Banking Reforms and Recent Developments in India for RBI Grade B Finance
Last updated: 2026-11-13 · MockMentor
The second half of the syllabus line "Banking System in India: Structure and Developments" is about how Indian banking has changed. RBI Grade B asks about this through questions on the Narasimham Committees, the 2019 bank mergers, the bad loan clean-up, lending rate benchmarks such as MCLR and EBLR, and new types of banks. For the descriptive paper, the twin balance sheet problem and the governance of public sector banks are perennial topics. This chapter traces the reforms from 1991 to today.
In one line: Indian banking moved from a controlled, state-led system to a competitive and well-regulated one through the reforms of the 1990s, new licences, a decade-long clean-up of bad loans and the mergers of public sector banks, and it now faces the challenges of deposits, digital risks and unsecured credit.
Basic concepts
- Financial repression: a system in which the government controls interest rates and directs bank money to itself or favoured sectors, as India did before 1991 with high CRR and SLR and administered rates.
- Prudential norms: rules on income recognition, asset classification, provisioning and capital that ensure banks show their true financial position.
- Twin balance sheet problem: a situation in which both over-leveraged companies and the banks that lent to them are under stress, so that neither invests or lends.
- Evergreening: giving fresh loans to a stressed borrower so that it can repay old loans, hiding the true level of bad loans.
- Bad bank: an institution that buys bad loans from banks so that banks can clean their books and focus on new lending.
- On-tap licensing: licences available throughout the year to eligible applicants, rather than in occasional rounds.
Why in News?
- Under the "One State, One RRB" policy, 26 regional rural banks were merged with effect from 1 May 2025, reducing their number to 28.
- The Banking Laws (Amendment) Act, 2025 changed rules on nominees, substantial interest and cooperative bank governance; its main provisions came into force in 2025.
- RBI will move banks from the "incurred loss" method to the expected credit loss (ECL) method of provisioning from 1 April 2027.
- Credit growth of banks slowed after RBI raised risk weights on unsecured consumer credit and on bank loans to NBFCs in November 2023; RBI rolled back the extra risk weight on loans to NBFCs in 2025.
Banking before 1991
After nationalisation in 1969 and 1980, banks spread to rural areas and lent to agriculture and small industry. Branches grew from about 8,000 in 1969 to over 60,000 by 1991, and the Lead Bank Scheme (1969) gave each district a lead bank. Yet by the late 1980s the system had serious problems:
- CRR and SLR together pre-empted more than half of deposits (CRR of 15% and SLR of 38.5% at their peak).
- Interest rates were set by RBI for deposits and loans of every type.
- Directed credit and loan melas (lending fairs) led to poor credit decisions.
- There were no proper accounting rules for bad loans, and many banks had very little capital.
- Productivity was low and customer service was poor.
The Narasimham Committees
First Narasimham Committee (1991)
The Committee on the Financial System, chaired by M. Narasimham, recommended:
| Recommendation | What followed |
|---|---|
| Reduce SLR to 25% and CRR gradually | SLR fell to 25% by 1997; CRR was cut in stages |
| Deregulate interest rates | Most deposit and lending rates were freed by the late 1990s |
| Introduce prudential norms on income recognition and asset classification | NPA norms from 1992-93, with the 90-day norm adopted from 2004 |
| Capital adequacy of 8% | Basel I norms introduced from 1992 |
| Allow new private banks and foreign banks | New private banks licensed from 1993 |
| Set up Asset Reconstruction Funds and special tribunals | Debt Recovery Tribunals from 1993 |
| Reduce directed credit (priority sector to 10%) | Not accepted; priority sector stayed at 40% |
Second Narasimham Committee (1998)
The Committee on Banking Sector Reforms recommended:
- Raise capital adequacy to 10% (RBI set 9% from 2000).
- Merge strong banks; close or merge weak banks.
- A 90-day rule for NPAs and stricter provisioning.
- Reduce government stake in public sector banks to 33%.
- Set up asset reconstruction companies, which came through the SARFAESI Act, 2002.
- Review laws relating to banking, which led to the changes in the RBI and BR Acts.
Entry of new banks
| Round | Banks licensed |
|---|---|
| 1993 guidelines | About ten new private banks, including HDFC Bank, ICICI Bank, Axis Bank (then UTI Bank) and IndusInd Bank |
| 2001 guidelines | Kotak Mahindra Bank and Yes Bank |
| 2013 guidelines (2014 licences) | IDFC Bank and Bandhan Bank |
| 2015 (differentiated licences) | 10 small finance banks and 11 in-principle payments bank licences, of which several surrendered |
| 2016 onwards | On-tap licensing of universal banks (2016) and small finance banks (2019) |
In 2021, an RBI Internal Working Group reviewed ownership rules. RBI allowed promoters to hold up to 26% of a bank's voting equity after 15 years but did not accept the proposal to let large industrial houses own banks. Small finance banks with a good track record can apply to become universal banks.
