Indian Financial Sector: Structure, Trends, and Turns

Authors

• Rakesh Mohan
  • Senior Fellow, Jackson Institute for Global Affairs, Yale University
  • Distinguished Fellow, Brookings India
• Partha Ray
  • Professor, Indian Institute of Management, Calcutta

Overview

• Examines the evolution of the Indian financial sector from 1950-2015.
• Divided into three phases:
  1. 1950s-60s: Laissez-faire with underdeveloped banking.
  2. 1970s-80s: Government-led financial development and financial repression.
  3. 1990s-present: Gradual financial deepening and liberalization.

Key Phases in Indian Financial Sector

1950-1990: From Laissez-faire to Government Control

• Reserve Bank of India (RBI): Established in 1935, central bank and regulatory authority.
• Pre-Independence Banking: Dominated by Imperial Bank, joint-stock, and foreign exchange banks.
• 1950s-60s: Banking failures and limited access to finance.
• 1969 & 1980 Nationalization: Large-scale nationalization of private banks, led by Indira Gandhi.
• Development Finance Institutions (DFIs): Set up to address capital market absence, later became non-viable.
• Co-operative Banks: Faced governance issues and political interference.
• Regional Rural Banks (RRBs): Established in 1975, focused on rural and agricultural credit.
• Post Office Savings Bank (POSB): Significant in financial inclusion but limited to savings and remittances.

1990s Onwards: Financial Sector Reforms

• Banking Reforms: Influenced by Narasimham Committee Reports (1991, 1998).
  • Reduction of CRR and SLR.
  • Modernized prudential norms and bank ownership structure.
• Monetary Policy: Transition to market-based instruments, repo rate as policy anchor.
• Private Banks: New licenses issued, introduction of credit recovery mechanisms.
• Technology in Banking: INFINET, RTGS, and core banking solutions drove modernization.
• Outcomes: Increase in financialization, improved profitability, efficiency, and stability.

Financial Markets

Equity and Debt Markets

• Equity Market: Developed with electronic trading and regulatory reforms.
• Debt Market: Predominantly private placements, limited to blue-chip companies.
• Mutual Funds: Growth in mutual funds, preference for debt-oriented schemes.

Insurance Sector

• Reforms: Opening to private and foreign players, establishment of IRDA.
• Challenges: Low insurance penetration, public sector dominance.

Pension Funds

• Reforms: Move from defined-benefit to defined-contribution systems.

External Sector

• Exchange Rate Policy: Move to managed floating exchange rate in 1993.
• Foreign Investment: Calibrated liberalization of capital account and foreign participation.

Non-Banking Financial Companies (NBFCs)

• Diversity and Regulation: Wide variety of NBFCs, some remain unregulated.
• Deposit-taking NBFCs: Subject to prudential regulations, ongoing issues with financial irregularities.

Concluding Observations

• Significant reforms over 25 years, progress in market determinants of interest and exchange rates.
• Future development areas: reducing public ownership, expanding insurance and pension systems, and developing institutional investors.

References

• Various reports and articles on the history and reform of India's banking, insurance, and financial markets.