Banking System

Key Facts

• Public Sector Banks reduced from 27 to 12 after consolidation: SBI merged 5 associates + Bharatiya Mahila Bank in 2017; 10 PSBs merged into 4 in April 2020.
• Urban Cooperative Banks (UCBs) were brought under Banking Regulation Act, 1949, via an amendment in 1966; after Banking Regulation (Amendment) Act, 2020, RBI gained enhanced supervisory powers over UCBs.
• Regional Rural Banks are owned in ratio 50:15:35 — Central Government : State Government : Sponsoring Bank.
• Small Finance Banks and Payments Banks were licensed by RBI starting 2015; Payments Banks cannot lend and can accept deposits up to Rs. 2 lakh per customer.

What are the primary functions of the Reserve Bank of India (RBI) and what legal basis governs its establishment?

The Reserve Bank of India (RBI) was established on April 1, 1935 under the Reserve Bank of India Act, 1934, initially as a privately owned institution. It was nationalised in 1949 and since then has been fully owned by the Government of India. The RBI serves as the supreme monetary and banking authority in India and performs several critical functions: (1) Issue of currency notes — it holds the monopoly on issuing currency under the Minimum Reserve System; (2) Banker to the Government — it manages the government's accounts, public debt, and foreign exchange; (3) Banker to banks — it holds statutory reserves of commercial banks and acts as lender of last resort; (4) Monetary policy formulation — since 2016, through the Monetary Policy Committee (MPC), it targets a flexible inflation band of 2–6% CPI; (5) Regulator and supervisor of the banking system — it enforces prudential norms under the Banking Regulation Act, 1949; (6) Manager of foreign exchange reserves under FEMA, 1999; and (7) Developmental role — it promotes financial inclusion and priority sector lending. The Central Office, where the Governor sits and policies are formulated, was originally in Calcutta but was permanently moved to Mumbai in 1937.

Explain the monetary policy instruments used by the RBI — Repo Rate, Reverse Repo Rate, SLR, and CRR — and how they work to control money supply.

The RBI uses both quantitative and qualitative instruments to regulate money supply and credit in the economy. The Cash Reserve Ratio (CRR) is the percentage of a bank's Net Demand and Time Liabilities (NDTL) that must be maintained as cash with the RBI — this money earns no interest for banks and directly reduces the funds available for lending. The Statutory Liquidity Ratio (SLR) requires banks to maintain a certain proportion of their NDTL in liquid assets such as gold, government securities, and approved securities — unlike CRR, banks earn returns on SLR assets. The Repo Rate is the rate at which RBI lends short-term funds to commercial banks against government securities; a higher repo rate makes borrowing costly, reducing money supply and checking inflation. The Reverse Repo Rate is the rate at which RBI borrows funds from commercial banks; raising it incentivises banks to park money with RBI, thereby reducing liquidity. The Marginal Standing Facility (MSF) rate allows banks to borrow overnight funds from RBI at a rate above the repo rate, even by dipping into their SLR holdings. Together, these instruments form the Liquidity Adjustment Facility (LAF) corridor, which the MPC adjusts to manage inflation and growth objectives. As of recent policy cycles, the RBI has used these tools actively to manage post-pandemic liquidity and inflation pressures.

Describe the structure of scheduled and non-scheduled banks in India, including the classification of commercial banks and cooperative banks.

India's banking structure is tiered and pluralistic. A scheduled bank is one listed under the Second Schedule of the RBI Act, 1934. To qualify, a bank must have paid-up capital and reserves of at least Rs. 5 lakh and must satisfy the RBI that its affairs are not conducted in a manner prejudicial to depositors' interests. Scheduled banks are further divided into Scheduled Commercial Banks (SCBs) and Scheduled Cooperative Banks. SCBs include: (a) Public Sector Banks (PSBs) — currently 12, after the 2017–2019 consolidation reduced their number from 27; (b) Private Sector Banks — both old private banks (e.g., South Indian Bank) and new private banks licensed post-1991 reforms (e.g., HDFC, ICICI); (c) Foreign Banks — operating through branches; (d) Small Finance Banks — licensed from 2015 to serve underserved segments; and (e) Payments Banks — launched in 2015–2017 to promote financial inclusion but restricted from lending. Regional Rural Banks (RRBs) are a distinct category, co-owned by the Central Government (50%), State Government (15%), and sponsoring bank (35%), and serve rural credit needs. Cooperative banks operate under dual regulation of the RBI and Registrar of Cooperative Societies (RCS). Urban Cooperative Banks (UCBs) were brought under the Banking Regulation Act, 1949, via an amendment in 1966. Non-scheduled banks are those not listed under the Second Schedule and have fewer RBI privileges.

