Banking reforms in India: The Union Budget 2026-27 announced a High-Level Committee on Banking for Viksit Bharat to align the sector with India’s next growth phase while protecting financial stability, inclusion and consumer protection. The government’s case is that banks now have stronger balance sheets, better asset quality and near-universal rural reach. That diagnosis is broadly correct. But the policy conclusion drawn from it is still too soft.
India’s banking system does not chiefly suffer from lack of slogans, committees or reform branding. It suffers from unresolved questions on public sector bank governance, state ownership, deposit mobilisation, regulatory pre-emption, and resolution architecture. Unless the committee addresses these directly, the new banking reform cycle will produce more presentation than change.
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Bankinf reform after the clean-up
The backdrop to the government’s move is undeniably stronger than it was in the bad-loan years. As of September 30, 2025, the gross NPA ratio of scheduled commercial banks had fallen to 2.15%; for public sector banks it was 2.50%, down sharply from crisis-era levels. Public sector banks also reported improved profitability and lower net NPAs in the first half of FY26. The system is no longer in rescue mode. That is precisely why this is the right time for deeper banking reform. Governments usually reform banks only when there is distress. India now has the rarer opportunity to reform from relative strength.
Yet the government’s own framing reveals the weakness in its approach. The Budget promises a comprehensive review. The Department of Financial Services speaks of customer journeys, technology, governance, risk management, innovation and workforce readiness under PSB Manthan 2025 and the broader Viksit Bharat roadmap. These are valid themes.
They are not a reform strategy. They read like a management agenda layered over a structural problem. India’s public sector banks are not held back mainly by insufficient digitisation plans or by the absence of enough thematic workshops. They are held back by the fact that ownership, appointments, incentives and accountability are still designed around the state’s convenience.
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Banking reforms and governance
That is where the government plans remain evasive. The IMF’s India FSAP was unusually clear: the role of the state in finance has diminished but remains significant, including through the use of the financial system for social and public finance goals. It also noted that some banks, particularly public sector banks, may need stronger capital buffers under severe stress.
More pointedly, the IMF said the finance ministry’s powers to intervene in regulatory and supervisory decisions should be limited or redesigned, and the governance framework of state-owned banks should move closer to that of private banks. That is the issue the Budget speech did not confront. India cannot modernise public sector banks while preserving the habits of administrative control that weakened them in the first place.
The government appears to prefer a less confrontational route: incremental managerial reform, selective opening of leadership positions, and perhaps more space for private and foreign capital. That may improve surface efficiency. It will not settle the central contradiction. A public sector bank cannot be asked to maximise commercial efficiency while remaining vulnerable to policy nudges, politically mediated lending expectations, and a board structure that does not fully resemble that of a market institution.
The old phrase of dual control still captures the problem. India does not need another long report that avoids naming it. It needs a committee willing to recommend that the state either governs these banks as owner-investor with clear distance from operations, or accepts that commercial discipline will remain partial.
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Bank mergers are the easiest answer
Another danger is that the government may use the committee to justify another round of public sector bank mergers. India has already reduced the number of PSBs substantially over the last decade. The easy bureaucratic argument is that more consolidation will create scale, improve efficiency and make Indian banks globally competitive. That argument is often overstated. Scale matters in banking, but scale without governance produces larger institutions with the same old weaknesses. Bigger balance sheets do not guarantee better underwriting, better boards or better internal control. They can simply produce banks that are harder to supervise and more difficult to resolve.
This matters because India’s banking reforms discourse has long preferred visible change over difficult change. A merger is visible. Governance reform is slower and politically harder. The committee should therefore set criteria before it entertains any further consolidation: whether a merger reduces concentration risk, whether it improves regional credit delivery, whether integration costs are justified, and whether the merged entity becomes more independent of ministry influence. Without such tests, another merger cycle will amount to administrative tidying masquerading as structural reform.
Foreign investment in PSBs is useful
The government also appears inclined to widen the role of foreign and market investors in banking. The Budget separately proposed a review of FEMA non-debt investment rules to create a more contemporary framework for foreign investment. In banking, this could support a gradual opening of capital structures, including in state-owned banks.
There is merit in that. Public sector banks have drawn heavily on taxpayer capital over the years, and healthier balance sheets make this a more credible moment to raise outside money. The Department of Financial Services’ annual report said PSBs mobilised ₹4.72 lakh crore from the market between FY15 and FY25 up to December 31, 2024.
