'Three Risks...' Zerodha Decodes RBI's Financial Stability Report

The Reserve Bank of India ( RBI ) recently released its Financial Stability Report, offering a comprehensive health check of the country’s financial system.

Zerodha , a leading brokerage firm, took to X (formerly Twitter) to distill the report’s insights into a thread, identifying three critical risks that could challenge India’s economic progress. While the firm emphasized that these scenarios might never materialize, it encouraged staying informed and prepared. Here’s a closer look at the key takeaways.

1. Household Finances: Rising Debt Amid Uneven Borrowing Trends
India’s household debt has risen to 42.9% of GDP , still below the 50–60% average of other emerging markets. However, the upward trend over the last three years raises concerns, especially as household debt in other countries has declined. Interestingly, this increase stems from more borrowers entering the system rather than larger individual loans, signaling improved access to credit—a positive development.

‘India’s household debt, at 42.9% of GDP, is still lower than in many other emerging markets, which often hovers around 50–60%. However, this number has been creeping up over the past three years, even as household debt in other countries has been going down. Interestingly, this rise is due more to an increase in the number of borrowers than larger individual loans, which indicates better access to credit—a good sign,’ as mentioned by Zerodha on X.
 

According to Zerodha, the loans fall into three primary categories:
Consumption loans: Personal loans, credit cards, and consumer durable loans.
Asset creation loans: Mortgages and vehicle loans.
Productive loans: Funding for agriculture, businesses, or education.
Consumption loans are gradually increasing, suggesting that more households are borrowing to cover everyday expenses.

Zerodha further highlighted a disparity in borrowing behavior based on creditworthiness. Subprime borrowers (lower credit scores) allocate 48% of their loans toward consumption, compared to 31% for super-prime borrowers (excellent credit scores), who primarily invest in assets like housing.

Super-prime borrowers’ per capita debt has risen significantly, strengthening repayment prospects as their debt fuels asset creation. However, the reliance on consumption loans among subprime borrowers could pose risks if repayments falter. Zerodha notes ‘However, the growing reliance on consumption loans among subprime borrowers could pose risks if they struggle to keep up with repayments. Keeping track of these trends is crucial for the overall stability of household finances.’

2. Pricey Valuations and Weak Corporate Earnings
India’s equity markets saw record highs in September 2024, driven by optimism despite slowing corporate earnings growth and high valuations. Even after a correction, India’s market outperformed emerging market peers, with the MSCI India Index delivering a 19.5% return in 2024, compared to 8.3% for the MSCI Emerging Markets Index.
Midcap, small-cap, and micro-cap stocks led the charge with returns exceeding 30%, outpacing the Nifty 50 Index’s 17% annualized return.

Zerodha adds, “A discounted cash flow model in the RBI’s Financial Stability Report points out that a higher equity risk premium—indicating stronger investor appetite for risk—has driven the Nifty Midcap 100 Index. On the other hand, the Nifty 50 Index’s gains are more closely tied to actual earnings growth.”

The RBI’s report flagged stretched valuations across metrics like price-to-earnings (P/E) ratios and market-cap-to-GDP. For midcaps and small-caps, valuations remain particularly elevated. To justify these levels, corporate earnings growth must surpass current expectations.
For instance, Nifty 50’s earnings growth is projected below 10%, but it needs to exceed 14% to align with current valuations. This gap is wider for pricier indices like midcaps and small-caps.

As quoted in the tweet by Zerodha, SEBI Whole Time Member Ananth Narayan G noted, “Prolonged mismatches of this nature can leave us with more of asset price inflation, rather than capital formation.”
 

3. Banking System: Hidden Vulnerabilities
While India’s banking system appears stable overall, vulnerabilities persist. Zerodha pointed out that three banks, accounting for 15% of total assets, continue to exhibit weaknesses. Though this marks an improvement from previous years, the risks cannot be ignored.

Banks are shifting from low-cost CASA deposits to higher-cost term deposits, which now account for 82% of new deposits raised in 2024–25. The rising reliance on high-interest certificates of deposit has also pushed up banks’ cost of funds by 148 basis points since March 2022, compressing net interest margins. Despite these challenges, return on equity and assets improved in September 2024.

However, asset quality raises red flags. While the gross non-performing asset (NPA) ratio is at a 12-year low of 2.6%, retail loans—especially unsecured ones like personal loans and credit cards—account for 51.9% of new NPAs. Zerodha also highlighted an alarming rise in Special Mention Account (SMA) loans, which signal early repayment stress. Public sector banks, in particular, saw a jump in SMA-2 loans for large borrowers.

What compounds the risk is the overlap between borrowers. Nearly half of those with credit cards and personal loans already carry significant housing or vehicle loans. Defaults in unsecured loans could trigger a domino effect, affecting larger debts.

Balancing Risks and Optimism
Zerodha summarized that while the risks in household debt, equity valuations, and the banking system are concerning, they are not insurmountable. Regulatory measures, such as raising risk weights on consumer credit, have already slowed growth in retail loans and lending to NBFCs, reducing systemic risks.

On the corporate front, sales growth of 6.2% in the first half of the fiscal year and improving debt-to-equity ratios offer some reassurance. However, rising borrowing costs and a drop in manufacturing operating profits warrant caution.

As Zerodha concluded, “It’s not all sunshine, but it’s not all doom and gloom either. We’ve done our part by giving you a report card for India—highlighting both the wins and the challenges.”

The firm left readers with a question: “What do you think 2025 holds for India? Will the nation continue its upward climb, or will these risks slow down the progress?”