Banking, RBI and Financial Markets

Every country needs one bank above all other banks: a bank that prints the currency, keeps the government's accounts, looks after the other banks and guards the value of money. This is the central bank, and in India it is the Reserve Bank of India (RBI). The idea of a central bank for India came from the Hilton Young Commission (1926); the RBI Act, 1934 created it, and it began work on 1 April 1935. At first it was a privately owned shareholders' bank. After Independence it was nationalised on 1 January 1949.

Why is the RBI called the lender of last resort? When a sound bank is short of cash and no one else will lend to it, the RBI steps in and lends, so that one bank's trouble does not spread as a panic through the whole system. Why banker's bank? Because commercial banks keep their CRR balances with the RBI, borrow from it at the repo rate, and settle their mutual payments through it.

Protecting the customer. The RBI began the Banking Ombudsman Scheme in 1995 so that customers could get quick and free redressal for deficiency in banking services; in November 2021 the earlier schemes were merged into the Reserve Bank - Integrated Ombudsman Scheme (RB-IOS). The Banking Codes and Standards Board of India (BCSBI) was set up in February 2006 to promote fair practices. Deposits in banks are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the RBI, up to Rs 5 lakh per depositor per bank (as of 2025).

A bank takes deposits from people who have spare money and lends them to people who need money, earning the difference. India's banking system is a pyramid. At the top stands the RBI. Below it are the scheduled banks, which are listed in the Second Schedule of the RBI Act, 1934 and can borrow from the RBI; the rest are non-scheduled. The scheduled group contains commercial banks (public sector, private sector, foreign, and regional rural banks) and cooperative banks. In recent years a new set of 'differentiated' banks has been added: small finance banks and payments banks.

Why nationalise? Before 1969 banks were mostly in private hands and lent to big business and industry in cities, while farmers, small traders and villages were left out. The government wanted banking to serve development, to prevent concentration of credit, to spread branches into rural areas and to mobilise savings. After nationalisation the number of branches rose sharply and bank credit started reaching agriculture and small industry through priority-sector lending.

The Supreme Court struck down the 1969 nationalisation law in the R. C. Cooper case (1970) on the ground of unequal compensation; Parliament then passed the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, which is the law behind both rounds of nationalisation.

Till 1991 Indian banks were more like government departments than businesses. The SLR and CRR together swallowed a very large part of their deposits, interest rates were fixed by the RBI, loans were directed to chosen sectors, and there were no real standards for accounting of bad loans. The crisis of 1991 forced a rethink, and the Narasimham Committee on the financial system (1991) gave the blueprint. The aim was simple: make banks competitive, profitable and sound, so that they lend wisely and survive on their own strength.

Capital adequacy means that a bank must hold enough of its own capital to absorb losses on its loans. The CRAR (Capital to Risk-weighted Assets Ratio) = capital / risk-weighted assets x 100. The international Basel norms (set by the Basel Committee on Banking Supervision of the BIS) ask for 8 per cent; the RBI asks Indian banks for a higher 9 per cent, and with the capital conservation buffer under Basel III the effective minimum is 11.5 per cent. More capital means a safer bank.

Non-Performing Assets (NPAs). A loan becomes an NPA when the borrower has not paid interest or principal for 90 days. NPAs are classified by how long they remain bad: substandard (an NPA for up to 12 months), doubtful (substandard for more than 12 months) and loss assets (considered uncollectable). Before a loan turns into an NPA, it passes through Special Mention Accounts (SMA): SMA-0 (1-30 days overdue), SMA-1 (31-60) and SMA-2 (61-90), an early-warning system. Gross NPA is the total of bad loans; Net NPA = Gross NPA minus the provisions the bank has made. The ratio of NPAs to total advances shows the health of banks. In 2016-17 the Economic Survey described the problem as the 'twin balance sheet' problem: stressed companies on one side, bad-loan-ridden banks on the other.

Priority Sector Lending (PSL) means that banks must lend a fixed share of their credit to sectors that the market would otherwise neglect but which matter for growth and equity. The target is 40 per cent of Adjusted Net Bank Credit (ANBC) for domestic commercial banks and foreign banks with 20 or more branches, and 75 per cent for small finance banks and RRBs. Within the 40 per cent there are sub-targets: 18 per cent for agriculture and 7.5 per cent for micro enterprises, plus a share for weaker sections. Categories: agriculture, micro, small and medium enterprises, export credit, education, housing, social infrastructure, renewable energy and others. Since April 2016 banks short of a target can buy Priority Sector Lending Certificates (PSLCs) from banks that have surplus.