Interest rate reforms and lending benchmarks
| System | Period | Basis |
|---|---|---|
| Prime Lending Rate (PLR) | 1994 to 2003 | Each bank's own rate for its best borrowers |
| Benchmark PLR | 2003 to 2010 | A reference rate, but most loans were below it, making it opaque |
| Base Rate | July 2010 to March 2016 | Minimum lending rate based on the average cost of funds |
| Marginal Cost of Funds based Lending Rate (MCLR) | From April 2016 | Based on the marginal cost of funds, so it reacts faster to policy changes |
| External Benchmark Lending Rate (EBLR) | From October 2019 | Floating loans to individuals and MSMEs linked to an external benchmark such as the repo rate or a treasury bill yield, and reset at least every three months |
The move to external benchmarks has improved transmission. A repo rate change now reaches new and existing EBLR-linked loans within a few months. Savings deposit rates were freed in 2011, so banks now set all deposit rates themselves.
The twin balance sheet problem and the clean-up
How the problem arose
During the boom of 2004 to 2011, banks, mostly in the public sector, lent heavily to infrastructure, power, steel and telecom projects. Delays in land acquisition and clearances, the cancellation of coal blocks and spectrum licences in 2012 and 2014, and the slowdown in growth turned many of these loans bad. Banks restructured them under schemes such as Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR) and the Scheme for Sustainable Structuring of Stressed Assets (S4A), which often only postponed recognition.
Asset Quality Review (2015)
RBI's Asset Quality Review in 2015-16 forced banks to recognise hidden bad loans. Gross NPAs of scheduled commercial banks rose to a peak of about 11.2% of advances in March 2018, and public sector banks reported heavy losses.
The "4R" strategy
The government followed a 4R approach:
- Recognition of NPAs transparently.
- Resolution and recovery through the Insolvency and Bankruptcy Code and other tools.
- Recapitalisation of public sector banks.
- Reforms in governance and operations.
Tools for resolution
| Tool | Detail |
|---|---|
| Insolvency and Bankruptcy Code (IBC), 2016 | Time-bound resolution of insolvent companies through the National Company Law Tribunal; creditors' committee decides the resolution plan |
| Banking Regulation (Amendment) Act, 2017 | Gave RBI the power to direct banks to start insolvency proceedings against large defaulters |
| Prudential Framework for Resolution of Stressed Assets (June 2019) | Lenders must review a default within 30 days and implement a resolution plan within 180 days, or make extra provisions |
| SARFAESI Act, 2002 | Enforcement of security without courts; sale of loans to asset reconstruction companies |
| National Asset Reconstruction Company Limited (NARCL) | A bad bank announced in the Union Budget 2021-22, set up in 2021 by banks, with India Debt Resolution Company Limited (IDRCL) as its resolution manager; the government guarantees its security receipts up to ₹30,600 crore |
| Lok Adalats and Debt Recovery Tribunals | Recovery of smaller loans |
Recapitalisation
The government put more than ₹3 lakh crore into public sector banks between 2015-16 and 2020-21, through Indradhanush (2015) and recapitalisation bonds announced in 2017. Banks also raised money from the market. Since 2021-22, public sector banks have largely funded themselves.
Results
By 2025, gross NPAs had fallen to around 2.3%, net NPAs to about 0.5%, and the capital ratio of the system was above 17%. Public sector banks earned record profits. The clean-up is one of the main reasons the banking system came through the COVID-19 shock without serious damage.
Mergers of public sector banks
| Year | Merger |
|---|---|
| 2017 | SBI absorbed its five associate banks and Bharatiya Mahila Bank |
| 2019 | Vijaya Bank and Dena Bank merged into Bank of Baroda |
| April 2020 | Oriental Bank of Commerce and United Bank of India into Punjab National Bank; Syndicate Bank into Canara Bank; Andhra Bank and Corporation Bank into Union Bank of India; Allahabad Bank into Indian Bank |
The number of public sector banks fell from 27 in 2017 to 12. The aim was to create fewer, larger and stronger banks that can lend to big projects, cut costs and compete globally. Critics noted that merging weak banks does not by itself fix their problems, and that integration of staff and technology takes years.