What are the key reforms in the Public Sector Banking (PSB) sector post-1991, and how has consolidation changed the landscape?

Post-1991, banking sector reforms were initiated based on the recommendations of the Narasimham Committee (1991 and 1998). Before 1991, the sector was highly regulated and credit allocation was directed by the government. Key reforms include: (1) Liberalisation of entry norms — new private sector banks were licensed in 1993–94 and again from 2014 onwards; (2) Prudential norms — capital adequacy requirements based on Basel frameworks were introduced, requiring a Capital to Risk-weighted Assets Ratio (CRAR) of 9% (higher than Basel III's 8%); (3) Asset quality norms — income recognition and provisioning norms for Non-Performing Assets (NPAs) were tightened; (4) Autonomy — boards of PSBs were given more operational independence; (5) Consolidation — the government merged weaker PSBs with stronger ones: State Bank of India absorbed 5 associate banks and Bharatiya Mahila Bank in 2017, reducing PSBs from 27 to 21, then further mergers in 2019–2020 reduced the count to 12 PSBs; (6) Recapitalisation — the government infused over Rs. 3.5 lakh crore into PSBs between 2017 and 2021 via recapitalisation bonds; (7) Insolvency and Bankruptcy Code (IBC), 2016, strengthened NPA resolution. The bad bank concept (National Asset Reconstruction Company Ltd., NARCL) was introduced in 2021 to aggregate and reconstruct stressed assets.

How are Non-Banking Financial Companies (NBFCs) regulated in India, and how do they differ from commercial banks?

Non-Banking Financial Companies (NBFCs) are financial institutions registered under the Companies Act and regulated by the RBI under Chapter III-B of the RBI Act, 1934. They perform many bank-like functions — lending, investment, hire-purchase — but are distinct from banks in key ways: (1) NBFCs cannot accept demand deposits (savings or current accounts); (2) they are not part of the payment and settlement system and cannot issue cheques; (3) deposit insurance by DICGC is not available to NBFC depositors; and (4) they are not subject to CRR requirements, though certain categories must maintain SLR. NBFCs are classified by size and systemic importance — Non-Deposit-taking Systemically Important NBFCs (NBFC-ND-SI) with asset size above Rs. 500 crore face stricter capital adequacy norms. Key NBFC categories include NBFC-MFIs (microfinance), NBFC-Factors, Infrastructure Finance Companies (IFCs), Housing Finance Companies (HFCs — now regulated by RBI since 2019 after NHB oversight), and Account Aggregators. The IL&FS crisis (2018) and DHFL collapse exposed systemic risks, prompting RBI to tighten liquidity coverage ratios, asset-liability management norms, and governance standards for large NBFCs. The Scale-Based Regulation (SBR) framework introduced in 2021 classifies NBFCs into four tiers based on size, with progressively stricter regulation for upper-layer NBFCs.

What is Priority Sector Lending (PSL), and how does the RBI enforce it through the Priority Sector Lending Certificates (PSLC) mechanism?

Priority Sector Lending (PSL) is a policy mandate requiring banks to direct a specified percentage of their Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher, to sectors deemed economically and socially important. The overall PSL target is 40% of ANBC for domestic scheduled commercial banks and foreign banks with 20 or more branches; the target is 40% for domestic banks but 32% for foreign banks with fewer than 20 branches. Within the 40%, sub-targets include: Agriculture — 18% (with at least 10% to small and marginal farmers), Weaker Sections — 12%, Micro Enterprises — 7.5%. Key categories include agriculture, MSMEs, education, housing, social infrastructure, renewable energy, and export credit. If a bank fails to meet its PSL targets, it must contribute the shortfall amount to funds managed by NABARD, NHB, or SIDBI. The Priority Sector Lending Certificate (PSLC) mechanism, introduced in 2016, allows over-achievers to sell certificates to under-achievers via the RBI's e-Kuber platform, providing market-based flexibility. Regional Rural Banks and Small Finance Banks have higher PSL targets (75%). The Lead Bank Scheme, including the Service Area Approach, assigns specific commercial bank branches to serve 15–25 villages for rural credit coverage.

An NPA is a loan or advance where the interest or principal payment has remained overdue for a period of 90 days. When a bank has too many NPAs, it loses money and cannot lend further. For example, if a large factory stops paying its monthly loan installments for three months, that loan becomes an NPA for the bank.

