Banking II: Institutions, Regulators, Inclusion, Digital Finance and Insurance
The second half of Unit 7 moves from banks to everything around them: the institutions that finance what banks do not, the regulators who divide the system between them, the reforms that carried banking to people it had never reached, the digital rails that now carry most payments, and insurance as the system's machinery for pooling risk. The paper asks this half almost entirely as matching — institution to purpose, regulator to sector, scheme to objective, insurance term to meaning — and the chapter is built as the tables those questions are drawn from.
2. The financial regulators
| Regulator | Established | Territory |
|---|---|---|
| Reserve Bank of India | 1935, under the RBI Act, 1934 | Banks, NBFCs, the money market, foreign exchange, payment systems, government debt |
| SEBI | 1988; statutory in 1992 | Securities markets, stock exchanges, mutual funds, listed companies, intermediaries |
| IRDAI | 1999, on the Malhotra Committee's recommendation | Life and general insurers, intermediaries, policyholder protection |
| PFRDA | 2003; statutory in 2013 | The National Pension System and other pension funds |
| IBBI | 2016 | Insolvency professionals and processes under the Insolvency and Bankruptcy Code |
| IFSCA | 2020 | The international financial services centre at GIFT City, as a unified regulator |
ℹ️ The coordinating body above them
The Financial Stability and Development Council, chaired by the Finance Minister and set up in 2010, brings the regulators together to watch systemic risk and settle turf between them. It is a coordination forum rather than a super-regulator: it has no licensing power of its own, and a question that gives it one has promoted it beyond its statute.3. Financial sector reforms and financial inclusion
Financial inclusion is the delivery of banking, credit, insurance and pension at affordable cost to those the formal system excluded — the rural poor, the informal worker, the small farmer. The Rangarajan Committee of 2008 defined it and set the direction, and the instruments that followed are asked as a set.
- Priority sector lending — a stated share of adjusted net bank credit, 40% for domestic banks, must go to agriculture, micro and small enterprises, education, housing, export credit and weaker sections, with sub-targets inside it.
- No-frills and Jan Dhan accounts — a basic savings account with no minimum balance, a RuPay debit card and an overdraft, opened under the Pradhan Mantri Jan Dhan Yojana from 2014, which carried account ownership to most adult Indians.
- Business correspondents — agents who carry banking to villages with no branch, transacting on the bank's behalf with a handheld device, after the 2006 guidelines.
- Self-help groups and microfinance — small groups, mostly of women, that save together and borrow from a bank against the group's record; the SHG-bank linkage programme run by NABARD is the largest such programme in the world.
- Direct benefit transfer — government payments credited straight to the beneficiary's account through the Aadhaar payment bridge, which removed the intermediary who used to take a share.
- Differentiated banks — payments banks, which take deposits up to a cap and cannot lend, and small finance banks, which lend to the underserved with three-quarters of credit to the priority sector, both licensed from 2015.
⚠️ A payments bank cannot lend
It accepts demand deposits up to a prescribed limit per customer, issues debit cards, and offers remittance and payment services — but it may not extend credit, and it invests its deposits in government securities and bank deposits instead. A small finance bank does lend, and that is the whole difference between the two licences. A question describing a bank that takes small deposits and gives small loans is describing a small finance bank, whatever else it says.4. Digitisation: internet and mobile banking, and the payment systems
Internet banking moved the branch onto the customer's computer; mobile banking moved it into the pocket; and the payment systems built beneath both are what turned India into the world's largest market for digital transactions by volume. The systems are asked by what they carry and how fast.
| System | Operated by | What it is for | Settlement |
|---|---|---|---|
| RTGS | RBI | Large-value transfers, minimum ₹2 lakh | Real time, gross, one by one; available round the clock since December 2020 |
| NEFT | RBI | Transfers of any value | Deferred net settlement in half-hourly batches, round the clock since December 2019 |
| IMPS | NPCI | Instant interbank transfer, 24×7, launched 2010 | Immediate |
| UPI | NPCI | Instant transfer between any two bank accounts using a virtual payment address, launched 2016 | Immediate; the rail beneath most retail apps |
| AePS | NPCI | Withdrawal, deposit and balance enquiry authenticated by Aadhaar biometrics, at a business correspondent | Immediate |
| BBPS | NPCI | A single interoperable platform for paying bills of every kind | Per transaction |
ℹ️ NPCI, and what is not a payment system
The National Payments Corporation of India is a not-for-profit company promoted by the RBI and the Indian Banks' Association in 2008, and it runs UPI, IMPS, RuPay, AePS, BBPS and the National Financial Switch that links ATMs. Two things are asked alongside it and belong to different categories: a prepaid payment instrument, or wallet, is a stored-value product that rides on these rails rather than a rail itself, and the central bank digital currency, the e-rupee piloted from 2022, is a liability of the RBI and therefore money rather than a payment system.5. Insurance: types, risk, insurability, reinsurance and the regulator
Insurance pools the risks of many so that the loss of a few can be met from the premiums of all. The syllabus divides it into life insurance, which pays on death or survival to a date — term, endowment, whole life, money-back, unit-linked — and non-life or general insurance, which indemnifies a loss — fire, marine, motor, health, liability. Life insurance is a contract of assurance, because the event insured against is certain and only its timing is uncertain; general insurance is a contract of indemnity, because it pays the loss actually suffered and no more.
