Structural Strain in Global Banking – Reassessing Institutional Resilience in India
Over the past year, the underlying stress indicators within the global banking system have become increasingly difficult to ignore. This is particularly true about the mid-sized and regional banks in the U.S. and Europe. Persistently high interest rates have triggered mark-to-market losses on bond portfolios and necessitated higher loan loss provisioning, steadily compressing capital buffers. These pressures don’t occur in isolation. Institutions such as the IMF and Moody’s have raised concerns about a confluence of tightening financial conditions, such as elevated asset valuations, constrained funding markets, and increased leverage within non-bank financial intermediaries. Taken together, these developments suggest that while everything may look hunky-dory on the outside, the system's resilience is being gradually undermined by compounding vulnerabilities across traditional as well as shadow banking sectors.
The global banking system might look stable on the surface, but a closer look reveals a different picture. Over the past year, there’s been a steady build-up of stress, especially in regional banks across the U.S. and Europe. While these signals may not have sparked panic yet, they are too consistent and too interconnected to be ignored.
As per a Global Stress Test recently run by the IMF, on average, systemic banks appeared to have healthy capital buffers of around 12.7% under baseline conditions. But the real concern lies in what happens if things don’t go as planned. If interest rates remain high or economic growth slows, the pressure on banks could increase sharply. We’ve already seen how quickly things can deteriorate. After the sudden collapses of Silicon Valley Bank and Signature Bank, Moody’s downgraded the entire U.S. regional banking outlook, citing rapid and visible signs of weakness.
In Europe, the warning signs are more technical but just as important. Some banks hold complex financial instruments, called Level 2 and Level 3 assets, which don’t have easily available market prices. In extreme cases, these assets are valued at nearly five times the bank’s core capital. If market liquidity dries up or asset prices shift suddenly, these institutions could face serious valuation shocks that ripple through their balance sheets.
Regulators and analysts are paying increasing attention to the changing scenario. The IMF has pushed for stronger and more consistent implementation of global banking rules, especially to manage risks emerging from non-bank financial players. S&P analysts have stressed the need for better early-warning systems, while Fitch and others have flagged rising macroeconomic threats—from global inflation to climate risks and geopolitical tensions—that could quickly erode bank margins.
Now, what could bring the banking sector back from the brink? Several factors, indeed!
Interest rates that stay higher for longer will keep pushing down the value of bonds and securities on bank books. Corporate and household debt levels are already high in many advanced economies, raising the risk of defaults. If confidence weakens further, banks may start hoarding liquidity, creating disruptions in interbank markets and increasing their reliance on central banks. And then there’s the vast and largely unregulated $63 trillion shadow banking sector, which is tightly linked to traditional banks. A shock in that part of the sector could spread quickly and unpredictably.
However, the most worrying part of these issues is that they won’t remain local for long. If the U.S. regional banks continue to struggle, the regional banking systems around the world could feel the tremors. With the funding lines interconnected throughout the world and cross-border exposures in place, it only means that financial stress in one corner of the world could shake the financial confidence in another corner too.
India, thankfully, is in a stronger position today than it was a few years ago. After facing back-to-back banking challenges between 2018 and 2020, asset quality has improved, thanks to tighter regulation and better oversight. Capital requirements are more conservative, and provisioning norms are stricter. But India isn’t immune.
Key Risks for Indian Banks
Second round effects: If U.S./EU banks deteriorate again, volatility could spill into Indian markets, tightening liquidity and funding.
Shadow finance linkage: Indian NBFCs and co operative banks remain sensitive to broader liquidity disruptions—past IL&FS runs showed how quickly this can mutate.
Asset re-pricing: Indian banks hold significant government and corporate bonds; global yield volatility may trigger mark-to-market losses, especially with potential further RBI rate cuts.
With domestic credit levels nearing 165 percent of GDP, any global contraction in credit or rise in risk aversion could slow growth and strain the Indian system as well.
Having said that, this isn’t a call for alarm—but a call for vigilance. The next financial disruption may not start in India, but it won’t stop at our borders. In an increasingly connected world, early recognition and coordinated action matter more than ever. We can’t afford to be caught off guard. The bottom line? India stands better prepared than in past cycles—but cross-border financial shockwaves and hidden leverage loops demand cautious replication of global regulatory best practices. Vigilance, forecasting, and adaptive resilience are India’s strongest guard.
