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The Indian banking sector has seen a remarkable transformation over the last decade, with profits soaring and non-performing assets (NPAs) declining. However, this turnaround did not happen overnight; it was the result of a series of critical steps taken during and after the asset quality review (AQR) initiated in 2015. While much of the public discourse on banking reforms has been politicized, it is essential to examine the underlying structural changes, data-driven reasoning, and long-term implications of these reforms.

Understanding the Crisis: The Build-Up of Bad Loans

To fully comprehend the significance of the AQR, we must revisit the period before the 2008 global financial crisis. During this time, the Indian economy was booming, and banks were flush with liquidity. This led to aggressive lending, particularly in infrastructure and corporate projects. Many of these projects were approved without adequate risk assessment, as bankers, driven by optimism, readily extended credit.

However, post-2008, several external and internal shocks disrupted these projects:

1. The Global Financial Crisis – The economic slowdown impacted demand, delaying project execution and reducing cash flows.


2. Policy Paralysis and Corruption Scandals – Bureaucratic delays and environmental clearances stalled numerous infrastructure projects.

3. Regulatory Uncertainty – Legal and policy shifts created ambiguity, making project completion difficult.

These factors led to a pile-up of bad loans. Instead of acknowledging the problem, many banks continued the practice of “evergreening” loans—rolling over debt without recognizing defaults.

The 2015 Asset Quality Review: A Necessary Shock

By 2015, it was evident that India’s banking system was carrying an unsustainable level of bad loans. The Reserve Bank of India (RBI), under Governor Raghuram Rajan, took the decisive step of launching an Asset Quality Review (AQR). This move forced banks to transparently classify their assets, moving away from the practice of hiding stressed loans.

The AQR had several key components:

1. Forensic Loan Review: Banks were required to rigorously assess their loan books and recognize stressed assets.


2. End to Evergreening: The practice of extending bad loans to avoid recognition was stopped.


3. Mandating Provisions for NPAs: Banks had to set aside funds to cover potential losses, strengthening their balance sheets.


4. Push for Capital Infusion: Recognizing bad loans was the first step; the next was to ensure that banks had enough capital to sustain losses.

The immediate impact of the AQR was a sharp rise in reported NPAs. According to RBI data, gross NPAs of scheduled commercial banks surged from 4.6% in 2014-15 to 9.3% in 2016-17. This created panic among investors and policymakers, but in hindsight, it was a necessary correction to prevent a deeper financial crisis.

Did Politics Overshadow Reform?

One of the contentious aspects of the AQR is whether its significance has been fully acknowledged. Critics argue that much of the success of India’s banking reforms has been attributed to later policy measures, while the foundational steps laid in 2015 have been overlooked.

A fundamental challenge in economic reforms is that painful corrective measures often yield benefits only after a time lag. The AQR exposed deep structural weaknesses, and its immediate impact was negative—banks suffered losses, and credit growth slowed. This made the policy politically unpopular, but in the long run, it created a healthier financial system.

The Role of Government: Bank Recapitalization and Reforms

Following the recognition of NPAs, the government had to step in with capital support. The Indradhanush and later the Bank Recapitalization Plan saw the government infuse ₹2.6 trillion into public sector banks between 2017 and 2021.

However, beyond capital infusion, deeper reforms were necessary to prevent a repeat of past mistakes:

Insolvency and Bankruptcy Code (IBC) 2016: This law created a structured mechanism for resolving stressed assets, reducing delays in debt recovery.

Merger of Public Sector Banks: Consolidation was initiated to strengthen weak banks and create larger, more stable institutions.

Strengthening Governance: RBI tightened norms around bank governance, limiting political interference in lending decisions.


These measures, coupled with the clean-up initiated by the AQR, eventually led to an improvement in banking sector metrics.

Where Does the Indian Banking Sector Stand Today?

As of FY 2023, Indian banks are in a much stronger position:

Gross NPAs have fallen below 5%, marking a significant improvement.

Credit growth is at a multi-year high, driven by retail and corporate lending.

Profitability has surged, with public sector banks reporting record earnings.


Despite these improvements, certain risks remain:

1. Rising Retail Loans: While corporate NPAs have declined, retail loan growth is accelerating. If not monitored, unsecured personal lending could create future stress.


2. Global Uncertainties: Higher interest rates in global markets can impact India’s banking sector by affecting foreign investments and corporate borrowings.


3. Need for Further Governance Reforms: While the banking sector is healthier, improving board-level governance and risk assessment remains crucial.

Lessons for the Future

The Indian banking sector’s experience offers several lessons:

1. Transparency is Non-Negotiable: Delaying the recognition of bad loans only makes problems worse.


2. Regulation Must Be Proactive: Periodic stress tests and forensic audits should be institutionalized.


3. Political Influence Should Be Minimized: Lending decisions must be based on economic rationale rather than political pressures.


4. Financial Discipline is Key: Banks must strengthen risk management frameworks to prevent excessive risk-taking during boom periods.


AQR as the Inflection Point

The turnaround of the Indian banking sector can be traced back to the bold reforms initiated during the 2015 Asset Quality Review. While it was a painful process, it laid the foundation for long-term stability. The challenge now is to ensure that India’s banking sector does not fall into the same pitfalls again—that means upholding transparency, strengthening governance, and maintaining financial discipline.

The economic landscape will continue to evolve, but the lessons from the past decade should serve as a guide for policymakers and bankers alike.