The gross non-performing assets (GNPA) of the Indian banking system are set to improve further to up to 2.1 per cent by the end of FY25, a report said on Friday.

GNPAs are likely to come at 2.5-2.7 per cent in FY24 and will improve further to 2.1-2.4 per cent by the end of FY25, domestic rating agency CARE Ratings said in the report.

It can be noted that the Reserve Bank of India (RBI) began the comprehensive exercise in the middle of the last decade by instructing banks to classify certain stressed assets as NPAs so that the balance sheets represent a true picture.

The rating agency also flagged a list of downside risks, which may result in its estimate not coming true, including a material weakening in asset quality due to the elevated interest rates, the impact of regulatory changes, a tighter liquidity environment and global issues.

It said GNPAs surged to 11.2 per cent in FY18 from 3.8 per cent in FY14 due to the AQR process of 2015-16, which pushed banks to recognise NPAs and reduce unnecessary restructuring and added that the stress was emanating from the exposure to big-ticket wholesale advances.

Starting from FY19, GNPAs have been seeing an improvement and touched a decadal low of 3.9 per cent in FY23 and were at 3 per cent in the December quarter of FY24.

The asset quality has improved due to recoveries, higher write-offs by banks and much lower slippages, the report said, adding that selling dud assets to asset reconstruction companies has also helped.

From a sectoral perspective, the agriculture sector's GNPA ratio reduced to 7 per cent in September, 2023 compared to 10.1 per cent reported in March, 2020, while the industrial sector reported a 4.2 per cent GNPA ratio in September, 2023 against 14.1 per cent in March, 2020 and 22.8 per cent in March, 2018.

The industrial GNPAs were down on corporate deleveraging, resolutions and write-offs. However, it continues to remain elevated in gems, jewellery and construction sub-sectors.

The retail loan GNPA was 1.3 per cent in September, 2023 against 2 per cent in March, 2020, the agency said, adding that a bulk of the stress is due to unsecured loans, credit card receivables and education loans.

"The performance of unsecured personal loans and restructured accounts continues to be monitorable," the agency said.