Banks’ Gross Bad Loan Ratio Predicted To Worsen By 2026, Says RBI Report

Banks’ gross bad loan ratio in India, which recently reached a 12-year low of 2.6% in September 2024, is expected to rise to 3% by March 2026 under a baseline scenario, as per the Reserve Bank of India’s (RBI) latest Financial Stability Report. This rise underscores potential risks related to credit quality, interest rate fluctuations, and geopolitical uncertainties that could impact the financial sector.

The gross bad loan ratio, or non-performing asset (NPA) ratio, is a crucial measure reflecting the proportion of bad loans to total advances. An increase in this metric signals potential stress in the banking system and can influence credit availability and overall financial stability.

Baseline And High-Risk Scenarios

While the baseline scenario projects a rise to 3%, the RBI warns that under high-risk scenarios, this ratio could escalate significantly. The report outlines two adverse conditions:

1. First High-Risk Scenario: The gross bad loan ratio could rise to 5%.
2. Second High-Risk Scenario: The ratio could increase further to 5.3%.

Despite these concerning forecasts, the RBI reassures that all banks are expected to maintain capital adequacy ratios above the minimum requirement of 9%, even in the most adverse circumstances.

Improvement In Asset Quality And Capital Buffers

Over the last decade, Indian banks have made considerable progress in improving asset quality. Several factors have contributed to this improvement, including:

• Recoveries and Write-Offs: Banks have focused on recovering bad loans and writing off legacy NPAs, reducing the overall burden.
• Controlled Credit Growth: Stringent credit approval processes have curtailed the growth of new bad loans.
• Capital Infusion: Banks have significantly increased their capital positions, creating a robust buffer against potential losses.

The Financial Stability Report emphasizes that these measures have strengthened the resilience of the banking system, allowing it to withstand shocks and maintain overall stability.

RBI’s Measures To Rein In Risk-Taking

In the past year, the RBI has implemented a series of regulatory measures aimed at mitigating risks within the financial sector. These include:

• Tightened Rules: New regulations for credit card and personal loan issuances to prevent excessive risk-taking.
• Increased Borrowing Costs For NBFCs: Measures to discourage risky lending practices by non-banking finance companies (NBFCs).
• Business Restrictions: Enforcement actions against non-compliant lenders to ensure adherence to regulatory norms.

The central bank has also stressed the need for financial institutions to adopt robust risk management and governance frameworks. It has encouraged banks to raise additional capital proactively, ensuring preparedness for potential challenges.

Non-Banking Finance Companies Show Resilience

The Financial Stability Report highlights the performance of NBFCs, which form a critical component of India’s financial ecosystem. Stress tests conducted by the RBI indicate that even under high-risk scenarios, NBFCs’ capital adequacy ratios would remain well above the required minimum levels.

This resilience is attributed to:

• Strengthened balance sheets over recent years.
• Improved risk management practices.
• Strategic diversification of portfolios to mitigate concentration risks.

The report underscores the vital role of NBFCs in supporting credit availability and economic growth, particularly in underserved segments of the market.

Key Performance Indicators Of Banks

The RBI’s report also sheds light on key performance indicators of Indian banks:

• Net Interest Margins: While margins have narrowed due to various macroeconomic factors, banks have managed to maintain profitability.
• Return On Equity (ROE) And Return On Assets (ROA): Both metrics have shown improvement, reflecting efficient capital utilization and better asset performance.
• Capital Buffers: Banks continue to maintain robust capital positions, ensuring they can absorb potential losses without compromising financial stability.

These positive trends highlight the sector’s capacity to navigate challenges while supporting economic growth.

Long-Term Outlook For The Financial Sector

The RBI remains optimistic about the future of India’s financial sector, supported by:

• Continued Balance Sheet Strengthening: Banks are expected to maintain their focus on improving asset quality and capital buffers.
• Regulatory Vigilance: The central bank’s proactive measures will help address emerging risks and ensure financial stability.
• Economic Growth: A growing economy is likely to drive credit demand and support the banking sector’s expansion.

However, the RBI emphasizes the importance of sustained vigilance and prudent risk management practices to mitigate potential disruptions and sustain growth momentum.

Implications For The Broader Economy

The projected rise in the gross bad loan ratio highlights the need for continued focus on credit quality and risk mitigation. While the banking system remains resilient, maintaining this strength will be crucial in supporting India’s economic ambitions.

The report’s findings serve as a reminder of the dynamic nature of the financial sector and the importance of adaptability in navigating challenges. With a sound regulatory framework and robust capital positions, Indian banks are well-equipped to contribute to the nation’s growth story.