Since 2013, India’s financial system has undergone a series of significant transformations, moving it from a state of fragility to one of relative strength. These reforms began when Morgan Stanley classified India as one of the “fragile five” nations, citing weak capital markets that contributed to financial instability, a lack of savings options for ordinary citizens, and a high cost of capital for businesses. A decade later, the picture has shifted dramatically, with India’s financial system experiencing greater stability, reduced dependency on foreign capital inflows, strong domestic savings, and enhanced exchange rate management.
Addressing Non-Performing Loans and Strengthening Banks
In 2013, the Reserve Bank of India (RBI) initiated an “asset quality review” led by Raghuram Rajan, a professor from the University of Chicago. This review exposed the twin-balance-sheet problem, revealing significant holes in both bank and corporate balance sheets. The government responded by introducing a bankruptcy code in 2016, writing off $106 billion in bad loans, injecting government funds, enforcing financial consolidation, and implementing stricter reporting rules. The three-year consolidation drive saw 27 government-owned banks merged into 12. Foreign banks were also permitted to acquire Indian banks, with DBS acquiring Lakshmi Vilas Bank in 2020, providing an outsider access to a vast branch network for the first time. As a result of these measures, non-performing loans at state-controlled banks have declined significantly, from 15% in 2018 to just 4%.
Rise of Private Banks and Financial Inclusion
Alongside the strengthening of weak financial institutions, India has witnessed the emergence of new private banks such as HDFC Bank. HDFC Bank is now among the top ten most valued banks globally, with a return on equity of 16%. This healthier financial ecosystem has facilitated broader access to credit for various sectors such as consumption, housing, and industry. The number of bank branches has also expanded by 60% since 2015, providing greater access to financial services in rural areas. Furthermore, a major initiative to assist low-income individuals in opening basic bank accounts has been a game-changer, with over 520 million accounts opened since 2014, attracting deposits of $28 billion. These accounts are linked to India’s digital payment and identification system, serving as valuable records for credit evaluation, which partly explains the recent increase in lending to small businesses.
Stock Market Boom and Capital Market Expansion
Indian stock markets have also witnessed a surge in activity, reflecting the success of Indian businesses and the expansion of available capital. The capitalization of Indian stock markets has grown significantly, surpassing Spain and now rivaling Hong Kong. Based on long-term growth rates, BCG predicts that India’s stock market will become the second largest by 2036. The proportion of Indians owning shares has increased from 7% to 20% since 2019, with systematic investment plans and mutual funds gaining popularity. Money flowing into the stock market has led to a record number of companies going public in 2024. While some may view this growth as a potential bubble, it could also be attributed to the Indian market’s relatively low penetration compared to developed markets.
Reform of Banking System and Growth of Alternative Financial Sources
The Indian financial system is restructuring to address imbalances. The share of assets held by the banking system has gradually declined, and BCG predicts it will continue to decrease from 48% in 2022 to 36% by 2030. This space is being filled by components of more mature capital markets, such as funds, pensions, insurance companies, private equity, and venture capital. The listing of Life Insurance Company of India in 2022 is a testament to this expansion. These sectors are keen on using capital to spur growth, creating additional investment opportunities.
International Recognition and Challenges
India is actively seeking upgrades to its borderline junk status from global ratings agencies, which would signal its growing financial stature and potentially lower capital costs. However, India’s financial sector also faces challenges. A surge in foreign venture capital investments since 2020 has recently imploded, with valuations of private firms being written down. This has affected some tech startups but does not appear to have impacted the broader public or domestic stock market. Additionally, the bond market remains underdeveloped, primarily serving to finance the government rather than long-term capital investments. India continues to seek foreign investment, and its inclusion in government-bond indices by JPMorgan and Bloomberg is a positive step.
Despite these challenges, India’s financial system has undergone a remarkable transformation, transitioning from fragility to strength. Reforms have been instrumental in strengthening banks, expanding access to finance, and fueling capital market growth. As India’s financial system continues to evolve and mature, it is well-positioned to support the nation’s economic development and enhance its global standing.
