India's banks are healthier, but the next stress point is already visible

A highlight of the Indian economy in recent years has been the strengthening of the balance sheets of banks. The banking system came under stress in the years following the global financial crisis of 2008. This coincided with excessive leverage in the corporate sector, and the resulting twin balance-sheet problem posed serious constraints on economic growth. However, the situation has changed markedly since then owing to policy intervention and improved management. The continued improvement was again highlighted in the Reserve Bank of India’s (RBI’s) “Report on Trend and Progress of Banking in India 2024-25”, released this week. Gross non-performing assets (GNPAs) in scheduled commercial banks are estimated to have declined from about 8.5 per cent in 2020 to a multi-decade low of 2.1 per cent (September 2025). Net NPAs also declined from about 3 per cent to 0.5 per cent during the same period. Fresh slippages have reduced while recovery has improved. In financial performance, the return on assets has improved while the return on equity has remained stable. The banking system is adequately capitalised and is in a position to support growth. 

While banking is stable and resilient, it needs to evolve and adjust to the changing dynamics of the Indian financial system. As has been noted by the RBI, banks will continue to face competition from non-banking sources in lending to the commercial sector. Further, loan growth has outpaced deposit growth, pushing up the credit-deposit ratio. Thus, banks could face challenges not only in deposit mobilisation but also in the credit market. The data shows that nearly half the financial flows to the commercial sector are coming from non-banking sources, including market instruments. As the debt market deepens over time, it is likely that large, better-rated companies may raise resources directly from the market, and banks would be servicing smaller firms, which could increase risks and costs. 

On deposits, the increasing exposure of Indian households to the capital market would mean banks need to offer better returns to attract deposits. Thus, competition on both deposits and lending could put pressure on interest margins and profitability. Banks need to carefully adjust to this change. It may also need regulatory support. In this context, one of the important aspects of banking is worth highlighting here. Banks are expected to ensure that a portion of credit flows to priority sectors, including agriculture, small and medium enterprises, education, and social infrastructure. The data shows that GNPAs in the priority sector at the end of March 2025 were 4 per cent, significantly higher than the overall level. Further, the share of the priority sector in GNPAs increased to 64.7 per cent in 2024-25, compared to 58.2 per cent in the previous year as non-priority sector NPAs declined. 

However, this also suggests that lending standards are comparatively weak in these areas. While the objective of supporting certain sectors or sections of society, which otherwise may not have access to credit, cannot be faulted, there is perhaps a need to review priority-sector norms. Banks are commercial enterprises and compete for business not only among themselves but also with other sources of credit. Thus, a more enabling environment with greater operational freedom would help achieve growth with stability.

 

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