The economic impact of Covid-19 was cushioned by abundant liquidity in the banking system, lowering of cost of funds and regulatory forbearance in asset classification of specified loans.

This helped banks report better than anticipated results despite subdued credit offtake. “India’s banking system faced the pandemic with relatively sound capital and liquidity buffers built assiduously in the aftermath of the global financial crisis and buttressed by regulatory and prudential measures,” Reserve Bank of India governor Shaktikanta Das said.

Das, however, warned that Covid-19 pandemic can result in balance sheet impairments and capital shortfalls as regulatory reliefs are rolled back. In his foreword to the RBI’s biannual financial stability report, Das also said that maintaining banking sector’s health remains a policy priority.

The RBI report has warned that worsening financials of the corporate sector is bound to have its impact on the banking system once the regulatory dispensations get lifted.

The central bank had declared a six-month moratorium which ended in August. It later announced a one-time loan recast package to help borrowers.

Das said that available accounting numbers obscure true recognition of stress at banks. Lenders should raise capital and alter their business models.

"Expansion in government's market borrowing programme following Covid-19 has imposed additional pressures on banks," he said.

Das warned of the divergence between the financial markets and the real economy. He also cautioned against ballooning stock and bond values.