India’s Financial Sector Reforms Need a Shake-up

Syllabus: GS3/ Economy

In Context

• India’s financial sector, particularly the Banking, Financial Services and Insurance (BFSI) space, is standing at a critical juncture. While reforms have been ongoing, there are still structural problems that need to be addressed.

Key Structural Issues in India’s Financial Sector

• Inconsistent Nomination Rules Across BFSI: No uniformity between banks, mutual funds, and insurance companies. Multiple nomination formats lead to legal ambiguities and litigation. Lack of clarity between nominee rights vs legal heir rights.
• Underdeveloped Corporate Bond Market: Despite policy pronouncements, India’s corporate bond market remains shallow, illiquid, and opaque.
  • This increases the cost of capital for businesses (potentially by 2-3%), hindering industrial growth and employment. The RBI’s past directive to NSE to develop a secondary bond market was reportedly “quietly ignored,” possibly due to higher profits in equity trading.
• Weak Ultimate Beneficial Ownership (UBO) Framework: India is a FATF member but struggles with UBO (Ultimate Beneficial Ownership) transparency.
• Shadow Banking: NBFCs, brokers, and margin lenders mimic banks without full regulation.
  • They offer margin funding at effective interest rates >20%, often without clear borrower knowledge.
  • RBI introduced a scale-based regulation (2022), but data collection and transparency remain weak.
• Fragmented Financial Consumer Protection: No single integrated financial consumer protection authority (unlike the U.S. Consumer Financial Protection Bureau (CFPB)).
  • Investors/savers face hurdles in grievance redressal across SEBI, RBI, IRDAI, PFRDA.
• Digital Financial Inclusion & Cyber Risk: UPI has transformed digital finance, but digital financial frauds have also spiked. RBI reported 13,530 fraud cases in FY23, involving ₹30,252 crore.
  • Many rural investors are still digitally excluded from mutual funds, bonds, insurance.

Government Initiatives and Reforms

• Banking Reforms: Reforms like EASE 2.0 and EASE 3.0 (Enhanced Access and Service Excellence) were introduced to improve operational efficiency, credit delivery, and customer service in public sector banks.
• Corporate Bonds: To reduce the overdependence on bank credit and deepen debt markets, the government launched the Credit Enhancement Scheme through SIDBI, intended to improve the credit rating of lower-rated bonds and attract investors.
  • The BSE Bond platform was established to facilitate online bond issuance and trading. SEBI also issued norms mandating that large corporates raise at least 25% of their borrowing through bonds.
• Retirement Finance: National Pension System (NPS), Atal Pension Yojana (APY), proposed pension reforms by PFRDA.
  • PFRDA is a statutory regulatory body that comes under the jurisdiction of the Ministry of Finance.
• Nomination: Recent SEBI 2024 circular of mandatory nomination or opt-out declaration for demat and mutual fund accounts.
• Shadow Banking: RBI’s scale-based regulatory framework for NBFCs (2022), crackdown on high-risk NBFCs.

Way Forward

• Harmonise Nomination Rules Across BFSI: One uniform nomination law for all financial instruments.
  • Clear distinction between nominee (trustee) vs legal heir (beneficiary) in law.
• Deepen Bond Markets: Incentivise corporates to issue bonds; develop market-makers and improve credit rating transparency.
  • Build a retail-friendly bond platform with RBI/NSE/BSE collaboration.
• Tighten UBO Disclosure and FATF Compliance: Lower UBO disclosure thresholds to 5% or even 1% in sensitive sectors.
  • Strict penalties for non-disclosure and delayed reporting.
• Enable Cost-Effective Retirement Products: Issue zero-coupon government bonds of 30+ years via online channels.
  • Integrate NPS with UPI-like auto-debit system for informal workers.
• Rein in Shadow Banking: Mandate comprehensive data collection on margin lending and NBFC transactions.
  • Integrate NBFC lending into CRILC database (RBI’s credit info platform).
  • Introduce risk-based capital norms for brokers offering financing.

Source: TH