The banking system, NPAs, IBC & financial-sector reform

The structure of Indian banking

India's banking system is a three-tier scheduled structure governed by the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949. A 'scheduled bank' is one listed in the Second Schedule of the RBI Act; it must maintain reserves with the RBI and gains access to the refinance window. The system comprises public sector banks (PSBs), private banks, foreign banks, regional rural banks (RRBs, set up under the RRB Act, 1976), cooperative banks, and small finance and payments banks (licensed from 2015 under the Nachiket Mor Committee, 2013, framework).

Nationalisation is the spine of the public-sector story. The government nationalised 14 major banks on 19 July 1969 and 6 more on 15 April 1980, bringing roughly 91% of banking assets under state control. This was reversed in trend by liberalisation: the Narasimham Committee I (1991) and II (1998) recommended reducing the number of PSBs, lowering the statutory pre-emption of bank funds, and adopting prudential norms. The biggest consolidation came on 1 April 2017 (SBI absorbed its associate banks and the Bharatiya Mahila Bank) and the mega-merger of 1 April 2020, which reduced PSBs from 27 (in 2017) to 12.

Monetary anchors banks must observe

Every scheduled bank operates within two reserve ratios the RBI sets under statute. The Cash Reserve Ratio (CRR), under Section 42 of the RBI Act, is the share of net demand and time liabilities (NDTL) parked as cash with the RBI; the Statutory Liquidity Ratio (SLR), under Section 24 of the Banking Regulation Act, is the share held in liquid assets such as government securities. Priority Sector Lending (PSL) norms require banks to direct 40% of adjusted net bank credit to agriculture, MSMEs, weaker sections and allied priorities.

Capital and ownership rules

PSBs are governed additionally by the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980. Capital adequacy follows the Basel III framework, phased in by the RBI from 2013, prescribing a minimum total capital of 9% plus a capital conservation buffer of 2.5%, exceeding the Basel minimum of 8%. The government recapitalised PSBs aggressively after 2015, including a Rs 2.11 lakh-crore package announced in October 2017 (partly via recapitalisation bonds).

Understanding this scaffolding is essential because every reform debate — bad loans, the IBC, privatisation — is a debate about who bears risk in a state-dominated banking system. PSBs still hold the bulk of stressed assets, which is why the architecture and the crisis are inseparable topics.

What an NPA is, and how the crisis built

A loan is a Non-Performing Asset (NPA) when principal or interest remains overdue for 90 days or more, per RBI's Income Recognition and Asset Classification (IRAC) norms. NPAs are classified as sub-standard (NPA up to 12 months), doubtful (beyond 12 months), and loss assets. The 'twin balance sheet problem' — over-leveraged corporates and bad-loan-laden banks — defined the mid-2010s. The trigger was the RBI's Asset Quality Review (AQR) of 2015, ordered under Governor Raghuram Rajan, which forced banks to reclassify evergreened loans honestly. Gross NPAs of scheduled commercial banks peaked at 11.2% in March 2018 before falling to a multi-decade low of 2.8% by March 2024.

The resolution toolkit before and after 2016

Earlier mechanisms — Lok Adalats, Debt Recovery Tribunals (under the RDDBFI Act, 1993), the SARFAESI Act, 2002 (which lets secured creditors seize collateral without court intervention), Corporate Debt Restructuring, and schemes like SDR and S4A — delivered poor recovery. The decisive reform was the Insolvency and Bankruptcy Code, 2016 (IBC).

How the IBC works

The IBC created a unified, creditor-in-control regime, replacing the old debtor-in-possession model. Key features:

• The Corporate Insolvency Resolution Process (CIRP) is time-bound: an outer limit of 330 days (270 + litigation, after the 2019 amendment).
• The National Company Law Tribunal (NCLT) adjudicates corporate insolvency; the NCLAT hears appeals; the Debt Recovery Tribunal handles individuals.
• A licensed Insolvency Professional runs the company; the Committee of Creditors (CoC), dominated by financial creditors, approves resolution plans by a 66% vote.
• The Insolvency and Bankruptcy Board of India (IBBI) is the regulator.
• Section 29A bars defaulting promoters from bidding back for their own companies.

The RBI's 'Dirty Dozen' list of June 2017 referred 12 large defaulters (including Essar Steel, Bhushan Steel, and Lanco) to the NCLT. Essar Steel (resolved 2019, ArcelorMittal paying Rs 42,000 crore) set the benchmark precedent, reinforced by the Supreme Court in Committee of Creditors of Essar Steel v. Satish Kumar Gupta (2019), which affirmed the CoC's 'commercial wisdom'. The COVID period saw IBC suspended for fresh defaults (June 2020–March 2021) and a pre-packaged insolvency route introduced for MSMEs in 2021.

Retain the headline numbers: IBC recovery rates have averaged around 30-32%, higher than predecessor mechanisms, but with realisations falling and timelines slipping well beyond 330 days in practice — the live reform debate examiners probe.

Why this matters for the exam

This topic spans Prelims GS and Mains GS-3 ('mobilisation of resources, banking, inclusive growth'). In Prelims, the RBI tests precise definitions and institutions: the 90-day NPA rule, SARFAESI versus IBC, the CoC voting threshold, Section 29A, which body adjudicates (NCLT vs DRT), and the difference between CRR and SLR and their governing statutes. A classic confusion the UPSC exploits is Bad Bank (NARCL) versus IBC — NARCL, the National Asset Reconstruction Company Ltd incorporated in 2021, is an ARC that aggregates and warehouses bad loans against security receipts (backed by a government guarantee on those receipts); it does not resolve insolvency the way the IBC does.

In Mains, the recurring question is analytical: has the IBC succeeded? The PYQ angle is sharp — 2021 GS-3 asked candidates to examine NPA-related policy; 2018 GS-3 probed banking-sector recapitalisation and merger logic. A high-scoring answer marshals data (gross NPA falling from 11.2% in 2018 to 2.8% in 2024), names the AQR (2015) as the turning point, credits the IBC's behavioural shift (the 'fear of losing the company' deterring default), and then offers a balanced critique: haircuts, delays beyond 330 days, NCLT under-capacity, and weak recovery for operational creditors.

The wider reform arc to memorise

Reform proceeds along several axes. Prudential reform: AQR, Basel III, the Prompt Corrective Action (PCA) framework that restricts weak banks. Resolution reform: SARFAESI (2002) → IBC (2016) → NARCL (2021). Ownership reform: the P. J. Nayak Committee (2014) recommended cutting government stakes in PSBs below 50% and creating a Bank Investment Company; the government has signalled PSB privatisation (Union Budget 2021-22 proposed privatising two PSBs and one general insurer). Governance reform: the Banks Board Bureau (2016), later reconstituted as the Financial Services Institutions Bureau (2022).

The unresolved tensions — recapitalisation as moral hazard, the politics of privatisation, the autonomy of the RBI as banking regulator versus owner-government's interests — are the discriminating points that separate a mediocre answer from a top decile one. Anchor every claim in a named committee, statute, or dated event, and the marks follow.