The recent disclosures by the IndusInd Bank about discrepancies in account balances related to currency derivatives have raised concerns whether it's just IndusInd Bank or others too have similar problems. IndusInd Bank disclosed on Monday that it has launched an internal review of a portion of its derivative portfolio after discovering discrepancies in account balances. The bank estimates these discrepancies could result in a financial impact of approximately 2.35% of its net worth, with analysts projecting a potential resultant loss of nearly Rs 1,600 crore in the March quarter.Now, the RBI has contacted several large banks to verify their hedging effectiveness and positions in the forex derivative market, ET has reported based on information from people aware of the matter.Indian banking sector has long recovered from the bad loans problem that weighed it down once. The sector is healthy, with improved asset quality, capital position and profitability, but there are some areas of concern too such as unsecured retail loans and micro-finance while hard gaze of the RBI and slow deposit growth also pose growth challenges.Bad loans ratio at a 12-year lowAsset quality of banks improved further and their gross non-performing assets (GNPA) or bad loans ratio declined to a 12-year low of 2.6 per cent in September 2024 on the back of falling slippages and steady credit demand, as per RBI. The net NPA ratio or the proportion of net non-performing assets in net loans and advances was at around 0.6 per cent, according to the RBI's December 2024 issue of the Financial Stability Report."Buoyed by falling slippages, higher write-offs and steady credit demand, the gross nonperforming assets (GNPA) ratio of 37 scheduled commercial banks (SCBs) fell to a multi-year low of 2.6 per cent," the report said. The improvement in asset quality of SCBs was broad-based across sectors and bank groups.According to the report, the share of large borrowers in GNPA of SCBs has steadily declined over the past two years. The asset quality of banks' large borrower portfolios has improved considerably, with the GNPA ratio falling from 4.5 per cent in March 2023 to 2.4 per cent in September 2024. In the large borrower segment, the share of standard assets in total funded amount has consistently improved over the past two years.Notably, none of the top 100 borrowers are classified as NPAs in September 2024. In terms of value, investment grade advances (rated BBB and above) constituted 91.5 per cent of the funded advances to large borrowers with long-term external ratings, the report said.However, the RBI also flagged concern over a sharp rise in write-offs, especially among private sector banks (PVBs), which could be partly masking worsening asset quality in unsecured lending segment and dilution in underwriting standards.The report cautioned that “vulnerabilities in the form of stretched equity valuations, pockets of stress in the microfinance and consumer credit segments, and risks from external spillovers require close monitoring.”Improving profitabilityProfitability of SCBs improved during H1:2024-25, with profit after tax (PAT) surging by 22.2 per cent (y-o-y), the report said. Public sector banks (PSBs) and PVBs recorded PAT growth of 30.2 per cent and 20.2 per cent, respectively, while foreign banks (FBs) experienced single digit growth (8.9 per cent). RBI said the banking stability indicator (BSI), which provides an assessment of the resilience of the domestic banking system, showed further improvement during H1:2024-25. The resilience of the domestic banking system has been bolstered by robust capital buffers, strong earnings and sustained improvement in asset quality.A significant profit milestone awaits India's public sector banks in 2024-25, and low NPAs and healthy credit growth are likely to combine to drive their profits past the Rs 1.5 lakh crore mark during the FY, PTI had reported in December citing official data. These banks already saw profits rise 25% to Rs 85,520 crore in the first half of the fiscal year compared to the same period last year. This positive trend builds on a record Rs 1.41 lakh crore profit in 2023-24, thanks to improved asset quality, lending, capital reserves, and returns. The gross non-performing assets (NPA) ratio dropped to 3.12% in September 2024 from a high of 14.58% in March 2018. The Capital to Risk (Weighted) Assets Ratio (CRAR) reached 15.43% in September 2024, significantly higher than the 11.5% mandated by the RBI. The RBI's 2015 Asset Quality Review and subsequent reforms are credited with turning around the banks' performance. PSBs have returned Rs 61,964 crore in dividends to shareholders over the last three years. Anticipated rate cuts by the Monetary Policy Committee could further boost credit demand.Liquidity coverage ratioThe liquidity coverage ratio (LCR) for banks, tested