Allied Perils

Allied perils refer to secondary or accompanying risks that arise alongside primary risks within financial and economic systems. In the context of banking, finance and the Indian economy, allied perils assume significant importance due to the interconnected nature of financial institutions, markets, regulatory frameworks and macroeconomic conditions. These perils do not operate in isolation; instead, they amplify existing vulnerabilities and can transform manageable risks into systemic crises. Understanding allied perils is therefore essential for evaluating financial stability, policy effectiveness and long-term economic resilience in India.
The Indian financial system, characterised by a dominant banking sector, expanding capital markets and increasing global integration, is particularly sensitive to such interlinked risks. Structural constraints, governance challenges and external shocks often interact, creating complex layers of allied perils that affect credit flow, investment confidence and economic growth.

Concept and Nature of Allied Perils

Allied perils are risks that emerge as indirect consequences of primary financial or economic risks. For example, a rise in non-performing assets (NPAs) is a direct banking risk, while its spill-over effects on credit availability, investor confidence and fiscal burden constitute allied perils. These perils may originate within institutions, markets or the broader economy, but their defining feature is interdependence.
In banking and finance, allied perils often arise due to:

• Interconnected balance sheets of banks and financial institutions
• Overlapping regulatory and supervisory gaps
• Behavioural responses such as panic, herd behaviour or risk aversion
• Macroeconomic linkages between growth, inflation, employment and fiscal stability

In India, where public sector banks play a major role and financial inclusion is a policy priority, allied perils have both economic and social implications.

Allied Perils in the Indian Banking Sector

The Indian banking sector faces several allied perils that stem from operational, structural and policy-related risks. One of the most prominent is the persistence of non-performing assets. While NPAs directly weaken bank profitability, their allied perils include reduced lending capacity, erosion of capital adequacy and increased reliance on government recapitalisation. This places pressure on public finances and diverts resources from development expenditure.
Another significant allied peril is asset–liability mismatch, particularly in long-term lending by banks. Infrastructure and housing loans with long gestation periods are often funded through short-term deposits. The resulting liquidity stress can trigger confidence crises, as witnessed during episodes of financial instability involving non-banking financial companies (NBFCs), which subsequently affected banks due to their exposure.
Governance and risk management failures also create allied perils. Weak credit appraisal, political interference in lending decisions and delayed recognition of stress lead to moral hazard. Over time, this undermines depositor trust and necessitates stricter regulatory intervention, which may constrain credit growth.

Allied Perils in Financial Markets

Financial markets in India, including equity, bond and derivatives markets, are increasingly integrated with global capital flows. This integration, while beneficial for investment and liquidity, generates allied perils related to volatility and contagion. Sudden capital outflows due to global monetary tightening or geopolitical events can destabilise domestic markets, affect exchange rates and complicate monetary policy.
Market-linked allied perils also arise from excessive speculation and leverage. Sharp corrections in equity markets can erode household wealth, reduce consumption and dampen investor sentiment. In the bond market, rising yields increase borrowing costs for both the government and private sector, creating a crowding-out effect that constrains productive investment.
Another allied peril is the growing interdependence between banks and financial markets. Banks’ exposure to market instruments means that market downturns can directly impact their balance sheets, while banking stress can simultaneously depress market confidence, creating a feedback loop.

Allied Perils Related to Monetary and Fiscal Policy

Monetary and fiscal policies, though designed to stabilise the economy, can generate allied perils if misaligned or poorly timed. For instance, prolonged accommodative monetary policy may support growth but can also encourage excessive borrowing and asset price inflation. The allied peril here is the formation of financial bubbles, which, when burst, impose long-term costs on banks and the economy.
Fiscal deficits constitute another major source of allied perils in India. High government borrowing increases interest rates and limits private sector access to credit. Over time, this can slow capital formation and weaken growth potential. Additionally, fiscal stress often leads to higher dependence on banks for financing, thereby increasing their exposure to sovereign risk.
The interaction between monetary tightening and fiscal constraints can further exacerbate allied perils. Efforts to control inflation through higher interest rates may strain indebted firms and households, leading to loan defaults and banking stress.

Allied Perils and the Non-Banking Financial Sector

The non-banking financial sector plays a critical role in India by catering to segments underserved by traditional banks. However, its rapid expansion has introduced allied perils related to regulation, liquidity and interconnectedness. NBFCs often depend on short-term market borrowings, making them vulnerable to liquidity shocks. When stress arises, banks and mutual funds exposed to NBFCs face spill-over risks.
The collapse or distress of large NBFCs has demonstrated how allied perils can spread across the financial system. Loss of confidence in one segment can lead to credit freezes, affecting small businesses, housing finance and consumption-driven sectors of the economy.

Allied Perils for the Indian Economy

At the macroeconomic level, allied perils in banking and finance directly affect economic growth, employment and income distribution. Credit contraction resulting from banking stress reduces investment and slows industrial activity. Small and medium enterprises, which rely heavily on bank credit, are particularly affected, leading to job losses and regional disparities.
Inflation and exchange rate volatility also represent allied perils. Financial instability can weaken the currency, increase import costs and fuel inflationary pressures. This disproportionately affects lower-income households, linking financial perils to social and developmental challenges.
Furthermore, repeated financial sector stress increases policy uncertainty. Frequent regulatory changes and crisis management measures, though necessary, may reduce long-term investor confidence and complicate economic planning.

Regulatory and Institutional Responses

India has adopted several regulatory and institutional measures to mitigate allied perils. Strengthening prudential norms, improving asset quality recognition and enhancing supervisory oversight are central strategies. Mechanisms such as the Insolvency and Bankruptcy Code have aimed to address credit risk and reduce spill-over effects.
Macroprudential regulation has gained prominence as a tool to manage systemic allied perils. Stress testing, capital buffers and liquidity requirements are designed to ensure that financial institutions can absorb shocks without transmitting instability to the broader economy.