India’s Financial Sector Reforms

India’s Financial Sector Reforms 29 May 2025

Despite ongoing reforms, the Banking, Financial services, and Insurance (BFSI) sector in India grapples with deep-rooted inefficiencies and trust deficits.

  • There is a need for deeper structural corrections, particularly in corporate bond markets, retirement planning instruments, nomination processes across BFSI, and the growing menace of shadow banking.

Key Issues In BFSI Sector

  • Nomination Confusion: Across BFSI verticals (banks, mutual funds, insurance), the rules governing nominees are inconsistent.
    • There is no harmonised nomination framework, with clarity on nominee rights versus legal heir claims.
  • Corporate Bond Market Crisis: 
    • Shallow, Low Volume and Illiquid: Limited participation restricts market depth and efficient price discovery.
    • Opaque Trading: Lack of transparency deters investors and reduces confidence.
    • Neglected Secondary Market: RBI’s directive to develop the secondary bond market was ignored by the National Stock Exchange (NSE), as equity trading gives higher margins over bonds.
    • High Cost of Capital: Inefficiency in the bond market keeps borrowing costs 2–3% higher, hurting industry and jobs.
  • Ownership Transparency and FATF: 
    • UBO Gaps: India, as an FATF member, is committed to transparency in capital flows, including identification of Ultimate Beneficial Owners (UBOs) but enforcement lags behind.
      • Ultimate Beneficial Owners (UBOs) refer to the natural persons who ultimately own or control a legal entity (usually 25% or more), even if the ownership is held indirectly through layers of intermediaries.
    • Opaque Foreign Investments: SEBI struggles to extract shareholder data from foreign investors (e.g., Elara, Vespera), hampering oversight and delaying regulatory action.
    • Loopholes in Disclosure Thresholds: India’s current UBO disclosure thresholds (10% for companies and 15% for partnerships as against 25% requirement of FATF) create loopholes that allow entities to structure investments just below these limits, thereby avoiding identification.
  • Retirement Planning Problems: 
    • Domination Of Annuities: Most Indian retirement plans rely on annuities, which carry high intermediation fees (often ~2%) from insurance companies.
      • Even young professionals in the BFSI sector lack access to efficient retirement tools.
    • Zero-Coupon Government Bonds: The better alternative for annuities are Zero Coupon Government Bonds. These long-dated, stripped securities offer low-cost, predictable returns and are ideal for retirement goals.
      • Avoiding a 2% fee over 30 years results in substantial savings gains.
    • Government has not launched large scale retirement products.
  • Shadow Banking Risks:  
    • Regulatory Blind Spot: Non-banking financial companies (NBFCs), margin lenders, repo traders, and brokers are offering bank-like services without being subject to full regulatory oversight.
    • High-Risk Lending Practices: Brokers extend margin funding at effective interest rates exceeding 20%, often without investor awareness.
    • Opaque Collateral Use: The broker holds the investor’s contribution as collateral, lends it back to them, and charges interest on the full amount — a classic shadow banking trick.

Suggested Measures

  • Harmonised Nomination Framework: Create a harmonised nomination framework across banks, mutual funds, and insurance sectors with clarity on nominee rights versus legal heir claims to avoid legal ambiguities and protracted litigation.
  • Structural Reform: Implement deeper structural reforms to develop the corporate bond market as a means to reduce the cost of capital and unlock industrial growth.
  • Ultimate Beneficial Ownership (UBO) Disclosure: Lower disclosure thresholds and mandate granular shareholder data to plug loopholes and ensure compliance with FATF’s UBO 2022 guidelines on ownership transparency.
  • Sovereign Instruments: Promote long-dated zero-coupon government securities as a retirement planning option, avoiding high intermediation margins of annuity-based products.
  • Regulation of Shadow Banking: Launch a comprehensive data-gathering initiative to map activities of NBFCs, margin lenders, and brokers offering bank-like services without full oversight.
  • Adopt Best Practices: India must follow the European Union’s approach by legislating for gathering comprehensive data on shadow banking activities.

Conclusion

India needs structural financial reforms to ensure transparency, investor trust, and long-term growth.

Main Practice

Q. Analyze the challenges faced by India’s corporate bond market . Suggest how targeted financial sector reforms can strengthen this market to support sustainable economic development. (10 Marks, 150 Words)

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UDAAN PRELIMS WALLAH
Comprehensive coverage with a concise format
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Quick Revise Now !
UDAAN PRELIMS WALLAH
Comprehensive coverage with a concise format
Integration of PYQ within the booklet
Designed as per recent trends of Prelims questions
हिंदी में भी उपलब्ध

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