The Reserve Bank of India's (RBI) annual assessment of the banking sector for 2024-25 paints a picture of robust health on the surface. However, a deeper look reveals emerging fault lines that could threaten the nation's broader financial stability. The central bank's 'Trends and Progress of Banking in India 2024-25' report, released recently, highlights a concerning trend: the rapidly expanding role of Non-Banking Financial Companies (NBFCs) and their deepening, complex ties with traditional banks.
Strong Foundations Mask Underlying Complexities
The report offers considerable reassurance regarding the core banking system. The Indian banking sector remained resilient, underpinned by strong balance sheets, sustained profitability, and high capital buffers. A key highlight is that bad loans, or non-performing assets (NPAs), have hit a multi-decade low. Simultaneously, NBFCs have also recorded robust performance, supported by double-digit credit growth and improved asset quality.
Yet, this positive aggregate data conceals a shifting landscape. In 2024-25, the balance sheet of NBFCs expanded at a double-digit rate, surpassing the growth of the previous year and notably outpacing the growth of scheduled commercial banks (SCBs). By the end of March 2025, NBFC credit reached approximately a quarter of the quantum extended by banks, with NBFCs outperforming bank credit growth in almost all segments except agriculture.
The Growing Web of Interconnected Risk
The interconnection between banks and NBFCs is evolving beyond simple lending relationships, creating new channels for potential risk transmission. While bank borrowings and debentures continued to be the primary funding sources for NBFCs (accounting for 72.9% as of September 2024), a more intricate link is forming through securitization.
Banks are increasingly acting as counterparties for securitization deals initiated by NBFCs. As NBFCs convert their loan assets into securities to generate liquidity and rebalance their books, banks are purchasing these securities to meet their priority-sector lending (PSL) targets. This symbiotic relationship, while beneficial for both parties in the short term, weaves a complex web where trouble in the NBFC sector could quickly spill over to the banking system.
This risk is amplified by the nature of NBFC lending. The report notes that a significant 25% of NBFC loans are directed towards sensitive sectors like capital markets and real estate. Furthermore, within industrial lending, the power sector—historically a problem area for banks—constituted 56.1% of NBFC credit to industry in March 2025.
Deposit Concentration and Regulatory Challenges
On the liabilities side, the rise of NBFCs presents its own set of challenges. Their ability to offer higher interest rates has fueled strong deposit growth, even without the safety net of deposit insurance. However, this market is highly concentrated. Just five major deposit-taking NBFCs account for a staggering 96.9% of aggregate deposits in the sector, raising the specter of a 'too-big-to-fail' scenario. A failure in one of these large entities could necessitate a taxpayer-funded bailout to prevent systemic collapse.
The regulatory stance has also added nuance to the dynamic. In November 2023, the RBI increased risk weights on bank exposures to NBFCs to curb excessive dependence. This led to a slight reduction in bank credit to NBFCs in 2024-25. However, these tighter weights were later restored as part of a broader effort to stimulate lending in the economy.
In essence, the current regulatory and monetary environment—characterized by eased policy and restored risk weights—is facilitating the expansion of NBFCs. The RBI's report serves as a crucial reminder that while credit expansion is desirable, it must not come at the expense of financial stability. The central bank must remain vigilant, monitoring these deepening interlinkages to ensure that the growing complexity within India's financial ecosystem does not sow the seeds of the next crisis.
