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As the Reserve Bank of India (RBI) cautions that the Gross NPA ratio could rise to 3% by March 2026, there is an urgent need for sustained vigilance and robust risk management in the banking sector, said Mr. Akshat Khetan, corporate and legal advisor and Founder of AU Corporate Advisory and Legal Services (AUCL).
While India's financial system remains resilient, several emerging challenges could impact asset quality and credit stability in the coming years.
"Despite the remarkable progress in reducing Non-Performing Assets (NPAs), the RBI has cautioned that the Gross NPA ratio could rise to 3% by March 2026. It highlights the need for sustained vigilance and robust risk management in the banking sector," Mr. Khetan said.
Analysing the key challenges to India's financial system, Mr. Khetan said that the ongoing volatility in global markets, geopolitical tensions, and trade disruptions could impact India's economic growth. That will affect the repayment capacity of businesses and individuals. A slowdown in key export-driven industries may lead to stress in sectors heavily reliant on international demand.
Interest rate fluctuations are yet another major challenge. Mr. Khetan said, "Fluctuating interest rates, driven by inflationary pressures and global monetary policies, could increase borrowing costs, leading to a rise in stressed assets. Likewise, higher interest rates may impact corporate borrowers, especially in capital-intensive industries like infrastructure, real estate, and manufacturing."
Sector-specific vulnerabilities must be taken seriously while analysing the challenges. Certain sectors, such as MSMEs (Micro, Small, and Medium Enterprises) and real estate, continue to face financial stress due to delayed payments, high input costs, and regulatory challenges. The banking sector must exercise caution in lending to industries that have historically contributed to high NPAs.
Rising retail loan stress is an equally strong challenge that needs attention. "While corporate NPAs have significantly declined, there is growing concern over rising stress in the retail loan segment, particularly in unsecured lending, personal loans, and credit cards. Banks and Non-Banking Financial Companies (NBFCs) need to adopt stricter underwriting practices to prevent slippages in retail credit," Mr. Khetan said.
Climate and environmental risks are also a significant challenge to the financial system of India. The increasing impact of climate change and environmental risks, such as erratic monsoons affecting agriculture and extreme weather events disrupting businesses, could contribute to financial distress, particularly in rural and agrarian economies.
Mr. Khetan has also highlighted out how RBI has emphasized the requisite measures to sustain the hard-earned gains in NPA reduction. "The RBI has very cautiously highlighted the need for certain result-oriented measures. First of all, banks must continue implementing AI-driven risk assessment models to detect early warning signs of potential loan defaults. Second, diversifying loan portfolios and avoiding excessive exposure to high-risk sectors will be crucial in maintaining asset quality," he said.
"As retail loan stress rises, enhanced digital surveillance, real-time credit monitoring, and predictive analytics will be essential for preventing future defaults. The Insolvency and Bankruptcy Code (IBC) and the National Asset Reconstruction Company (NARCL) should continue playing a pivotal role in fast-tracking resolution processes for stressed assets. With evolving economic uncertainties, maintaining adequate capital reserves and adhering to Basel III norms will be key for Indian banks to absorb potential shocks," he added.
India's banking sector has demonstrated remarkable resilience in reducing NPAs, but proactive risk management, policy reforms, and technological advancements will be critical in ensuring long-term stability. As the sector moves forward, a balanced approach—combining sustained credit growth with risk-aware lending—will be essential in mitigating future challenges and fortifying India's financial ecosystem.
