Indian financial system remains sound despite global headwinds

The Reserve Bank of India’s December 2025 Financial Stability Report underscores the resilience of India’s financial system despite rising global macroeconomic and financial market risks

RBI has released the December 2025 edition of the Financial Stability Report (FSR) on December 31st, which is an important study as to the soundness and the strength of the resilience of the Indian financial system and risks to financial stability.

This report reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC). The FSR is a half-yearly publication with contributions from all financial sector Regulators. It represents the collective assessment of the sub- Committee of the Financial Stability and development Council on current and emerging risks to the stability of the Indian Financial System.

This assessment and stress testing of Banking, NBFC, Fintech, Entire Financial Eco system, along with Macro Economic Risks with Global Macro Economic outlook with domestic outlook followed by Global and domestic financial markets assessment of risks are important and useful study and needs every player in this sector to go through thoroughly and understand the opportunities and challenges and prepare for mitigating the risks and threats.

The Report being prepared by the sub- Committee of FSDC, apart from the financial sector but also covers stress testing of mutual funds, stress testing analysis of Clearing Corporation, financial system network and contagion analysis, lastly Insurance sector from the point of view of Solvency, and emerging areas of stress.

This is a vital study and assessment as in the market all these sectors are interlinked and any liquidity and failure, default in any one sector of the financial sector, will have an implications on the system as a whole and it is therefore as a system as a whole, all the factors of stress testing to be carried out and their individual assessment will provide lot of inputs for overall financial resilience and stability.

From the domestic macro economic and financial risks perspective, India in the recent period has registered a strong real GDP growth of 7.8 per cent for Q1 & 8.2 per cent for Q2 2025-26, headline inflation has been on much lower side than the targetted inflation which has led to RBI lowering the repo rate to 5.25 per cent and with the positive reforms like GST rationalisation, earlier Income tax relief etc coupled with massive capex for infrastructure expanding and manufacturing thrust through PLI scheme etc have enhanced economic resilience.

It is also gratifying that the Banking, NBFC sector and the domestic financial system remains sound as per the RBI study, supported by strong balance sheets like profitability, return on assets, good capital buffer, enhanced provisions coverage ratios, lowest net NPA levels, along with easy financial conditions and low volatility.

However, the current global uncertainties, uncertainties on trade and other policies, could have an impact on the exchange rate volatility, dampen trade, corporate earnings can can be affected, and FDI can be weakened. Global correction in Equity Markets can have a correction in the domestic equity market, which can tighten financial conditions. However, India's macro economic strength has led to enough buffers to withstand adverse shocks.

The Indian Banking Sector continue to show strong capital and liquidity buffers, improved asset quality and steady profitability. From the data furnished in the Report, it is visible that credit growth is higher than the deposit growth, particularly in the current year upto September 2025, credit growth is 11 per cent whereas deposit growth is at 9.8 per cent.

The sharp fall in the share of CASA deposits and the rise of time deposits across the bank group continued. This will affect the margin to a certain extent, particularly when interest rates are to be reset for credit in view of the repo rate reduction, whereas existing term deposits will be repriced on maturity, and in the case of long-term deposits, the higher rate at which they were contracted earlier will take a longer period to reprice.

Banks are also relying on high market related certificates of deposits, which will add to their cost of deposits as the core deposits growth are not to the extent required in line with the credit growth. Banks have to step up the deposit mobilisation drive to garner CASA deposits.

On the Asset quality and Provisioning, GNPA ratio is at 2.2 per cent and NNPA ratio is at 0.5 per cent. Slippage ratio has come down to 0.7 per cent and provisions coverage ratios have improved to 76.0 per cent. With global uncertainties and any impact on the domestic economy, Banks have to be aware of the risks arising to export credit, corporate earnings decline, etc, to protect Banks assets becoming stress.

The high increase in personal unsecured lending, even though moderated after RBI intervention, needs more monitoring as the likely probability of default in these unsecured loans are higher. With volatility in market risks, interest rates risk, forex risk, equity risks, bond market volatility may have an impact on income and asset quality, which have to be hedged from the capital buffers.

With a stable scenario, banks were able to manage risks well and could register high profitability. As earlier stated, in these periods of uncertainty, there is a likely impact on NIM and profitability.

According to Report, NII growth of SCB declined sharply to 2.3 per cent in September 2025 as compared to earlier periods. EBPT growth and PAT growth has also come down in September 25 at the rate of 9.8 per cent and 3.8 per cent respectively as compared to double digits growth in 2023-24 and 2024-25.

Net Interest Margin ( NIM) recorded a broad based 20 bps fall in September 2025 over March 2025, which is due to a relatively higher decline in yield on assets than in cost of funds. This is likely in the interest rates decline scenario, as earlier mentioned, as the interest rates on most of lending are based on market-based yield, the outstanding loans will be repriced whenever there is a repo rate cut, which will lead to a decline in yield on assets.

With the lesser growth in EBIT and Net Profit, both return on equity ( ROE ) and return on assets ( ROA) have declined in the last two half years according to RBI, but remained at comfortable levels. Notable positive aspects is that the CETI ratio and CRAR are both at a higher level at 14.8 per cent and 17.2 per cent. Liquidity Coverage ratios,(LCR ) of All Scheduled Commercial Banks (SCBs) remained at 132.7 per cent as at September 25.

Similarly, Net Stable Finding Ratio ( NSFR ) stood at 124.7 per cent indicating comfortable liquidity buffers. Overall, the health of the SCBs remains sound with strong capital buffers and liquidity buffers, improved asset quality and robust profitability.

Macro stress test assesses the resilience of SCBs to withstand adverse macroeconomic shocks. The test attempts to project the capital ratios of banks over a one-and half years horizon under three scenarios, baseline and two adverse macro scenarios. It is glad to note that the macro stress test results reaffirmed the resilience of SCBs to the assumed macroeconomic shocks.

System level CRARwhich is as of September 25 at 17.1 per cent, may fall to 16.8 per cent under the baseline scenario, 14.5 per cent under adverse scenario 1 and to 14.1 per cent under adverse scenario 2. This is much above the regulatory requirement.

However, Banks have to continuously raise additional capital to remain under capital buffers to meet the growing requirement of credit, as well as remain resilient and stable in any unforeseen adverse scenario.

RBI in the FSR report indicates that stress tests confirm the resilience of mutual funds and clearing corporations. It is also stated that Non- Banking Financial Companies ( NBFCs) remain robust, supported by strong capital buffers, solid earnings and improving asset quality.

The insurance sector continues to display balance sheet resilience, and the consolidated Solvency ratios remain above the minimum threshold limit.

(The author is former Chairman & Managing Director of Indian Overseas Bank)