could begin to create viable partnerships and go-to-market models for frontier industries (such as electric-vehicle batteries and charging points), build up their green finance product suites, and create internal glide paths on financed emissions. Banks could also consider their sustainability organization in anticipation of the larger build-out of climate finance capabilities.
To succeed in a rapidly changing landscape and build resilience, banks could invest more on scalable, secure technology, as well as fundamentally shift the way they find, attract, and develop talent.
8. Invest in technology resilience to manage operational risks
Technology resilience is a multidimensional discipline that requires purposeful design and active ongoing management. Indian banks could focus on three key areas: first, modernizing core systems and API management, while keeping flexibility and scalability in mind and clear governance and ownership that is assigned across infrastructure, application, and event management; second, building a robust cloud strategy able to deliver load management effectively, enabling data access in a secure manner to decision makers; third, heightened cybersecurity, information security, and data privacy norms. Data governance is also important—clear data ownership and an ongoing maintenance structure are required to allow maximum value extraction and risk mitigation arising from digital and analytics.
9. Revamping employee value propositions
The banking talent mix has evolved over the past few years and more people with product management, technology, data analytics, and design skills are needed. At the same time, attrition rates across these and frontline functions are at an all-time high, with some exceeding 40 percent on an annualized basis. Compensation is only one of the ways to address the talent challenge—banks could consider empowering employees and encouraging collaboration, mentoring new colleagues in a structured approach, and look at improving the work environment, tooling, and recognition strategies. They could also revamp their employee value proposition both internally and externally, identify levels of satisfaction and attrition across critical roles, and ensure that talent strategies are discussed at CXO and board levels.
Indian banks have remained strong through the recent volatility in the banking sector. However, they can no longer rely solely on financial benchmarks and need to look through a holistic lens to address other financial and non-financial metrics. Resilient leaders could act on the vital steps detailed above to ensure consistent value creation, mitigate risk, and remain customer-centric in an increasingly competitive industry.