Context:

The stability of a modern economy depends fundamentally on the strength of its financial system. Banks, non-banking financial institutions, payment systems, and capital markets not only drive economic activity but also possess the capacity to support the entire economic framework during times of crisis. Global financial history clearly demonstrates that when financial stability weakens, its impact is not limited to the economic sphere alone; it extends deeply into social and political domains as well. The Global Financial Crisis of 2008 is a direct example, where instability in the financial sector adversely affected employment, social security, and governance structures.

• • • • Today, as the global economy navigates geopolitical tensions, high interest rates, supply-chain disruptions, and rapid technological change, assessing India’s financial position becomes even more relevant. In this context, the Financial Stability Report published by the Reserve Bank of India indicates that India’s banking system remains robust overall. At the same time, certain emerging trends pose potential risks to financial stability in the future—particularly unsecured retail credit, fintech-based digital lending, and challenges associated with crypto-assets.

Key Highlights of the Financial Stability Report:

• • • • According to the report, India’s overall fiscal health remains stable. Sovereign debt is at a sustainable level, supported by the upgrade of India’s credit rating to ‘BBB’ by S&P Global Ratings, a favorable interest rate–growth differential, and a relatively low level of foreign currency liabilities.
      • While markets exhibit optimism driven by prospects related to Artificial Intelligence (AI), the report cautions that such optimism may mask underlying vulnerabilities and increase susceptibility to global spillovers.
      • Lending in the fintech sector has grown sharply by 36.1%; however, the Reserve Bank of India has expressed concern over higher impairment levels among borrowers who have taken unsecured loans from five or more lenders.
      • The report also highlights that the widespread adoption of foreign-currency-denominated stablecoins could undermine India’s monetary sovereignty, weaken policy transmission, and increase the risks of money laundering.
      • On the currency front, the Indian rupee has depreciated against the US dollar, influenced by a deterioration in terms of trade, higher tariffs compared to trading partners, and a slowdown in capital inflows. Despite these pressures, the banking sector remains strong: Scheduled Commercial Banks (SCBs) maintain adequate capital buffers, and the Gross Non-Performing Asset (GNPA) ratio declined to a multi-decadal low of 2.2% as of September 2025.

Financial Stability and Its Importance:

• • • • Financial stability refers to a condition in which financial institutions, markets, and infrastructure operate smoothly without major disruptions, are able to absorb internal and external shocks, and continue to support the real economy. It is not a concept confined merely to bank balance sheets; it also encompasses consumer confidence, investor sentiment, the reliability of payment systems, and the credibility of policymakers.
      • For a developing country like India, financial stability assumes even greater importance, as economic growth, employment generation, and poverty alleviation are directly linked to a well-functioning financial system. Any financial instability tends to impact the most vulnerable sections of society first and most severely, thereby increasing inequality and the risk of social unrest.

Resilience of the Indian Economy:

• • • • In recent years, the Indian economy has faced several significant global and domestic shocks—such as the COVID-19 pandemic, fears of a global slowdown, supply disruptions, and geopolitical conflicts. Despite these challenges, India’s economic growth has remained relatively strong. A key reason for this resilience is that India’s growth has been primarily driven by domestic demand.
      • The continued strength of the services sector, increased public capital expenditure, investment in infrastructure, and the expansion of the digital economy reflect India’s economic resilience. Public capital expenditure has encouraged private investment through a “crowding-in effect,” thereby supporting both the quality and demand for bank credit. At the same time, contained inflation and prudent monetary policy have played an important role in maintaining overall macroeconomic stability.
      • This resilience indicates that the Indian economy is increasingly being anchored in structural reforms rather than relying solely on short-term policy interventions.

