Indian banks' asset quality outlook remains stable, West Asia impact limited: Report

Indian banks will likely maintain benign asset quality trends, with deleveraging in unsecured lending limiting incremental stress and the West Asia crisis having minimal impact on asset quality, according to a report by Goldman Sachs.

Indian banks will likely maintain benign asset quality trends, with deleveraging in unsecured lending limiting incremental stress and the West Asia crisis having minimal impact on asset quality, according to a report by Goldman Sachs. According to the report, the outlook for asset quality of Indian banks has improved significantly over the past five years, with overall stress remaining contained. Moreover, the concerns have largely been limited to granular unsecured loans -- particularly in the consumer unsecured and microfinance (MFI) segments.

"In our view, aggressive lending in these segments drove over-leveraging and triggered the non-performing loan (NPL) cycle; however, this impact was largely restricted to mid-sized private banks," GS noted, adding "State-Owned Enterprise (SoE) banks had no exposure to this segment, while large private banks experienced negligible to manageable impacts." Further, the risk of fresh bad loans in these segments remains low, supported by significant deleveraging over the past 12-18 months. The MFI loan book has contracted 25 per cent from its peak of Rs 4.4 trillion in QE-Mar-24, while consumer unsecured loan growth slowed to 10-12 per cent in FY25/FY26 from 25-30 per cent in FY23/FY24.

Despite this moderation, consumer credit remains structurally underpenetrated in India, with unsecured loans accounting for only 18 per cent of the overall retail loan book, GS noted. In MFI, around 80-90 per cent of the loan book at several banks is now covered by the government-backed Credit Guarantee Fund for Micro Units (CGFMU), providing a cushion against any sharp increase in NPL formation. "The primary incremental debate regarding asset quality centers on MSME loans," as per GS. It noted that the segment has grown at a CAGR of around 20-25 per cent over the past three to five years, raising concerns over potential asset quality stress. However, GS remains relatively less concerned, noting that banks have not moved down the risk curve and a significant portion of MSME lending is backed by adequate collateral.

Meanwhile, it flagged that while "MSME loans have grown at a faster pace," the sector can witness pressure "if the impact of the West Asia crisis or El Nino proves more severe than expected." (ANI)