How 2024 Banking Reforms Will Shape India's Economic Future

By simplifying nomination processes & improving access, the laws address hurdles to formal financial participation.

Union Finance Minister Nirmala Sitharaman.

(Photo: PTI)

The Banking Laws (Amendment) Bill, 2024, introduced in the Lok Sabha, seeks to address various structural, operational, and governance challenges within India’s banking sector that has faced significant headwinds over the last few years. This comprehensive legislation proposes amendments to critical laws, including the Reserve Bank of India Act, 1934; the Banking Regulation Act, 1949; the State Bank of India Act, 1955; and the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980.

With over 400 million Indians relying on the need of banking services daily, can the Banking Laws (Amendment) Bill, 2024, redefine trust in the sector and secure financial inclusion for millions more? It's critical in that context to examine the broader economic implications of the bill, detailing its potential impact on financial stability, credit growth, and investor confidence.

One of the key amendments introduced by the bill pertains to enhancing governance standards in banking institutions. For instance, the proposed changes in the Banking Regulation Act, 1949, include increasing the tenure of directors in cooperative banks from eight to 10 years and aligning governance structures with the Constitution’s Ninety-Seventh Amendment Act, 2011. Additionally, provisions such as mandating directors of central cooperative banks to serve on state cooperative bank board’s aim to create a more interconnected and accountable governance framework.

These governance reforms are expected to bring greater stability to the banking sector. By ensuring stronger oversight and continuity in leadership, banks will likely adopt more prudent risk management practices.

By addressing governance lapses, India’s banking sector can avoid the pitfalls of past crises, such as the staggering Rs 10 lakh crore in non-performing assets (NPAs) during the early 2020s.

The macro dynamics of the banking sector has unfortunately reduced the NPAs by increasing write-offs which is deeply problematic in its own sense (it doesn’t take the debt or its actual effect away) but acts simply as a book-keeping/accounting cleansing exercise to show surficial improvement in banking health (explained here).

Depositor Protection and Investor Confidence

Securing and Maintaining Trust in banking institutions begins with depositor protection. I have previously analysed the issue in relevance to the Indian scenario emerging from waning depositor-confidence and lowering deposit-rates which signals a liquidity crisis for banks – especially in tackling or addressing crises.

The Banking Laws (Amendment) Bill, 2024, takes significant strides to reinforce public trust, aligning banking regulations by introducing critical measures to safeguard depositor interests and enhance investor confidence. It raises the threshold for defining “substantial interest” in a banking company from Rs 5 lakh to Rs 2 crore. This revision reflects inflationary adjustments and ensures that regulatory scrutiny is focused on significant stakeholders.

Furthermore, amendments to sections 45ZA, 45ZC, and 45ZE of the Banking Regulation Act allow depositors to nominate up to four individuals for simultaneous or successive access to their deposits and lockers.

These provisions aim to make banking services more user-friendly, secure, particularly in the event of unforeseen circumstances like the death of a depositor. Such measures may over time also seek to safeguard depositor rights, helping to enhance public trust in banking institutions, thereby encouraging greater participation in formal financial systems. The real concern is whether an ‘amendment’ in law actuals makes its operation and realisation viable – so far there is little evidence of this.

Operational Efficiency and Reporting Needs

The Banking Laws (Amendment) Bill, 2024, proposes synchronising reporting deadlines to the rhythm of fortnights, months, and quarters, eliminating the discord of alternate Fridays and public holidays. This revision eliminates ambiguities associated with alternate Fridays and public holidays, streamlining statutory reporting to the Reserve Bank of India (RBI).

Transformed reporting efficiency is crucial for timely regulatory interventions and ensures that policy decisions are based on accurate and up-to-date data.

For instance, the amendment to Section 42 of the RBI Act modifies the definition of “fortnight,” enhancing consistency in reporting demand and time liabilities. Such measures contribute to better monetary policy formulation and implementation, thereby fostering economic stability.

Unclaimed dividends and shares often lie dormant, a testament to inefficiencies within the financial system. This bill addresses this by channeling these idle funds into the Investor Education and Protection Fund (IEPF), ensuring they serve a purpose while remaining accessible to rightful claimants by providing a mechanism for claimants to access their dues through established rules under the Companies Act, 2013.

Another notable change is the provision allowing PSBs greater discretion in determining auditor remuneration. This reform empowers banks to engage auditors competitively and ensures high-quality audits. Improved audit quality will likely lead to better financial disclosures and reduce instances of mismanagement or fraud.

The bill enacts significant reforms to bolster cooperative banks, which are vital to India's rural and semi-urban economies. Notably, it extends the maximum tenure for directors from eight to ten years, promoting leadership continuity and stability.

