Reserve Bank of India (RBI) governor Sanjay Malhotra has cautioned that long stretches of calm in the financial system can breed the very vulnerabilities that later cause trouble. Speaking at the Fifth Kautilya Economic Conclave on 3 October 2026, he explained how India approaches financial stability, which global risks worry the central bank, and why he considers the domestic system resilient for now.
Mr Malhotra defined financial stability as the ability of the financial system to support economic and financial transactions, manage risks and absorb shocks. In a stable system, banks, markets and market infrastructure keep delivering the services households and businesses rely on, even under stress, and people retain the confidence to save, borrow, invest, insure, make payments, manage risk and plan ahead.
He acknowledged that the global system has stayed resilient, despite repeated shocks, and that India has enjoyed strong balance sheets across banks, corporates, governments and households for a long time. That record, he argued, is why the subject deserves attention. Citing Hyman Minsky's Financial Instability Hypothesis, he noted that prolonged stability encourages risk-taking and leverage, while fading memories of past crises weaken the appetite for prudence. He was not pointing to any imminent stress, he said, but the past two decades show that banking stress can build quickly and take years to resolve. It took nearly a decade to clean up the legacy of excessive lending and non-performing assets (NPAs) from the early 2000s.
The governor added that the international order that followed the Washington Consensus, which supported decades of globalisation and relative stability, is under considerable strain. Geopolitical and geo-economic fragmentation, shifting alliances, trade restrictions, repeated supply shocks, technological disruption and climate-related risks are interacting in ways that are hard to predict and harder to model using historical relationships. Central banks, he said, cannot look at price stability and financial stability in isolation from these developments.
On institutions, Mr Malhotra pointed out that the Reserve Bank of India Act, 1934 does not explicitly mandate financial stability, but the responsibility is implicit in the RBI's functions. The preamble gives it responsibility for monetary and price stability, Section 45W requires it to regulate the financial system to the country's advantage, and the Foreign Exchange Management Act, 1999 (FEMA) provides for orderly development and maintenance of the forex market. Price stability cannot be achieved without financial stability, he said, since a stable system is essential for monetary policy transmission and for realising the economy's full growth potential. As regulator and supervisor of banks, non-banking financial companies (NBFCs) and payment systems, and as lender of last resort and deposit insurer, RBI has the mandate, capability and tools to spot vulnerabilities and act in time. The Financial Stability and Development Council (FSDC) and its sub-committee provide the platform for exchanging information and coordinating with other regulators and government agencies.
On approach, he said no central bank can prevent every shock, whether it comes from the real economy, geopolitics, commodity prices or technological disruption. The aim is for the financial system to act as a shock absorber, so the focus is on resilience. RBI pursues this through prudent regulation, risk-based supervision, macroprudential measures, liquidity support including emergency liquidity assistance, and resolution. Regulation aims for a well-capitalised, liquid and well-governed system, while recognising that removing all risk would choke innovation and investment. Supervision combines off-site and on-site work and increasingly relies on data analytics, technology-enabled surveillance and thematic reviews to catch risks early. Stress tests are run periodically, and the RBI publishes its assessment with other regulators in the half-yearly Financial Stability Report (FSR).
Countercyclical macroprudential policy, he said, is particularly important for leaning against the build-up of vulnerabilities over the financial cycle. Risk weights on commercial real estate were raised in 2007, and in 2023 risk weights on certain consumer credit exposures and on bank lending to NBFCs were increased in view of the rapid growth in unsecured credit. On the lender-of-last-resort role, he acknowledged a possible conflict with price stability when inflation is high, which calls for targeted and temporary tools, provided the crisis is one of liquidity and not solvency. During the COVID-19 pandemic, RBI offered such facilities to financial intermediaries and markets, including NBFCs, microfinance institutions (MFIs), mutual funds and affected sectors such as micro, small and medium enterprises (MSMEs). Monetary policy is not usually used to tackle financial stability risks, he said, as the RBI follows a separation principle: monetary policy for price stability, and targeted regulatory, supervisory and macroprudential tools for identified risks. Since monetary policy can reach every corner of the system, however, financial stability is kept in mind in policy discussions.
Turning to global risks, Mr Malhotra said the system has absorbed the supply shock from the West Asia conflict well, but the environment remains challenging, as the conflict has added to inflationary pressures and financial vulnerabilities. He identified five risks.
The first is high global debt. Debt-to-gross domestic product (GDP) ratios have risen, maturities have shortened and sovereign bond yields have hardened sharply. Higher borrowing costs can narrow fiscal space and worsen debt dynamics for governments, strain corporate debt-servicing capacity, and cause sovereign bond losses that weaken bank balance sheets just when governments face pressure to support troubled banks. Emerging markets with large sovereign debt held by non-residents may also face capital outflows if the carry trade unwinds.
