India's banking sector has made significant progress. But sustaining the next phase will require reforms. Bad loans fell from 8.21% in FY20 to 2.21% in FY25. Return on equity rose from 0.78% to over 14%. RBI and other banks have done a remarkable job of bringing the sector to good health. But the present scenario warrants a shift in gears.
The biggest issue is access to credit for microenterprises. To close this gap, the banking sector would have to grow by at least 30%. The challenge becomes larger when we add rising corporate and underserved retail credit needs, especially given that bank deposits are not growing fast enough. This is a structural, not cyclical, challenge, driven by a post-pandemic fall in household savings.
Addressing this requires active dialogue between regulators, policymakers and market participants. The following actions can be taken:
Recalibration of pre-emption
Globally, many economies have minimised or eliminated reserve requirements, relying, instead, on Basel 3 liquidity frameworks. India has also implemented these measures, which makes even its reduced CRR of 3% duplicative. Further calibration of CRR could be considered over time.
Also, SLR could be optimised to prevent excessive maintenance of high-quality liquid assets and higher yield/ lower cost enabled. Issues like penalties for daily CRR/SLR shortfalls, liquidity coverage ratio (LCR) run-off rates and mandatory CRR not counting towards LCR can also be reviewed. Recalibration could include reduction/forbearance in these areas. Further, debt market funding should ideally be excluded from reserve requirements to eliminate effective interest rate differential banks incur vis-a-vis corporates.
Revisiting C/D
Several countries have credit-to-deposit (C/D) ratios consistently above 100%, allowing credit growth beyond deposit constraints. Treating C/D as a hard limit raises deposit costs and slows lending. As India has adopted Basel 3 frameworks, it can revisit C/D - drop it as any limitation, or expand the denominator to include other suitable funding sources.
Reworking PSL
While the priority sector lending (PSL) framework is essential, current sub-targets don't reflect evolving economic needs. For instance, healthcare is not explicitly represented. Sub-targets need revision and should be updated regularly. Also, PSL computational quirks that apply PSL targets to PSL books could be refined. Other reforms (shifting from quotas to target outcomes, etc) could ensure the composition of bank lending ultimately reflects GDP composition.
Closing MSME credit gap
Only around 14% of MSMEs have access to formal credit, despite contributing over 31% of GDP and nearly half of exports. The challenge is no longer one of data availability but of delivery. DPI, such as GST data, the Account Aggregator framework, unified lending interface (ULI) and cash flow-based lending, now provides building blocks for better underwriting.
The next step is wider adoption by lenders, calibrated guarantee schemes and faster invoice financing. Regulators, policymakers and lenders need to work together to provide credit where it's most needed, and lay the groundwork for a virtuous self-funding cycle to kick in.
Cost-efficient deposit growth
Banks could be allowed to offer relationship pricing on deposits. In the US, banks can offer higher interest rates to customers with whom they have multi-product relationships, which reduces customer churn. Further, banks here have a significant deposit growth opportunity in rural/semi-urban areas, which have only a 26% deposit share, well below their share of GDP.
Sharper risk-based pricing
Risk- based pricing is applied today in broad bands. We need a better assessment of borrower differences, with transparency and fairness. This would also require a deeper corporate debt market with a robust yield curve. While this requirement is at least two decades old, one should persevere.
Measures could include operationalising the market-making policy announced in the 2026 budget, easing restrictions on writing derivatives, allowing issuers to reuse past filings, persuading domestic institutions to hold more corporate bonds than government securities, and increasing FII participation.
Driving investments
There is merit in raising the 20% FDI cap on PSBs (while safeguarding public control), as significant investments are needed for credit growth. Hence, establishment of a 'Committee on Banking for Viksit Bharat' is a welcome step. India's gross fixed capital formation-to-GDP ratio needs to rise to 35%, mostly from the private sector.
Where investment announcements are not executed, root causes need to be understood. Continued efforts to deepen investor confidence in equity markets will also be important. Nearly half of the 112 large IPOs in FY26 were trading below their issue price by April. Such falls could hurt retail investors and entail forex losses.
These measures will not only boost long-term GDP growth but also drive a 30-bps or more uptick in near-term GDP growth, and help soften the blow of geopolitics and crude oil prices.
Shetty is CEO, Deloitte South Asia,and Puri is senior adviser, Deloitte
