RBI Governor Sanjay Malhotra warns against complacency over financial risks

RBI Governor Sanjay Malhotra on Saturday (October 3) warned against complacency over the financial system’s current resilience, saying prolonged periods of stability could encourage risk-taking and leverage, leaving economies vulnerable to shocks.

“Today's resilience may not necessarily imply tomorrow's immunity,” Malhotra said, calling for continued vigilance to identify emerging vulnerabilities and keep the financial system strong and resilient.

Financial stability

Speaking at the Kautilya Economic Conclave, Malhotra said the experience of the past two decades had shown that financial stress can build quickly but take years to resolve. It took nearly a decade to clean up the legacy of excessive lending and non-performing assets from the early 2000s, he said.

“We cannot afford to become complacent; the economic and financial costs of allowing vulnerabilities to build up are simply too high,” he said.

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Malhotra said financial stability should not be about preventing every shock, which is impossible, but about ensuring that the financial system can absorb and contain their impact. He outlined five broad priorities, including better risk assessment, granular data, system-wide resilience, safeguards around financial innovation and stronger regulatory and resolution frameworks.

Markets, debt among key risks

The RBI governor flagged rising global debt, elevated leverage, private credit and stretched valuations linked to artificial intelligence as emerging risks to financial stability.

Higher debt-to-GDP ratios, shorter debt maturities and elevated sovereign bond yields could narrow fiscal space and put pressure on corporate debt-servicing capacity, he said. Emerging markets with high levels of sovereign debt held by non-residents could also face capital outflows if carry trades unwind.

The impact is already visible in financial markets, UIDAI Chairperson and World Bank Executive Director Neelkanth Mishra remarked. He pointed to higher fuel prices and bond yields, saying rising rates were already affecting mortgage rates and new mortgage issuance.

Malhotra also cautioned that a slowdown in the AI investment or earnings cycle could trigger a sharp repricing of AI-related assets. Rising leverage among hedge funds, option sellers, exchange-traded funds and other non-bank financial intermediaries could amplify such corrections and transmit stress across markets.

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Private credit is another area of concern, he said, with some high-profile defaults pointing to possible weaknesses in lending standards.

Inflation, global shocks

Malhotra said financial authorities must also account for shocks originating outside the financial sector, including geopolitical events, commodity price movements and technological disruptions.

For India, he said, the economy remains exposed to the West Asia conflict through higher commodity prices and external-sector pressures. However, he said India was navigating these risks from a position of strength, citing low inflation and strong growth among major economies.

Malhotra said the RBI generally follows a “separation principle”, using monetary policy to maintain price stability while deploying targeted regulatory, supervisory and macroprudential measures to address financial stability risks.

AI, cyber risks

Malhotra said the next financial crisis may not necessarily begin in a bank or even within the financial sector. It could originate with a geopolitical event, cyber attack or technological failure and spread through an increasingly interconnected financial system.

AI has heightened concerns over cyber security, model risk, dependence on third-party technology providers and the erosion of human oversight and accountability, he added.

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“With the development of sophisticated AI tools which have tremendous autonomy and problem-solving capabilities, the most immediate concern is regarding cyber risk,” Malhotra said, particularly given the interconnected nature of financial systems that increasingly operate across national borders.

He called for better understanding of network dependencies and contagion channels, with scenario analysis becoming a central part of risk management.

Financial system challenges

The RBI governor also stressed that resilience cannot stop with banks. It must extend across non-banking financial institutions, financial markets, payment systems, technology infrastructure providers, critical third parties and cross-border financial networks.

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Better and more granular data will be crucial, he said, as information on NBFIs, interconnected exposures, technological developments and cross-border positions remains fragmented.

The challenge, Malhotra said, was to build a financial system capable of absorbing both anticipated and unforeseen shocks, supported by resilient institutions, deeper markets, credible safety nets, effective resolution mechanisms and forward-looking regulation. “The challenge before us is to build a financial system that can withstand shocks that we can anticipate, and even those we cannot yet foresee,” he said.

(With agency inputs)