The second is stretched asset valuations, particularly those linked to artificial intelligence (AI). The AI investment cycle has been a major support for global markets, with strong earnings driving large gains in related equity valuations. As the cycle matures, any slowdown in AI investment or earnings could trigger a sharp repricing, especially across the AI value chain. High risk appetite has encouraged leverage, and together with declining free cash-flows at major AI firms this could amplify corrections and volatility.
The third is high leverage. Hedge funds, option sellers, exchange-traded funds and other non-bank financial intermediaries (NBFIs) have increased leverage in equity and bond markets, which he called a sign of a maturing financial cycle. This is a concern because equity valuations are stretched and links between banks and NBFIs have deepened on both the funding and asset sides, moving beyond a mainly funding-based relationship into a wider network of balance sheet interlinkages. Any tightening of financial conditions could therefore spill over to banks and other markets.
The fourth is private credit, where some high-profile defaults point to weak lending standards. The fifth is cyber risk compounded by AI, which has heightened cyber risk, model risk, third-party dependence and the erosion of human oversight and accountability. With increasingly sophisticated and autonomous AI, cyber risk is the most immediate concern, particularly for a highly interconnected system without national borders. Large differences in cyber capability and resilience among countries affect jurisdictions far from the source of weakness. While each risk alone may not be a concern at present, he said, their simultaneous occurrence could put significant pressure on the global financial architecture.
On the implications for India, he said that as a large open economy it is hypothetically exposed to global developments. India remains affected by the West Asia conflict through higher commodity prices and external sector pressures, but it is navigating this phase from a position of strength, backed by strong macroeconomic fundamentals and a resilient financial system. Further resilience-building steps include diversifying import sources, raising self-sufficiency in energy and other critical resources, building petroleum reserves, accelerating the energy transition, improving the competitiveness of domestic manufacturing, deepening integration into global value chains, widening market access through free trade agreements and promoting trade settlement in local currencies.
Indian government bond yields have risen only partly in response to higher global energy prices and bond yields, which he attributed to prudent fiscal management, continued fiscal consolidation, credible monetary policy and easing underlying inflationary pressures. Indian equity markets have corrected in recent months from high valuations, but in an orderly manner. Corrections in AI-linked valuations in advanced economies, if they occur, could be positive for capital inflows into India.
On AI and cybersecurity, directions issued in 2026 strengthen technology and cyber-risk governance for commercial banks, covering board oversight, defined responsibilities for chief information security officers (CISOs), and controls on access, third-party arrangements and incident response. Draft model risk guidance for regulated entities, including NBFCs, sets out safeguards across the model life cycle, such as risk-based oversight, explainability, red-teaming and human oversight. Private credit in India is still small and not assessed to be a risk, while NBFCs, despite growing interconnectedness with banks, are assessed to be strong.
Overall, Mr Malhotra described the Indian financial system as very resilient, supported by healthy balance sheets at banks and NBFIs. The June 2026 FSR stress tests show the banks' aggregate Common Equity Tier 1 (CET1) ratio staying comfortable under all adverse scenarios, while NBFCs had an average capital to risk-weighted assets ratio (CRAR) of 24.6% as on 31 March 2026, against a regulatory requirement of 15%. He warned, however, that today's resilience does not guarantee tomorrow's immunity, and that RBI will remain vigilant.
He closed with five priorities for policy-makers. First, some shocks are inevitable, and stability is about strengthening resilience and containing amplification so the system can keep providing services in all states of the world. Second, a new generation of systemic risks is emerging that is increasingly exogenous, cross-border and interconnected. The next crisis may not begin in a bank or even in finance, but could start with a geopolitical event, a cyberattack or a technological failure, which makes mapping dependencies and contagion channels and making scenario analysis central to risk management essential.
Third, monitoring and assessment frameworks must improve which requires better and more granular data. Information on NBFIs, interconnected exposures, technology dependencies and cross-border positions remains fragmented, and data quality will increasingly determine the quality of risk assessment. Fourth, resilience must be system-wide, since a strong banking system is necessary but not enough. It must extend to NBFIs, markets, payment systems, technology infrastructure, critical third parties and cross-border networks, because instability anywhere can threaten stability everywhere. Fifth, innovation should reinforce and not fragment the foundations of trust. AI, tokenisation and new forms of financial intermediation can greatly improve efficiency, but only if the system preserves sound institutions, settlement finality, the singleness of money and financial integrity.
Mr Malhotra said the task is to build a system that can withstand both anticipated and unforeseen shocks, which requires resilient institutions, better data, deeper markets, credible safety nets, effective resolution mechanisms, and regulation and supervision that are proactive, forward-looking and proportionate. If that succeeds, he said, financial stability will remain largely invisible, and in central banking invisibility is perhaps the most meaningful measure of success.
