Banking Sector Reforms

Balancing the interest of lenders and borrowers


From UPSC perspective, the following things are important :

Prelims level: Not much

Mains level: Paper 3- Problems of banks in India

The article suggests the 5 point strategy to balance the interest of borrowers and lenders. Banks hold the special significance for the country and so require special and stricter regulation.


  •  COVID creates deep pain but we must resist consistently choosing borrowers over lenders.
  • We should persist with our multi-year five-pillar strategy to sustainably raise our Credit to GDP ratio from 50 per cent to 100 per cent.

Issue of lending

  • A modern economy grows by lending.
  •  But fiscal constraints or natural disasters often create temptations to disguise spending as lending.
  • The last 20 years have given three lessons:
  • 1) Giving loans is easier than getting them back.
  • Corporate credit growing from Rs 18 lakh crore in 2008 to Rs 54 lakh crore in 2014 created a Rs 12 lakh crore bad loan problem.
  • 2) Accounting fudging and restructuring would not help.
  • 3) Government banks need more than capital.
  • Government banks’ risk-weighted assets are lower than two years ago despite a Rs 2 lakh crore capital infusion.

History recommends patiently balancing financial inclusion and stability by persisting with our five-pillar strategy.

1) Bank competition

  • Raising credit availability and lowering its price needs competition-driven innovation.
  • Capital should be chasing Indian banking given its high net interest margins, high market cap to book value ratios, and massive addressable market.
  • Yet, the RBI’s on-tap licencing has few applications pending.
  • We need many more banks.

2) Private bank governance

  • Private banks are only 30 per cent of deposits but 80 per cent of bank market capitalisation.
  • Private banks are a special species with 20 times leverage, but this makes privatised gains and socialised losses possible.
  • Recent failures suggest problems with public shareholder collective action and the attention, skill, and courage of board directors.
  • Private bank governance must move from a perpetual private fiefdom to trustees that hand over in better condition to the next generation.

3) Government bank governance

  • Over 10 years, government companies have sunk from 30 per cent of India’s market capitalisation to 6 per cent.
  • Government banks mirror this decline — their 70 per cent bank deposit share translates to only 20 per cent bank market capitalisation share.
  • Many have irrational employee costs to market capitalisation ratios ex- Bank of India with 58 per cent.
  • We need only four government banks with strong governance and no tax access for capital.

4) RBI’s regulation and supervision

  • Recent failures in financial institutions reinforce the importance of statutory auditors, ethical conduct, shareholder self-interest, and risk management.
  • They also suggest a first-principles review that raises the RBI’s regulation and supervision.
  • Zero failure is impossible, but the RBI should boldly re-imagine its current mandate, structure and technology.

5) Non-bank regulatory space

  • Regulatory differences traditionally existed between banks and non-banks.
  • But progress in payments, MSME lending, and consumer credit suggest that non-banks are as important for financial inclusion.
  • They need more regulatory space and supervision.


We won’t test the RBI’s COVID worst-case scenario of 14.7 per cent bad loans but handling the inevitable COVID bank pain needs resisting short-termism. In the long run, we are not all dead.

Original article:

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