Macroeconomic sensitivity of the banking and financial sector of India

By Riya Sharma on March 11, 2024

The Indian financial services system has been dynamic for decades, contributing significantly towards the economic growth of India. The financial sector includes banking institutions and non-banking institutions like the insurance sector, mutual funds, micro-finance institutions, and non-banking financial companies (NBFCs). The performance of these institutions is affected by a wide range of factors such as market competition, internal strategic changes, and macroeconomic conditions. Of these, macroeconomic factors take precedence because not only do they reflect monetary policy implications, but they also enable banks to conduct credit and risk assessments of borrowers.

It is therefore important to understand the types and extent of the impact of macroeconomic changes on the banking and financial services industry. This article aims to evaluate how the Indian banking and financial services industry has reacted to recent macroeconomic shocks.

Some of these shocks include the global financial crisis of 2007-08, the environmental crisis (Tohoku earthquake and tsunami) of 2011, the COVID-19 pandemic of 2019, and the ongoing Russia-Ukraine war that started in 2023. It is important to emphasize the impact of these economic downturn points on the banking and financial sector, especially in controlling credit and the supply of money in such situations (Manikyam, 2014).

Regulatory framework of banking and finance sector of India

An understanding of the regulatory framework is necessary as it helps to understand the role of the regulatory bodies in the sector’s reaction to macroeconomic events. The regulatory bodies are independent government bodies assigned to ensure the smooth functioning of the banking and financial system of the country. They also work to protect the rights of investors and customers and provide efficient sound management in the financial markets (Gulati et al, 2022). There are six regulatory bodies under the framework of the financial system of India:

  • Reserve Bank of India (RBI): The supreme regulatory body is the Reserve Bank of India which regulates the banking sector under the Banking Regulation Act, of 1949. RBI administers cooperative banks, development finance institutions, and NBFC in cooperation with NABARD. It maintains price stability and controls the money supply flow through monetary policy.
  • Securities and Exchange Board of India (SEBI): regulated by the SEBI Act 1992, it is responsible for the effective functioning of the capital market. It conducts audits and punishes misconduct in the form of fines and penalties.
  • Insurance Regulatory and Development Authority of India (IRDAI): Insurance companies registered under the IRDA Act, 1999, are controlled by the IRDAI to secure the policyholders.
  • PFRDDA & AMFI: The pension industry and mutual funds industry are regulated by the Pension Fund Regulatory and Development Authority (PFRDA) and the Association of Mutual Funds in India (AMFI), respectively.
  • Ministry of Corporate Affairs (MCA): This body governs the corporate sector and ensures to maintain fair competition amongst the companies (Manikyam, 2014).

Finance sector performance and trends

Financial institutions, as explained before, are of two types; banking and non-banking. The figure below shows different types of institutions that fall under each category.

The largest market share in India in 2023 was claimed by HDFC Bank, followed by ICICI Bank and SBI Bank. Overall, the banking sector has shown improving performance in recent years with increased profitability, rising Return on Assets (ROA), Capital Risk Weighted Asset Ratio (CRAR) and Return on Equity (ROE), and lower non-performing assets (NPAs). The non-banking financial companies also show an upward trend in key profitability parameters as of March 2023 (Monthly Economic Review, 2023). A better understanding of the key financial ratios of these banks gives an insight into their recent performance:

  • The availability of capital to the risk-weighted assets of a bank is measured by the Capital to Risk-Weighted Asset Ratio (CRAR). A healthy bank is considered to have a higher CRAR. As per RBI, the CRAR of scheduled commercial banks was 16.8% in September 2023, which is considered healthy (RESERVE BANK OF INDIA, 2023).
  • The leverage ratio which measures the banks’ capacity to meet the long- term financial obligations along with interest, and the coverage ratio have been moderate for a few years.
  • Liquidity ratios indicate the ability of a bank to cover short-term liabilities and the demand of customers to withdraw cash (Bansal, 2014). The current ratio of State Bank of India, one of the biggest banks in India, increased to 1.93 in 2021 while the other banks like PNB, HDFC, ICICI, and Yes Bank hovered around 1 (James, Sharma, & Paul, 2022). To maintain this ratio, banks need to keep appropriate cash reserves. The financial sector needs to maintain these ratios to increase profitability.

