India’s Financial Sector – Challenges & Reforms

The government and regulators have attempted incremental reform in banking, financial services, and insurance (BFSI), yet systemic frictions persist. These frictions are not just inefficiencies, but are barriers that deter savers, discourage investors and delay growth. A truly professional, transparent and investor-friendly financial sector demands deeper structural corrections, particularly in corporate bond markets, retirement planning instruments, nomination processes across BFSI.

What are the CHALLENGES that the financial sector in India is facing?

1. Nomination regime: Across BFSI verticals, the rules governing the nominees are inconsistent. A citizen can nominate a single person for one account but multiple for another, with different rights attached. This patchwork approach not only lacks legal clarity but confuses the ordinary citizens & benefits only those who seek to exploit the legal ambiguities.

2. Underdeveloped Corporate Bond Market: An underdeveloped bond market in India is a large structural lacunae in our financial landscape. Despite several initiatives over the years, the corporate bond market in India remains shallow, illiquid & opaque. An efficient bond market is significant for business growth as it can reduce funding costs by 2 to 3%. RBI once directed the NSE (National Stock Exchange) to develop a secondary bond market, but no development has been done in this regard so far.

3. Lack of transparency in capital flow: As a member of FATF, India is committed to implementing global KYC norms, which include clear identification of UBOs (Ultimate Beneficial Owners). FATF in its updated guidelines has underscored the need for countries to maintain accurate & accessible ownership data to prevent misuse of financial structures. But, the practical implementation of this guideline remains a challenge for e.g. SEBI recently has had to ask 2 Mauritius-based FPIs to disclose their shareholder’s data related to their holdings in listed Indian company – because these 2 firms had not complied with multiple disclosure requests.
Opacity in ownership structures weakens the market integrity & inhibits long-term investments, both domestic & foreign.

4. Limited retirement planning products: Retirement planning in India is mostly routed through annuities. These annuities are costly due to intermediation margin charged by the insurance companies. There are simpler & cheaper alternatives such as ‘Zero-coupon G-Secs’, but the government & the RBI has shown little interest in promoting them as retirement products. This complacency is not only preventing the young professionals from getting financial gains but also preventing us from building a vibrant, low-cost retirement ecosystem based on sovereign credibility.

5. Shadow Banking: Shadow banking which includes NBFCs, margin lenders, repo traders, and brokers is an ominous blind spot in Indian financial sector. They are offering bank-like services without being subjected to full regulatory oversight. The global economists have already warned that the next financial crisis could originate from here, just like the 2008 financial crisis originated from unregulated derivatives in USA.

What are the REFORMS & INITIATIVES already been taken?

1. Basel Norms Implementation: India has progressively adopted and implemented Basel I, II, and III norms for capital adequacy and risk management. This ensures that Indian banks maintain sufficient capital buffers to absorb potential losses, enhancing their resilience.

2. Asset Quality Review (2015): The RBI initiated an AQR to ensure transparent recognition of stressed assets, leading to the reclassification of many stressed accounts as Non-Performing Assets (NPAs).

3. Prompt Corrective Action (PCA) Framework: The RBI’s PCA framework allows for stricter supervision and intervention in financially weak banks, helping to restore their health and prevent systemic risks.

4. Central KYC (CKYC) Registry Revamp: A new CKYC registry will be rolled out in 2025, streamlining customer verification and making banking and investment processes more efficient.

5. Scale-Based Regulation (SBR) for NBFCs: Introduced a tiered regulatory framework for NBFCs based on their size, activity, and perceived risk, with stricter regulations for larger and more systemically important NBFCs. Post events like the IL&FS crisis, the RBI has significantly tightened regulatory oversight on NBFCs regarding governance, asset-liability management (ALM), and capital adequacy.

6. Financial Sector Legislative Reforms Commission (FSLRC) Recommendations: While not all recommendations have been implemented, the FSLRC’s report provided a blueprint for comprehensive legislative reforms aiming for a non-sectoral, principles-based financial law. Key themes include consumer protection, micro-prudential regulation, resolution mechanisms, and systemic risk management.

7. Financial Stability and Development Council (FSDC): The FSDC, established by the government, plays a crucial role in maintaining financial stability, enhancing inter-regulatory coordination, and promoting financial sector development.

What can be the way forward (REFORMS NEEDED)?

1. Reforms in nomination regime: Government needs to bring a harmonised nomination framework, with clarity on nominee rights vis-a-vis legal heir claims.

2. Reforms in Shadow Banking: India needs to bring the legislation to regulate the shadow banking similar to EU’s legislation that aims to gather comprehensive data on shadow banking activities. It will help in brining transparency in shadow banking & saving lakhs of retail investors from losing their savings in future (e.g. IL&FS Crisis).

3. Corporate Bond Market Development: Further reforms to deepen the corporate bond market, making it an attractive alternative to bank finance, including facilitating easy access to global capital markets for Indian companies.

4. Regulatory Sandboxes and Innovation Hubs: Continue to utilize and expand regulatory sandboxes to allow FinTech innovations to be tested in a controlled environment, fostering responsible innovation.

5. Data for transparency v/s Privacy: Establishing clear and comprehensive data governance frameworks that balance data sharing for transparency & financial innovation with robust data privacy protection for customers. The revamped CKYC registry is a step in this direction, but its full potential needs to be realized.

6. Consumer Protection and Financial Literacy:

• Addressing Mis-selling: Stricter enforcement and deterrents against mis-selling of financial products, especially complex insurance and investment products, ensuring transparency and appropriate disclosure of risks and costs.
• Continuous Financial Literacy: Expanding targeted financial literacy programs, particularly for vulnerable groups and those newly brought into the financial fold through digital channels, to empower informed decision-making.

CONCLUSION:
India’s financial sector reforms must go beyond slogans and cosmetic amendments. We need a coherent, forward-looking strategy that harmonizes rules across verticals, nurtures a deep bond market, innovates in retirement finance, and reins in shadow banking.