How reforms in banking shifted from boosting competition to building scale

It was 8.30 pm on Saturday, July 19, 1969, when then Prime Minister Indira Gandhi took to the airwaves. “Some of you have, perhaps, already heard that the Government has nationalised, by an ordinance, fourteen of the biggest commercial banks incorporated in India,” she declared. Another six were nationalised in 1980, bringing the bulk of commercial banking under state ownership.

 

And so it remained till the economic liberalisation of 1991, which marked a paradigm shift.

 

That year, the Committee on the Financial System, chaired by M Narasimham, recommended that banking licences be opened up for more private players. It asked the government to “indicate” that there won’t be further nationalisation, to “remove the existing disincentive for the more dynamic among the private banks to grow”.  

 

 

Two years later, the Reserve Bank of India followed up on this with its guidelines on the entry of private-sector banks. This finally opened the door for increased private activity in a sector where public-sector banks (PSBs) had 91 per cent of bank branches and handled 85 per cent of business at the time.

 

On July 21, 1993, RBI provided in-principle approval to HDFC and Unit Trust of India, or UTI (its lender later became Axis Bank), for starting banking companies. More banks followed suit in the subsequent years — including ICICI Bank, IndusInd Bank and Development Credit Bank (now DCB Bank).

 

The reforms in the sector can be categorised into three phases: The first was about making a break with the past by issuing fresh banking licences to the private sector. The phase under guidelines issued in 2001 led to the creation of Kotak Mahindra Bank in 2003 and YES Bank in 2004. The third phase, under revised licensing norms announced in 2013, resulted in the establishment of Bandhan Bank and IDFC Bank (which later became IDFC First Bank).

 

The RBI also introduced a differentiated banking framework in 2014 aimed at deepening financial inclusion, which led to the creation of small finance and payments banks — designed to cater to underserved customer segments and expand access to formal banking services.

 

Last year, the banking regulator approved AU Small Finance Bank’s application to convert to a universal bank. The RBI also laid down eligibility criteria for the voluntary conversion of small finance banks into universal banks.

 

At present, India’s banking sector comprises 12 lenders from the public sector, 21 from the private sector, and 11 small finance and five payments banks. The landscape now also boasts of a diverse set of non-banking financial lenders.

 

Private-sector lenders such as HDFC Bank, ICICI Bank and Axis Bank have grown into some of the country’s largest financial institutions, while PSBs have undergone consolidation.

 

Now, more than three decades after India opened its banking sector to private players, the RBI appears focused on strengthening and scaling existing institutions rather than adding more, reflecting the growing role of non-bank lenders.

 

Private sector competition

 

While nationalisation helped widen access to banking, the system had also become characterised by directed lending, administered interest rates and limited competitive pressure.

 

The 1991 reforms therefore represented a fundamental change in the approach to banking. In this backdrop, the Narasimham Committee had recommended the entry of private banks, not with the aim of privatising existing PSBs, but to introduce competition.

 

The change faced resistance from sections of the banking workforce and unions. Bank employee organisations opposed several aspects of the liberalisation process, including the entry of private banks, computerisation and restructuring, which they feared could affect employment and the role of public-sector banking.

 

In 1997, nine bank unions and officers’ associations called a nationwide strike and opposed, among other measures, the establishment of local-area private banks.

 

The story of UTI Bank best illustrates how gradual the transition was. The bank was promoted by UTI, LIC and government-owned general insurance companies and began operations in 1994. It was, therefore, a private-sector bank in regulatory terms, but its institutional origins were closely linked to the public sector.

 

The new banks nevertheless introduced a different competitive model. Unlike PSBs, which had spent decades building branch networks and deposit franchises, the new private lenders could build their businesses around technology, more commercially oriented operating models and faster product development.

 

Over time, this helped the new entrants move beyond their initial status as challengers. HDFC Bank, ICICI Bank, Axis Bank and Kotak Mahindra Bank developed large deposit and lending franchises and became major national institutions.

