The Erosion of Bank Dominance in India’s Financial System

For decades, Indian banks have been the default arteries of credit. In 2022-23, they supplied 60% of the economy’s funding needs. Two years on, that share has slipped to 51%, a fall sharper than in past cycles. Regulation played a part, tighter curbs on unsecured retail lending have cooled bank loan growth; but the real story is elsewhere: capital markets and non-bank lenders have seized the moment.

Equity’s Unexpected Ascendancy
Equity markets were the year’s surprise workhorse. A seven-percentage-point jump in their share of funding is remarkable in a country where debt has traditionally dominated. What is striking is not just the scale of issuance but its breadth: mid-sized and small firms now routinely tap IPOs, buoyed by retail investors whose enthusiasm has more than compensated for foreign institutions’ fickleness. This democratisation of capital formation could deepen India’s financial resilience, provided mom-and-pop investors do not bolt when markets turn.

The Rise of NBFCs
 Non-bank finance companies, too, expanded their turf, gaining three percentage points of share. They are plugging gaps left by banks, especially for microfinance and MSMEs. Yet their hunger for growth is evident in thinner spreads, riskier borrowers and creeping stress in loan books. The RBI has noticed, tightening prudential norms. But unlike banks, NBFCs remain more loosely tethered to monetary levers.

Policy Headaches
 The broader consequence is a weakening link between interest rates and economic activity. With firms raising funds through equity, bonds or private pools, the Reserve Bank’s rate tweaks carry less bite. Transmission, the holy grail of monetary policy, becomes fuzzier as the centre of gravity shifts away from regulated banks.

A Structural or Cyclical Shift?
 Past episodes of non-bank surges in India proved fleeting; markets stumbled, banks regained ground. The difference this time is the equity market’s starring role, powered by a retail base that seems undeterred by volatility. If they prove more steadfast than foreign capital and alternative credit vehicles keep scaling up, India may be inching toward a funding model less bank-centric than ever before.

For policymakers, that raises an uncomfortable possibility: in the next downturn, banks may no longer be the reliable anchor they once were.