But equity reform without governance reform will disappoint investors and change little. Foreign or institutional shareholders do not by themselves create commercial discipline if the state remains dominant in appointments, strategic direction and implicit policy use of banks. More market capital is desirable. More market scrutiny is desirable. Neither can substitute for clarity on who these banks are meant to serve and how they are meant to be governed. The government’s present approach risks trying to capture the valuation benefits of market participation without conceding the institutional discipline that market participation requires.
Deposit growth is the quieter banking problem
The sharper weakness in the current government plans is their relative silence on deposit mobilisation. Credit growth has outpaced deposit growth in major parts of the system. In the public sector bank review meeting for H1 FY26, the Department of Financial Services said PSB advances grew 12.3% year-on-year while deposits grew 9.6%. That gap is not a technical detail. It goes to the viability of the next credit cycle. A banking system cannot keep being judged mainly by loan growth while the liability side becomes tighter and more expensive.
This is where the government’s banking reforms instinct remains incomplete. It speaks of growth, technology and inclusion, but not enough about household savings behaviour, deposit pricing, competition from market instruments, and the tax and regulatory environment shaping where savers place money. A future banking strategy for India must ask why households should keep allocating long-term savings to bank deposits when other instruments offer higher returns or more attractive tax treatment. If the committee ignores the deposit problem and focuses only on credit delivery, it will be misreading the sector’s next constraint.
Reserve requirements and directed lending
A serious banking reforms agenda must also review the burden of regulatory pre-emption. Indian banks continue to operate under layers of reserve and liquidity requirements that reflect prudence but also compress lending flexibility. The IMF’s FSAP notes that public sector banks and foreign banks invest the largest share of assets in securities, and that liquidity coverage remains well above Basel requirements. That is reassuring from a stability perspective. It also means a large banking system is devoting significant balance-sheet capacity to mandated or prudential holdings rather than productive credit.
The question is not whether safeguards should disappear. The question is whether they remain calibrated for an economy that wants banks to finance industrial expansion, infrastructure, MSMEs, green transition and household consumption all at once. The same applies to priority-sector lending. Directed credit has outlived several economic regimes. It still serves political and social purposes, but it is no longer enough to defend it by habit.
The committee should ask whether credit outcomes for agriculture, micro-enterprises and weaker borrowers are being served by existing quotas, or whether banks have simply learned to comply mechanically. Reform here would be politically difficult. That is why it is necessary.
Digital banking policy and tech adoption
The government’s current language on banking modernisation leans heavily on technology adoption, AI road maps and digital customer journeys. That emphasis is understandable. But India’s banking challenge is not merely to make old banks more digital. It is to decide whether the regulatory system is ready for digital banks India can trust at scale. Public digital infrastructure has transformed payments. It has not yet been matched by a full regulatory architecture for deposit-taking digital banks.
This is a more complex issue than the government’s rhetoric suggests. A lightly regulated digital-bank experiment would be dangerous. A heavily restricted one would be pointless. India needs a licensing framework that allows digital-native banking models under strict standards on capital, governance, data use, cyber resilience and resolution. The IMF has already underlined the need to keep strengthening supervision, including cybersecurity oversight and credit risk management. Technology cannot be treated as a substitute for supervision. Nor should digital ambition become an excuse for regulatory forbearance.
Banking reforms must include failure
The most underappreciated gap in the government’s plans is on bank resolution and deposit insurance. The World Bank’s 2025 financial sector assessment said India still lacks a resolution framework aligned with international standards and that the deposit insurance framework should be strengthened by streamlining and shortening payout processes. That is not a marginal issue. Any government that wants larger, more market-linked and more technology-dependent banks must also build a credible framework for institutional failure.
Indian policy has often treated banking reforms as a story of expansion, inclusion and stability. It is also a story of controlled exit. If resolution tools remain limited and payout mechanisms remain slower than they should be, the burden of future distress will again fall on ad hoc state action. That would mean the state keeps the downside while talking up reform on the upside. The committee should not postpone this subject because it is politically unattractive. A banking system that cannot fail safely cannot grow safely either.
The High-Level Committee on Banking for Viksit Bharat could still matter. The timing is right. The sector is healthier. The government has political room. But the broad thrust of current official thinking suggests an emphasis on managed modernisation rather than institutional restructuring. That will not be enough. India does not need a second Narasimham Committee in symbolism alone.
It needs a report willing to recommend fewer things and mean them more: reduce ministry intrusion in public sector banks, differentiate ownership, make boards accountable, address the deposit challenge, recalibrate regulatory pre-emption, redesign priority-sector lending, create a digital-bank licensing regime, and enact a credible resolution framework.
The banking system has earned that level of seriousness. The government has not yet shown it.