India’s banking sector looks stable but overall financial stability faces risks of increasing complexity

Bad loans are at a multi-decade low. Non-banking financial companies (NBFCs) also recorded robust performance, supported by double-digit credit growth, improved asset quality and comfortable capital cushions.

On the face of it, all is well. However, a close read reveals a disturbing trend that could potentially endanger financial stability: the growing role of NBFCs and their close inter-connectedness with banks. A single sentence says it all.

In 2024-25, the “balance sheet of NBFCs saw double-digit expansion, surpassing the growth recorded in the previous year.”

In contrast, the consolidated balance sheet of scheduled commercial banks (SCBs, regional rural banks excluded), grew slower. In short, the growth of NBFCs outpaced that of banks in 2024-25.

By end-March 2025, NBFC credit was around a quarter of the quantum extended by banks, with NBFC credit growth surpassing that of banks in all segments except agriculture and allied activities. Clearly, NBFCs are adept at cherry-picking. But not always wisely, it would seem.

So, 25% of their total loans were to sensitive sectors, including capital markets and real estate, with significant investment in securities and advances against commodities.

Likewise, loans to the power sector, the Waterloo of SCBs in the second decade of this century, accounted for the largest share of NBFC credit to industry at 56.1% in March 2025. As before, debentures and bank borrowings remained the main source of funding for NBFCs (72.9% last September).

Although RBI had increased the risk weights on bank loans to NBFCs in November 2023 to moderate their over-dependence on bank funds, bank credit to NBFCs reduced only a bit in 2024-25, and these weights were later restored as part of an effort to spur lending overall.

However, banks and NBFCs are interlinked not only through the medium of bank loans. Banks are increasingly acting as counter-parties for securitization by NBFCs.

As NBFCs turned assets into securities to generate liquidity, rebalance their exposures and comply with regulations, banks became willing partners in order to meet their priority-sector lending goals. In the process, we now have yet another channel of risk transmission.

NBFCs are not as closely regulated as banks and should things go wrong with the former, the latter could suffer in ways that endanger financial stability.

On the liabilities side too, the growing presence of NBFCs poses some dangers. On one hand, the higher rates of interest they offer have given them strong deposit growth, despite the absence of deposit insurance, which should help lower their reliance on bank money.

On the other, the concentration of deposits—five major deposit-taking NBFCs account for 96.9% of aggregate deposits—could spell a ‘too-big-to-fail’ scenario, resulting in taxpayer money being used to bail out a failed-but-systemically important NBFC.

In a nutshell, RBI’s restoration of lower risk weights for bank lending to NBFCs, along with its easing of monetary policy, might be helping these financiers expand their footprint.

But RBI must stay on guard against this adding to systemic risk. Credit expansion must not come at the cost of financial stability.