Case for Easing Banking Regulations

Context

• The Union Budget 2025-26 sets the stage for India’s economic expansion, projecting GDP growth from $3.7 trillion (2023-24) to $7 trillion (2030-31).
• Achieving this goal requires strong fiscal and monetary policies, infrastructure development, and efficient capital allocation.

Challenges for India’s Economic Growth

• Low Private Sector Investment: Private sector investment-to-operating cash flow has dropped from 114% (2008-09) to 56% (2023-24).
  • Reasons: Uncertainty in future demand and geopolitical risks.
• Limited Credit Access for MSMEs: Large corporates access bank credit, equity, and bond markets, while MSMEs face credit shortages.
  • Household savings shifting to mutual funds and pension schemes, reducing banks’ credit availability.
• Regulatory Constraints on Banking Liquidity: 30% of bank deposits are locked in regulatory preemptions (SLR: 26%, CRR: 4%).
  • High Liquidity Coverage Ratio (LCR) requirements further reduce lendable resources.
  • Banks invest ₹13 trillion in G-Secs out of ₹40 trillion deposit inflows, limiting funds for lending.
• Outdated Priority Sector Lending (PSL) Framework: PSL requirement at 40% does not align with current economic priorities.
  • Pricing does not reflect credit risk, affecting bank profitability.
• Lower Credit Growth than Nominal GDP Growth: Credit growth lagging behind GDP growth, impacting financing for expansion.
  • Over-regulation on interest rates and clean lending reduces financial inclusion.
• Rupee Volatility and Liquidity Impact: Defending the rupee against a strong dollar reduces market liquidity.
  • Leads to an overvalued rupee without effectively strengthening forex reserves.
• High Bank Tech Investment with Low Returns: Indian banks spend 5% of annual expenditure on technology.
  • Global comparison: Tech investment in banking at 9%, while revenue growth is only 4%.
  • Free UPI transactions increase operational costs without revenue generation.
• Underdeveloped Derivatives Market: India’s government bond market share in global indices: 3% (Indonesia: 14.5%).
  • Cash market liquidity is adequate, but the derivatives market remains weak.

What Needs to Be Done?

• Boost Private Sector Investment: Incentivize corporate investment through tax benefits and ease of doing business reforms.
  • Strengthen demand confidence through policy stability and infrastructure growth.
• Improve Credit Access for MSMEs: Encourage risk-based pricing and cash-flow-based lending instead of collateral-heavy lending.
  • Strengthen fintech partnerships to expand MSME credit reach.
• Reduce Regulatory Preemptions on Banking Liquidity: Reassess the need for both SLR and LCR; globally, only LCR is used.
  • Allow banks more flexibility in investing funds instead of excessive G-Sec purchases.
• Revamp Priority Sector Lending (PSL): Update PSL guidelines to reflect changes in GDP structure and economic needs.
  • Ensure PSL pricing reflects credit risks, improving bank profitability.
• Increase Credit Growth to Match GDP Growth: Expand financial inclusion with AI-driven risk assessment and digital lending models.
  • Reduce regulatory burdens on interest rates and clean lending.
• Manage Rupee Stability Without Reducing Liquidity: Avoid excessive intervention in currency markets; instead, focus on long-term forex management.
  • Strengthen domestic investment avenues to reduce dependence on external inflows.
• Ensure Sustainable Bank Technology Investment: Explore small transaction fees on UPI to compensate for network costs.
  • Implement global best practices for cost-recovery models.
• Develop India’s Bond and Derivatives Market: Ease regulations to increase India’s global bond market share.
  • Encourage institutional investors (IRDAI, PFRDA, SEBI) to use derivatives for risk management.

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