India's financial sector reforms need a shake-up

The Hindu

28-05-2025

India's financial sector stands at an inflection point. For years, the government and regulators have attempted incremental reform in banking, financial services, and insurance (BFSI), yet systemic frictions persist. These frictions are not just inefficiencies. They are barriers that deter savers, discourage investors and delay growth. A truly professional, transparent and investor-friendly financial sector demands deeper structural corrections, particularly in corporate bond markets, retirement planning instruments, nomination processes across BFSI, and the growing menace of shadow banking.
On nomination and nominees
Let us begin with the nomination conundrum. Across BFSI verticals (banks, mutual funds, insurance), the rules governing nominees are startlingly inconsistent. A citizen can nominate a single person for one account but multiple for another, with different rights attached. This patchwork approach does not have logical or legal clarity. Rather, it confuses ordinary savers and benefits only those who seek to exploit legal ambiguities, often through protracted litigation.
What public interest is served by maintaining three separate nomination regimes? A harmonised nomination framework, with clarity on nominee rights versus legal heir claims, is overdue. If the disconnect exists for a good reason, the government must share the evidence and case studies that justify it.
Zooming out, the larger structural lacuna in India's financial landscape is the underdeveloped corporate bond market. Despite years of policy pronouncements, it remains shallow, illiquid and opaque. This matters because the cost of capital is the single biggest determinant of business viability. An efficient bond market can reduce funding costs by 2% to 3%, potentially unlocking massive gains for industry and employment. The Reserve Bank of India once mandated the National Stock Exchange (NSE) to develop a secondary bond market, but this directive was quietly ignored. Why? Equity trading offers more profit, especially through opaque algorithmic strategies that have previously attracted regulatory scrutiny and journalistic exposés. When a journalist called out malpractices, the NSE responded with a ₹ 100-crore defamation suit, only to be admonished by the High Court later. India's bond market reform cannot be divorced from broader regulatory concerns either, particularly around transparency in capital flows. As a member of the Financial Action Task Force (FATF), India is committed to implementing global Know Your Customer (KYC) norms, which include clear identification of Ultimate Beneficial Owners (UBOs). FATF's updated guidelines in 2022 underscore the need for countries to maintain accurate and accessible ownership data to prevent misuse of financial structures.
Yet, practical implementation remains a challenge. For instance, in recent months, the Securities and Exchange Board of India (SEBI) has had to press two Mauritius-based foreign portfolio investors (Elara India Opportunities Fund and Vespera Fund) to disclose granular shareholder data related to their holdings in listed Indian firms. These funds reportedly did not comply with multiple disclosure requests, complicating regulatory oversight and delaying enforcement actions.
Moreover, India's current UBO disclosure thresholds (10% for companies and 15% for partnerships) create loopholes that allow entities to structure investments just below these limits, thereby avoiding identification. This makes it difficult for regulators to ascertain the true economic interest behind trades in Indian exchanges or bond markets, particularly when routed through jurisdictions such as Mauritius.
While this is not unique to India, opacity in ownership structures does weaken market integrity and may inhibit sustained long-term investments, both domestic and foreign.
Retirement planning
Additionally, the long-term needs of India's young professionals, especially those in BFSI itself, remain unmet. Retirement planning in India is mostly routed through annuities — products that are costly due to the intermediation margin taken by insurance companies.
There is a simpler and cheaper alternative that exists: long-dated zero-coupon government securities. The math is compelling, removing the 2% intermediation fee over a 30-year period leads to massive gains for the saver. We already have the technology to 'strip' principal and coupon payments and offer these as zero-coupon bonds, but the government and the Reserve Bank of India (RBI) have shown little initiative. We are missing an opportunity to build a vibrant, low-cost retirement ecosystem anchored on sovereign credibility.
Shadow banking
Then comes the most ominous blind spot: shadow banking. Non-banking financial companies (NBFCs), margin lenders, repo traders, and brokers are offering bank-like services without being subject to full regulatory oversight. This is not a fringe issue. Global economists warn that the next financial crisis could originate here, just as the 2008 financial crisis did in the United States via unregulated derivatives.
In India, retail investors are being financed by brokers who offer loans masked as margin funding. The effective interest rates in such transactions can easily exceed 20%, often without the investor even realising it. 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. Does the Finance Ministry or RBI even know the scale of this lending?
The European Union has already passed legislation to gather comprehensive data on shadow banking activities. India must follow suit. Transparency must precede regulation, and data is the first step toward transparency.
India's financial sector reforms must go beyond slogans and cosmetic amendments. We need a coherent, forward-looking strategy that harmonises rules across verticals, nurtures a deep bond market, innovates in retirement finance, and reins in shadow banking.
Vaishu Rai is Legislative Assistants to Members of Parliament (LAMP) Fellow 2025 - PRS Legislative