A bank account is the doorway to the modern economy. Without it, a farmer cannot get a loan at a fair rate, a worker cannot receive wages safely, and a widow cannot receive her pension directly. Financial inclusion means making basic financial services (a savings account, credit, insurance, pension and payments) available to every person, especially the poor and the weak, at an affordable cost and in a fair manner. The RBI's own approach has moved from simply opening accounts to making sure the accounts are actually used.

PMJDY was announced on 15 August 2014 and launched on 28 August 2014 with the mission of 'banking the unbanked'. Its core is a basic savings bank account with no minimum balance, a RuPay debit card that carries accident insurance (Rs 2 lakh for accounts opened after 28 August 2018), and an overdraft facility for eligible account holders. It works with the JAM trinity: Jan Dhan account + Aadhaar + Mobile, which lets the government send subsidies and benefits straight into the beneficiary's account through Direct Benefit Transfer (DBT), cutting out middlemen and leakage.

The government also launched three low-cost social security schemes on 9 May 2015, so that the newly opened accounts could carry insurance and a pension. All three are linked to the account holder's bank account, and the premium is auto-debited.

The RBI's Financial Inclusion Index (FI-Index) measures how deep and wide financial inclusion is across the country in a single number from 0 to 100. It was introduced in 2021 and is published every year (for the year ending March). It is built from 97 indicators grouped into three sub-indices: Access (weight 35 per cent), Usage (45 per cent) and Quality (20 per cent). Usage carries the highest weight because an unused account is a closed door that merely looks open.

Payments in India. The legal base is the Payment and Settlement Systems Act, 2007, under which the RBI regulates and supervises all payment systems. Retail payment systems run by the National Payments Corporation of India (NPCI), an umbrella organisation set up in 2008 as a not-for-profit company promoted by the RBI and the Indian Banks' Association, which created IMPS, UPI, RuPay, AePS, BBPS and NETC (FASTag). The RBI itself runs the two big interbank systems, RTGS and NEFT.

Everyday banking. Deposits are of two kinds. Demand deposits (savings and current accounts) can be withdrawn at any time; time deposits (fixed and recurring deposits) are locked for a fixed period and pay higher interest. A savings account is for individuals and pays interest; a current account is for businesses with many daily transactions and pays no interest. A cheque is a written order to a bank to pay a stated sum from the drawer's account; it is a negotiable instrument under the Negotiable Instruments Act, 1881, and a cheque is valid for three months from its date. A cheque with two parallel lines across the corner is a crossed cheque: it can be paid only into a bank account, not in cash, so it is safer.

Think of Radhika's father, who has saved some money. He can keep it in a bank, or he can lend it to a company that needs money to build a factory. The company, in turn, wants to borrow from many people instead of one bank. Financial markets are the places (today mostly electronic) where such savers and borrowers meet. The market for short-term funds (up to one year) is the money market; the market for long-term funds (more than one year) is the capital market. In India the RBI mainly watches the money market, and SEBI watches the capital market.

Primary and secondary market. When a company sells new shares to raise money, this happens in the primary market, and the money goes to the company. The first such public sale is the Initial Public Offering (IPO); later issues are Follow-on Public Offers (FPO); other routes are rights issue (to existing shareholders), private placement / QIP and Offer for Sale (OFS). After that, investors trade the existing shares among themselves on the secondary market, that is, on a stock exchange, and the company gets no new money from these trades. This is why the stock exchange is called the 'secondary' market and why it still matters: it gives investors an exit and gives the shares a price.

A stock index is a barometer of the market: it tracks the combined price movement of a basket of chosen shares. When the index rises, shares are generally rising: a bull market (optimism, buying; the bull thrusts its horns upward). When it falls, it is a bear market (pessimism, selling; the bear swipes its paws downward). A circuit breaker is an automatic halt in trading when the index moves too much in a day (market-wide breakers work at 10, 15 and 20 per cent), meant to cool panic. Free-float means only the shares actually available for public trading are counted, not those held by promoters.

Demat and depositories. Earlier, shares were printed paper certificates that could be lost, forged or delayed. The Depositories Act, 1996 introduced dematerialisation: shares are held in electronic form in a demat account, like money in a bank account. Two depositories hold the records: NSDL (National Securities Depository Ltd, the first, 1996) and CDSL (Central Depository Services Ltd, 1999). An investor deals through a depository participant (DP) and a stock broker.