 

The evolution also changed the role of foreign banks in the market. Several foreign lenders that once competed aggressively in consumer banking subsequently scaled back or exited those businesses, with domestic private-sector banks acquiring their portfolios and customers.

 

Several foreign banks that once had a meaningful retail presence in India have exited or significantly pared their consumer banking operations by selling them to domestic private lenders.

 

For instance, Citibank sold its consumer business — including retail banking, credit cards, wealth management and consumer loans — to Axis Bank in 2022. Standard Chartered sold its Rs 4,100-crore personal loan portfolio to Kotak Mahindra Bank in 2024, and, in 2026, agreed to transfer its standalone credit card portfolio to Federal Bank, while retaining customers with broader banking relationships.

 

More recently, Deutsche Bank agreed to sell its retail banking, private banking and wealth management business in India to Kotak Mahindra Bank for Rs 282 crore.

 

“One of the main reasons India has issued so few banking licences over the last 25 years is the restriction on corporate houses entering banking. Large corporate groups are among the few entities with the capital required to build banks at scale. Once they are excluded, the pool of potential applicants becomes much smaller,” said former RBI deputy governor H R Khan, who is currently part-time chairman and independent director at AU Small Finance Bank.

 

There are some large NBFCs that could potentially transition into banks, Khan says, but many of them have either not shown interest or have faced regulatory and supervisory hurdles. The small finance bank framework was also expected to create a pipeline of future universal banks, but progress has been slower than anticipated. “Regulators have also become more cautious over time,” he adds.

 

Rise of NBFCs

 

Large lenders such as Bajaj Finance, Tata Capital and Mahindra Finance have emerged as major credit providers, lending to segments that may once have been served through the route of new bank licences.

 

“At present, many large NBFCs appear comfortable remaining NBFCs rather than converting into banks,” Khan says. This was evident from the fact that not a single large NBFC applied for a universal banking licence even after the process was brought on tap.

 

Industry observers note that while a banking licence provides access to low-cost deposits, it also brings significant regulatory obligations, including reserve requirements, priority-sector lending norms and tighter supervision.

 

For many large NBFCs, the costs and operational adjustments required to become banks may outweigh the benefits. As a result, the debate within the financial sector has increasingly shifted from whether India needs more banks to whether it needs larger and better-capitalised ones.

 

Over the years, the RBI’s focus has shifted to specialised licences such as small finance banks. “NBFCs have become a major force in the financial system. Many large corporate-backed NBFCs are now bigger than some banks and have realised that converting into banks may not necessarily be attractive given the regulatory costs and restrictions that come with a banking licence,” says Abizer Diwanji, founder, NeoStrat Advisors LLP.

 

The PSB consolidation

 

A consolidation of PSBs was initiated a few years back when, first, State Bank of India merged its associate banks as well as Bharatiya Mahila Bank in 2017. That was followed by the merger of Vijaya Bank and Dena Bank with Bank of Baroda in 2019, and then six others were folded into four large anchor banks in 2020.

 

“The debate today is no longer about whether India needs more banks. The focus is on creating larger banks,” Diwanji says. The RBI can achieve this through consolidation, privatisation, capital infusion and ownership changes, he adds. A more likely route is to help existing smaller banks scale up or allow large NBFCs to transition into banking over time, rather than issuing fresh licences.

 

The RBI’s current approach appears to favour scale through consolidation, capital infusion and ownership changes rather than a fresh round of universal banking licences. The regulator has also encouraged foreign banks to establish locally incorporated subsidiaries and has shown a greater willingness to strengthen existing institutions.

 

Going forward, sector experts see a greater scope for mid-sized banks to expand through fresh capital and acquisitions, while large NBFCs could eventually transition into banking entities through mergers or restructuring rather than through entirely new licences.

 

With private lenders having established themselves as major competitors and PSBs having undergone consolidation, the focus is increasingly on creating institutions that are larger, better capitalised and capable of supporting the next phase of economic growth. 

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The report said the credit landscape was becoming more concentrated and differentiated, with district- and industry-level data giving lenders greater visibility into local credit patterns and opportunities.