The Reserve Bank of India (RBI) has cautioned that banks’ exposure to retail loans needs “close monitoring” and lending to micro enterprises is showing “nascent stress”.

Despite the asset quality “remaining benign” in both these segments amid “above-average loan growth”, they remain vulnerable to the spillover effects of the US-Israel war with Iran.

On retail loans, the RBI in its latest Financial Stability Report (FSR) said “risks to asset quality could increase, especially if overall economic conditions weaken due to the West Asia conflict and impact borrower cash flows”.

As of 31 March 2026, the gross non-performing assets (NPAs) in secured and unsecured retail loans stood at 0.7% and 1.7%, respectively.  

Faced with a squeeze on margins as deposits have trailed behind credit growth, banks have expanded credit to higher-yielding segments such as micro, small and medium enterprises (MSME) and retail.  

“Banks that meaningfully increased their MSME and retail lending experienced relatively muted pressure on net interest margins, even as CASA (current account savings account) shares declined, indicating that higher yields from these segments partly compensated for rising funding costs,” the RBI said in its report.

Funding is emerging as a key challenge for banks as their liability profile is shifting from low-cost CASA to higher-cost term deposits and certificates of deposits (CDs), pushing up the marginal cost of funds. This has coincided with investment preferences of savers shifting towards higher-yielding equities and mutual funds, altering the composition of bank deposits that attract higher run-offs.  

The inverse relationship between CASA deposits’ share and interest rates has weakened, compared with previous interest rate cycles. As competition for household savings intensifies and banks’ deposit franchise gets affected, it could weigh on the profitability despite credit demand remaining strong.

The report also pointed out that banks have been running down their excess statutory liquidity ratio (SLR) investments to fund credit growth, resulting in declining liquidity coverage ratio (LCR) buffers. The recent measures by the RBI and the government, however, are expected to attract foreign currency inflows and ease funding pressures on banks by improving their access to lower-cost rupee liquidity.

Housing debt climbs to 45.5% of GDP

India’s household debt reached 45.5% of gross domestic product (GDP) at the end of September 2025, driven mainly by non-housing retail loans.

The RBI said in its report that household sector debt constituted 58.4% of total borrowings as of March 2026. 

Household debt as a share of GDP has remained above its five-year average of 42.9% since September 2023, the report said.

Borrowings for consumption purposes accounted for nearly half of total household debt, followed by loans for productive purposes, while loans for asset creation expanded at a slower pace.

Among emerging market economies, India stands fourth after China (third position with household debt of 59% of GDP, Malaysia (69.9%), and Thailand (87.3%), the RBI said.

Housing shifts increasingly to large-ticket loans

Continuing with the trend in recent years of housing loans moving towards higher-value segments, the share of Rs 50 lakh and above credit limits accounts for 44.7% of the total portfolio as of 31 March 2026.

The shift has happened over time, with housing loans below Rs 25 lakh having a share as high as 60.6% of total outstanding as of March 2014. This reflected the focus on affordable housing, now a declining segment as developers have moved increasingly to constructions in the mid-to premium segment.

Despite the shift towards bigger-sized loans, bad loans in the segment remain low for banks. The gross NPA ratio in housing loans has declined from pre-Covid levels, falling to 0.5% in March 2026 from 1.2% in March 2019.