Indian Banking System - Structure, Types of Banks, NPAs, Banking Reforms, and Recent Developments
The Indian banking system is the backbone of the economy. It collects savings, gives credit to households and businesses, runs the payment system, and helps the government deliver welfare directly to citizens. For UPSC, banking is important for GS3 (Economy), GS2 (governance, regulation, financial inclusion), and also for Prelims (terms, institutions, and recent reforms).
Why in News (2024-2026 context)
- Bank asset quality has improved strongly. RBI's "Trend and Progress of Banking in India 2024-25" highlighted multi-decadal low GNPA levels for scheduled commercial banks.
- Digital public infrastructure is reshaping credit delivery (Account Aggregator, ULI, digital lending framework, etc.).
- Regulators and government continue reforms on NPAs, insolvency, priority sector lending, and system liquidity management.
Key Definitions (Exam-Ready)
Bank: A financial institution that accepts deposits and provides loans and other financial services (payment, remittance, credit, investment services).
RBI: India's central bank; regulates currency, monetary policy, banking supervision, payment systems, and overall financial stability.
Scheduled Bank: A bank included in the Second Schedule of the RBI Act, 1934 (generally larger, regulated banks meeting specific conditions).
NPA (Non-Performing Asset): A loan/advance where repayment (principal/interest) is overdue beyond the regulatory threshold (commonly 90 days for many loan categories).
GNPA vs NNPA: GNPA is total gross NPAs; NNPA is NPAs after subtracting provisions.
CRR & SLR: Regulatory requirements that influence liquidity and credit creation (CRR is cash reserve with RBI; SLR is liquid assets to be maintained by banks).
Capital Adequacy (CRAR): Capital-to-risk weighted assets ratio; shows bank's buffer against losses.
1) Structure of the Indian Banking System
A) Core Pillars
- Reserve Bank of India (RBI): Central bank; regulates and supervises banks, manages monetary policy, issues currency, and ensures financial stability.
- Banks: Commercial banks (including PSBs, private, foreign), regional rural banks, small finance banks, payment banks, and cooperative banks.
- Development Finance Institutions (DFIs) & Specialised Institutions: Institutions supporting long-term development finance, infrastructure, MSMEs, housing, agriculture, exports, etc.
- Non-Banking Financial Companies (NBFCs): Provide credit and financial services but generally do not have full "bank" functions like demand deposits (varies by category). They are important for credit flow and can affect systemic stability.
- Deposit Insurance & Consumer Protection: Deposit insurance (DICGC), ombudsman mechanisms, and customer protection directions.
🏦 Indian Banking System Structure
RBI regulates all; DICGC provides deposit insurance; FSDC coordinates financial stability
B) Regulatory and Institutional Framework (UPSC-friendly)
| Component | Role in the System | UPSC Points |
|---|---|---|
| RBI | Banking regulation, supervision, monetary policy, payments, financial stability | RBI Act, 1934; Banking Regulation Act, 1949; lender of last resort |
| Government (DFS, MoF) | Policy direction, PSB ownership, financial sector reforms | Recapitalisation, governance reforms, inclusion schemes |
| DICGC | Deposit insurance for bank depositors (within limits) | Financial stability and depositor confidence |
| FSDC (system-level) | Coordination on financial stability (multi-regulator coordination) | Macroprudential oversight |
| Payment System Institutions | Enable safe and efficient payments | Digital payments, fintech regulation, consumer safeguards |
UPSC PYQ Theme (Banking System)
UPSC often tests: (i) RBI's role and instruments, (ii) differences between types of banks, (iii) NPAs and resolution tools (IBC, SARFAESI), and (iv) digital finance architecture and its risks.
2) Types of Banks in India
A) Broad Classification
- Commercial Banks: Main credit and payment institutions for households and businesses.
- Cooperative Banks: Member-owned institutions, important for rural/agri credit and local finance.
- Specialised / Niche Banks: Regional rural banks, small finance banks, payment banks.
- Foreign Banks: Bring global practices, capital, and competition, but operate under Indian regulation.
