RBI's Financial Stability Report flags rising NPAs, global economic risks

Indian banking sector stable, but global debt and economic volatility loom large

As the eventful year 2024 drew to a close, the bi-annual “Financial Stability Report” (FSR) of the Reserve Bank of India (RBI), published this week, offered an overview of the current state of the Indian financial system and provided a broad understanding of what to expect in the year ahead. In terms of financials, gross non-performing assets (GNPA) in the banking system — supported by lower slippages, write-offs, and credit demand — declined to a 12-year low of 2.6 per cent in September 2024, while net non-performing assets were at 0.6 per cent of the book. Although balance sheets in the Indian banking system have steadily improved over the past decade and are now in a position to support private investment and growth, the FSR highlighted GNPA could increase marginally to 3 per cent under the baseline scenario by March 2026. This will need to be monitored.

 

There has been considerable focus on retail lending over the past year. In fact, the RBI had increased risk weightings on certain kinds of consumer lending from banks and non-banking financial companies (NBFCs) in late 2023. As a result, both banks’ retail lending and lending to NBFCs moderated. The retail side of the book for banks remains stable with a GNPA of 1.2 per cent. GNPA for unsecured retail loans was slightly higher at 1.7 per cent and slippages in this segment also dominate the fresh creation of NPAs. Notably, small finance banks have higher GNPA in their retail portfolio at 2.7 per cent and should review their lending practices before it becomes a bigger problem. As for NBFCs, their overall position remains healthy. Growth in bank borrowing in their liabilities has declined significantly, which must be welcomed. However, NBFCs have increased their foreign borrowing, which could increase risks in the case of sharp currency movements, a real possibility in the present context.

 

Although the banking and financial sectors are stable, the risks in 2025 could emanate from other sources. Growth in gross domestic product slipped to 5.4 per cent in the second quarter. While it is expected to revive in the second half of the year, more efforts will be needed to sustain higher growth over the medium term. The inflation rate based on the consumer price index is expected to moderate in the coming months, but the extent to which monetary policy can support growth remains to be seen. Bigger challenges in 2025, however, are likely to originate from the global economy, particularly the US. The US Federal Reserve has revised its projection for policy interest-rate cuts, which has led to significant financial-market volatility. Relatively high US interest rates will attract capital and strengthen the dollar, which will put pressure on other currencies, particularly in emerging markets.

 

The pressure may increase substantially if President-elect Donald Trump pursues his stated policies after taking office later this month. The rupee has remained relatively stable, largely because of the aggressive intervention of the RBI, which may not be sustainable for an extended period. There is another big issue that the global economy will have to deal with. As the FSR highlights, global public debt is projected to have exceeded $100 trillion by the end of 2024 and is expected to surpass 100 per cent of GDP by 2030. Global debt is driven primarily by the two largest economies, posing a potential risk to the stability of the global financial system. Indian policymakers, while making interventions to push economic growth, will need to be prepared to deal with such risks.