Indian banks are preparing for asset quality stress from the second quarter onward due to the West Asia conflict, with senior bankers anticipating visible impact in upcoming financial results. According to The Economic Times, fuel price hikes will erode disposable incomes of retail borrowers, while rising input costs risk compressing corporate margins. As Kotak Mahindra Bank's executive director Paritosh Kashyap noted, "The impact of the West Asia crisis on fuel prices, inflation and rupee depreciation will certainly affect multiple industries-SMEs, large corporates as well as small borrowers. In Q2, all of this impact will be visible in the financials of those companies." The inflationary lag effect makes Q2 asset quality a critical monitorable for the sector, with banks' books remaining clean for now but facing pressure from sustained high energy prices. ICRA's senior vice president Anil Gupta confirmed that "The asset quality stress is likely to start reflecting from the second quarter results of lenders, as the inflationary impact of fuel price hikes will weigh on disposable incomes of retail borrowers, while higher input costs will potentially squeeze corporate margins."
Small and medium enterprises face significant pressure from the West Asia conflict, with lenders becoming increasingly cautious about lending to this segment. Yes Bank's managing director Vinay Tonse confirmed the bank is pulling back from MSME lending until there is greater visibility on the conflict's trajectory, stating "Over the next couple of months, we will not be aggressive in lending to micro, small and medium enterprises (MSMEs) until we derive greater comfort that the situation has stabilised and clarity emerges on the war." As Kotak's Kashyap explained, "SMEs will be squeezed from both ends-they may not be able to pass on cost increases to their anchor corporates, while raw material, supply chain and input costs are all rising simultaneously." ICRA projects system-wide gross NPAs at 2.0-2.1% in FY27, with deterioration concentrated in private bank portfolios given their heavier exposure to unsecured retail and MSME credit. The agency noted that credit guarantee scheme support could provide partial relief to both borrowers and lenders during this challenging period.
According to reports from Moody's Ratings, Indian banks are among the more exposed in the Asia-Pacific region due to the economy's high dependence on energy imports from West Asia. The US-based rating agency highlighted that sustained high energy prices from the prolonged West Asia conflict will impact Asia-Pacific banks' credit profiles through their loan portfolios and financial channels. As reported by Moody's, the agency expects financial conditions to remain relatively tight across energy-importing economies, with the central scenario reflecting a sustained Strait of Hormuz disruption through the third quarter of 2026, with oil prices averaging $90-110 per barrel during much of the year. The ongoing stalemate over the US-Iran deal has further intensified these risks for Indian banks.
India's macro indicators reinforce the banking sector's concerns, with the wholesale price index surging to 8.3% in May 2026 on soaring fuel costs, while the merchandise trade deficit ballooned to $28.4 billion in April - among the highest monthly readings in recent years. The rupee has depreciated 7.04% in calendar year 2026, with the bulk of the fall 5.01% occurring between March 2 and May 21, directly coinciding with the oil price spike triggered by the conflict. SBI chairman CS Setty warned in the bank's 2026 annual report that "The economic fallout of the conflict may lead to lower GDP growth and higher inflation in FY27," noting that RBI regulatory dispensation and fiscal measures were being deployed proactively to absorb the shock. ICRA pegs India's real GDP growth at 6.5% in FY27, assuming crude at $85 per barrel, with credit growth moderating sharply to 11-11.7% from 15.9% in FY26.
As reported by Moody's, India's non-bank lenders face particular pressure, given their large exposure to unsecured retail loans, where asset quality deterioration is expected. In contrast, Indian banks' sizeable agriculture exposure should see only modest deterioration, as adequate fertiliser stockpiles limit import cost shocks, though higher diesel prices will still pressure farm cash flows. The central bank in India faces pressure to raise rates to contain inflation and currency weakness, which will raise banks' funding costs and amplify risks to credit quality. The Economic Times reports that India is seeking to boost its fertiliser reserves for the upcoming kharif sowing season by floating tenders for 1.7 million tonnes of urea to counter global supply chain issues stemming from ongoing West Asia conflicts.
According to Moody's, Indian banks enter this period with good capital and provisioning buffers, positioning them well to absorb credit losses without threatening solvency. The agency noted that despite these pressures, Indian banks possess strong capital buffers that provide resilience against the expected credit stress from sustained high energy prices and economic disruption. This strong capital position is particularly important given the anticipated increase in funding costs and credit quality risks that the central bank may need to address through monetary policy adjustments. The Times of India reports that the rating agency said Indian banks are among the more exposed in the region, given the economy's high dependence on energy imports from the Middle East and the consequent pressure on inflation, interest rates and borrower cash flows.
