The Reserve Bank of India (RBI) has painted a picture of cautious optimism mixed with clear warnings for the year 2026. In its latest Financial Stability Report released in December 2025, the central bank states that while India's domestic economic foundations and banking sector remain robust, the economy faces significant threats from global instability and deepening financial connections at home.
Domestic Strength Shadowed by Interconnected Risks
The report underscores that the primary structural vulnerability within India's financial system is the growing web of connections between traditional banks and non-bank financial companies (NBFCs). These tighter links have helped in channeling credit more effectively through the economy. However, they have also created new pathways for financial contagion, where trouble in one sector can quickly spread to another.
NBFCs continue to depend heavily on banks for funding. At the same time, banks have significantly increased their exposure to NBFCs through instruments like co-lending agreements, securitisation deals, and direct assignments of loans. This concentration is becoming a risk: nearly 80% of all securitised assets now come from just a handful of large NBFCs. Furthermore, private sector banks are sitting on substantial non-funded exposures that could turn into real losses during a period of economic stress.
Global Storm Clouds: The Biggest Threat to India
According to the RBI, external factors dominate the risk profile for India in the coming year. The most immediate dangers stem from ongoing geopolitical conflicts, rising trade tensions between major economies, and a fragmenting global economic landscape. These issues can transmit stress to India through three main channels: disrupted trade flows, volatile international capital movements, and turbulence in financial markets.
The report notes that global markets, while currently buoyant, are in a fragile state. Valuations appear stretched, with gains heavily concentrated in US technology and artificial intelligence stocks. Combined with record-high public debt levels in advanced nations, this sets the stage for potential disorderly corrections in both equity and bond markets worldwide.
Rupee Under Pressure: A Key Transmission Channel
Exchange rate volatility is identified as a critical channel through which global risks can impact India. The Indian rupee has been weakening against the US dollar, a trend that persists even when the dollar is soft against other major currencies. This pressure reflects adverse terms of trade, the impact of tariffs, and a slowdown in foreign capital inflows into the country.
Financial market indicators are flashing warning signs. The trading range for the rupee has widened, volatility has increased, and risk reversals in currency derivatives are pointing towards a bearish near-term outlook for the currency.
Banks: Strong but with Visible Weak Spots
The Indian banking sector enters 2026 from a position of underlying strength, with improved capital buffers and asset quality. However, the RBI report highlights several areas of concern that need close monitoring.
Stress is becoming evident in certain segments of unsecured retail lending, which has seen rapid growth. Banks' treasury incomes have also become more sensitive to swings in bond yields and currency values, making profits more volatile. A persistent challenge remains the gap between credit growth and deposit growth, with deposits lagging, which could pressure banks' lending capacity and margins.
In summary, the RBI's message is clear: India's financial system is resilient but not immune. The path through 2026 will require vigilant management of domestic linkages and a prepared stance against inevitable global shocks.
