September 10, 2018
India has a robust and resilient financial system marked by a disciplined banking structure and non-banking institutions
By far the largest chunk of household savings is held with public sector banks that account for around 70 per cent of assets
FDI in private banks and insurance companies is permitted up to 49 per cent, while it is up to 100 per cent for non-banking bodies
India’s vast deep foreign exchange market, where currencies are traded, integrates the nation with the rest of the world
India has a robust and resilient financial system, which is more than able to meet the growing financing requirements of the country. In this, banks form the largest financial sector intermediary. India’s competitive banking system, which includes public sector banks, private banks, foreign banks, regional rural banks and co-operative banks, have recently added small finance banks and payment banks. Public sector banks account for around 70 per cent of the assets of the banking sector.
There is also a vibrant non-banking finance sector, including housing finance companies and specialist agencies, for refinancing agriculture and small-scale industries. Several micro-finance companies are also present in the market. In these institutions, interest rates are set by the financial markets, which take their cue from the monetary policy stance of India’s central bank, the Reserve Bank of India (RBI).
India has a system of independent multiple regulatory authorities responsible for different areas of financial services. The RBI, besides laying down monetary policy, managing the currency and managing the public debt, supervises commercial banks, payment banks, small finance banks, urban co-operative banks and non-banking finance companies. The regional rural banks and the rural co-operative banks are under the supervision of the National Bank for Agriculture and Rural Development (NABARD).
Meanwhile, foreign direct investment in private banks and insurance companies is permitted up to 49 per cent, while it is up to 100 per cent for non-banking finance companies. In practice, taking foreign portfolio investment into account, foreign ownership in some private banks is much higher. Total foreign ownership in private banks, including both FDI and FPI, is capped at 74 per cent.
By far the largest chunk of household savings is held with bank deposits. Bank lending is a little over half India’s gross domestic product (GDP), while bank deposits amount to around 70 per cent of the GDP. Alongside, a source of short-term funds has been the Commercial Paper (CP) market. In recent times, this has become an important source of short-term borrowing by companies. Banks can also access the overnight call money market, the repo market and the certificates of deposit (CD) market.
The repo-rate is the policy rate and is set by the Reserve Bank of India’s Monetary Policy Committee (MPC). The MPC decides its policy rate and other monetary policy measures at its bi-monthly meetings. The MPC has an inflation-targeting mandate to keep consumer price inflation at 4 per cent with a band of 2 percentage points above and below 4 per cent.
The small savings market is another part of the Indian financial system, important for its role in promoting financial inclusion. Government and post office savings schemes fall under this category. Interest rates on these schemes are now linked to market rates. In recent years, the government has taken a giant leap towards financial inclusion under its programme of opening no-frills savings accounts with banks under the Pradhan Mantri Jan Dhan Yojana.
Housing finance companies are under the remit of the National Housing Bank (NHB). The Registrar of Cooperatives of different states in the case of single state cooperatives and the Central Government in the case of multi-state cooperatives are joint regulators, with the RBI for urban co-operative banks, and with NABARD for rural cooperative banks.
India also has a deep foreign exchange market in which currencies are traded. This is a market dominated by banks and it has both spot and derivative products. While India has floating exchange rates, the Reserve Bank sometimes intervenes in the market to ensure there are no abrupt and destabilising changes in exchange rates. Since the rupee is floating and foreign portfolio flows have easy access to the Indian capital markets, India’s financial system is closely integrated with the rest of the world.
No overview of the Indian financial system can be complete without a mention of its rapid adoption of technology. Technology is enabling lower cost delivery of financial services, facilitating rapid and seamless payments and settlement systems and making possible increased access to financial services to the financially excluded population. The thrust towards promoting digital payments by the government will open up new opportunities for banks and other financial services firms.