Revisiting the Relationship Between Credit Risk and Credit Growth in the Indian Banking Sector: Does Economic Policy Uncertainty Matter? 

Abstract

This paper examines the relationship between credit risk (primarily measured by the gross NPL ratio), credit growth, and economic policy uncertainty (EPU) for a panel of 52 Indian commercial banks from 2005-2023. Using fixed effects and panel quantile regression models, we find a Ushaped relationship between credit growth and credit risk. While moderate credit growth reduces credit risk, excessive growth increases credit risk and deteriorates asset quality, with stronger effects observed at higher levels of credit risk. Long-term and unsecured credit growth significantly amplifies credit risk compared to short-term and secured loans. Additionally, higher EPU worsens the impact of credit growth on credit risk, particularly for banks already facing elevated credit risk, although public sector banks are less affected. These findings suggest two main policy imperatives: first, regulating credit growth through thresholds and stricter criteria, especially for long-term and unsecured loans, and second, reducing EPU through transparent and consistent policy frameworks. Such measures can foster sustainable credit expansion and strengthen overall banking stability.