Mumbai, Jun 30 (PTI) The Reserve Bank on Tuesday said Indian financial system remains resilient, underpinned by strong bank and non-bank balance sheets, as gross non-performing assets of banks have touched a multi-decadal low of 1.8 per cent at end-March 2026.

Despite repeated shocks, the global financial system has thus far demonstrated notable resilience, with markets remaining orderly after an initial bout of volatility following the outbreak of the West Asia conflict, said the Financial Stability Report (FSR).

"India's sound macroeconomic fundamentals place it in a stronger position than many of its peers and provide greater resilience to external shocks than in past crisis episodes," said the half-yearly publication, with contributions from all financial sector regulators.

The report, however, flagged that exchange rate volatility may rise if oil prices increase due to the delayed normalisation of supply chain disruptions and additional demand to replenish inventory.

At the same time, it added that the interim peace deal between Iran and the US can provide tailwinds to Indian economic growth.

"The domestic financial system remains resilient, underpinned by strong bank and non-bank balance sheets. Scheduled Commercial Banks (SCBs) remain safe and sound, supported by strong capital and liquidity buffers, continued improvement in asset quality, and stable profitability," the report said.

The gross non-performing assets of Indian banks came down to a multi-decadal low of 1.8 per cent as of March 2026. The stock of NPAs is expected to inch up to 1.9 per cent in the baseline scenario, the central bank added.

"The aggregate GNPA ratio of 46 banks may edge up from 1.8 per cent in March 2026 to 1.9 per cent by March 2028 under the baseline scenario," it said in the report, which comes amid headwinds from the West Asia conflict.

It, however, said that the banking system's resilience is intact, but funding is emerging as a key challenge as savers chase higher-yielding avenues like equities and mutual funds to park their money.

Banks' liability profile is shifting from low-cost current and savings account (CASA) to higher-cost term deposits and certificates of deposit, pushing up the marginal cost of funds, the RBI said, adding that banks have resorted to higher-yielding loan avenues like small business lending to protect margins.

Amid the threats posed by Anthropic's Mythos model, the RBI said AI-enabled cyberattacks are the "most important near-term challenge" for banks from a cyber threats perspective.

In the Foreword to the report, RBI Governor Sanjay Malhotra said that the global economy and the financial system are being reshaped by two profound forces -- growing geopolitical fragmentation and technological disruption brought about by rapid advances in artificial intelligence (AI).

Despite ongoing conflicts and persistent supply chain disruptions, the global economy has remained resilient, buoyed in part by optimism about potential AI-driven productivity gains, he said, adding that the near-term outlook, however, remains uncertain amid the rapidly evolving global environment.

"The Indian economy and the financial system have demonstrated remarkable resilience despite facing external shocks of significant magnitude. Strong growth, low inflation, healthy balance sheets of financial and nonfinancial firms, and ample buffers have helped preserve macro-financial stability," Malhotra said.

"Nevertheless, we remain alert to evolving external and domestic risks and are committed to further strengthening the guardrails that protect our economy and financial system from potential shocks," he said.

The FSR also emphasised that, though headwinds from the West Asia conflict are receding with the signing of the interim peace deal, the Indian economy and financial system remain susceptible to geopolitical tensions and associated shocks.

"A sharp correction in global equity markets, particularly if driven by a reassessment of corporate earnings growth and elevated valuations in AI-related stocks, could spill over to domestic markets," it said.

The report said the West Asia conflict and consequent increase in global uncertainty also impacted emerging market economies (EMEs) like India through the financial channel.

"The exchange rate came under sustained depreciation pressure due to weakening of capital inflows and higher hedging demand from importers and investors.

"Notwithstanding sustained fiscal consolidation, government bond yields, especially at the longer end, came under pressure mainly reflecting geopolitical tensions and rising energy prices," it said.

However, RBI said the pressure on the exchange rate and bond yields has eased post the measures taken by the Reserve Bank and the Government to attract capital flows, helping overall financial conditions to ease.

It also flagged that fiscal deficit can come under pressure because of the higher prices of energy and other commodities, their limited pass through to pump prices, excise duty cuts and higher outgo on subsidies.

"'... the interim peace deal has laid the foundation for cessation of this conflict and normalisation of supply chains, which could provide tailwinds to growth," the report said.

The country entered the recent bout of global turbulence triggered by the West Asia conflict with stronger macroeconomic fundamentals, it said, conceding that while India's resilience provides an important buffer, some impact is inevitable given the country's substantial dependence on imported energy.

The RBI said most of the high-frequency indicators for April-May 2026 point to continued resilience in economic activity which suggests that growth has remained "firm" in Q1FY27.

"Nevertheless, elevated oil and other commodity prices and weaker global growth could adversely affect India's domestic growth in 2026-27," it said.

On the inflation front, it said a combination of conflict-driven supply shock and projected weak monsoon due to El Nino can push headline inflation to the higher end of the tolerance band or around 6 per cent in Q3FY27 and also worsen inflation expectations.

The recent decline in net FDI (foreign direct investment) may reflect the tightening of global financial conditions, it said, adding that foreign portfolio flows to India have also been under pressure..

The report also highlighted that the overall debt of the household sector continued to trend upward and touched 45.5 per cent of the country's gross domestic product (GDP), due to an uptick in non-housing retail loans..

The central bank said the increase in household sector debt was due to rising non-housing retail loans, which constituted 58.4 per cent of total borrowings as of March 2026. Their share has increased steadily over time, consistently outpacing housing loans as well as agriculture and business loans. PTI MSU AA NKD MR