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

Overview

Indian banks are poised to sustain healthy asset quality, supported by reduced unsecured lending and limited impact from the West Asia crisis, according to a Goldman Sachs report. The outlook has improved significantly over the past five years, with overall stress contained. Separately, brokerage Bernstein noted credit growth accelerated to around 20% year-on-year in the June 2026 quarter, the highest in over four years, while Motilal Oswal Financial Services declared that Indian banks are in their best shape in a decade.

Goldman Sachs: Deleveraging to Limit Stress

The Goldman Sachs report, covered by ANI and The Economic Times, said Indian banks will likely maintain benign asset quality trends. Deleveraging in unsecured lending is expected to limit incremental stress, and the West Asia crisis is seen having minimal impact on asset quality.

According to the report, concerns have largely been limited to granular unsecured loans, particularly in 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," Goldman Sachs noted, adding that state-owned enterprise (SoE) banks had no exposure, while large private banks experienced negligible to manageable impacts.

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% from its peak of ₹4.4 trillion in QE-Mar-24, while consumer unsecured loan growth slowed to 10-12% in FY25/FY26 from 25-30% in FY23/FY24.

Despite moderation, consumer credit remains structurally underpenetrated, with unsecured loans accounting for only 18% of the overall retail loan book. In MFI, around 80-90% of the loan book at several banks is covered by the government-backed Credit Guarantee Fund for Micro Units (CGFMU), providing a cushion against any sharp increase in NPL formation.

The report flags MSME loans as the "primary incremental debate" on asset quality, given the segment's CAGR of 20-25% over the past three to five years. However, Goldman Sachs 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. It cautions that the MSME sector could witness pressure if the impact of the West Asia crisis or El Nino proves more severe than expected.

Bernstein: Credit Growth Reaches 20% YoY

Bernstein, in a report covered by The Tribune, said credit growth in the banking system rose to around 20% year-on-year in the June 2026 quarter, the highest in more than four years. However, deposit growth continued to lag, keeping the loan-to-deposit ratio (LDR) near decade-high levels.

"Growth momentum improved meaningfully during the quarter, with system credit growth accelerating to Rs 20% YoY (or Rs 18% adjusted for reporting changes), while deposit growth continued to lag," Bernstein said.

The report attributes part of the reported increase to changes in fortnightly reporting requirements introduced in December 2025; the underlying credit growth is estimated at around 18%. The recovery is broad-based, led by industrial and services lending. Large corporate borrowings, which account for nearly 70% of industrial loans, and higher funding demand from NBFCs were key drivers. Bank credit to NBFCs grew by more than 30% in recent months, aided by higher bond-market rates that encouraged reliance on bank loans.

Despite the high LDR, bank margins remained broadly stable, with fresh lending and term-deposit rates having largely stabilised. The spread between fresh loan yields and term-deposit rates remains higher than the spread on outstanding portfolios, indicating that incremental loan growth remains margin-accretive.

Bernstein also highlighted healthy asset quality and improving credit costs, which have helped keep profitability near decade-high levels. It expects the banking sector to maintain healthy growth in FY27, supported by favourable liquidity conditions and improving nominal credit growth, though possible policy tightening later in the year could slow the pace. The brokerage retained its FY27 loan-growth estimate at around 13-15% and expects net interest margins to remain broadly stable, with asset quality staying benign.

Motilal Oswal: Banks in Best Shape in a Decade

Motilal Oswal Financial Services, in a post on social media platform X, stated that Indian banks are in their best shape in a decade, with NPAs near historic lows and balance sheets strengthened by robust capital buffers. The firm highlighted the significant improvement in the health of the banking sector, pointing to cleaner balance sheets and stronger fundamentals.

"Indian banks are in their best shape in a decade. NPAs are near historic lows," Motilal Oswal said in its post.

Recent banking-sector data show gross non-performing assets of scheduled commercial banks fell to a multi-decadal low of around 1.8% in March 2026, while net NPAs stood at about 0.4%. Capital adequacy remained comfortable.

Motilal Oswal's assessment is broadly in line with the Reserve Bank of India's latest Financial Stability Report, which showed banks remained resilient, with strong capital buffers and the ability to withstand severe stress scenarios. The improvement in asset quality marks a sharp turnaround from the previous decade's stress, when elevated corporate leverage and mounting bad loans weighed on the sector.

With NPAs at historically low levels and capital positions healthy, banks are better placed to expand lending while maintaining prudent underwriting standards, the firm noted.