Users of banking services are also expanding in India. There is a rise in bank accounts from 53% in 2016 to 78% of the population in 2021 (Chaudhry, 2023). The total deposits and the number of ATMs’ have also increased. The government also made efforts to assist the underprivileged through the Pradhan Mantri Jan Dhan Yojana which helped in the upliftment of the banking sector (Modi & Baral).

Reaction of the finance sector to the global recession of 2008

The banking and financial services industry is sensitive to the macroeconomic conditions. For instance, during the global financial crisis of 2008, Non-performing assets (NPA) started rising. There was a liquidity crisis in the currency exchange market as the Indian rupee depreciated greatly, resulting in large deficits. However, due to the economic liberalization that took place in the early 1990s’ in India, there was availability and access to credit even during the recession. The stock market revived, and the interest rates stabilized within a year. Hence, the government did not lose control over financial services and balanced the banking sector in a few quarters.

The environmental crisis of 2011

In 2011, the world’s largest net credit provider, Japan was hit by the Tohoku Earthquake and Tsunami (Japan: Spillover Report for the 2011 Article IV Consultation and Selected Issues, 2011). That, combined with record-high greenhouse gas emissions and temperatures, set off an environmental crisis. During this crisis, banks needed higher reserves to support recovery.

However, whenever there is a crisis associated with natural disasters people begin to withdraw cash from their bank accounts and the role of banks remains limited (Nguyen, Diaz-Rainey, & Roberts, 2023). This can also lead to credit risk in banks. However, the bank rates, repo rates and reverse repo rates do not fluctuate much in the period of disaster, but the deposit ratio may fall (Nguyen, Diaz-Rainey, & Roberts, 2023). Moreover, it has been established in the literature that Japan’s economic performance has a huge impact on the rest of Asia. With a 1% rise in financial stress in Japan, there is around 0.2% stress in financial markets in Asia (Japan: Spillover Report for the 2011 Article IV Consultation and Selected Issues, 2011).

Covid-19 pandemic of 2019

In 2019, during the COVID-19 pandemic, many Indian financial services were left shattered. NPAs and demand for liquidity rose rapidly, resulting in lower profits, return on assets (ROA) and return on equity (ROE) ratio (Qadri, et al., 2023). The use of online banking increased due to convenience and accessibility, leading to cyber security issues. Due to the rise in banks’ NPAs, the credit ratings of banks were negatively impacted. The stock market showed a sharp decline (Lemos, 2020).

RBI cash reserve ratio (2005-2023) (India Cash Reserve Ratio, 2024)
RBI repo rate (2000-2024)(Pattabiraman, 2021)

Despite that, the government announced several measures to restore the economy. RBI reduced the repo rate to 4.4% and reversed the repo rate to 4%. The cash reserve ratio (CRR) was also decreased by 1% (India Cash Reserve Ratio, 2024). Credit was increased by supplying money at lower rates. The central bank attempted to stabilize the economy by providing export credit and increasing liquidity in the economy (Panchal, 2021).

Russia-Ukraine War of 2024

The current Russo-Ukrainian war has impacted the stock prices of the banking and financial services industry. 64.4% of the Nifty50 index consists of financial services companies (Tiwari, Kumar, & Tiwari, 2022). In the aftermath of the Russia-Ukraine war, the Nifty50 started declining and stock prices for the banking sector also showed a negative trend. The credit risk of banks has also increased.

Room for innovations

Overall, increasing borrowings and loans and diminishing profitability in a period of shock leave a vacuum in the banking systems. However, on the upside, innovations fill the vacuum.


COVID-19 increased the popularity of digital transactions through the use of e-wallets, UPI (Unified Payment Interface), and cardless ATM transactions.

Another innovation in the banking sector is related to predictive banking using AI chatbots to interact with customers in real-time and Aadhar-enabled payments systems.

The figure shows an upward trend in the adoption of chatbots by India Banks. These advancements in the financial sector provide convenience, the discipline of budget, and lower transaction risk amongst the users.

In light of the crisis, it is evident that the Indian financial system possesses the resilience necessary to rebound. This resilience is further bolstered by ongoing macroeconomic reforms that adapt to evolving circumstances. While there remains room for enhancement and expansion within the finance sector, it is notable that following each macroeconomic shock, the central bank (RBI) and other banking stakeholders effectively navigate the economy towards recovery through strategic employment of monetary and fiscal policies.

Nevertheless, it is imperative to conduct a thorough examination of the implications and risks associated with the expansion of the financial sector. Subsequent articles in this study will delve deeper into this analysis, shedding light on these crucial considerations.


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