Banking for Viksit Bharat

A very costly clean-up with no accountability has been completed, but much deeper reforms are needed

India is celebrating a clean-up of the banking system. The 4R framework — Recognition, Resolution, Recapitalisation and Reforms — under which this clean-up was undertaken was unfortunately weak on reforms and on holding those responsible accountable. It is like Agatha Christie’s Murder on the Orient Express, where, in the end, the crime was committed by everyone involved: Politicians, regulators (the Reserve Bank of India), bank managers and crooked capitalists, with the taxpayer as the ultimate collective victim, but no one was held responsible.   

Now the roster for the “Banking for Viksit Bharat” high-level panel, which was announced in the 2026-27 Union Budget, is being finalised. Its broad mandate is to assess: 

Global-scale mergers: Consolidation strategies to build Indian mega-banks capable of ranking in the world’s top-tier banks. 

Foreign holding rules: Potentially lifting current caps on foreign ownership to broaden capital liquidity. 

Boardroom AI mandate: Formally incorporating artificial intelligence (AI) governance and ethical framework compliance into board-level strategy. 

Why we need a “strategy” to build a global bank is not clear to me. What we do still need are some more basic reforms that should have preceded —  or at least accompanied — the exorbitantly costly clean-up, which required an injection of ₹3-4 trillion until FY2021 and around ₹16-17 trillion in writeoffs of bad loans by the banking system. The non-performing assets (NPAs) originated from the easy credit policies during the United Progressive Alliance government to fund the boom from 2003-08 and then ostensibly help India recover from the impact of the global financial crisis of 2008-09 (see chart). 

 

But the easy credit policies were continued for too long. In addition, capital inflows emanating from the massive global spillovers into India were not sterilised, which led to huge injections of liquidity into the system. The resulting indiscriminate lending ended up in very large NPAs. The Asset Quality Review initiated by the RBI in 2015 showed that gross NPAs, which were 4.1 per cent of all loans in 2014, were as high as 11.1 per cent by 2018, with state-owned banks’ NPAs at 14.6 per cent.  This was not new bad loans but just their recognition — the first R. 

The huge injection of public money and bad loan writeoffs, as well as the use of a new Insolvency and Bankruptcy Code (IBC) for the second R — resolution — have helped reduce gross NPAs to 1.9 per cent by March 2026, while banks have been recapitalised — the third R. But the IBC has now been weakened, and there is very little accountability for those responsible. Alleged fraudsters Vijay Mallya, Nirav Modi, and Mehul Choksi were allowed to flee India and have not been brought to justice, while the lenders that failed to conduct due diligence have faced no serious penalties. 

The weakest part of the 4Rs was reforms. The only reform carried out was consolidation, shrinking the number of public-sector banks (PSBs) from 27 to just 12 by 2020, while the Prompt Corrective Action framework was used to nurse them back to health. But merging very weak banks into somewhat less weak banks hardly constitutes a reform. 

Despite the massive clean-up, the banking system still functions inefficiently, and credit remains costly compared with comparator countries — by at least 200-300 basis points, and even more for non-preferred borrowers. India’s credit-to-gross domestic product ratio also remains very low — more comparable to that of Bangladesh and Indonesia and far below those of the rapidly growing economies of Vietnam and Thailand (see chart). If India has cleaned up its banks, why have they still been unable to lift their game and substantially increase the credit-to-GDP ratio? 

The new Viksit Bharat Banking Committee should consider three additional critical reforms for a better financial system. 

First, the relationship between the RBI as regulator and the owner of state banks — that is the government — needs untangling. When, in 2017, the finance minister at the time blamed weak supervision by the RBI as the reason for their poor performance, the RBI governor responded that its regulatory powers over PSBs were diluted. The RBI approves the appointment of private bank chief executive officers  to ensure they are “fit and proper”. It has often turned down unsuitable CEOs for private banks — but for PSBs, those appointments are made by the Ministry of Finance. Moreover, RBI staff sit on the boards of PSBs, and the regulator is thereby complicit in all their decisions, which it is supposed to supervise and regulate.  

Another complication is that the RBI is also the debt manager of the government and, therefore, tries to keep government borrowing costs low, a role that interferes with its monetary policy function. Public-debt management should be in the Ministry of Finance or in an independent debt management agency. 

Second, one reason for the high NPAs was that commercial-bank lending was used to finance longer gestation infrastructure projects — an asset-liability mismatch — normally financed by bonds. India’s bond market development is held back by financial repression using an antiquated instrument called the statutory liquidity ratio (SLR) — which requires banks to hold government securities. The SLR rate has declined from a peak of 38.25 per cent in 1992 but remains at 18 per cent, higher than that of even Bangladesh or Pakistan. Get rid of SLR. 

Third, all commercial banks are required to lend 40 per cent to agriculture, exports and micro, small and medium enterprises (MSMEs). Remove directed lending from commercial banks: Establish or designate one or two banks to perform priority-sector lending such as for exports and agriculture. For MSMEs, a Mudra scheme to provide non-collateralised lending has already been in place and non-banking financial companies are a major source of credit for MSMEs. Their growth should be encouraged.  

I would normally add a fourth reform, privatisation of some of the state banks, as NPAs in private banks were smaller than in PSBs. Two of them were slated for privatisation. But there is a caveat: This should be done only if we are sure they will not end up in the hands of large corporations. 

Using a heart patient analogy, the banking sector clean-up is like angioplasty — it has cleaned the arteries. This has, no doubt, allowed the banking system a chance to resume normal function. But to pump faster to finance Viksit Bharat, India must strengthen and streamline the regulatory system, remove unnecessary mandates on the banking system, and create a balanced financial system with a much stronger bond market. More fundamental reforms are needed. 

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The writer is distinguished visiting scholar, Institute for International Economic Policy, George Washington University