BT Explainer: West Asia war may not impact banks. But margin pressures are emerging. Here’s why

The ongoing conflict between US and Iran has disrupted supply chains and impacted sectors, majorly dependent on energy imports. However, the impact on the banking sector is seen to be limited for now. 

“Qualitatively, at least, when we speak to our clients, they come back and tell us the impact is at this stage minimal. Banks are less exposed to the sectors that are more impacted, according to Peeyush Dalmia, senior partner at McKinsey and Co. 

He pointed that banks didn’t have a lot of exposure to sectors like hospitality and restaurants, which had been hit by the conflict. 

US and Israel have been at war with Iran since March and therefore, at least in the January-March quarter earnings, there was no visible impact. Could there some impact visible in the April-June quarter? According to Dalmia, he hasn’t heard from any clients of rising slippages so far. 

While, there may not be any immediate impact from the war, there are early signs of banks seeing margins squeeze as operating costs rise and provisions are likely to rise to due to some expected asset quality issues in the unsecured loan segment. 

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“We have had 3-4 years of great cycle where asset quality has been fantastic. And when you have a period like that, you tend to have slightly more exuberance in terms of how people underwrite etc, and that catches up. So, that’s where you will start seeing some uptick on the asset quality front, ” pointed Dalmia. 

According to him, large banks are not facing any capital issues. But, some smaller banks may have to raise capital, which may not be easy amid the current market volatility, and may see growth slow if capital issues aren’t addressed. 

More acquisitions seen 

Over the past 12-18 months, there have been several large deals in India’s banking and financial services space. 

Japan’s Sumitomo Mitsui Financial Group acquired a stake in Yes Bank lasf year. Another Japanese banking major MUFG  picked up a stake in Shriram Finance and more recently Mizuho Financial snapped up Avendus Capital. In between, Emirates NBD acquired a stake in RBL Bank. 

Dalmia sees scope for more such deals as large strategic investors eye a slice of the sector’s long-term growth potential. 

“We will see more acquisitions in the market. There are enough and more opportunities for strategic investors to come in and transact, particularly if you are taking a 10-15 year view, ” he pointed. 

While there is growing foreign investor interest in the sector, a few foreign banks are also scaling back. Deutsche Bank, for instance, is looking to sell its retail business in India. Citigroup sold its India consumer business over three years back as a part of a broader exit from several markets. 

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Dalmia stresses one can’t be “half-hearted” about India and must go “all in” if one has to scale in the country over time. 

“I may have a small shop, I will do some credit cards, sell some personal loans… That kind of model doesn’t work. If you want to be here, you have to be all in. This is what we tell all our clients,” he said.

AI Spending on the rise

McKinsey in a report released on Tuesday noted that spending in technology and Artificial Intelligence was on the rise in the banking and financial services sector, but adoption remained uneven, and there were legacy infrastructure challenges.

Technology has become a core strategic enabler in banking, with progressive core modernization, resilience uplift, cost-efficient operations, and AI-driven data capabilities now critical to scaling growth, managing risk, and improving customer experience, according to McKinsey. Agentic AI was beginning to enhance productivity, but large-scale deployment was still at a nascent stage, it said.

Being a regulated industry, it is unlikely that we will be see AI on a customer-facing application on a large scale any time soon, but AI could make lot of internal processes efficient, pointed Dalmia.