India's Banking Sector in 2025: Stability Amid Rising Risks in Unsecured Loans
The Indian banking sector remains stable and well-capitalized, yet emerging risks in unsecured loans and global market volatility are raising concerns, according to the Economic Survey 2025. While overall financial health remains robust, key indicators suggest the need for cautious optimism moving forward.
Banking Sector Stability and Growth
India’s banking system has demonstrated strong resilience over the past year, with gross non-performing assets (NPAs) hitting a 12-year low of 2.6%. This improvement reflects the success of regulatory measures, better risk management, and stronger economic fundamentals. The country’s financial institutions have shown an ability to withstand economic shocks while maintaining robust credit growth.
However, a new challenge is emerging—rising stress in unsecured personal loans and credit card defaults. As of September 2024, 51.9% of new NPAs in retail loans originated from slippages in the unsecured loan book. This is a concerning trend, as defaults in smaller loans can create a ripple effect, leading to financial instability across multiple credit portfolios.
Unsecured Loans: A Growing Concern
The Reserve Bank of India’s (RBI) Financial Stability Report (FSR) for December 2024 highlights a critical issue: nearly half of personal loan and credit card holders also have larger secured loans, such as home or vehicle loans. This means that a default on unsecured loans could increase the likelihood of borrowers defaulting on secured loans as well, posing a systemic risk.
In response to rapid credit expansion, the RBI raised risk weights on unsecured retail loans by 25 basis points in November 2023. This regulatory move was intended to curb excessive lending in the unsecured segment. Despite these efforts, the segment continues to grow rapidly, reflecting high consumer demand and increased financial accessibility.
Credit Growth Moderation and Deposit Mismatch
Credit growth, while still strong, has shown signs of moderation in recent months due to a high base effect and regulatory tightening in certain sectors. A growing concern highlighted in the Economic Survey is the widening gap between credit expansion and deposit growth. Banks are lending at a faster rate than they are accumulating deposits, which could lead to liquidity constraints if not managed effectively.
- Housing loans remain the largest contributor to credit expansion, driven by rising urbanization and government-backed initiatives for affordable housing.
- Capital-to-risk-weighted assets ratio (CRAR) of scheduled commercial banks (SCBs) stands at 16.7%, well above the regulatory minimum, indicating strong capital buffers.
- Profit after tax (PAT) for SCBs surged by 22.2% year-on-year (YoY) in H1 FY25, reflecting improved operational performance, higher credit demand, and better asset quality.
- Return on equity (RoE) and return on assets (RoA) have shown steady growth, reinforcing the banking sector’s overall financial strength.
Global Market Volatility: A Potential Risk Factor
Despite strong domestic performance, the Economic Survey 2025 warns that global market volatility remains a significant risk. Any major correction in the U.S. stock market, for example, could lead to shifts in global financial conditions, affecting Indian markets in multiple ways:
- Foreign Portfolio Investment (FPI) Outflows: A sudden downturn in global equity markets could lead to capital flight from emerging markets, including India, impacting liquidity and stock market stability.
- Currency Stability: Global financial turbulence can influence foreign exchange rates, potentially leading to depreciation of the Indian rupee, making imports costlier and fueling inflation.
- Inflation Risks: External shocks, such as fluctuating crude oil prices, could contribute to inflationary pressures, affecting household spending and corporate profitability.
- Interest Rate Movements: If global central banks tighten monetary policies due to inflation concerns, Indian financial institutions may face increased borrowing costs, impacting credit availability.
Regulatory Vigilance and Future Outlook
The Economic Survey emphasizes the importance of macro stress tests, which indicate that Indian banks can withstand adverse economic conditions while maintaining capital adequacy. However, continued regulatory vigilance is essential to ensure stability amid growing uncertainties.
To mitigate potential risks, key measures recommended include:
- Strengthening risk assessment frameworks for unsecured lending.
- Encouraging banks to enhance capital buffers in anticipation of external financial shocks.
- Monitoring credit-deposit ratios to prevent liquidity mismatches.
- Promoting responsible lending practices, especially in high-risk sectors.
Conclusion
India’s banking sector remains resilient and well-positioned for future growth, but risks in unsecured loans and global volatility require careful monitoring. While policy interventions have helped in stabilizing financial conditions, banks must adopt prudent lending practices to mitigate potential stress.
As India continues its economic growth trajectory, ensuring financial stability through proactive regulation and sound banking practices will be key to sustaining long-term prosperity.