SEBI (Securities and Exchange Board of India) is the regulator of the securities market. It was set up on 12 April 1988 by a government resolution (non-statutory) and got statutory powers through the SEBI Act, 1992. Its headquarters is in Mumbai. It has a chairman and members appointed by the Union Government. Its aim is to protect investors, regulate and develop the securities market. Appeals against SEBI's orders go to the Securities Appellate Tribunal (SAT) and then to the Supreme Court. Earlier, the Controller of Capital Issues decided the price and size of share issues; it was abolished in 1992 so that companies could price issues freely under SEBI's supervision.

Most of us cannot study hundreds of companies or know when to buy and sell. A mutual fund solves this by pooling the money of many investors and handing it to a professional fund manager, who invests it in shares, bonds and other securities. Each investor gets units in proportion to the money invested, and the profit or loss is shared in the same proportion. A mutual fund is set up by a sponsor as a trust, managed by an Asset Management Company (AMC) and regulated by SEBI. The price of one unit is its Net Asset Value (NAV) = (market value of the fund's assets minus its liabilities) divided by the number of units outstanding.

Insurance is a way of sharing risk. Many people pay a small premium into a common pool; the few who suffer a loss are paid from it. The person who buys the policy is the policyholder (insured), the amount promised is the sum assured, and the person who receives it is the nominee. Insurance works on a few principles: utmost good faith (the buyer must disclose all facts), insurable interest (you can insure only what you would suffer by losing) and, for general insurance, indemnity (you are compensated for the actual loss, never more). Life insurance is not an indemnity contract, because no sum can replace a life, so a fixed sum is paid.

The FDI limit in insurance has risen step by step: 26 per cent when private entry was allowed (2000), 49 per cent in 2015, 74 per cent in 2021, and 100 per cent after the Sabka Bima Sabki Raksha Act of December 2025 (in effect from February 2026). Raising the cap brings capital and technology, but the insurer must still be an Indian company. The point of all these reforms is the same as in banking after 1991: let private competition improve service while a regulator guards the policyholder.

Pension. A pension protects you after earning stops. The Old Pension Scheme (OPS) was a defined-benefit scheme: the government paid a fixed pension, linked to the last salary, out of its own budget, which became a growing burden. The National Pension System (NPS) is a defined-contribution scheme: the employee and employer put money into an individual account, the money is invested in a mix of equity, corporate bonds and government securities by pension fund managers, and the pension depends on the corpus built. NPS started on 1 January 2004 for central government employees joining on or after that date (armed forces excepted) and was opened to all citizens from 1 May 2009. It is regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

A commercial bank takes deposits that can be withdrawn at short notice, so it prefers to lend for short periods. But a steel plant, a power station or a rural irrigation project needs money for ten or twenty years. India therefore built special Development Finance Institutions (DFIs), which give long-term finance to industry, agriculture, housing, exports and infrastructure. Alongside them grew Non-Banking Financial Companies (NBFCs), which lend like banks but are not banks. Together they fill the gaps that ordinary banks leave.

NABARD was set up on 12 July 1982 on the recommendation of the Shivaraman Committee, taking over the agricultural credit functions of the RBI and the Agricultural Refinance and Development Corporation. It does not mainly lend to farmers directly; it refinances banks (cooperative banks, RRBs and commercial banks) that lend to agriculture and rural industries, supervises cooperative banks and RRBs, and promotes rural development, for example through the Rural Infrastructure Development Fund (RIDF, 1995-96) and the SHG-Bank Linkage Programme (1992). Think of NABARD as the 'bank of rural banks'.

NBFCs. A Non-Banking Financial Company is a company registered under the Companies Act that lends, invests in shares and bonds, or does hire purchase, leasing or chit-fund business, but is not a bank. Every NBFC must be registered with and is regulated by the RBI (Chapter III-B of the RBI Act, 1934). It differs from a bank in three important ways. It cannot accept demand deposits (savings or current accounts), it is not part of the payment and settlement system and cannot issue cheques drawn on itself, and its depositors do not get deposit insurance from the DICGC. Because they often reach borrowers whom banks avoid, NBFCs are sometimes called 'shadow banks'.

Since October 2022 the RBI uses scale-based regulation for NBFCs: they are sorted into four layers (Base, Middle, Upper and Top) according to size and risk, and larger NBFCs face stricter rules, closer to those for banks. The same year the older categories of asset finance, loan and infrastructure finance companies were merged into a single category, NBFC-Investment and Credit Company (NBFC-ICC). This followed the 2018 crisis at IL&FS, when the failure of a large NBFC showed how a shadow bank can shake the whole system.