- Risk classification — pure risk, where the outcome is loss or no loss, is insurable; speculative risk, where gain is also possible, is not. Fundamental risk affects whole populations and particular risk affects individuals, and insurers handle the second far more readily than the first.
- Risk management runs through identification, measurement, and then treatment — avoid the risk, reduce it, retain it, or transfer it. Insurance is the transfer option, and it is chosen for risks of low frequency and high severity, which is why nobody insures a pencil and everybody insures a house.
- What limits insurability — the loss must be accidental and outside the insured's control, definite and measurable in money, large enough to matter but not catastrophic to the whole pool at once, and shared by a large number of similar exposures so that the law of large numbers works. Moral hazard, where cover changes behaviour, and adverse selection, where only the high-risk buy, are the two failures an insurer prices against.
- Reinsurance — an insurer insuring part of the risk it has written with another insurer, to spread exposure and protect its capital; the ceding company keeps the customer, the reinsurer takes a share of premium and claim. GIC Re is India's national reinsurer, and every insurer must cede a prescribed share to it.
⚠️ Reinsurance is not double insurance
Double insurance is the insured taking two policies on the same risk, and under indemnity the insured still recovers only the actual loss, shared between the insurers by contribution. Reinsurance is the insurer's own contract with a reinsurer, to which the original insured is not a party and of which they may not even know. One protects the customer against a loss; the other protects the insurer against having too many customers with the same loss.The Insurance Regulatory and Development Authority of India was set up under the IRDA Act, 1999 on the recommendation of the Malhotra Committee, which had also recommended opening the sector to private and foreign participation after the nationalised monopolies of LIC since 1956 and the four general insurers since 1972. IRDAI licenses insurers and intermediaries, approves products, prescribes solvency margins, protects policyholders through a grievance mechanism and the ombudsman, and sets rural and social sector obligations that every insurer must meet. The foreign investment cap in insurance, raised in stages, stood at 74% from 2021.
Key takeaways
- An NBFC cannot take demand deposits, is outside the payments system and carries no deposit insurance; ICICI and IDBI converted from development institutions into banks, and NaBFID was set up in 2021 to fill the gap.
- RBI for banks and money, SEBI for securities and mutual funds, IRDAI for insurance, PFRDA for pensions, IBBI for insolvency; the FSDC coordinates them and is not a super-regulator.
- Priority sector lending is 40% of adjusted net bank credit for domestic banks; a payments bank cannot lend and a small finance bank can — that is the whole difference between the two licences.
- RTGS and NEFT are the RBI's, RTGS settling gross in real time above ₹2 lakh and NEFT in half-hourly net batches; UPI, IMPS, AePS and BBPS are NPCI's; a wallet rides the rails and the e-rupee is money, not a system.
- Life insurance is assurance and general insurance is indemnity; only pure risk is insurable; reinsurance is the insurer's own contract and not double insurance; IRDAI came from the Malhotra Committee in 1999.
Practice questions (9)
Attempt each one before opening the answer. Every explanation names the tempting wrong option as well as the right one, because that is where marks are lost.
A payments bank licensed by the RBI differs from a small finance bank in that a payments bank:
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Answer: A — Cannot extend credit
Both are differentiated bank licences introduced in 2015 to deepen financial inclusion, and both accept deposits — a payments bank up to a prescribed limit per customer. The difference is on the asset side: a payments bank may not lend at all and must place its deposits in government securities and bank deposits, while a small finance bank exists precisely to lend to small borrowers, with three-quarters of its credit going to the priority sector. Both are regulated by the RBI, and neither is confined to rural areas, though small finance banks must keep a quarter of their branches in unbanked rural centres.Mutual funds in India are regulated by:
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Answer: A — SEBI
A mutual fund pools investors' money into a portfolio of securities and issues units against it, so it is a securities market participant and falls to the Securities and Exchange Board of India, which lays down its three-tier structure of sponsor, trust and asset management company and regulates its schemes, disclosures and expenses. The RBI regulates banks, NBFCs and the money market, and while a bank may sponsor a mutual fund the fund itself is SEBI's. IRDAI regulates insurers, including unit-linked insurance plans that resemble mutual funds but are insurance products, and PFRDA regulates pension funds under the National Pension System.Which of the following transfers is settled on a real-time gross basis?