Governance reforms in public sector banks
- P. J. Nayak Committee (2014): found weak governance in public sector banks and suggested a Bank Investment Company to hold government shares, reduction of the government stake below 50% and more board autonomy.
- Indradhanush (2015): a seven-point plan covering appointments, the Bank Board Bureau, capitalisation, de-stressing, empowerment, accountability and governance.
- Bank Board Bureau (2016): advised on top appointments. It was replaced in 2022 by the Financial Services Institutions Bureau (FSIB).
- EASE reforms (Enhanced Access and Service Excellence): an annual reform agenda since 2018, measured through an index, covering customer service, credit, digital banking and governance.
- Separation of chairman and chief executive roles in private banks, and limits on the tenure of chief executives (15 years, or 12 years for a promoter chief executive, with a maximum age of 70).
Rescue of private banks
- Global Trust Bank (2004): merged with Oriental Bank of Commerce.
- Yes Bank (2020): placed under moratorium; SBI and other banks invested in it under a reconstruction scheme.
- Lakshmi Vilas Bank (2020): merged with DBS Bank India, the Indian subsidiary of a Singapore bank.
- PMC Bank (2019): a cooperative bank fraud; its business later moved to Unity Small Finance Bank.
These cases led to stronger supervision of private and cooperative banks and faster action by RBI.
Developments of the last few years
Financial inclusion and new banks
- Pradhan Mantri Jan Dhan Yojana (2014) opened over 55 crore basic accounts.
- Payments banks and small finance banks were licensed to reach the unbanked; several small finance banks have grown into large lenders.
- Business correspondents and digital channels carry banking to villages.
Digital and technology changes
- Core banking across all scheduled banks, mobile banking and UPI.
- Digital Banking Units: 75 units in 75 districts were opened in October 2022.
- Account Aggregator framework (2021) for consent-based sharing of financial data.
- Unified Lending Interface, a platform developed by the Reserve Bank Innovation Hub for faster small loans.
Regulatory changes
- Scale-based regulation of NBFCs (2021), which brought large NBFCs closer to banks in their rules.
- Co-lending between banks and NBFCs for priority sector loans (2020), with a wider framework covering all regulated entities from January 2026.
- Risk weights: RBI raised risk weights on unsecured consumer loans and on bank loans to NBFCs by 25 percentage points in November 2023 to slow risky lending, and reversed the increase on loans to NBFCs from April 2025.
- Expected credit loss framework from April 2027.
- Revised Basel III standardised approach for credit risk from April 2027.
- Merger of HDFC Ltd with HDFC Bank (July 2023), the largest merger in Indian corporate history, which created one of the world's largest banks by market value.
Consolidation of RRBs
RRBs were reduced in phases: from 196 in 2005 to 133 in 2012, 43 by 2021, and 28 under the "One State, One RRB" policy in 2025. The Regional Rural Banks (Amendment) Act, 2015 allowed RRBs to raise capital from sources other than their owners, and some RRBs are being prepared for listing.
Challenges that remain
- Deposits growing more slowly than loans, which raises banks' cost of funds and pushes them to borrow through certificates of deposit.
- Rising stress in unsecured retail loans, credit cards and microfinance.
- Governance and pay constraints in public sector banks.
- Digital frauds and mis-selling of financial products.
- Concentration of risk in a few large banks, which are systemically important.
- Weak urban cooperative banks.
- The need to fund infrastructure, MSMEs and the climate transition.
Way forward
- Keep the gains of the clean-up by recognising stress early under the ECL framework.
- Give public sector banks professional boards and freedom to compete, and consider bringing the government stake down to 51% or below in some banks.
- Develop the corporate bond market so that banks are not the only source of long-term funds.
- Use digital public infrastructure for credit underwriting.
- Strengthen consumer protection and the fight against fraud.
- Consider the next stage of consolidation and allow strong small finance banks to grow into universal banks.
Possible exam and interview questions
- What were the main recommendations of the Narasimham Committees? How far have they been implemented? (620 words)
- Explain the twin balance sheet problem. How did India resolve it? (420 words)
- Distinguish between MCLR and EBLR. Why did RBI move to external benchmarks?
- Evaluate the success of the 2019 and 2020 mergers of public sector banks.
- Interview: Is there still a case for public ownership of banks in India?
Related reading: banking system in India, risk management and Basel norms, and economic reforms since 1991.
More in Finance
Prepare with MockMentor
RBI Grade A/B 2027 Super-Elite Course (₹7,500) – Complete Phase 1 and Phase 2 preparation with the Descriptive Writing Programme. 365 days validity.