The gross non-performing asset (NPA) ratio of Indian banks continued to show improvement in the second quarter of the current financial year, reaching a fresh decadal low, according to a Reserve Bank of India (RBI) report released today.

The improvement in the asset quality of banks, which began in 2018-19, continued into the first half of 2023-24. The gross NPA ratio fell to 3.2% at end-September from 3.9% at end-March, the RBI said in its 'Trend and Progress of Banking' report.

The consolidated balance sheet of banks expanded by 12.2% in FY23. This was the highest in nine years and was driven by credit to retail and services sectors.

As per the report, higher net interest income and lower provisioning led to a boost in net interest margin (NIM) and profitability in FY23.

The banking system and the non-banking financial companies (NBFCs) remain resilient, backed by high capital ratios, improved asset quality and robust earnings growth. "This is supporting double-digit credit growth and domestic economic activity," the RBI said.

"Sustaining this improvement requires further strengthening of governance and risk management practices and building up of additional buffers."

The gross NPA ratio remained the highest for the agricultural sector and the lowest for retail loans, the report showed.

During FY23, the total amount of frauds reported by banks declined to a six-year low, while the average amount involved in frauds was the lowest in a decade, the RBI said.

The balance sheets of non-banking financial companies (NBFCs) expanded at a fast pace in FY23, led by double-digit credit growth. However, notwithstanding the overall robust health of the sector, certain concerns remain, the RBI warned. 

The RBI has asked NBFCs to broad-base their fundraising to limit reliance on banks as it called for strengthening balance sheets and guarding against frauds and data breaches. 

Given the strategic importance of NBFCs in the financial system, the high level of interconnectedness between banks and non-banks merits close attention, it said.

Given the strategic importance of NBFCs in the financial system, the high level of interconnectedness between banks and non-banks merits close attention, the RBI said. 

"Although banks are well-capitalised, they need to constantly evaluate their exposure to NBFCs as well as the exposure of individual NBFCs to multiple banks," it added.

NBFCs on their part should focus on broad-basing their funding sources and reduce over-dependence on bank funding.

"Overall, banks and NBFCs need to further strengthen their balance sheets through robust governance and risk management practices to meet the growing aspirations of the Indian economy."