Agri loans emerge as biggest asset quality risk for Indian banks

A non-performing asset, or NPA, is a loan whose scheduled repayments have remained overdue long enough for the bank to classify it as impaired. The gross NPA ratio measures such loans before provisions are deducted, as a share of total loans. A higher ratio signals that more lending is failing to generate expected repayments.

That matters because unpaid loans reduce interest income and can force banks to set aside provisions for possible losses. For example, agricultural loans had a 5.1% gross NPA ratio in the second quarter of 2026. Industry and services each stood at 1.5%, while retail loans stood at 1%. Farm lending therefore represented the banking system’s clearest stress point.

The wider system was healthier, with gross NPAs at 1.8%. Agricultural bad loans have also fallen from above 10% during 2020-21. Still, weak farm incomes after poor rainfall could raise arrears. BMI expects no material system-wide deterioration, supported by stronger capital and earnings buffers.

In the second quarter of 2026, agricultural loans recorded a 5.1% gross NPA ratio. Industry loans and services loans each had a ratio of 1.5%, while retail loans stood at 1%. The comparison shows that farm credit carried substantially more reported repayment stress than the other major categories.

Measured in percentage points, agriculture was 3.6 points above both industry and services. It was 4.1 points above retail. Agriculture’s ratio was also about 3.4 times the industry and services ratios, and 5.1 times the retail ratio. These figures made agriculture the clearest outlier.

The difference matters even though agricultural bad loans have dropped from more than 10% during 2020-21. BMI said the weak southwest monsoon could pressure farm borrowers, but greater irrigation, food buffers, diversified rural incomes, and stronger bank buffers should limit broader damage.

Farmers commonly depend on crop sales for repayment cash. When rainfall is below average, crops may produce less, planting or harvesting conditions can worsen, and farm incomes can fall. That weakens borrowers’ repayment capacity and can increase overdue agricultural loans.

The risk is especially relevant after India’s southwest monsoon ended 12.6% below its long-period average, the weakest rainfall since 2015. BMI said lower farm incomes could add to agricultural loan arrears. The effect may be uneven because irrigation coverage, crop conditions, and local relief measures differ across regions.

The rainfall deficit does not automatically mean a banking crisis. The principal kharif crop had already been harvested, and the rabi crop is less dependent on southwest monsoon rainfall. Government food buffers and more diversified rural incomes may also cushion households. Still, farm-loan stress could emerge as repayment obligations fall due.

Agricultural loan stress can take longer to appear because repayment and NPA classification are linked to crop seasons. Farmers may receive income only after planting, harvesting, and selling crops. A weak monsoon can damage earnings first, while the related missed repayment or formal classification occurs later.

BMI highlighted this timing difference in its assessment of the 2026 rainfall deficit. A poor season can reduce farm income without immediately producing a reported NPA. The banking data may therefore look stable initially, even as borrowers’ ability to repay is weakening. This is why early field monitoring matters.

Punjab National Bank said it had launched a large programme to connect with farmers and monitor ground conditions. Banks and State Level Bankers’ Committees may also offer restructuring or moratoriums. Such measures can delay or reduce formal defaults, although they do not remove the underlying risk if farm incomes remain weak.

SMA-2 means a loan account has repayments overdue by more than 60 days and up to 90 days. It is an early warning category. The account shows serious repayment delay, but it has not yet crossed the threshold used to classify the loan as a non-performing asset.

This distinction helps banks identify borrowers who may need attention before losses become formal NPAs. Punjab National Bank reported that agricultural SMA-2 accounts fell to ₹89 crore from ₹314 crore a year earlier. That decline suggested less near-term repayment stress in that specific category, although PNB remained mindful of drought conditions.

An NPA is a later and more severe classification of repayment failure. SMA-2 accounts can still return to regular repayment if conditions improve or relief is provided. Banks may consider restructuring or a moratorium for affected agricultural borrowers, as Canara Bank’s leadership noted regarding drought-prone areas.

BMI does not treat the similarly weak 2015 and 2026 monsoons as equivalent banking threats. The earlier deterioration was driven mainly by a corporate bad-loan cycle, not agricultural stress. Industry loans’ gross NPA ratio climbed from 6.2% in the first quarter of 2015 to 22.5% in the first quarter of 2018.

That surge damaged asset quality across the banking system. In 2026, agricultural loans remain the main stress point, but the broader system’s gross NPA ratio had declined to 1.8%. The principal kharif crop was already harvested, while the rabi crop is less dependent on southwest monsoon rainfall.

Banks also entered this period with stronger buffers. Total capital stood at 18% in the first quarter of 2026, common equity tier-1 capital at 15.1%, and return on assets at 2%. Irrigation, food buffers, and diversified rural incomes should further limit transmission into system-wide loan losses.

Loan restructuring changes repayment terms, while a moratorium temporarily pauses repayments. These measures can prevent a short-term income shock from immediately becoming a default. State Level Bankers’ Committees may use them for affected agricultural borrowers, giving farmers time to recover after a poor season.

Other protections reduce the size of the income shock. Irrigation makes crops less dependent on southwest monsoon rainfall. Government food buffers can support food availability and reduce pressure from weak harvests. Diversified rural incomes give households other sources of cash when farm earnings fall. Canara Bank said its exposure to drought-prone areas was about ₹13,900 crore, but not all of it was expected to come under stress.

These tools do not eliminate credit risk. They can, however, slow its transmission into bank arrears and NPAs. BMI said the harvested kharif crop, less monsoon-dependent rabi crop, and these cushions should limit material deterioration in system-wide asset quality.