India Overhauls Banks, Pushes Corporate Bonds for Long-Term Capital

Banking Sector Overhaul Underway

Financial Services Secretary M. Nagaraju announced the formation of a High-Level Committee on Banking for Viksit Bharat. The committee will conduct a comprehensive review, moving beyond past efforts to improve the operational efficiency and capital use of public sector banks (PSBs). Its focus will be on balance sheet constraints and leveraging PSB capital more effectively to support India’s growth without compromising financial stability. This comes as PSBs show improved profitability and capital adequacy, trading at attractive valuations compared to private banks. Still, the sector faces challenges like non-performing assets (NPAs) and the ongoing issue of funding long-term loans with short-term deposits. The committee will also examine costs and find ways for regulators and institutions to improve credit flow, emphasizing effective regulation.

Boosting the Corporate Bond Market

Alongside banking reforms, India is working to develop its corporate bond market as a key source of long-term capital. Secretary Nagaraju noted that banks, limited by their reliance on short-term deposits, are not ideal for financing projects that need 10 or 20 years of funding. India’s corporate bond market has grown to about ₹53 trillion by March 2025, representing 15-16% of GDP. However, it makes up only 10-15% of total corporate debt, far below the 30-50% in the U.S. and Eurozone. A major hurdle is that the market mainly serves highly-rated issuers (AA and above), leaving smaller and mid-tier companies struggling to access capital. Developed markets like the U.S. and EU see broader issuance, including in ‘A and below’ segments. Expanding this market is essential for funding infrastructure, industry, and new sectors, while also reducing risks in a system heavily reliant on banks.

Regulatory Support for Market Growth

The Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) are enhancing regulations to support bond market growth. Recent steps include introducing electronic bidding, Request for Quote (RFQ) systems for price discovery, and improving retail investor access via online platforms. The RBI also allowed corporate bonds in banks’ Held-to-Maturity (HTM) portfolios, lifting previous limits. Future plans involve credit indices, credit derivatives, and total return swaps (TRS) to boost liquidity and risk management, aiming for more efficient and accessible corporate debt markets. These regulatory actions are part of a wider strategy to promote market-based financing and build a more stable financial system supporting India’s 2047 vision.

Challenges Remain Despite Reforms

Significant challenges remain despite the reform efforts. Banks still face liquidity and solvency risks from funding long-term assets with short-term liabilities, a problem seen in past crises like IL&FS. While India’s secondary bond market is active for government securities, it has lower liquidity for corporate bonds than in developed economies, with many investors holding bonds long-term rather than trading them. This lack of liquidity, combined with the concentration among top-rated issuers, limits capital access for less creditworthy companies. Although stricter oversight is planned, implementing these rules could add new operational burdens for financial institutions. The historical prevalence of NPAs in PSBs has damaged balance sheets and asset quality, showing that resolving these legacy issues is a key task.

Future Prospects

These efforts show India’s aim to create a more varied and market-driven financial system. The goal is to direct capital more efficiently to long-term growth, decrease reliance on bank loans, and improve access for a wider range of companies. While inflation risks may temper aggressive interest rate cuts, economic growth projections remain strong, creating a supportive environment for these financial market changes. Success depends on effective implementation, more investor involvement, and ongoing regulatory adjustments to build a dynamic capital market.