Furthermore, directors of central cooperative banks are now permitted to serve on state cooperative bank boards, fostering a more cohesive governance structure. The legislation also mandates that cooperative banks adhere to stricter cash reserve and asset maintenance requirements, aligning them with national banking standards.

These measures are expected to bridge the governance gap between cooperative and commercial banks, thereby fostering greater integration within India’s financial system. Enhanced regulatory oversight of cooperative banks will also ensure that rural and semi-urban areas, which rely heavily on these institutions, experience improved financial services.

By updating regulations on cash reserves and statutory liquidity ratios, the bill aims to strengthen banks' defenses against potential liquidity crises. Notably, it revised penal interest rates for cash reserve shortfalls to better reflect current economic conditions, thereby incentivising compliance and promoting prudent financial management.

Improved financial stability directly impacts economic growth by ensuring that banks can continue to extend credit to businesses and consumers. A robust banking system also mitigates the risk of systemic crises, which could otherwise derail economic progress.

Several provisions of the bill are designed to enhance financial inclusion. According to the RBI, the Financial Inclusion Index has been on a steady rise from 60.1 in the fiscal year 2023, up from 43.4 in 2017, this indicates a significant progress in financial inclusion.

By simplifying nomination processes and improving access to banking services, the amendments address longstanding barriers to formal financial participation.

Cooperative banks, which serve a significant portion of the rural population, are expected to benefit from the governance reforms, enabling them to expand their outreach and improve service delivery.

Financial inclusion is a critical driver of economic growth, as it facilitates the mobilisation of savings and improves access to credit for underprivileged sections of society. The bill’s focus on depositor protection and operational efficiency further encourages individuals to transition from informal financial systems to organised banking networks.

Potential Challenges

The Banking Laws (Amendment) Bill, 2024, while ambitious, faces notable challenges.

Increased compliance requirements could overwhelm smaller cooperative banks with limited resources, necessitating extensive capacity-building support.

Attracting qualified directors and auditors remains another obstacle, particularly for smaller institutions. Moreover, the effective and transparent use of unclaimed funds transferred to the Investor Education and Protection Fund (IEPF) requires robust oversight to prevent inefficiencies or misuse. Balancing the objectives of inclusivity, stability, and operational efficiency with the costs and complexities of implementation will be critical for the bill to achieve its transformative goals.

The Banking Laws (Amendment) Bill, 2024, holds immense potential to modernise India’s financial system by fostering resilience, inclusivity, and governance reform.

However, its success hinges on addressing implementation challenges, especially for smaller banks, and ensuring transparent fund management.

The current high LDR (Elevated Loan to Deposit ratio) reflects sectoral or micro-imbalances rather than macro-imbalances. Large corporates are borrowing less, while HHs, MSMEs, and the agricultural sector are borrowing more but generating weak demand.

Furthermore, if viewed from a bird’s eye macro-lens, firms, due to a compressed demand position and slowing consumption expenditure are sitting on credit and cash without substantially investing in building ‘new capacity’ or inventories (a point this author has repeatedly argued). 

My sense is that since credit (despite its high demand) is not being used to ‘invest’ (create something new or rather add to productivity), but rather is financing borrowings, or existing debt (from households to firm to government level), this will only create additional troubles for India’s macroeconomic position ahead, unless productive investment picks up across sectors.

Credit cycles will also become weaker over time (as there is only a certain amount of space till which the RBI will borrow and finance in the absence of sufficient savings, investments coming in) and that will subsequently affect overall growth too (which is already at a break event point if not at a precariously low position).

There is a strong need to intersectionally study and understand the deposit-credit growth gap problem in context to other macroeconomic vulnerabilities, which need the underlying market conditions and design to be structurally altered – not merely tinkered with.

The government’s inactions (its inability to understand the structural tenets of the current crisis and its economic and financial implications) may be ignored at the cost of the nation’s financial health and economic robustness, driving it down to its own peril ultimately.

A series of amendments in terms of a new Bill may be welcome in spirit but may do limited reform if other institutional stakeholders, including the (public and private) banking bureaucracy and management, fail to adequately implement it.

With inputs from Aryan Govindakrishnan and Ankur Singh.

(Deepanshu Mohan is a Professor of Economics, Dean, IDEAS, Office of Inter-Disciplinary Studies, and Director of Centre for New Economics Studies (CNES), OP Jindal Global University. He is a Visiting Professor at the London School of Economics, and a 2024 Fall Academic Visitor to the Faculty of Asian and Middle Eastern Studies, University of Oxford. This is an opinion article, and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)