Strength of the Banking System and Impact of Reforms:

• • • • The Indian banking system has faced serious challenges in the past. At one point, high levels of Non-Performing Assets (NPAs) were the most significant concern for banks. Weak credit discipline, inadequate corporate governance, and insufficient regulatory oversight had undermined the banking sector.
      • However, notable improvements have been observed in recent years. The implementation of the Insolvency and Bankruptcy Code (IBC), bank recapitalization, improvements in credit appraisal processes, and the strengthening of risk management frameworks have led to a historic decline in NPAs. Today, Indian banks operate with better capital adequacy, greater transparency, and stronger balance sheets, providing a solid foundation for financial stability.
      • Nevertheless, it is important to acknowledge that the reform journey is not yet complete. Delays in IBC processes, large haircuts, and governance-related challenges in public sector banks suggest that further deepening of banking reforms remains necessary.

Unsecured Retail Credit:

• • • • While the banking system appears strong, the rapid expansion of unsecured retail credit has emerged as a potential risk. Personal loans, credit cards, and “buy now, pay later” products have made credit extremely accessible.
      • Credit accessibility, in itself, is not negative, as it supports consumption and boosts short-term economic activity. Problems arise, however, when credit growth outpaces borrowers’ actual repayment capacity. Since unsecured loans lack collateral, the risk to the banking system increases significantly in the event of defaults.
      • If this trend remains unchecked, rising household debt levels and a widening credit-to-GDP gap could generate systemic risks. This situation recalls the sub-prime crisis of 2008, where excessive and irresponsible lending pushed the global financial system into deep turmoil.

Fintech and Digital Lending:

• • • • The fintech revolution has made India’s financial system more inclusive. Digital payments, rapid loan approvals, and data-driven credit assessment have extended financial services to segments that were previously excluded from the formal financial system. This represents a major achievement in advancing financial inclusion.
      • However, alongside rapid growth in fintech lending, weak underwriting standards, inadequate regulatory oversight, and the accumulation of multiple loans from different sources by the same borrower have become serious concerns. This underscores that technological innovation cannot progress sustainably without appropriate regulation.
      • A coordinated regulatory framework, robust data-sharing mechanisms, and effective consumer protection norms will be essential to maintain a balance between innovation and stability in this sector.

Crypto-Assets and Monetary Sovereignty:

• • • • The digital age has challenged traditional notions of money. Crypto-assets and stablecoins are creating a parallel system outside the conventional financial framework. While proponents view them as symbols of decentralization and financial freedom, regulators consider them potential threats to financial stability and monetary sovereignty.
      • In particular, foreign-currency-denominated stablecoins could weaken the effectiveness of central bank monetary policy. If large-scale transactions shift outside the traditional currency system, the central bank’s ability to exercise monetary control may be compromised, posing a serious challenge to monetary sovereignty. In this context, Central Bank Digital Currency (CBDC) emerges as a balanced solution, enabling the adoption of technological innovation while preserving monetary control.

Social Dimension of Financial Stability:

• • • • Financial stability is not merely an economic concept; it has an equally important social dimension. Instability in the banking system directly affects employment, savings, and social security. Middle- and lower-income groups are especially vulnerable during financial crises.
      • Therefore, financial stability cannot be confined to numerical indicators and ratios alone. It must also encompass ethical lending practices, consumer protection, and financial literacy.

Way Forward:

India’s financial system stands at a critical juncture today. On one hand, there is a strong banking system, improved capital positions, and economic resilience; on the other, there are risks stemming from unsecured credit, fintech lending, and crypto-assets. For policymakers, the foremost challenge is to maintain a balance—ensuring responsible credit expansion, fostering innovation alongside regulation, and advancing financial inclusion.

Conclusion:

Financial stability is not a static condition but a continuous process that demands constant vigilance, timely intervention, and forward-looking policies. The Indian banking system has strengthened itself by learning from past weaknesses, yet future challenges are more complex and multi-dimensional. If India succeeds in maintaining a balance between strength and caution, it will not only remain resilient to global financial uncertainties but also establish financial stability as a public good, thereby paving the way for sustainable and inclusive economic growth. This will be the true test of India’s financial stability.

UPSC/PCS Main Exam Question: What does the Reserve Bank of India’s Financial Stability Report indicate about India’s economic situation? Discuss the emerging risks and policy options.