B) A Simple Table for Prelims
| Type | Core Purpose | Typical Customers | Key Notes |
|---|---|---|---|
| Public Sector Banks (PSBs) | Broad-based credit, inclusion, priority sector support | Households, MSMEs, agriculture, government-linked activities | Government majority ownership; large network |
| Private Sector Banks | Competition, efficiency, retail + corporate banking | Retail, MSMEs, corporates | Often stronger tech and customer experience |
| Foreign Banks | Trade finance, high-end corporate/wealth services | MNCs, high-net-worth customers, trade businesses | Limited branches; strong global connectivity |
| Regional Rural Banks (RRBs) | Rural credit and inclusion | Farmers, rural MSMEs, SHGs | Focus on rural/semi-urban areas |
| Small Finance Banks (SFBs) | Financial inclusion with bank-like services | Small borrowers, micro enterprises | More flexible than traditional models for small-ticket credit |
| Payment Banks | Payments + deposits (limited), not full lending | Remittances, small deposits, digital payments users | Designed to deepen digital payments and inclusion |
| Cooperative Banks (Urban/Rural) | Community/member-based banking | Local communities, small businesses, agriculture | Governance quality matters; supervision strengthened over time |
🏛️ 7 Types of Banks in India
C) Prelims Angle vs Mains Angle
Prelims Angle
- Know differences: SFB vs Payment Bank vs RRB vs Cooperative Bank.
- Know "scheduled vs non-scheduled" concept, and RBI's supervisory role.
Mains Angle
- How banking structure supports inclusion but creates governance challenges (especially in co-ops and PSBs).
- How niche banks and fintech improve access but increase operational/cyber risks.
3) What Banks Actually Do (And Why Regulation Matters)
A) Core Functions
- Mobilise savings: deposits from households and businesses.
- Provide credit: loans to agriculture, MSMEs, industry, infrastructure, services, households.
- Run payments: NEFT/RTGS/UPI/card payments; critical for economic activity.
- Support monetary transmission: RBI policy rates influence bank lending/deposit rates.
- Financial inclusion: accounts, remittances, micro-credit, direct benefit transfers (DBT).
B) Credit Creation (Simple Explanation)
Banks keep only a part of deposits as reserves (CRR with RBI and liquid assets under SLR). The remaining part can be lent. When banks lend, money circulates in the economy and new deposits can be created again through the banking system. This is why banking is strongly regulated: small weaknesses can amplify across the system.
4) NPAs (Non-Performing Assets) and Asset Quality
A) What is an NPA?
An NPA is a loan that is not being repaid as per schedule. In exams, remember: NPAs reduce profitability, require provisioning (reducing capital), and restrict future lending capacity.
B) Asset Classification (Exam-Oriented)
| Category | Meaning (Simple) | Why it matters |
|---|---|---|
| Standard Asset | Regular repayment | Healthy loan book |
| Sub-standard Asset | Loan turned NPA recently (early stress stage) | Higher monitoring and provisioning |
| Doubtful Asset | NPA for longer duration; recovery uncertain | Even higher provisioning; impacts capital |
| Loss Asset | Considered uncollectible or of little value | Needs full/near-full provisioning/write-off |
📊 Asset Classification Flow
Regular repayment
Early NPA stage
Recovery uncertain
Uncollectible
⚠️ Higher classification = Higher provisioning = Lower capital available for lending
C) Why NPAs Happen (Causes)
- Macro/Business cycle: downturns, demand shocks, commodity price volatility.
- Project-related issues: delays in land acquisition, clearances, cost overruns, weak contracts.
- Weak credit appraisal: poor due diligence, over-optimistic projections, inadequate collateral assessment.
- Governance and fraud: diversion of funds, connected lending, weak internal controls.
- Sectoral stress: infrastructure, real estate cycles, MSME working-capital stress.
- External shocks: global crises, supply disruptions, geopolitical instability.
D) Why NPAs Matter (Impact)
- Lower profits: more provisioning and lower interest income.
- Lower capital: capital gets consumed by losses; banks may need recapitalisation.
- Lower credit growth: banks become risk-averse; economy may face a credit slowdown.
- Higher cost of credit: risk premiums rise; good borrowers also pay more.
E) Recent Asset Quality Trend (Useful for Answers)
RBI's "Trend and Progress of Banking in India 2024-25" highlighted that the GNPA ratio of scheduled commercial banks declined to 2.2% at end-March 2025 and further to 2.1% by end-September 2025, reflecting sustained stress resolution and improved underwriting.
5) How India Resolves NPAs (Tools + Institutions)
A) The "Recognition–Resolution–Recapitalisation–Reforms" Approach
- Recognition: detect stress early, classify correctly, stop "evergreening".
- Resolution: recover dues or restructure realistically; exit unviable projects.
- Recapitalisation: ensure banks maintain adequate capital buffers.
- Reforms: improve governance, accountability, and risk management.
🔄 The 4Rs Approach to NPA Resolution
B) Key NPA Resolution Mechanisms (UPSC List)
- IBC (Insolvency and Bankruptcy Code): time-bound insolvency resolution for corporates (strong deterrence effect; improves creditor rights).
