Indian Banking Sector Explained: Challenges, Opportunities, and its Future

The Indian banking and financial system have come a long way since its early days. As of 2022, the total assets across all banking sectors (public and private banking) crossed $2.67 trillion.

India has one of the world’s largest retail banking and financial services institutions – with 12 public sector banks, 22 private banks, 46 foreign banks, 56 regional rural banks, 1485 urban cooperative banks, and 96000+ rural cooperative banks, along with other credit institutions.

This is a long jump from its pre-independence or post-independence phases. Before we got independence, India had just 600 banks, with the Bank of Hindustan founded in 1770 in Calcutta being the very first established bank in the country.

Prominent among these is the Imperial Bank of India, which was formed by merging three existing banks in 1921. The Imperial Bank of India was nationalized in 1955 and became the State Bank of India, which is today the largest public sector bank in India.

Similarly, if we look at the post-independence scenario, the banking system in India focused majorly on providing financial services to the poor and rural populations, which largely depended on local money lenders for financial assistance.

With this aim, the Government of India nationalized the banks under the Banking Regulation Act of 1949, and a total of 14 nationalized banks were present, including the Reserve Bank of India (RBI).

However, the most significant push to India’s financial system came in 1991, when the government invited private players to invest in India. This led to the liberalization of the banking system in India and led to the formation of the top private banking institutions like HDFC Bank, Axis Bank, ICICI Bank, DCB, and IndusInd Bank.

Going by this trend, the future of financial services in India is on a solid growth trajectory, with India now surpassing the UK to become the 5th largest economy globally.

Here’s a look at the current trends shaping the global financial services industry and the opportunities it presents for the banking system in India.

Banking Since 2020: The Global Outlook and How it is Shaping the Indian Banking Sector

The global economic outlook looks gloomy, as several factors hinting towards a recession-like scenario.

First, the geopolitical events, especially post-COVID-19 and the Russia-Ukraine war, have had a lasting impact, and as per the International Monetary Fund, the global growth projects were downgraded to 3.2% for 2022.

These include the issues due to global oil prices remaining volatile, sanctions imposed on Russia by Western countries, and continuing energy shortages that could lead to high costs.

However, despite the global challenges, India’s overall financial system seems to be going steady and doing relatively well.

As a result, the IMF projection for India’s economic growth in 2022 is at 6.1%, ahead of China (4.4%), Saudi Arabia (3.7%), and Nigeria (3%). In contrast, the US is projected at 1% growth, while Russia, Italy, and Germany could suffer degrowth.

Although India’s financial system has seen great heights and has a relatable stable approach given the current global economic outlook, this is not to say that the banking system in India hasn’t faced issues.

Some of the most recent challenges that continue to have a heavy influence on India’s financial system include the following:

• The rise of Non-Performing Assets (NPAs), including bad loans or problems in the agricultural and corporate sectors. Currently, the country’s NPAs have crossed ₹10 lakh crores, with more than 70% being from the corporate sector.
• The increasing number of frauds, including accounting fraud, demand draft fraud, uninsured deposits, fraudulent loans, and others. The RBI in 2022 reported total fraud cases of around 9103, the biggest being the PNB scam of ₹11,000 crores, Vijay Mallya defaulting lenders for Rs. 9000 crores, and several others that we have witnessed recently.
• Lack of banking for the underserved and rural population, which is approximately 69% of India’s total population. Around 1.4 billion Indians do not have access to formal banking, as per the World Bank report.
• Lack of reach in rural areas, where technical enablement and use of financial services remain a big challenge.

India’s Banking System Opportunities

In a statement by Kristalina Georgieva, Managing Director, IMF, to the press, she mentions how “India deserves to be called a bright spot on this otherwise dark horizon because it has been a fast-growing economy, even during these difficult times, but most importantly, this growth is underpinned by structural reforms.”

According to IBM’s Report titled ‘Banking on India,’ India’s banking systems are experiencing significant disruption and change and have invested majorly to bank on technology transformations.

Some of the important initiatives undertaken by the central government for financial enablement and digitization are proving to have fruitful results. As per the report, the opportunities that India can unlock thanks to these initiatives include:

• Financial Inclusion: 300 million individuals opened a bank account for the first time since the government initiative to provide accessible and affordable financial services to the masses, called the Pradhan Mantri Jan Dhan Yojana, in 2014. Since 2011, the unbanked population has been cut down to half. In addition, 55% of Jan Dhan account holders are women, and 67% of the account holders reside in rural and semi-urban areas.

• Digital Payments: In 2016, the Government of India launched the UPI (Unified Payment Interface) System and BHIM, along with the National Payments Corporation of India (NPCI). This has improved mobile banking and online payments, creating a digital revolution.

• Rise of Neo Banking: In 2021, the Niti Ayog proposed to set up ‘digital banks,’ which rely on the internet to offer their services instead of physical branches. This will revolutionize how banking as a service is provided to customers and create new opportunities for rural and urban sectors.

The Future of Indian Banking

In the future, India’s financial system will witness a greater emphasis on providing improved and personalized services to clients.

This will be coupled with being able to match competitive rates through the introduction of Neo-banks and other digital lending options that are now available to customers.

The future will see robust growth driven by innovation and investment in infrastructure, digital enablement, and a focus on mobile and internet banking.

As per IBEF, India’s fintech market is expected to reach ₹6.2 trillion in 2025. It will witness greater regulatory support, such as the advent of RBI’s regulatory sandbox, which will allow fintechs to test out their concepts and innovations before going live.

Further, it will work with 4200+ fintech startups to create a more disruptive, accessible, and innovative future. This can catalyze major initiatives to enable India’s financial services offerings to be more robust and fast-paced, including:

• The use of blockchain creates a more decentralized and safe process for banking processes. Banking institutions like Axis Bank, Kotak Bank, and Yes Bank have already partnered with blockchain firms to allow customers to get cross-border remittances via Ripple, and there could be more implementations underway.

• Use of Artificial Intelligence systems for chatbots, fraud detection, risk management, investment, and other banking processes.

• Increase in peer-to-peer (P2P) lending, especially given the new regulations capping a potential lender’s exposure to ₹10 lakh and limiting it to not more than 36 months. This will make P2P lending safer and less risky while enabling an option for customers with low financial requirements to benefit from these platforms.

Conclusion

To recap all that was discussed in the blog, increasing privatization and digitization are the central themes that will continue to evolve India’s financial system in 2022 and beyond.

As we move to a more inclusive, non-traditional, and affordable banking system, focusing on internal controls, credit risk management, managing NPAs, and the adoption of technology will play a vital role in carving the future of growth in our overall financial system.

With positive steps being taken, including the rise of fintech and microfinancing options, the inclusion of the unbanked population, and initiatives for digitizing finance, the banking system in India will be the third-largest in the world by 2025, with the chances of becoming a $5 trillion economy by FY 2029.

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