India’s banking sector faces a paradox. Interest rates are rising, corporate credit is expanding, and the economy continues to project strong growth. Yet banks remain caught between mounting funding costs, long-term loan commitments and the persistent risk of corporate defaults. The Reserve Bank of India’s decision to tighten monetary policy may help contain inflationary pressures, but it will not, by itself, resolve the structural weaknesses that have made large corporate lending a source of concern.

The central question is not simply whether higher interest rates will improve banks’ profitability. It is whether the banking system can continue financing capital-intensive corporate projects without compromising the interests of depositors, small businesses and ordinary borrowers.

Corporate credit has crossed ?69 lakh crore, rising from ?63.19 lakh crore in FY2024-25 to ?69.22 lakh crore in FY2025-26. Loans to large industries account for approximately ?32.3 lakh crore, with credit to the segment reportedly growing by 17.7 per cent year-on-year. Infrastructure, manufacturing, energy and green technology have driven much of this demand. These investments are essential to economic development, but their scale also raises questions about how banks assess risk, allocate capital and recover money when projects fail to deliver.

The RBI’s reported decision to raise the repo rate by 25 basis points to 5.50 per cent on October 7, 2026, marks a shift towards tighter monetary conditions. The implications extend well beyond the financial markets. Higher policy rates can increase borrowing costs across the economy, making housing, vehicle and personal loans more expensive. Businesses may postpone investment, while households could find themselves paying more to finance consumption.

For banks, however, the consequences are less straightforward. Higher lending rates can improve interest income, but the benefit depends on how quickly banks can reprice their loans compared with their deposits. If competition for household savings forces lenders to offer higher deposit rates, the additional income from lending may be offset by a rising cost of funds. A rate increase is therefore no automatic guarantee of healthier bank balance sheets.

The pressure on deposits is particularly significant. As households increasingly explore mutual funds and equity markets, banks are finding it harder to mobilise low-cost savings. This creates an uncomfortable incentive: lenders must protect their margins while competing for funds and maintaining credit growth. If that competition encourages excessive risk-taking in retail or corporate lending, the immediate gains could eventually translate into higher losses.

The more fundamental problem lies in the concentration of credit among large corporate borrowers. Reliance Industries, the Adani Group, Bharti Airtel, JSW Steel, Tata Steel and Vedanta operate across sectors that require enormous and often long-term investments. Ports, power plants, telecommunications networks, refineries and industrial facilities cannot generate returns overnight. Their financing needs are legitimate, but the risks must be measured against the duration of the projects, the borrowers’ repayment capacity and the availability of alternative sources of capital.

Banks are particularly vulnerable when short-term deposits finance projects that may take decades to generate adequate cash flows. This maturity mismatch can leave lenders exposed to liquidity pressures even when their loan portfolios appear substantial. Funds committed to long-term projects cannot always be recovered or redeployed when fresh credit demand emerges elsewhere in the economy.

The consequences are felt most acutely by smaller borrowers. When large corporate exposures absorb capital and liquidity, banks have less flexibility to extend credit to micro, small and medium enterprises. These businesses frequently depend on bank loans to finance working capital, purchase equipment, pay employees and expand production. Restricting their access to affordable credit can undermine employment and entrepreneurship, weakening the wider economy that banks are supposed to support.

The problem becomes more serious when corporate borrowers default. Over the past 12 financial years, banks have reportedly written off nearly ?10 lakh crore in loans to large corporations and the services sector. A write-off can clean up a bank’s balance sheet for accounting purposes and create room for fresh lending, but it does not necessarily mean the money has been recovered. The distinction between removing a bad loan from the books and recovering public money must remain central to any assessment of banking health.

Recovery through insolvency proceedings, including mechanisms under the National Company Law Tribunal, has historically been limited. If recoveries remain substantially below the amounts owed, the gap raises difficult questions about the effectiveness of resolution procedures, the quality of lending decisions and the accountability of those responsible for approving large exposures.

The burden of failure cannot be allowed to become an invisible cost borne by ordinary depositors. Banks mobilise savings from millions of households, many of which depend on interest income for financial security. When large loans turn bad, provisions and losses can erode profits, restrict future lending and weaken confidence in the banking system. Although depositors do not automatically bear every corporate loss directly, persistent financial stress can affect the returns banks offer and the services they are able to provide.

Nor should the argument be reduced to a choice between corporate investment and financial prudence. India needs infrastructure, industrial expansion and energy-transition projects. Large companies can deliver investments that smaller enterprises cannot undertake independently. But the economic importance of a borrower must not become a substitute for rigorous credit assessment. No company should receive favourable treatment merely because its projects are large, politically prominent or associated with national development priorities.

A sound banking system must distinguish between productive risk and poorly assessed exposure. Banks need transparent lending criteria, stronger monitoring of large accounts, credible stress tests and independent scrutiny of related-party exposures. Their boards must also possess the expertise to assess modern financial risks, including cybersecurity threats and complex corporate structures. Supervisory oversight should focus not only on whether banks meet capital requirements but also on whether they are building dangerous concentrations of risk.

The RBI, for its part, faces a difficult balancing act. Inflationary pressures, currency volatility and global uncertainty may justify a cautious monetary stance. Governor Sanjay Malhotra has reiterated the central bank’s commitment to price and financial stability. Yet monetary tightening must be calibrated carefully. Raising rates too aggressively can suppress credit demand and increase repayment stress, while keeping rates too low for too long can encourage excessive borrowing and weaken the fight against inflation.

The rupee’s depreciation, volatile energy prices and uncertain global conditions further complicate the outlook. Higher interest rates may support monetary stability, but they cannot independently resolve the structural causes of currency pressure or repair weaknesses in corporate balance sheets. Nor can the RBI rely on interest-rate policy to solve problems arising from poor credit appraisal, weak recovery mechanisms or inadequate governance.

The reported increase in corporate borrowing through traditional banks, as some companies turn away from higher-yielding corporate bonds, makes the issue more urgent. Bank credit remains indispensable, but it should not become the default financing channel for every large corporate investment. A deeper corporate bond market, more diversified financing options and stronger disclosure standards could distribute risk more effectively across the financial system.

Ultimately, the test of banking health is not the volume of credit extended or the headline level of corporate investment. It is whether loans generate sustainable economic value, repayments arrive on time and losses are recognised and resolved without compromising the system’s capacity to serve the broader economy.

Higher interest rates may offer some relief by moderating borrowing demand and improving lending returns where repricing outpaces deposit costs. But that relief will be limited if banks continue to lock up vast sums in long-duration exposures without adequate safeguards.

India’s banking system needs more than an interest-rate adjustment. It needs better credit discipline, faster and more effective recoveries, transparent accountability for failed loans and a fairer balance between large corporate borrowers and smaller enterprises. The objective should not be to stop banks from financing growth, but to ensure that the risks of financing that growth are properly assessed and fairly distributed.

A banking system cannot be considered healthy simply because its credit portfolio is expanding. Its real strength lies in the quality of its lending, the resilience of its balance sheets and its ability to protect the trust placed in it by depositors. Until those fundamentals improve, a repo-rate hike will remain a limited remedy for a much deeper corporate debt problem.