India's Financial Sector Reforms
The Budget 2026 has initiated crucial shifts in India's financial sector reforms, aiming to address deeper structural problems.
Key Proposals
- Introduction of a market-making framework for corporate bonds.
- Development of total-return swaps and bond-index derivatives.
- Establishment of an Infrastructure Risk Guarantee Fund.
- Recycling Central Public Sector Enterprises' real estate assets through Real Estate Investment Trusts (REIT).
Structural Imbalance in Banking
Indian banks have been shouldering risks typically absorbed by markets in mature systems, leading to overburdened bank balance sheets and a fragile financial system.
Current Scenario
- Government securities in India are 90% of GDP, comparable to large economies.
- Corporate bonds are only 15%-16% of GDP, much smaller than in countries like the U.S., China, or Germany.
- Banks carry 60%-65% of non-financial corporate debt, unlike 30% in the U.S. and 40% in Europe.
Challenges
- Banks face a mismatch in duration, financing long-term projects with short-term deposits.
- The government spent over ₹3.2 lakh crore on bank recapitalization since 2017.
- Limited capital for small firms and new borrowers due to capital tied in long-term corporate loans.
Corporate Bond Market Limitations
- Bonds outstanding are less than 15% of GDP, compared with over 80% in the U.S.
- Private placements dominate, and secondary market liquidity is weak.
- The market is skewed towards top-rated firms, with limited household and foreign investor participation.
Impact on Monetary Policy
The concentration of risk in banks restricts effective monetary policy transmission, affecting interest rate adjustments.
Necessary Reforms
Budget 2026 measures aim to reallocate risks from banks to markets, potentially enhancing the resilience of India's financial system.
Author: Saumitra Bhaduri, Professor, Madras School of Economics
