The latest round of banking stress tests confirm that bad loans will likely settle at a multi-year low of 2.5 percent this fiscal, provided there is no fresh trouble.
According to RBI’s Financial Stability Report released Thursday, bad loans as a proportion of overall loans touched a 12-year low of 2.8 percent in 2023-24, but could rise to 3.4 percent under severe stress.
As for sectors, agriculture saw the highest impairment ratio in the previous fiscal, while retail loans saw an across-the-board reduction in gross non-performing assets (NPAs). The industrial sector, too, saw its asset quality improve across multiple sub-sectors. A key indicator of asset quality, the ratio of special mention accounts—where payments are overdue by 60-90 days—is showing relatively low levels of potential impairments. On balance, domestic financial conditions are buttressed by healthy balance sheets across financial institutions, improving asset quality, adequate provisioning and robust earnings.
It’s heartening that banks have enough capital buffers to overcome any macroeconomic shock, while their earnings remain robust. In other words, the Indian banking system is well-positioned to spur credit growth. However, it’s the demand that needs to pick up pace. While the growth in the services sector, especially in retail loans, seems unstoppable, a rise in industrial credit remains elusive.
Banks also seem to be wary of large borrowers or handing out big-ticket loans, which actually led to a disproportionate rise in bad loans just a few years ago. But it’s also true that such caution has helped lower the gross NPA ratios. According to the RBI, the sustained reduction in the gross bad loans since March 2020 has been primarily due to a persistent fall in new NPA accretions and increased write-offs.
But unlike in the past, when the RBI would warn about rising stress in industrial loans, this time the central bank raised red flags over household debt. With overall household savings declining and financial liabilities increasing, it noted that household debt warrants close monitoring from a financial stability perspective.
Households’ financial liabilities shot up post-pandemic, while their savings declined to 18.4 percent of GDP in 2022-23, down from an average of 20 percent during 2013-22. The government had attributed the decline to a rise in physical and financial assets. That could be true; but it’s also essential to prevent any build-up of reckless lending.