Banking on the brink: An incremental cost-based view of financial stress

Abstract

We undertake a comprehensive evaluation of stress and its determinants for Indian banks, from the viewpoint of opportunity cost incurred under diverse stress events. Using a sample of 39 banks in India over the 2005–22 period, the study reveals size, ownership and operating inefficiencies as the principal determinants of stress. A sharp rise in delinquencies draws proactive policy intervention, which mitigates stress at subsequent time periods. Higher quantum of corporate loan exposure was found to relieve banking stress. The study meaningfully augments extant literature landscape on banking default prediction by establishing efficacy of stress score as a potent Early Warning Indicator (EWI) of banking distress. Our findings pinpoint the need for rigorous monitoring of regulatory capital, liquidity and credit screening standards of Indian banks. The study offers valuable guidance for proactive policy intervention, aimed at minimizing the adverse impacts of stress on banking stability. © 2025 Elsevier B.V.