Banking Central | Be watchful in good times to avert bad ones

The RBI must be watchful of cracks in the system even in good times

India's banking sector has weathered several storms in recent years, with crises like the Yes Bank’s near-collapse in 2020, the DHFL meltdown in 2019 and the PMC Bank scam the same year exposing deep fissures in governance, risk management, and regulatory oversight.

When one looks back, it is clear that these episodes not only shook public trust but also necessitated massive bailouts and restructuring, costing the exchequer dearly. But, since the PMC fiasco, the sector has enjoyed a relative calm, with no major failures surfacing.

Right now, everything looks good but that’s when the regulators and lenders must double down on caution.

It’s looking good

According to the Reserve Bank of India's Financial Stability Report for June, the gross non-performing asset (NPA) ratio has dipped to a multi-decadal low of 2.3 percent as of March 2025, down from 2.8 percent a year earlier.

The capital adequacy ratio (CAR), a key measure of a bank's ability to absorb losses, stands at a record high of 17.2 percent, well above the regulatory minimum of 11.5 percent, providing a sturdy buffer against shocks.

Stress tests conducted by the banking regulator indicate that even under adverse scenarios, most banks would maintain CAR above 9 percent, underscoring the sector's soundness.

The liquidity metrics are equally encouraging. The liquidity coverage ratio (LCR) for scheduled commercial banks averages over 130 percent, far exceeding the 100 percent requirement, ensuring they can meet short-term obligations amid volatility.

Credit growth has been robust at around 15 percent year-on-year, outpacing deposit mobilisation, which has grown at a steady 11-12 percent. The provision coverage ratio (PCR) hovers around 75-80 percent for many lenders, reflecting prudent setting aside of funds for potential bad loans.

Finally, the RBI's Financial Inclusion Index has climbed to 67 in March, signalling broader access to banking services and a more inclusive financial ecosystem.

All the key parameters collectively suggest that Indian banks are in their best shape in years, bolstered by post-crisis reforms like the Insolvency and Bankruptcy Code and enhanced supervisory frameworks.

But there are persisting risks in the system.

Guard up

Global uncertainties — from geopolitical tensions in West Asia to trade frictions — could trigger capital outflows and rupee volatility, straining banks' foreign currency exposures.

Cyber threats loom large, with the RBI flagging rising incidents of digital frauds that could undermine operational resilience.

Non-banking financial companies (NBFCs), closely linked with banks through lending channels, face risks from escalating funding costs, deteriorating asset quality and household debt stress, potentially spilling over into the broader system.

Climate-related risks, too, are emerging as a blind spot, with extreme weather events impacting agriculture and infrastructure loans.

Remember that most of the past crises erupted not during downturns but amid seeming prosperity, often due to hidden governance lapses, evergreening of loans, and regulatory blind spots. Yes Bank's downfall was rooted in overexposure to stressed sectors, while PMC's fraud highlighted weak internal controls.

The absence of major failures post-PMC owes much to the RBI's proactive measures, including prompt corrective action frameworks and stricter norms on large exposures. But easing off now could reverse these gains. Banks must invest in advanced risk analytics, stress testing for unconventional threats and robust board oversight. Regulators should intensify on-site inspections, enforce granular data reporting, and collaborate with fintech overseers to plug gaps in the shadow banking space.

 (Banking Central is a weekly column that keeps a close watch on and connects the dots regarding the sector's most important events for readers.)