- SARFAESI: secured creditors can enforce security interest without lengthy court processes (subject to legal safeguards).
- DRTs (Debt Recovery Tribunals): specialised forums for recovery.
- ARCs (Asset Reconstruction Companies): buy stressed loans and attempt recovery.
- One-time settlement / restructuring frameworks: for viable borrowers with temporary stress.
- Bad Bank model (NARCL–IDRCL): for aggregation and resolution of large legacy stressed assets.
🛠️ NPA Resolution Toolkit
C) "Bad Bank" (NARCL) and Government Guarantee
The government approved a guarantee of up to ₹30,600 crore for security receipts issued by NARCL, with validity linked to issuance/settlement conditions. This is aimed at faster transfer and resolution of legacy NPAs.
D) Insolvency Reform Updates
Government updates have indicated continued focus on improving insolvency outcomes; for example, the Insolvency and Bankruptcy Code (Amendment) Bill, 2025 was introduced in Lok Sabha on 12 August 2025 to address delays and improve efficiency and transparency.
6) Banking Reforms in India: A Chronological Overview
A) Big Milestones (High-Value UPSC Content)
| Period | Reform Theme | What Changed |
|---|---|---|
| 1969 & 1980 | Bank nationalisation | Expanded branch network and priority sector focus |
| 1991 onwards | Liberalisation | Competition, prudential norms, improved regulation, entry of new private banks |
| 2000s | Recovery and risk frameworks | SARFAESI, better supervision, stronger provisioning norms |
| 2014 onwards | Inclusion + digital push | Mass account access, DBT, rapid digital payments adoption |
| 2016 onwards | NPA clean-up & insolvency | IBC-based resolution, better recognition, governance reforms |
| 2019-2020 | PSB consolidation | Mergers aimed at scale, efficiency, and better risk capacity |
| 2021 onwards | Institutional NPA resolution | NARCL–IDRCL for large stressed assets; continued reforms in recovery |
| 2022 onwards | Digital lending regulation | Stronger consumer protection, transparency, and regulated entity accountability |
📅 Banking Reforms Timeline
B) Governance and Risk Management Reforms (Mains Points)
- Better credit underwriting: improved appraisal, data-driven scoring, portfolio monitoring.
- Stronger supervision: tighter rules on outsourcing, KYC/AML compliance, and audits.
- Focus on fraud and cyber risk: improving operational resilience and incident reporting.
- Capital buffers: maintaining CRAR and improving profitability to absorb shocks.
RBI's banking performance assessments have also highlighted strong capital buffers; for example, CRAR around 17%+ has been cited in summaries of recent banking performance reports.
7) Digital & New-Age Banking Reforms (Fintech + DPI)
A) Digital Lending Guidelines and Default Loss Guarantee (DLG)
RBI issued the digital lending guidelines (September 2022) and published detailed FAQs, focusing on transparency, grievance redressal, and regulated-entity responsibility for lending done through digital partners.
RBI also issued a framework and FAQs on Default Loss Guarantee (DLG) arrangements in digital lending to bring clarity, reduce regulatory arbitrage, and improve consumer protection and accountability.
B) Account Aggregator (AA) Framework
The Account Aggregator framework enables consent-based sharing of a user's financial data (from multiple financial information providers) to improve credit underwriting and reduce paperwork, while keeping the user in control through consent architecture. Government updates have also published adoption progress snapshots (e.g., as of 30 September 2025).
C) Unified Lending Interface (ULI)
ULI is a technology-based initiative to make credit delivery more frictionless by enabling standardised, consent-based flow of financial and non-financial data to lenders (useful especially for rural and MSME borrowers).
D) Digital Rupee (e₹) – Where it fits in banking
RBI's official FAQs (updated in November 2025) state that the digital rupee is being pilot tested in both retail and wholesale segments. For UPSC, focus on: purpose (safe digital legal tender), design choices (privacy vs compliance), and potential impacts on payments and banking intermediation.
🚀 Digital Banking Infrastructure
Theme: Speed + Inclusion + Consumer Protection + Innovation
8) Recent Developments (High-Scoring for 2024-2026 Answers)
- Asset quality at multi-decadal lows: RBI's banking performance report for 2024-25 highlighted GNPA ratio at 2.2% (end-March 2025) and 2.1% (end-September 2025) for scheduled commercial banks.
- Priority Sector Lending (PSL) update: RBI revised PSL norms to include lending to the National Cooperative Development Corporation (NCDC) as eligible for PSL, and tightened compliance to prevent double counting through stronger reporting/auditor certification requirements.
