Banks Can Survive Even If You Don’t Pay Off Your Loan? Myth Or Truth?

India’s banking sector has long stood as a pillar of stability in an economy prone to cyclical challenges, policy shifts, and global shocks. In recent months, analysts and regulators have expressed confidence that Indian banks are in a strong position to absorb potential loan losses, a claim that warrants deeper analysis.

This article explores why the country’s banks are viewed as resilient, backed by improved asset quality, prudent provisioning, stronger balance sheets, and regulatory foresight.

The Foundation of Resilience: Strengthened Balance Sheets

Over the past decade, Indian banks, particularly public sector banks (PSBs), have undertaken a massive clean-up of their balance sheets. The non-performing asset (NPA) cycle that peaked around FY2018 has largely been brought under control through better recognition norms, the Insolvency and Bankruptcy Code (IBC), and aggressive write-offs.

Gross NPAs for the banking system declined to 3.0% of gross advances in FY2025, compared with nearly 11.2% in FY2018. This remarkable improvement reflects stronger underwriting standards, enhanced monitoring, and diversified loan books. Simultaneously, the capital adequacy ratio (CAR) across scheduled commercial banks (SCBs) has risen to over 16%, comfortably above the regulatory requirement of 11.5%.

Moreover, with higher profitability and improved internal accruals, banks are better equipped to create contingency buffers. This means even if credit quality deteriorates slightly due to macroeconomic slowdowns, the impact on their balance sheets is expected to remain manageable.

Credit Growth and Provisioning Trends

Credit growth has remained robust, reflecting the confidence of both lenders and borrowers in the current financial environment. However, prudent provisioning remains a key buffer that ensures stability in case of asset quality slippages.

Credit Growth and Provisioning Coverage Ratio (PCR) of Indian Banks (FY2020–FY2025)

(*Estimated figures for FY2025 based on industry trends)

The consistent rise in the provisioning coverage ratio (PCR) highlights how Indian banks are building robust financial cushions. Higher PCR ensures that even in cases of defaults, losses are already pre-emptively absorbed. Furthermore, the slowdown in NPA accretion, despite accelerated lending, suggests improved credit assessment frameworks.

In summary, while loan books have expanded rapidly, the underlying prudence in provisioning and capital buffers demonstrates that Indian banks are lending from a position of strength, not vulnerability.

Regulatory Vigilance and Macroprudential Safeguards

The Reserve Bank of India (RBI) has played a critical role in shaping this resilience. Its proactive supervision, periodic stress tests, and macroprudential regulations have helped pre-empt systemic risks. The central bank’s insistence on early recognition of stressed assets, coupled with stringent capital and liquidity requirements, has ensured that Indian banks maintain sufficient shock absorption capacity.

Additionally, the introduction of frameworks such as the Prompt Corrective Action (PCA) has instilled greater discipline. Banks under PCA are required to curtail risky lending and strengthen their capital, thereby preventing systemic contagion.

The RBI’s continuous efforts to transition to risk-based supervision have also been pivotal. This approach allows regulators to assess vulnerabilities dynamically rather than reactively. Stress testing results over the last few quarters indicate that even under severe macroeconomic stress, the overall capital adequacy of the banking sector would remain above regulatory thresholds, a testament to the sector’s preparedness.

Asset Quality Diversification and Sectoral Balance

A key contributor to the current optimism around Indian banks’ resilience is the diversified loan portfolio across sectors. Unlike the pre-2018 period when exposure was heavily concentrated in infrastructure and corporate lending, today’s credit mix is more balanced.

Retail loans, especially mortgages, vehicle loans, and personal credit, now account for over 40% of total bank advances, compared to less than 30% a decade ago. Corporate lending has moderated, while MSME and agricultural sectors have received targeted policy support. This diversification reduces concentration risk and ensures that stress in one segment does not heavily impact the system as a whole.

Sectoral Composition of Bank Credit (FY2015 vs FY2025)

The shift towards retail and MSME lending has also made asset quality more stable. Retail NPAs remain among the lowest in the system, averaging around 1.5%, as these loans are typically granular and secured. As a result, banks are now less exposed to large-ticket corporate defaults that historically triggered asset-quality shocks.

Overall, this structural rebalancing of loan books has been instrumental in making banks’ earnings and asset quality less cyclical.

Earnings Momentum and Internal Capital Generation

The profitability of Indian banks has seen a substantial rebound in recent years. Higher net interest margins (NIMs), robust loan growth, and lower credit costs have collectively improved return ratios. In FY2024, the aggregate return on assets (RoA) of SCBs reached 1.3%, the highest in over a decade, while return on equity (RoE) climbed to nearly 14%.

This surge in profitability is crucial because it strengthens internal capital generation, enabling banks to absorb potential shocks without relying excessively on external capital infusions. For public sector banks, this marks a significant shift from the period between 2016 and 2019, when government recapitalisation was the main lifeline.

Private banks, with their stronger earnings base and diversified portfolios, are further amplifying sectoral resilience. Many have also invested in advanced analytics and risk management systems, improving early warning mechanisms for delinquency detection.

Emerging Risks and the Road Ahead

Despite the strong fundamentals, certain headwinds could test the sector’s resilience. Rising unsecured retail lending, global interest rate volatility, and potential slowdown in export-linked industries could trigger localised stress pockets. Additionally, climate-related risks and cyber threats are emerging as new dimensions of financial stability concerns.

Nevertheless, the preparedness of Indian banks, both in terms of capital buffers and governance frameworks, positions them well to manage these evolving risks. Continuous regulatory oversight, digital risk management, and conservative capital management remain key to sustaining this resilience.

Conclusion

Indian banks have come a long way from the stressed asset cycle that once threatened financial stability. Today, they stand as well-capitalised, well-provisioned institutions capable of withstanding moderate to severe shocks. Strong profitability, improved asset quality, diversified credit exposure, and rigorous regulatory supervision have together built a safety net that enables them to absorb potential loan losses without systemic disruption.

While vigilance must continue, the current outlook indicates that India’s banking sector is not just stable but structurally stronger, capable of driving sustainable credit growth even in the face of cyclical economic pressures.

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LoansJagat Team

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