By: Udaibir Das
India’s rise as the world’s fifth-largest economy is a defining moment, but sustaining this momentum and ensuring long-term, sustainable growth demands a hard look at its financial system. Rapid economic expansion has stretched the system in multiple directions, exposing structural weaknesses, regulatory gaps, and emerging systemic risks. The IMF’s latest Article IV Consultation and Financial Sector Assessment Program (FSAP) recognizes the growing strengths of India’s financial system but also highlights key vulnerabilities — delays in strengthening regulatory oversight, a shallow bond market, limited exchange rate flexibility, and rising risks in digital finance and nonbank financial institutions. India must act decisively in an increasingly volatile global financial environment to ensure its financial system remains globally competitive while supporting domestic economic priorities. The need for deeper financial markets, stronger institutions, and a more adaptive policy framework is no longer a distant ambition but an urgent policy imperative.
Since the 2008 Global Financial Crisis, India’s banking system has improved significantly, with stronger prudential regulations, better capital buffers, and declining non-performing assets. NPAs fell to 3.2% in 2024, the lowest in a decade — but the IMF warns they could rise to 5.8% under macro-financial stress, revealing the fragility of credit risk management. A significant concern is the continued dominance of public sector banks, which hold 60% of total banking assets. While they serve a critical role in financial inclusion, they also contribute to concentrated credit risks and inefficiencies in capital allocation. Their influence extends to the expansion of nonbank financial institutions, raising risks of spillover contagion due to their deep linkages with banks.
The rise of nonbank financial institutions has played a crucial role in expanding credit access, particularly for sectors underserved by traditional banks. However, their increasing interconnectedness with banks has created systemic risks. While regulatory oversight has improved, concerns persist over liquidity mismatches, dependence on short-term wholesale funding, and opaque risk exposures. The IMF underscores the need for stricter liquidity stress tests, higher capital adequacy norms, and better regulatory alignment between banks and NBFIs. Strengthening these measures will be crucial to containing risks and preventing financial contagion.
India’s capital markets have gained momentum, with the National Stock Exchange surpassing China in IPO volume in 2024, raising $19.5 billion through 268 IPOs. This surge signals growing investor confidence and deeper market liquidity. However, the corporate bond market remains severely underutilized, accounting for only 17% of GDP, far below peer economies like Malaysia and South Korea, which stand at 35–40%. As a result, businesses rely disproportionately on bank financing, making corporate credit cycles more vulnerable to economic downturns. Expanding the bond market is critical for diversifying financing channels and improving capital allocation efficiency. The IMF identifies three key reform priorities: broadening the institutional investor base to create stronger demand for corporate bonds, improving secondary market liquidity to help price discovery, and streamlining regulatory processes for corporate debt issuance and more participation. Without these reforms, India’s capital markets will continue to lag behind its vibrant equity markets, constraining long-term investment and economic stability.
The IMF’s review of India’s exchange rate management highlights a growing trade-off between currency stability, external competitiveness, and financial market flexibility. The Reserve Bank of India holds over $630 billion in foreign exchange reserves, providing a critical buffer against external shocks. However, frequent currency market interventions have limited exchange rate flexibility, raising concerns over external competitiveness and financial market efficiency. India’s push for rupee internationalization is a strategic step toward reducing reliance on U.S. dollar-denominated payment settlements. But for this initiative to succeed, India must expand rupee-based financial instruments to facilitate cross-border trade, improve offshore rupee market liquidity to attract global investors, and create a more predictable regulatory framework to encourage sustained foreign capital flows.
Few economies have embraced digital finance as rapidly as India. The Unified Payments Interface processed over $2.4 trillion in transactions in 2024, cementing India’s position as a global leader in real-time payments. Meanwhile, the Digital Rupee is positioning India at the forefront of monetary digitization and cross-border payment efficiency. The IMF and BIS recognize India’s CBDC initiative as one of the most technically advanced emerging markets. However, digitization brings its own set of risks. Cybersecurity threats, rising cases of digital fraud, and the growing dominance of a few large fintech players raise concerns over market concentration and systemic vulnerabilities. Stronger consumer protection laws, enhanced cybersecurity measures, and stricter oversight of dominant digital payment firms can help improve systemic resilience.
As India’s global economic influence expands, the strength and adaptability of its financial system will shape both domestic stability and India’s international financial integration. However, domestic macro-financial and economic stability must remain the priority before global ambitions can be fully realized. A comprehensive review is, therefore, imperative. By deepening financial resilience, accelerating capital market reforms, and fostering global financial integration, India can reinforce its position as a stable, competitive, and inclusive financial powerhouse — one that is fully aligned with its long-term economic ambitions.
Udaibir Das is a Distinguished Fellow at ORF America, Visiting Professor at NCAER, Senior Non-Resident Adviser at the Bank of England, Senior Adviser to the International Forum for Sovereign Wealth Funds, Distinguished Visiting Faculty at the Kautilya School of Public Policy, and Senior Advisor at the Toronto Centre. He previously held roles at the BIS, IMF, Reserve Bank of India, and Bank of Guyana.