The government’s announcement that it will set up a high-level committee to draw up a road map for India’s banking sector is timely. Without a clear strategy for the financial ecosystem, meeting the country’s growth aspirations will be difficult; credit remains a critical catalyst. While some recommendations of earlier committees can be revisited, the context has changed dramatically. Rapid technological shifts and the growing ubiquity of artificial intelligence threaten to fundamentally alter how businesses—including banks—operate. That said, India’s financial sector needs a set of basic structural fixes.
Foremost among them is scale. Indian lenders remain puny by global standards. As Financial Services Secretary M Nagaraju noted earlier this week, India’s credit-to-GDP ratio needs to almost treble—to about 150% from the current 56%. To take and absorb risk efficiently, banks must be far larger than they are today. Consolidation is one obvious route. To its credit, the government has already executed one round of public sector bank mergers—no small achievement given strong union resistance. There is now a case for going further, including selective mergers among smaller private sector banks and with stronger peers.
Future of small finance banks and governance reform
In this context, it would also be useful to assess the performance of small finance banks and examine whether they should continue as standalone entities or be merged into larger banks. Without adequate scale or a sufficiently broad deposit base to lower funding costs, lenders cannot price credit competitively.
Stronger balance sheets would also inspire investor confidence and enable banks to raise growth capital from markets. Governance reform is another long-standing priority. Multiple committees, including the PJ Nayak Committee, have argued that state-owned banks need greater autonomy. Reducing the government’s role in operational and governance decisions would minimise interference, professionalise management, and improve competitiveness with global peers. A smaller ownership footprint would also make public sector banks more attractive to long-term investors.
Foreign investment, NBFCs, and regulatory choices ahead
There are indications that the government is considering allowing foreign investors to own up to 49% in state-run banks—a sensible step. Strategic foreign investors can bring not just capital but also global best practices in risk management, technology adoption, and governance. The Reserve Bank of India and the government have already taken a constructive approach by facilitating strategic stakes by foreign institutions such as SMBC and NDB in private sector banks. Their willingness to invest reflects confidence in the strength of these institutions. The next logical step would be to revisit voting rights caps, currently limited to 26%, to encourage deeper and more active participation by long-term investors. Of course, India cannot rely solely on foreign capital to build a stronger banking system. Policymakers should also consider granting bank licences to financially sound non-banking financial companies (NBFCs). Several NBFCs have demonstrated an ability to deploy technology efficiently across operations while managing risk prudently—in some cases outperforming traditional banks.
The regulator’s reluctance to allow large industrial conglomerates to own banks is prudent. However, a calibrated expansion of licences to well-run NBFCs, which can attract both domestic and foreign capital, deserves serious consideration. For such investors to commit meaningfully, operational flexibility will be key. Letting go of some legacy controls is therefore a necessary first step if India is to build a banking system capable of supporting sustained high growth. The government must speedily decide on the constitution and the terms of reference of the high-level committee. Losing time is never a good option.