As the union budget for the financial year 2023-24 was rolled out on February 1 in Parliament, the Union Finance Minister Nirmala Sitharaman emphasized the need for reforms in the Banking Regulation Act, which further corroborates the assertions that banking reforms are indispensable for making economic headway. The performance of the Indian banking sector is firmly correlated with the overall health of the economy, perhaps more so than any other sector. The sector is tasked with supporting other economic sectors like agriculture, small-scale businesses, exports, and banking activities in developed commercial areas and remote rural areas. The improvement of asset quality, application of rational risk management procedures, and capital adequacy are some of the main functions of the Indian banking system. Banking sector reforms are implemented to improve the condition of the banking system. Multiple banking sector reforms have been introduced in India in the context of economic liberalisation and the growing trend toward globalisation. The main objective is to improve operational efficiency and promote banks’ health and financial reliability, so that Indian banks can meet internationally recognised standards of performance.
India has a long history of both public and private banking. Modern banking in India began in the eighteenth century, with the founding of the English Agency House in Calcutta and Bombay. In the first half of the nineteenth century, three presidency banks were founded. After the 1860 introduction of limited liability, private banks began to appear, and foreign banks entered the market. The beginning of the twentieth century saw the introduction of joint stock banks. In 1935 the presidency banks were merged to form the Imperial Bank of India, subsequently renamed the State Bank of India. That same year, India’s central bank, the Reserve Bank of India (RBI), began operation. Following independence, the RBI was given broad regulatory authority over commercial banks in India. In 1959 the State Bank of India acquired the state-owned banks of eight former princely states. Thus, by July 1969, approximately 31 percent of scheduled bank branches throughout India were government-controlled as part of the State Bank of India. India’s post-war development strategy was in many ways a socialist one, and the government felt that banks in private hands did not lend enough to those who needed it most. In July 1969, the government nationalized all banks whose nationwide deposits were greater than Rs. 500 million, nationalizing 54 percent more of the branches in India and bringing the total share of branches under government control to 84 percent. After nationalization, the Indian banking sector expanded in breadth and scope at a rate perhaps unmatched by any other country. Indian banking has been remarkably successful at achieving mass participation and which gives us a lucid view that banking reforms were part of continuum economic reforms in India from the very beginning, especially from India’s economic sovereignty era. But these past reforms in the banking sector in India have never warded off trendy upheavals because the banking sector always demands cotemporaneous reforms with each passing day which will precisely befit the ongoing economic climate of a country. Therefore, the banking sector in India has always remained the controversy’s favourite child because of the myriad of convulsions it witnessed and with each convulsion throwing the entire economy out of gear.
The crisis in the banking sector has always remained an inveterate problem in the country’s financial history and always has put this question to the fore against this particular sector and whether it has been compromising on fulfilling its fiduciary obligation. In 1913, John Maynard Keynes after surveying the state of banking in the country, wrote in Indian Currency and Finance, “In a country so vulnerable for banking as India, (it) should be conducted on the safest possible principles”. His warnings have proven factual and equitable. In January 2021, the Reserve Bank of India (RBI) warned of a looming credit crisis, projecting that the gross NPA (non-performing assets or bad loans) ratio for Indian commercial banks would increase from 7.5 per cent in September 2020 to 13.5 per cent in September 2021. If the macroeconomic environment worsened, the ratio could even rise to 14.8 per cent, the central bank warned. (The gross NPA ratio, a measure of the banking sector’s health, is the overall percentage of bad loans to total loans issued.) This doubling of NPAs will obviously weaken banks, they will have to make provisions for the expected defaults, reducing the capital available for new loans and making bankers more wary of lending, which would limit the credit available to businesses to fund their activities. It could also raise the cost of credit, thereby stifling growth. India’s bad debt problem is concentrated in the public-sector banks – though “concentrated” may be the wrong word, given that public-sector banks account for more than 70 percent of total lending in India. The impaired loans are primarily to the corporate sector rather than households, with defaults arising from factors such as overcapacity, falling commodity prices, and troubled infrastructure projects. The Reserve Bank of India is trying to bring problems into the open, having conducted an Asset Quality Review and enhancing the reporting of restructured assets. It has also asked banks to initiate forced-bankruptcy proceedings against 12 large defaulters that, between them, account for 25 percent of the banking system’s non-performing loans. This high level of non-performing loans is eroding the ability of public-sector banks to retain earnings and is thereby damaging their capital positions. Under Basel III norms, banks must have capital adequacy ratios of at least 11.5 percent. The reasons for such failures are quite transparent. In essence, the sloppy regulatory oversights, weak supervision, absence of accountability, susceptibility to misuse by prominent figures and the ineptitude to learn from past mistakes keep adding to the woes of the financial system. Recently in the year 2020, the failure of Yes Bank when it was put under a moratorium by the RBI, announcing that depositors can’t withdraw more than Rs 50,000 excluding exceptional circumstances. To revive the bank which had a loan book of three lakh crore, if the government and RBI wouldn’t have come up in support, this could have led to a full-blown crisis as approximately one-third of the financial system was in a state of plight. India’s central bank, despite being in constant touch with the management of Yes Bank in finding a solution for improving the balance sheet and liquidity, couldn’t determine the impending disaster. The bank indicated they are likely to be successful and gave false hopes assuring the situation was under control. It struggled to acquire serious investors ready to infuse their capital. Besides, it witnessed a regular outflow of liquidity that further deteriorated their financial position. In November 2019, PMC (Punjab and Maharashtra Co-operative bank), a bank with a legacy of more than three decades in meeting the financial requirements of small and middle-class merchants, came down with a loud thud due to corrupt lending. Inadequacy in detecting suspicious transactions, deceitful practices, dummy account operations, and violation of standard operating systems and procedures by the board of committee appointed, the bank’s management are compelling reasons behind a scam of this magnitude. Therefore, to ensure other commercial or government-undertaking banks don’t meet the same fate as PMC or Yes Bank and the economy doesn’t pay a heavy price, the framework of a robust reform for resolution is quite imperative.
The reforms in the Indian banking sector have been introduced to increase the efficiency, stability, and effectiveness of banks. Some of these recent reforms are:

