Global rating agency Moody’s has cautioned that the asset quality of Indian banks may see a moderate deterioration over the next 12 to 18 months, with non-performing loans (NPLs) expected to rise up to 3.0%. However, despite this forecast, the agency has maintained a ‘stable’ outlook for India’s banking system.
Decline in NPLs Followed by a Possible Increase
The banking sector in India had seen significant improvement in asset quality in recent months. As per Moody’s report, system-wide NPLs had dropped to 2.6% by September 2024, compared to 7.3% in March 2024. This decline was primarily driven by recoveries and write-offs of old problem loans.
However, Moody’s expects NPLs to rise again due to stress in unsecured retail loans, microfinance loans, and small business loans. The rating agency also pointed out that loan-loss provisioning costs and slippage ratios may increase slightly from their currently low levels.
Factors Contributing to Rising NPLs
Moody’s has identified several reasons for this potential increase in bad loans:
- Economic Slowdown: Growth has moderated in recent quarters.
- Higher Interest Rates: Past increases in interest rates are affecting borrowers.
- Aging Unsecured Loans: Older unsecured retail loans are showing signs of stress.
Despite these concerns, Moody’s reassured that unsecured retail loans make up only 10% of total system-wide loans and that banks have built sufficient reserves to absorb losses.
Corporate Loans Remain Strong
Moody’s report also highlighted that corporate loans continue to perform well. Indian companies have reduced their debt burdens, and strong earnings growth is helping maintain their loan quality.
Banking Sector to Benefit from Favorable Conditions
While challenges exist, Moody’s believes the Indian banking sector will continue to operate in a favorable environment. Factors such as government capital expenditure, tax cuts for the middle class to boost consumption, and monetary easing will support growth.
India’s real GDP growth is expected to exceed 6.5% in FY26 (March 2026), further supporting the banking sector.
Loans and Deposits Growing at a Steady Pace
The Indian banking system has been facing pressure on the liabilities side, but Moody’s expects loan growth to keep pace with deposits. The system-wide loan-to-deposit ratio (LDR) is likely to stay around 80%.
As per RBI data (February 21, 2025):
- Bank credit grew by 11.0% year-on-year (YoY).
- Deposits grew by 10.3% YoY.
A year ago, credit growth was significantly higher at 20.5% YoY, while deposits grew by 13.1% YoY (as of February 23, 2024). The gap between credit and deposit growth has since narrowed, bringing more balance to the banking system.
Conclusion
While Indian banks may see a moderate increase in bad loans, Moody’s maintains a stable outlook for the sector. Strong corporate loan performance, government policies, and economic growth will help banks navigate potential challenges. The overall banking system remains well-positioned for the future, despite concerns over unsecured retail loans and economic moderation.
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