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The Indian banking system appears to be in robust health. According to a Reserve Bank of India (RBI) report, bad loans have fallen to a 12-year low of 2.6% in September 2024.

This improvement in asset quality is evident across all sectors, with banks also reporting a healthy increase in profitability. Their provision coverage ratios are strong, and their capital positions remain stable.

However, stress tests conducted by the RBI indicate that only four banks are slightly below the minimum capital requirement under one adverse scenario. These tests also suggest that, even in the event of a macroeconomic downturn, the banks would remain adequately capitalized. Despite these positive developments, certain areas of concern remain.

There are signs of strain in the unsecured retail loan segment, where data shows a significant rise in write-offs. This could be partly obscuring a decline in asset quality and a loosening of underwriting standards. Over half of the bad loans in the retail sector stem from slippages in the unsecured loan book.

The microfinance sector, which typically serves low-income households, also shows signs of stress. The share of stressed loans in this segment has increased, with impairment rates remaining high among borrowers with multiple loans. Furthermore, the number of borrowers with loans from four or five lenders has risen, suggesting growing indebtedness.

In the consumer credit sector, the report indicates that 11% of personal loan borrowers who took out loans below Rs. 50,000 are overdue. While 60% of borrowers have taken financial loans under Rs.50,000, the overdue rate remains concerning. Additionally, 60% of these borrowers have secured more than three loans in the current financial year, pointing to rising household leverage and repayment stress.

The report also highlights a significant increase in non-performing assets (NPAs) for gold loans, which surged by 30% to Rs. 6,696 crore as of June 2024, compared to Rs. 5,149 crore just three months earlier.

On a more positive note, large borrowers appear to be performing better. Over the past few years, the bad loans of the banks’ largest borrowers have steadily declined. For example, the bad loan ratio for large borrowers decreased from 4.5% in March 2023 to 2.4% in September 2024.

However, loans with overdue principal or interest payments between 31 and 90 days saw an increase during the September quarter. By the end of September 2024, unhedged external commercial borrowings stood at $65.48 billion.

These potential vulnerabilities and areas of stress warrant close monitoring.