What are the key reforms in the Public Sector Banking (PSB) sector post-1991, and how has consolidation changed the landscape?

Post-1991, banking sector reforms were initiated based on the recommendations of the Narasimham Committee (1991 and 1998). Before 1991, the sector was highly regulated and credit allocation was directed by the government. Key reforms include: (1) Liberalisation of entry norms — new private sector banks were licensed in 1993–94 and again from 2014 onwards; (2) Prudential norms — capital adequacy requirements based on Basel frameworks were introduced, requiring a Capital to Risk-weighted Assets Ratio (CRAR) of 9% (higher than Basel III's 8%); (3) Asset quality norms — income recognition and provisioning norms for Non-Performing Assets (NPAs) were tightened; (4) Autonomy — boards of PSBs were given more operational independence; (5) Consolidation — the government merged weaker PSBs with stronger ones: State Bank of India absorbed 5 associate banks and Bharatiya Mahila Bank in 2017, reducing PSBs from 27 to 21, then further mergers in 2019–2020 reduced the count to 12 PSBs; (6) Recapitalisation — the government infused over Rs. 3.5 lakh crore into PSBs between 2017 and 2021 via recapitalisation bonds; (7) Insolvency and Bankruptcy Code (IBC), 2016, strengthened NPA resolution. The bad bank concept (National Asset Reconstruction Company Ltd., NARCL) was introduced in 2021 to aggregate and reconstruct stressed assets.

What is Priority Sector Lending (PSL), and how does the RBI enforce it through the Priority Sector Lending Certificates (PSLC) mechanism?

Priority Sector Lending (PSL) is a policy mandate requiring banks to direct a specified percentage of their Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher, to sectors deemed economically and socially important. The overall PSL target is 40% of ANBC for domestic scheduled commercial banks and foreign banks with 20 or more branches; the target is 40% for domestic banks but 32% for foreign banks with fewer than 20 branches. Within the 40%, sub-targets include: Agriculture — 18% (with at least 10% to small and marginal farmers), Weaker Sections — 12%, Micro Enterprises — 7.5%. Key categories include agriculture, MSMEs, education, housing, social infrastructure, renewable energy, and export credit. If a bank fails to meet its PSL targets, it must contribute the shortfall amount to funds managed by NABARD, NHB, or SIDBI. The Priority Sector Lending Certificate (PSLC) mechanism, introduced in 2016, allows over-achievers to sell certificates to under-achievers via the RBI's e-Kuber platform, providing market-based flexibility. Regional Rural Banks and Small Finance Banks have higher PSL targets (75%). The Lead Bank Scheme, including the Service Area Approach, assigns specific commercial bank branches to serve 15–25 villages for rural credit coverage.

Key Facts

• National Asset Reconstruction Company Ltd. (NARCL), the 'bad bank', was incorporated in 2021 to aggregate NPA portfolios from banks for resolution.

What are the key reforms in the Public Sector Banking (PSB) sector post-1991, and how has consolidation changed the landscape?

Post-1991, banking sector reforms were initiated based on the recommendations of the Narasimham Committee (1991 and 1998). Before 1991, the sector was highly regulated and credit allocation was directed by the government. Key reforms include: (1) Liberalisation of entry norms — new private sector banks were licensed in 1993–94 and again from 2014 onwards; (2) Prudential norms — capital adequacy requirements based on Basel frameworks were introduced, requiring a Capital to Risk-weighted Assets Ratio (CRAR) of 9% (higher than Basel III's 8%); (3) Asset quality norms — income recognition and provisioning norms for Non-Performing Assets (NPAs) were tightened; (4) Autonomy — boards of PSBs were given more operational independence; (5) Consolidation — the government merged weaker PSBs with stronger ones: State Bank of India absorbed 5 associate banks and Bharatiya Mahila Bank in 2017, reducing PSBs from 27 to 21, then further mergers in 2019–2020 reduced the count to 12 PSBs; (6) Recapitalisation — the government infused over Rs. 3.5 lakh crore into PSBs between 2017 and 2021 via recapitalisation bonds; (7) Insolvency and Bankruptcy Code (IBC), 2016, strengthened NPA resolution. The bad bank concept (National Asset Reconstruction Company Ltd., NARCL) was introduced in 2021 to aggregate and reconstruct stressed assets.

How are Non-Banking Financial Companies (NBFCs) regulated in India, and how do they differ from commercial banks?

