The bad loans of Indian banks could rise up to 9.5% of their total lending by September next year, the Reserve Bank of India predicted on Wednesday.

In its biennial financial stability report, the central bank noted that this would be the case in a “severe stress scenario”, if India’s Gross Domestic Product contracts by 2.1% in the second half of this financial year and rises by 1.1% in the first half of fiscal year 2022-’23.

In a “baseline scenario”, under which the GDP rises by 6.3% in the second half of the current fiscal and by 12.5% in the next financial year, the bad loans could rise to 8.1%, the Reserve Bank of India said.

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In September this year, bad loans accounted for a six-year low of 6.9% of the total loans, the RBI report said. However, the central bank noted that research from emerging economies have showed that bad loans typically peak in six to eight quarters after the onset of a recession.

India’s economy had slipped into a recessionary phase in the second quarter (July-September) of the previous financial year (2020-’21). An economy is considered to be in a technical recessionary phase when the GDP contracts for two or more consecutive quarters.

Hit by a nationwide coronavirus lockdown, India’s economy had contracted by an unprecedented 23.9% in the first quarter (April-June) of the previous financial year, and by 7.5% in the second quarter.

Projection of bad loans under various scenarios. PSBs stand for public sector banks, PVBs for private banks, FBs for foreign banks and SCBs for scheduled commercial banks. (Source: RBI financial stability report)

The financial stability report released on Wednesday, however, indicates an improvement in the loan resolution scenario of Indian banks. In the last financial stability report released in July, the RBI had predicted that bad loans could rise up to 9.8% by March 2022 even under the “baseline scenario”.

“As highlighted in this issue of the financial stability report, financial institutions in India have remained resilient amid the pandemic, and stability prevails in the financial markets, cushioned by policy and regulatory support,” RBI Governor Shaktikanta Das wrote in the foreword of the document released on Wednesday.