Indian banks are likely to maintain stable asset quality despite continuing geopolitical uncertainty in West Asia, with slower growth in unsecured lending and reduced exposure to vulnerable segments expected to limit the risk of fresh bad loans, according to a Goldman Sachs report. The global investment bank said the asset-quality outlook for Indian lenders has improved substantially over the past five years, leaving the banking sector better positioned to absorb potential external shocks.

Goldman Sachs said concerns over asset quality have largely been concentrated in granular unsecured lending, particularly consumer unsecured loans and the microfinance (MFI) segment. Aggressive credit expansion in these areas had contributed to higher leverage among borrowers and triggered a non-performing loan (NPL) cycle, with the impact largely concentrated among mid-sized private banks. State-owned banks had no exposure to this particular segment, while stress at large private-sector banks remained limited to manageable levels, according to the report.

Unsecured lending slows

The risk of fresh stress has eased following significant deleveraging across vulnerable lending segments over the past 12-18 months. Goldman Sachs noted that the MFI loan book has contracted by 25% from its peak of Rs 4.4 trillion recorded in March 2024.

Growth in consumer unsecured loans has also moderated. Such lending expanded by around 10-12% in FY25 and FY26, compared with much faster growth of 25-30% during FY23 and FY24. The slowdown indicates that banks have become more cautious in extending credit in segments that previously experienced rapid expansion and rising repayment stress.

The changes are significant for the broader asset-quality outlook because unsecured loans generally carry greater credit risk than secured lending. A sustained moderation in growth, combined with borrower deleveraging, could therefore reduce the pace at which new stressed assets emerge.

West Asia impact seen limited

Goldman Sachs expects the ongoing West Asia crisis to have a limited direct impact on the asset quality of Indian banks. While geopolitical disruptions can affect businesses, trade, commodity prices and borrower cash flows, the report suggests that banks' reduced exposure to vulnerable lending categories provides an additional buffer.

The assessment comes as Indian lenders enter the period of heightened global uncertainty after several years of improvement in bad-loan conditions. The banking sector has also benefited from more disciplined credit expansion and lower exposure to segments that previously generated disproportionate stress.

MFI sector gets credit cover

The microfinance sector has another layer of protection through the Credit Guarantee Fund for Micro Units (CGFMU). According to Goldman Sachs, around 80-90% of the MFI loan book at several banks is now covered by the government-backed guarantee mechanism.

Such coverage could help cushion banks if non-performing loans increase sharply in the segment. However, the underlying quality of borrowers and the ability of financial institutions to maintain disciplined underwriting will remain important factors in determining future asset quality.

Consumer credit still has room

Despite the recent moderation, Goldman Sachs noted that consumer credit remains structurally underpenetrated in India. Unsecured loans account for around 18% of the overall retail loan book, indicating that the segment still has considerable potential for expansion.

For banks, the challenge will be to capture that growth without repeating the aggressive lending cycle seen in earlier years. Overall, the Goldman Sachs assessment indicates that Indian lenders are entering a period of geopolitical uncertainty with stronger asset-quality buffers, lower exposure to risky unsecured lending and more measured credit growth.