Indian banks and FDI: As India sets its sights on becoming a $5 trillion economy by the end of the decade, the banking sector will serve as a critical pillar in achieving this ambition. Financial services secretary M Nagaraju recently urged banks to expand lending and raise capital through diverse means to support the country’s growth momentum. With India’s credit-to-GDP ratio standing at 56%, there is a wide gap to bridge — one that will require the financial sector to more than double this ratio to around 130% in the coming years.
Public sector lenders have begun responding. The State Bank of India has raised ₹25,000 crore via qualified institutional placements (QIPs) in 2025, while other public sector banks plan to mobilise ₹20,000 crore through similar routes. Although the capital adequacy ratio of 46 major banks hit a record 17.2% in March 2025 — well above regulatory norms — this capital cushion must be deepened further to sustain rising credit demand.
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Untapped potential of foreign capital
A major constraint in mobilising long-term capital lies in India’s restrictive foreign direct investment (FDI) norms for the banking sector. Currently, FDI is capped at 74% for private banks and 20% for public sector banks, with a single-entity limit of 15% unless waived by the Reserve Bank of India. To ease capital constraints, the government is reportedly considering reforms to relax these ceilings. Loosening the single-entity cap and widening the FDI window could attract patient capital, particularly from long-term institutional investors.
However, foreign inflows will not come automatically. Investors remain wary due to past regulatory unpredictability and the scars left by the non-performing asset (NPA) crisis of the previous decade. A more investor-friendly regulatory framework and clarity on governance standards will be needed to rebuild trust and ensure steady flows of foreign capital.
Indian banks: Legacy of NPAs and risk aversion
Much of the current caution in bank lending is rooted in the crisis that engulfed the sector between 2014 and 2018. Years of excessive lending — especially to infrastructure and real estate projects — culminated in a sharp rise in bad loans. By 2018, gross NPAs had surged to 11.2% of total advances, compelling banks to focus on balance sheet repair rather than credit expansion.
Though gross NPAs have since declined to 2.8% as of March 2025, risk aversion still colours credit decisions, particularly when it comes to sectors like micro, small, and medium enterprises (MSMEs), which are vital for job creation but often deemed high-risk.
Operational gaps: Public vs private
Operational inefficiencies continue to hamper many public sector banks. Issues such as slow decision-making, legacy systems, and high overhead costs persist. While private banks like HDFC and ICICI have made significant gains in digital banking and automation, the overall sector trails global peers in technology adoption and customer experience. This digital divide must be addressed if Indian banks are to scale effectively and meet the demands of a rapidly formalising economy.
Credit growth is yet to catch up with deposit mobilisation. As of June 27, 2025, credit offtake grew by 9.5% year-on-year, compared to a 10.1% increase in deposits. While large corporations have turned to bond markets and alternative financing channels, credit demand has shifted toward MSMEs. Banks must recalibrate to serve this new demand centre by tailoring products and risk-assessment frameworks that enable financial inclusion without compromising asset quality.
Innovative capital strategies
To meet future credit needs, banks must go beyond equity placements. Instruments such as Basel III-compliant Additional Tier 1 (AT1) bonds, Tier 2 capital, green bonds, and sustainability-linked loans offer viable options. Global financial hubs and offshore bond markets remain underutilised by Indian banks but present an opportunity to diversify funding sources while managing interest costs.
The path to sustainable growth lies not just in capital accumulation but also in enhancing operational efficiency. Digital transformation can be a force multiplier, helping banks reduce costs, improve service delivery, and broaden financial access. Strengthening data infrastructure and analytics capabilities will also enhance risk management and allow more targeted lending.
Simultaneously, banks must redouble efforts to mobilise savings in an increasingly competitive financial landscape. Reimagining retail deposit strategies—through better incentives, improved digital interfaces, and customer-centric product design—will be key.
Environmental, social, and governance (ESG) alignment is no longer optional. As global capital becomes more selective, Indian banks must integrate ESG frameworks into their operations and disclosures. At present, only SBI and HDFC feature among the world’s top 100 banks by assets—well behind global leaders from China and the United States. ESG adoption can improve not only investor confidence but also help attract global talent and funding.
Consolidation for strength
The government appears open to further consolidation among public sector banks. Past mergers have shown gains in scale and efficiency, and the case for more such integration remains strong. Larger, better-capitalised banks can deliver more robust credit flows and withstand economic shocks with greater ease.
Indian banks have made notable progress in extending basic financial services to the masses. Flagship schemes like the Jan Dhan Yojana, Jeevan Jyoti Bima Yojana, and Suraksha Bima Yojana have drawn millions into the formal financial fold. Such efforts are crucial not just for equity but also for economic resilience. Formal inclusion supports credit discipline, broadens the deposit base, and enhances household economic security.
India’s banking sector is now at a defining juncture. If the goal of becoming a $30-trillion economy by 2047 is to be more than aspirational rhetoric, banks must overhaul outdated systems, shed risk aversion, and engage actively with global capital markets. The government has signalled its intent through FDI liberalisation proposals and support for new financial instruments. But ultimately, the onus lies with banks to respond—with speed, ambition, and strategic vision.