A Budgetary Signal as Banks Cannot Bear It All
Background
India’s financial system has historically been bank-centric, with banks acting as the primary source of long-term finance for corporates and infrastructure. However, rising stress on banks due to maturity mismatch, repeated recapitalisation, and limited credit flow to productive sectors has highlighted structural weaknesses.
Against this backdrop, Budget 2026 signals a strategic shift: deepening market-based finance, especially the corporate bond market, so that banks are no longer forced to “bear it all”.
Budget 2026: Key Financial-Sector Reform Proposals
- Market-Making Framework for Corporate Bonds
Market-making framework refers to a system where designated entities continuously buy and sell corporate bonds to ensure liquidity, stable prices, and smooth functioning of the bond market.
- Development of New Risk-Management Instruments
- Total Return Swaps (TRS)
Total Return Swaps (TRS): A financial derivative where one party receives the total return (interest and price changes) of a bond or asset without owning it, in exchange for periodic payments.
- Bond Index Derivatives
Bond Index Derivatives: Financial instruments whose value is derived from a bond market index, used by investors to hedge risk or gain exposure to overall bond market movements.
Significance:
Strengthens the risk-hedging ecosystem, essential for deeper bond markets.
- Creation of Infrastructure Risk Guarantee Fund to reduce infrastructure financing risk.
- Recycling of Central PSE real estate assets through Real Estate Investment Trusts (REITs).
Structural Imbalance in India’s Financial System
- India has a deep government bond market, with government securities about 90% of GDP. However, corporate bond market is shallow at only 15–16% of GDP.
- Deep government bond market refers to a large, liquid, and well-developed government securities market with high trading volume, wide participation, and efficient price discovery.
Comparison with other countries: United States: over 80% of GDP and China: about 45–50% of GDP
Implication: Weak corporate bond market forces banks to provide long-term finance.
Excessive Dependence on Banks for Corporate Financing
Indian banks carry 60–65% of non-financial corporate debt. Compared to: United States: 30% and Europe: 40%
Vulnerability and recapitalisation
Maturity mismatch risk: Banks fund themselves using short-term deposits but lend for long-term infrastructure projects such as: Highways; Power plants; Telecom networks. This causes a maturity mismatch and increases financial vulnerability.
Fiscal burden due to bank recapitalisation: Since 2017, government injected over ₹3.2 lakh crore into Public Sector Banks (PSBs).
Implication: Public funds used to absorb private credit losses. This creates fiscal burden (hidden cost to taxpayers).
Impact on Credit Availability
- Capital locked in long-term corporate loans reduces lending to:
- MSMEs
- Small firms
- First-time borrowers
Outcome:
Credit constraints for employment-generating and productive sectors.
Weak Corporate Bond Market Structure
Corporate bonds constitute less than 15% of GDP and are issued mostly through private placements, limiting transparency. Thus, ownership of Corporate Bonds is concentrated among few institutional investors.
Impact on Monetary Policy Transmission
Weak transmission mechanism: Banks burdened with long-term loans cannot adjust lending rates easily. Results in inefficient transmission of RBI monetary policy.
Contrast:
In developed economies, bond markets transmit monetary policy efficiently via market interest rates.
Budget 2026 reforms to develop corporate debt market
- Market-making framework: Ensures continuous buying and selling of bonds. Improves liquidity and price discovery.
- Infrastructure Risk Guarantee Fund: Provides partial government guarantee for infrastructure loans.
- Reduces risk for private investors and encourages infrastructure financing through markets.
- Real Estate Investment Trusts (REITs) for CPSE assets
- REIT definition: Investment vehicle that owns income-generating real estate. Monetises public sector real estate assets and attracts private investment.
Conclusion
Budget 2026 marks a strategic reorientation of India’s financial architecture—from a bank-dominated model to a market-based system. By strengthening the corporate bond market and risk-sharing mechanisms, the Budget acknowledges a core reality: banks cannot indefinitely finance long-term growth without systemic risk and fiscal costs. A deeper bond market is therefore not optional, but essential for sustainable, inclusive, and resilient economic growth.
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