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Answer: A — RTGS
Real Time Gross Settlement, operated by the RBI, settles each transfer individually and finally the moment it is processed, without netting against other transfers, which is why it is reserved for large values with a minimum of ₹2 lakh. NEFT is the deferred alternative: transfers accumulate and are settled net in half-hourly batches, so a payment may take up to that long to reach the beneficiary. Cheque truncation and the electronic clearing service are batch systems too, settling on a net basis at fixed clearing times. Gross means one by one; net means offsetting many at once — that distinction is the whole question.A contract of life insurance is a contract of assurance rather than of indemnity because:
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Answer: A — The event insured against is certain to occur and only its timing is uncertain
General insurance indemnifies: it restores the insured to their position before a loss that may or may not happen, and pays the actual loss and no more. Life insurance cannot work that way, because a human life has no market value to restore and because death is certain — only when it happens is unknown. So the contract fixes a sum to be paid on death or on survival to a date, and that sum is assured rather than measured against a loss. Premiums are usually periodic, not single; all insurance is IRDAI's, not the RBI's; and the sum assured bears no relation to any loss because there is no loss to measure.Which of the following risks is NOT insurable in principle?
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Answer: A — A speculative risk, where the outcome may be a gain as well as a loss
Insurance covers pure risk, where the only possible outcomes are loss or no loss and the loss is accidental, definite, measurable and shared across many similar exposures. A speculative risk — a business venture, a stock market position, a bet — carries the possibility of profit as well as loss, and insuring it would remove the incentive that makes the venture worth taking and invite moral hazard on a scale no pool could bear. Fire, theft and motor accident are all pure risks and are among the commonest lines of general insurance; none of them is entered into in the hope of gain.Reinsurance is best described as:
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Answer: A — An insurer transferring part of the risk it has underwritten to another insurer
Reinsurance is the insurer's own insurance: having written more risk than it wishes to hold, it cedes a share of the premium and of any claim to a reinsurer, spreading its exposure and protecting its capital, while the original policyholder deals only with the ceding company and may not know a reinsurer exists. The second option describes double insurance, which is the insured's act and is governed by contribution between the insurers. Revival of a lapsed policy and marine or transit cover are ordinary insurance operations with no second insurer involved. GIC Re is India's national reinsurer.The Insurance Regulatory and Development Authority was established on the recommendation of the:
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Answer: A — Malhotra Committee
The Malhotra Committee, reporting in 1994, reviewed an insurance sector that had been a state monopoly since LIC in 1956 and the four general insurers in 1972, and recommended opening it to private and foreign participation under an independent regulator. The IRDA Act, 1999 gave effect to that and the Authority began functioning in 2000. The Narasimham Committees dealt with banking reform, the Rangarajan Committee of 2008 with financial inclusion, and the Kelkar Committee with tax reform — each is the answer to a different question in this unit, which is why they appear together as options.UPI, IMPS and AePS are operated by:
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Answer: A — The National Payments Corporation of India
NPCI is the not-for-profit umbrella body promoted by the RBI and the Indian Banks' Association in 2008 to run retail payment systems, and it operates UPI, IMPS, AePS, BBPS, RuPay and the National Financial Switch. The RBI owns and operates the two systemically important systems directly — RTGS and NEFT — and regulates NPCI under the Payment and Settlement Systems Act, 2007, which is the distinction the question tests. SEBI has no role in payments, and the Indian Banks' Association is a co-promoter of NPCI rather than an operator of anything.Under RBI norms, the priority sector lending target for domestic scheduled commercial banks is what share of adjusted net bank credit?
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Answer: A — 40%
Domestic scheduled commercial banks must direct 40% of adjusted net bank credit, or the credit-equivalent of off-balance-sheet exposure if higher, to the priority sector — agriculture, micro and small enterprises, education, housing, export credit and weaker sections — with sub-targets inside it, of which 18% for agriculture is the best known and is the figure the second option offers. Foreign banks with fewer than twenty branches face the same 40% reached in phases. The 75% figure is the priority sector requirement for small finance banks, which exist specifically to lend to the underserved and are held to a far higher share.