- Bad bank guarantee reaffirmed in recent updates: Government communication reiterated the guarantee framework for NARCL security receipts (up to ₹30,600 crore) to support faster legacy NPA clean-up.
- Insolvency reform push: Updates note a continuing reform agenda to reduce delays and improve outcomes (including the IBC Amendment Bill, 2025 introduced in August 2025).
- System liquidity actions (Jan 2026): RBI plans to inject significant liquidity through bond purchases, FX swaps, and repo operations, with specific operations announced for late January and early February 2026.
📈 Key Banking Metrics (2025)
9) Key Challenges in the Indian Banking System
A) Structural and Operational Challenges
- Credit quality cycles: NPAs can rise again when growth slows or specific sectors face stress.
- Governance issues: especially in entities with weak internal controls or poor accountability.
- Risk concentration: exposure to particular sectors (real estate, infrastructure, unsecured retail) can create vulnerability.
- Cyber and fraud risk: digital growth increases fraud vectors and operational risk.
- Cooperative sector weaknesses: governance and compliance gaps can affect depositor trust.
B) Emerging/Contemporary Risks (Good for Mains)
- Climate risk: physical and transition risks can impact loan portfolios (agri, infrastructure).
- Fintech partnerships: speed improves inclusion, but outsourcing and consumer protection must be strong.
- Global spillovers: geopolitical shocks and global financial tightening can affect credit and capital flows.
10) Way Forward (Answer-Ready Points)
- Strengthen early warning systems: better monitoring of stress (SMA signals, cash-flow tracking, sector dashboards).
- Speed up resolution: improve capacity of insolvency ecosystem, reduce litigation delays, increase recovery efficiency.
- Improve governance: professional boards, risk culture, accountability, and fraud controls.
- Balance inclusion with prudence: expand credit access (MSMEs, agriculture) while maintaining underwriting discipline.
- Digital trust: stronger cyber security, grievance redressal, transparency in digital lending and fintech partnerships.
- Capital and buffers: maintain capital adequacy and provisioning to absorb future shocks.
Prelims-Focused Quick Revision Points
- RBI regulates and supervises banks; uses monetary tools to influence liquidity and credit.
- Know types: PSB, private, foreign, RRB, SFB, payment bank, cooperative bank.
- NPA basics: GNPA vs NNPA, asset classification, why provisioning matters.
- Resolution toolkit: IBC, SARFAESI, DRT, ARC, NARCL.
- New-age reforms: Account Aggregator, ULI, digital lending guidelines, digital rupee pilots.
Mains Practice Questions (UPSC-style)
- "Improving bank asset quality is necessary but not sufficient for sustained credit growth." Discuss with reference to NPAs, capital adequacy, and governance reforms.
- Explain the role of IBC and NARCL in resolving stressed assets. What are the limitations of these mechanisms?
- How do digital public infrastructures (Account Aggregator, ULI) improve credit delivery? What new risks do they create?
- Discuss the challenges in cooperative banking and suggest reforms to improve governance and depositor protection.
- Evaluate the impact of priority sector lending on financial inclusion and bank profitability. How can PSL be made more effective?
Practice MCQs
-
Q1. Which of the following best describes the Account Aggregator framework?
- (a) A government scheme for subsidised agricultural loans
- (b) A consent-based system to share financial data securely among regulated entities
- (c) A mechanism to merge weak banks into strong banks
- (d) A platform that replaces KYC requirements
Answer: (b)
-
Q2. Which of the following are common tools used for NPA resolution in India?
- (a) IBC and SARFAESI
- (b) DRTs and ARCs
- (c) NARCL for certain large legacy stressed assets
- (d) All of the above
Answer: (d)
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Q3. A key difference between a Payment Bank and a Small Finance Bank is:
- (a) Payment Banks can freely lend like universal banks
- (b) Small Finance Banks typically focus on inclusion-oriented lending, while Payment Banks focus on payments and deposits with lending restrictions
- (c) Small Finance Banks are not regulated by RBI
- (d) Payment Banks can issue currency
Answer: (b)
-
Q4. GNPA ratio refers to:
- (a) Net NPAs as a percentage of total assets
- (b) Gross NPAs as a percentage of gross advances
- (c) Gross NPAs as a percentage of bank deposits
- (d) Net NPAs as a percentage of net worth
Answer: (b)
-
Q5. RBI's digital lending framework primarily emphasises:
- (a) Unlimited outsourcing of lending decisions to fintechs
- (b) Regulated entity accountability, transparency, and customer protection in digital lending
- (c) Removal of grievance redressal mechanisms
- (d) Only cash-based lending models
Answer: (b)