by the Reserve Bank of India (RBI) on two stress scenarios, showed that almost no bank would fail to maintain LCR above the minimum requirement of 100%. As of September 2024, all banks have maintained LCR comfortably above the regulatory requirement of 100%. The average banking system LCR declined to 128.5% over the year, from 135.7% in September 2023 due to an increase in net cash outflows. The LCR for public sector banks declined sharply to 127.4% from 142.1% in September 2023, while the LCR for private sector banks stood at 126.1% as of September 2024.Poor deposit growthIndian banks are advancing more loans than they are incrementally garnering deposits, the latest central bank data showed, pointing to only a partial success for dedicated lender programmes aimed at boosting the deposit base and de-risking the credit environment, ET has reported. The banking sector's incremental loan-to-deposit ratio (LDR) on a three-month rolling basis reached nearly 126% as of February 7, 2025. The incremental LDR stands at 103% so far this fiscal year, pointing to the persisting weakness in deposit mobilisation despite more circumspect advances toward unsecured loans and non-bank financing. As of February 7, credit climbed 11.3% year-on-year, while deposits saw a more modest increase of 10.6%.An analysis by India Ratings highlights that deposits have consistently trailed the banking system's credit growth since FY22, with an average gap of 416 basis points. This disparity has pushed system-wide LDR higher, reaching 80.4% in the first half of the current fiscal year. A rising LDR indicates that banks are increasingly relying on borrowed funds or other means to fund their credit growth rather than deposits, which could limit their lending capacity in the medium term.A report by Motilal Oswal Securities underscores the competitive pressures banks are facing. It notes that many banks are focusing on enhancing their credit-deposit (CD) ratios, leading to heightened competition for deposits. At the same time, public sector banks are also becoming more competitive, further intensifying the battle for depositors' funds.Concerns over micro lendingSmall finance banks with a higher share of micro loans are in the most challenging situation with the ongoing stress in the microfinance sector, which saw the average gross non-performing assets (NPA) rising to an 18-month high of 11.6% at the end of September 2024. As a group, these lenders had 15.3% of their cumulative microfinance portfolio as NPAs. Industry-level data till end of December is not available just yet, but the overall sectoral asset quality is likely to worsen, quarterly earnings showed.ET reported in January that the RBI developed ‘supervisory discomfort’ with a couple of small finance banks (SFBs) due to high concentration risks and rising asset quality stress. The banking regulator has also told these banks to explore mergers to gain scale and minimise concentration risks, three executives tracking the sector said. “Small finance banks are under the ‘close supervision’ of RBI,” said one of the persons. “Amalgamation between banks is one of the options that have been thought of at the regulatory level to address the concerns.”Non-performing assets in the microfinance sector surged to an all-time high of Rs 50,000 crore, or 13% of the gross loans, at the end of December last year, ET reported on February 27. The portfolio at risk that may turn NPA rose to 3.2% of the total loans, from 1% a year ago, reflecting a severe deterioration in overall credit discipline. Consolidated data isn't available on stressed unsecured advances at NBFCs, with fintech-led non-bank lenders involved in the business of riskier personal loans often taken as a proxy to assess the extent of the value at risk. The Fintech Association for Consumer Empowerment, a self-regulatory body, said personal loans outstanding by fintech companies dropped to Rs 66,683 crore at the end of September 2024, compared with Rs 74,057 crore a quarter ago. Unpaid loans over 90 days increased to 3.4% from 3.2% in the same period.Recently, the RBI lowered the capital buffer lenders needed to assign against such loans after having raised the risk weights nearly 15 months ago. It restored the older risk weights on loans to NBFCs effective April 1, and those on microfinance lenders and borrowers immediately."Sanjay Malhotra, the new Reserve Bank of India governor, is right to unwind some of his predecessor’s hawkish controls on a runaway consumer-credit boom," Bloomberg columnist Andy Mukherjee has written recently. "There was a time to throw sand in the wheels of commerce. Right now, though, a sputtering growth engine needs lubrication. Still, Malhotra must be cautious. There is a crack in the structure of the world’s fastest-growing major economy. Speeding up subprime loans could be risky down the road."