Non-Banking Financial Companies (NBFCs) are financial institutions registered under the Companies Act and regulated by the RBI under Chapter III-B of the RBI Act, 1934. They perform many bank-like functions — lending, investment, hire-purchase — but are distinct from banks in key ways: (1) NBFCs cannot accept demand deposits (savings or current accounts); (2) they are not part of the payment and settlement system and cannot issue cheques; (3) deposit insurance by DICGC is not available to NBFC depositors; and (4) they are not subject to CRR requirements, though certain categories must maintain SLR. NBFCs are classified by size and systemic importance — Non-Deposit-taking Systemically Important NBFCs (NBFC-ND-SI) with asset size above Rs. 500 crore face stricter capital adequacy norms. Key NBFC categories include NBFC-MFIs (microfinance), NBFC-Factors, Infrastructure Finance Companies (IFCs), Housing Finance Companies (HFCs — now regulated by RBI since 2019 after NHB oversight), and Account Aggregators. The IL&FS crisis (2018) and DHFL collapse exposed systemic risks, prompting RBI to tighten liquidity coverage ratios, asset-liability management norms, and governance standards for large NBFCs. The Scale-Based Regulation (SBR) framework introduced in 2021 classifies NBFCs into four tiers based on size, with progressively stricter regulation for upper-layer NBFCs.

Explain the role of the National Payments Corporation of India (NPCI), UPI, and digital banking infrastructure in transforming India's payment ecosystem.

The National Payments Corporation of India (NPCI), set up in 2008 under the aegis of the RBI and the Indian Banks' Association (IBA), operates the core payment infrastructure of India. It manages the National Financial Switch (NFS), which is the largest network linking all ATMs across banks, enabling interbank cash withdrawals. NPCI also operates: (1) Unified Payments Interface (UPI) — a real-time payment system launched in 2016 that allows instant interbank fund transfers 24x7 using Virtual Payment Addresses (VPAs); UPI processed over 100 billion transactions annually by 2023–24; (2) RuPay — India's own card payment network competing with Visa and Mastercard; (3) IMPS — Immediate Payment Service for 24x7 interbank transfers; (4) NACH — National Automated Clearing House for bulk payments; (5) FASTag — RFID-based electronic toll collection; (6) BBPS — Bharat Bill Payment System for utility bill aggregation. The Aadhaar Payment Bridge (APB) and AePS (Aadhaar-enabled Payment System) extend digital payments to last-mile beneficiaries using biometric authentication. Core Banking Solution (CBS) integrates a bank's branches into a single centralised system, allowing customers to transact from any branch. The Account Aggregator framework, launched in 2021, enables consent-based financial data sharing across institutions, powering the India Stack's financial layer. India's digital public infrastructure (DPI) in payments has become a global model, with UPI being expanded to countries like Singapore, France, UAE, and Bhutan.

These are special bonds issued by the government specifically to fund banks. The government gives the bond to the bank and gets shares in return. The bank gets a safe asset (the bond) which earns interest. This improves the bank's balance sheet without the government having to find immediate tax money. Example: The ₹2.11 lakh crore plan of 2017 relied heavily on these bonds.

Banks classify NPAs based on how long they have been unpaid. A 'Sub-standard' asset is one that has been an NPA for 12 months or less. A 'Doubtful' asset remains an NPA for more than 12 months. A 'Loss' asset is one where the bank or auditors identify that the money can never be recovered. For example, if a shopkeeper stops paying for 2 years, the loan moves from Sub-standard to Doubtful.

This term describes a double crisis in the Indian economy. First, private companies are over-leveraged, meaning they have too much debt and cannot pay. Second, the banks have high NPAs and cannot lend more money. This creates a cycle where companies cannot grow and banks cannot support them. For example, a steel company in debt stops paying the bank, making the bank too weak to help a new tech startup.

This is a measure of a bank's available capital expressed as a percentage of its risk-weighted credit exposures. It acts as a buffer to protect depositors. In India, the RBI usually requires a higher CAR than the global Basel III minimum. For example, if a bank has ₹100 in risky loans and the CAR is 9%, it must keep ₹9 as its own capital safety net.

IBC is a modern law passed in 2016 to solve the NPA problem quickly. It provides a time-bound process to either save a failing company or sell its assets to pay back creditors. If a company defaults, creditors can take the case to the National Company Law Tribunal (NCLT). A professional then manages the company to find a solution within 180 to 330 days. Example: The Bhushan Steel case was resolved using IBC.