A sharp correction in US equities could impact domestic equities and tighten financial conditions
India’s financial system is well placed to weather turbulence and shocks | Photo Credit: SUSANNAH IRELAND
The recently released Financial Stability Report (FSR) has taken a rather serious view of global risks to the financial system arising out of geo-politics and trade, while emphasising that India’s financial system is well placed to weather turbulence and shocks.
The report flags the fragility arising out of “AI optimism” and the growth of stablecoins, with ample liquidity supporting “risk-on sentiment across asset classes”. Remarkably, it hints at dangers of “rising interconnectedness” across assets, pointing to high hedge funds leverage and opaque private credit markets. In India’s case, however, there is no major cause for worry as balance sheets are sound across the corporate, banks and NBFC segments and reserves are ample. But uncertainties could increase exchange rate volatility, dampen trade and reduce corporate earnings, the FSR says. A sharp correction in US equities could impact domestic equities and tighten financial conditions, it observes. However, the asset quality of Indian banks has improved with the reduction in risky infrastructure and project finance lending. Gross NPAs and net NPAs were down to historic lows of 2.2 per cent and 0.5 per cent, respectively, by September 2025. Capital buffers are also robust with capital to risk assets ratio at 17.2 per cent and liquidity coverage ratio at 131.7 per cent, which are well above the statutory requirements.
But the shift in bank credit from large industries to retail loans is not necessarily desirable. Credit growth to large companies has slowed to 5.8 per cent by September 2025. But, in their bid to grow their business, banks have increased their unsecured retail loan portfolios, which carry higher risk. The gross NPAs remain elevated in this category at 1.8 per cent compared to 1.1 per cent for retail advances in general. Private sector banks have been taking higher risk in this category, holding 56.8 per cent of unsecured retail credit as of September 2025 and accounting for 75.8 per cent slippages in this category.
The report also flags a few challenges for banks. One, banks are finding it hard to garner deposits, as markets are offering attractive returns. With banks also raising funds at a higher rate from the bond market, their net interest margins could come under pressure. Two, the steepening of the yield curve and increasing spread between State government securities and G-secs is leading to more funds being parked in the former, especially by private sector banks. State government bonds held by private banks have registered 29 per cent increase in September 2025, year on year. This trend can impact credit growth. Three, the rise in bond yields will impact treasury income, as a third of banks’ income comes from other income. Four, increase in acquisition of loans originated by NBFCs by banks through securitisation, pass through certificates and co-lending arrangements can create problems as the quality of these assets is inferior to their own. In sum, this is a time for cautious optimism.
Published on January 4, 2026
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