R. Suryamurthy
India’s banking sector is set to maintain its strong asset quality, largely shielded from global economic uncertainties by robust domestic conditions, according to a new report from Moody’s Ratings. The report, published on June 3, 2025, projects the system-wide nonperforming loan (NPL) ratio to remain between 2% and 3% over the next 12 months, a slight improvement from 2.5% at the end of December 2024.
Driving this resilience are supportive domestic economic factors, including government capital expenditure, tax cuts aimed at boosting consumption, and monetary easing. Furthermore, India’s limited reliance on goods trade acts as a buffer against external risks. The Reserve Bank of India (RBI) has also played a crucial role in ensuring financial and price stability, with recent accommodative measures including significant liquidity injections and a reduction in the benchmark repo rate. These actions are expected to improve borrowers’ debt serviceability over time.
Wholesale Loans Bolster Asset Quality
Wholesale loans are a cornerstone of Indian banks’ portfolios, alongside retail and agriculture loans. The quality of these loans is expected to remain healthy, underpinned by strong corporate profitability and low leverage levels. Although small businesses, which are significant contributors to India’s exports, could face challenges if trade tensions escalate, posing some asset risks for banks.
Within the retail segment, a clear divergence in asset quality is emerging between secured and unsecured loans. While secured retail loans have consistently low NPL formation rates, unsecured loans have seen an increase in new NPLs over recent quarters. This trend is anticipated to continue, potentially leading to weaker asset quality for small private sector banks compared to their larger counterparts and public sector banks.
Housing loans, the largest component of retail loans, are expected to remain stable, supported by consistent employment, adequate LTV ratios, and steady appreciation of housing prices driven by urbanization. Other secured loans, like property-backed business loans, are also projected to maintain low NPL ratios.
However, the quality of vehicle loans, particularly for two-wheelers, is likely to soften as pent-up demand wanes and loans mature. Delinquencies for two-wheeler loans have risen, often linked to younger, lower-income borrowers with nascent credit habits. Despite this, two-wheeler loans constitute a minor portion of the overall vehicle loan book.
Impairments in unsecured retail loans, including microfinance, are expected to remain elevated. Rapid growth in unsecured lending due to fierce competition has led to increased borrower leverage. Stress is particularly evident among holders of small-sized loans, subprime borrowers, and low-income earners. Microfinance providers are actively managing this by implementing loan write-offs and capping the number of lenders and unsecured debt per borrower. While gold loan holders have also seen increased leverage, collateralization limits potential losses.
Regulatory Measures and NBFC Stability
The RBI’s macro-prudential measures have been instrumental in preventing excessive loan growth. The central bank’s November 2023 increase in risk weights for unsecured retail loans and exposures to non-bank finance companies (NBFCs) significantly slowed growth in these segments. Although risk weights for NBFC loans were subsequently lowered in April 2025, bank lending to the sector is still expected to align with overall credit expansion.
Furthermore, the RBI has introduced draft guidelines in April 2025 to curb risks from gold loans, proposing a 75% LTV ratio ceiling throughout the loan tenure for certain gold loans. Breaches will incur an additional 1% charge for standard asset provisioning, and renewals of bullet repayment loans will only be permitted after full interest repayment. These measures are anticipated to slow the growth of this loan segment. Overall, system-wide loan growth is forecasted to be 11%-13% in the fiscal year ending March 2026, a decrease from the 17% average observed between March 2022 and March 2024.
Asset risks from exposures to NBFCs, which represent about 9% of total bank loans, are expected to remain contained. The sector is generally well-capitalized and profitable, despite some increases in delinquencies for certain loan types. Improving funding conditions and the strategic use of foreign-currency debt are also bolstering NBFC stability. However, some microfinance NBFCs facing significant credit losses may need to raise capital.