The Indian banking sector: Navigating regulatory reforms and market dynamics

The Indian banking sector has undergone a significant transformation over the past decade, shifting from a predominantly nationalised system to a competitive landscape with a growing private-sector presence. Key regulatory measures, including stringent management of Non-Performing Assets (NPAs) and enhanced capital adequacy requirements, have played a pivotal role in stabilising the sector amidst various challenges.

Regulatory revolution

The sector’s journey began with the Banking Regulation Act of 1949 and experienced major shifts in 1969 and 1980 with the nationalisation of 20 banks. The liberalisation programme in 1991 re-opened the sector, with the Reserve Bank of India (RBI) issuing licenses to private banks, leading to the current diverse banking ecosystem. Recent regulatory changes have fortified the sector, enabling it to withstand global financial crises effectively.

Addressing non-performing assets

India’s NPA crisis peaked in 2010-11, with non-performing loans reaching 11% of total assets. Proactive regulatory measures, such as the early warning system and Prompt Corrective Actions, have reduced NPAs to manageable levels. The COVID-19 pandemic saw timely interventions like loan moratoriums and liquidity support, further stabilising the sector.

Corporate governance reforms

Recent reforms include tenure caps for directors and stricter eligibility criteria, enhancing governance standards. Promoters must hold a minimum equity stake for a defined period, ensuring long-term commitment and stability. These measures aim to prevent conflicts of interest and improve the overall governance framework.

Tighter retail lending rules

The RBI has increased risk weights on retail loans, particularly unsecured ones, requiring banks to hold more capital against these exposures. This move aims to ensure compliance with Capital Adequacy Ratio (CAR) requirements and mitigate credit risks, especially in the retail lending segment.

Shifting lending and deposit patterns

Private sector banks are gaining market share in both advances and deposits, though lending more than collecting in deposits poses sustainability challenges. Rural areas contribute significantly to deposits, while urban funds are diverted to alternative investments. This shift necessitates a focus on maintaining competitive lending rates and controlling operational costs.

Conclusion

The Indian banking sector stands at an inflexion point, balancing regulatory reforms with market dynamics. Continued focus on governance, risk management, and operational efficiency will be crucial for sustaining growth and stability in the evolving financial landscape.

This article draws on insights from the conclusions paper of the IMA India CFO Forum held in Pune in November 2024, which included valuable discussions with Jaimin Bhatt, the retired Group CFO of Kotak Mahindra.