National Asset Reconstruction Company Limited (NARCL)
Setting up of the NARCL was announced in the Union Budget 2021-22. The objective was to construct a ‘bad bank’ which would house bad loans of Rs. 500 crores (US$ 62.63 million) and above. There are already 28 existing asset reconstruction companies (ARCs) on the market. However, due to the sizeable and fragmented nature of the bad loan book held by different lenders, significant amounts of NPAs continue to appear on bank balance sheets. Thus, more choices and alternatives like the NARCL are required. NARCL will have a dual structure – it will consist of an asset management company (AMC) and an asset reconstruction company (ARC) to recover and manage stressed assets. It is a collaboration between private and public sector banks (PSBs), but PSBs will maintain 51% ownership in NARCL. NARCL will be capitalised through equity from banks and non-banking financial companies (NBFCs). If necessary, it will also issue new debt. The guarantee provided by the Government of India will lower the need for up-front capital. The NARCL will be assisted by the India Debt Resolution Company Ltd (IDRCL). In August 2022, the NARCL offered to buy the distressed loan accounts of five companies, including Future Retail
.

India Debt Resolution Company Ltd. (IDRCL)
The IDRCL is a service company/operational entity whose purpose is to manage the assets of the NARCL with the help of turnaround experts and market professionals. The NARCL will buy assets by presenting an offer to the lead bank; IDRCL will be included for management and value addition after NARCL’s offer is accepted. Public FIs and PSBs will hold a 49% stake in IDRCL, and the rest will be with private banks.

Digital Rupee
The central bank’s digital currency (CBDC), the RBI’s digital rupee, was announced in the Union Budget 2022-23, and is expected to be launched by the end of this financial year. India’s digital economy is predicted to benefit greatly from the introduction of the digital rupee. A CBDC is a digital representation or token of a nation’s legal currency. A CBDC can benefit customers with better liquidity, scalability, acceptance, the convenience of transactions with anonymity, and quicker settlement. Similar to how UPI made digital cash more user-friendly, this development will increase people’s access to digital currencies. Adopting the digital rupee is expected to help cross-border remittances and reduce transaction cost for businesses and the government. The digital rupee would reduce the settlement risk in the financial system.

National Bank for Financing Infrastructure and Development (NaBFID)
The NaBFID has been set up as a Development Financial Institution (DFI) to aid India in developing long-term infrastructure financing. The NaBFID has both developmental and financial objectives.
Unlike banks, DFIs do not take deposits from the general public. Instead, they raise funds from the government, the market and multilateral institutions, and are often backed by the government’s guarantee. The government initially holds 100% of the shares in the bank, which may subsequently be reduced to 26%. The NaBFID was set up as a corporate body with an authorised share capital of Rs. 1 lakh crore (US$ 12.53 billion). The NaBFID plans to finance multiple projects that are a part of India’s Rs. 6 trillion (US$ 75.18 billion) National Monetisation Pipeline.
Inarguably, the Indian financial regulators have brought up and rolled down multifarious reforms in the banking sector from time to time as per the country’s evolving economic posture. However, with the proliferating population and the West’s intention to shift its manufacturing base as well as supply/value chains from China to India and elsewhere, it is essential to say ‘yes’ to neoteric banking reforms. This calls for a paradigm shift in the banking sector to improve its resilience and maintain financial stability.
Though the universal banking model has been widely preferred, there is a need for niche banking to cater to the specific and varied requirements of different customers and borrowers. Essentially, these specialised banks would ease access to finance in areas such as RAM (retail, agriculture, MSMEs), infrastructure financing, wholesale banking (mid and large corporates) and investment banking (merchant banking and financial advisory services). Hence, risk management can be more specific and the neo-banks can leverage the technology to further (digital) financial inclusion and finance higher growth of aspirational/new India. These specialised banks will not indulge in cross-selling of insurance and mutual funds and instead offer niche financial services to customers. They can have the need-based infrastructure and be staffed with professionals with specialised skill sets from the market. Regulatory surveillance through prudential supervision and control over the banks may be easier.
Further, the proposed DFI/niche banks may be established as specialised banks to have access to low-cost public deposits and for better asset-liability management. Then the depositors/investors will have wider options to park their money into various time buckets based on their risk appetite, thereby taking advantage of the yield curve. Further, the existing strong local area banks and urban cooperative banks may be converted into RAM (retail, agriculture, MSMEs) banks and be freed from dual control. They also may be encouraged to get listed on a recognised stock exchange and adhere to ESG (Environment, Social Responsibility, and Governance) framework to create value for their stakeholders in the long run.
While fostering and endorsing niche banking, the government should rigidify the loose ends by allowing them to build diversified loan portfolios and have cross-holdings to mitigate market risks, establishing sector-wise regulators, bestowing more powers to deal effectively with wilful defaulters, and paving the way for the corporate bond market (shift from the bank-led economy) to create a responsive banking system in a dynamic real economy.

Zubair Mushtaq is a Gold Medallist in Business & Financial studies from Kashmir University. He is presently working as an Economics lecturer at Kashmir Harvard Higher Secondary School, Naseem Bagh

Zubair Mushtaq