India's Banking Sector Remains Resilient Despite Rising Funding Costs: RBI Report

New Delhi, Jul 1 (KNN) India’s banking sector remains resilient with strong capital buffers, healthy asset quality, robust profitability and adequate liquidity, according to the Reserve Bank of India’s (RBI) latest Financial Stability Report.

The report also noted that  rising funding costs and intensifying competition for deposits are emerging as key challenges. 

Banking Sector Remains Financially Strong 

The RBI report said the banking sector has strengthened steadily in recent years, with key indicators such as capital adequacy, liquidity, profitability, asset quality and loan-loss provisions remaining robust, reported Economic Times.

It added that there are no signs of emerging stress, with Special Mention Account-2 (SMA-2) loans and credit costs continuing to decline.

Rising Deposit Costs Put Pressure on Margins 

Healthy bank balance sheets have supported credit growth, particularly fresh lending. However, banks are increasingly relying on higher-cost term deposits and certificates of deposit (CDs) as low-cost current and savings account (CASA) deposits lose share, adding pressure on funding costs and profitability amid stronger competition for household savings.

The report noted that banks have also utilised excess statutory liquidity ratio (SLR) investments to sustain credit growth, leading to lower liquidity coverage ratio (LCR) buffers. 

Recent measures to improve capital flows are expected to ease funding pressures by increasing access to lower-cost rupee liquidity.

MSME and Retail Lending Support Profitability 

To protect margins, banks have expanded lending to higher-yielding segments such as micro, small and medium enterprises (MSMEs) and retail loans. 

According to the RBI, lenders with greater exposure to these segments have faced relatively lower pressure on net interest margins as higher loan yields helped offset rising funding costs.

Despite strong credit growth in MSME and retail portfolios, asset quality has remained stable. 

The report noted early signs of stress among micro enterprises, but the overall gross non-performing asset (NPA) ratio in the MSME segment continued to improve. 

As of end-March 2026, gross NPA ratios in the retail segment stood at 0.7 percent for secured loans and 1.7 percent for unsecured loans.

RBI Flags Geopolitical Risks to MSMEs 

The RBI cautioned that the MSME sector remains vulnerable to disruptions from the ongoing West Asia conflict. 

While the current impact appears limited, it said banks' exposure to MSME and retail loans requires close monitoring, as prolonged geopolitical tensions could affect borrower cash flows and asset quality.

(KNN Bureau)