Imagine India\u2019s GDP growth had collapsed to 3 per cent; inflation was about to hit double digits; exports were tanking; and the country\u2019s twin deficits \u2014 in the government\u2019s budget, and in the nation\u2019s current account \u2014 were out of control. It\u2019s only when the Reserve Bank of India tries to imagine such a dire scenario for March 2019 that its simulation exercise for bad loans throws up a figure of 17.3 per cent of state-run banks\u2019 total assets. Since most reasonable investors would dismiss the possibility of economic ruin lurking just around the corner, they\u2019re likely to take comfort from the central bank\u2019s baseline estimate of distress: 16.3 per cent. While that\u2019s still a scary number for a group of lenders that control 70 per cent of the banking system\u2019s assets, it suggests the bulk of the pain is already in the rear-view mirror. With state-run financial institutions disclosing an aggregate nonperforming asset ratio of 15.6 per cent in March, a 0.7 percentage point increase projected over 12 months could even give rise to hopes of a recovery. However, putting too much faith in the RBI\u2019s stress test could end up misleading investors. The asset-quality problem is very likely heading for the 20 per cent mark. Just look at the last three years of data. In June 2015, 2016 and 2017, the baseline estimates of distress RBI gave in its stress tests were on average 3 percentage points lower than the actual NPAs of government-controlled lenders nine months later. In fact, the outcomes were around 2 percentage points worse than what the central bank saw when it asked its crystal ball about a \u201csevere stress\u201d scenario. What if this year is no different? To make an allowance for the RBI\u2019s optimism, you should add 3 percentage points to its baseline NPA projection of 16.3 per cent. In other words, almost a fifth of Indian state-run banks\u2019 assets might have soured by March next year. If the broader economy deteriorates, as many as 10 out of 21 taxpayer-funded lenders could risk falling short of minimum regulatory capital, the RBI says. Don\u2019t be surprised if that happens anyway \u2014 even without macroeconomic indicators flashing red. The gross bad-loan ratio for India\u2019s overall banking system \u2014 including public-sector as well as fully privately owned lenders \u2014 may rise to 12.2 per cent, the highest in almost two decades, RBI estimates show. When will this cycle start reversing? Until the nation\u2019s new bankruptcy law grows up a little, big checks from buyers of stranded corporate assets will remain stuck in court proceedings. Meanwhile, the RBI has taken away the various restructuring options banks used as fig leaves to keep classifying dud loans as standard. That welcome rule change could, in itself, test banks\u2019 balance sheets more severely this year than any economic shock in the RBI\u2019s vector auto-regression model. For India\u2019s banks, 20 per cent NPAs could arrive well before the proverbial light at the end of the tunnel. Investors hardly need to summon up visions of an economic dystopia to arrive at that conclusion.