Kamal Ghorui
Reports that the Department of Financial Services (DFS) under the finance ministry is examining a pathway for NBFCs to convert into banks could prove to be one of the most consequential financial reforms of this decade.
This is not a new debate. For more than fifteen years, I have argued that the NBFC model, once it crosses a certain size, faces a structural ceiling. It is not a question of ambition or capability. It is a question of architecture.
An NBFC at scale becomes a caterpillar that has outgrown its form. To survive and thrive, it must become a butterfly.
The liability problem no one talks about enough
On the asset side, large NBFCs today look increasingly like banks. They lend across retail, MSME, housing and vehicle segments. They comply with tighter capital norms. They are subject to scale-based regulation under the supervision of the Reserve Bank of India (RBI). Regulatory arbitrage has narrowed considerably.
But the liability side tells a different story.
Most NBFCs do not have access to granular, low-cost retail deposits. They depend heavily on bank borrowings, bond markets and wholesale funding. In normal times, this model works. In stressed times, it wobbles.
Liquidity tightens. Markets freeze. Refinancing costs spike.
When an NBFC is small, this is manageable. When it becomes systemically large, it becomes a vulnerability — not just for the institution, but for the financial system.
We have seen this movie before.
The mismatch between long-term assets and market-dependent liabilities is the single biggest structural risk in large NBFCs. No amount of regulatory tightening can fully eliminate this imbalance unless the liability franchise itself changes.
That change comes only with deposit access.
That change comes only with becoming a bank.
India’s own proof of concept
India does not need to theorise. We have lived examples.
Kotak Mahindra Bank began life as an NBFC before transitioning into a bank in the early 2000s. That conversion did not dilute prudence; it strengthened the institution. A diversified deposit base transformed its funding stability and growth trajectory.
IDFC First Bank evolved from a development finance and NBFC framework into a full-fledged bank. The transition enabled balance sheet diversification and long-term sustainability.
These are not isolated stories. They are evidence that institutional evolution, when well supervised, deepens the system rather than destabilising it.
Why this reform is urgent now
India’s credit ecosystem has changed dramatically. NBFCs today account for a substantial share of incremental credit in retail and MSME segments. They are no longer peripheral players. They are central to financial intermediation.
As India aspires toward a developed-economy financial architecture, three realities stand out:
First, large NBFCs are already systemically important.
Second, their asset profiles resemble banks.
Third, their liability structures remain structurally fragile.
Allowing eligible, well-governed NBFCs to convert into banks would achieve two powerful objectives simultaneously:
Strengthen Financial Stability :Deposit franchises provide stickier funding. They reduce dependence on wholesale markets. They improve resilience during liquidity stress. A stronger liability base lowers systemic contagion risk.
Deepen Financial Intermediation : More banks mean broader deposit mobilisation, stronger monetary transmission and wider credit penetration. India needs deeper credit markets to sustain high growth. Structural evolution of large NBFCs can accelerate that deepening.
This is not regulatory relaxation. It is regulatory maturation.
Conservatism has its limits
The RBI has historically taken a cautious approach toward licensing and conversions — and rightly so. Banking is built on trust. Governance failures in banking are costly.
But today’s context is different. Supervision has strengthened. Governance norms have tightened. Scale-based regulation has created differentiated oversight. Many large NBFCs are already operating under frameworks that resemble bank-like scrutiny.
The policy question now is not whether NBFCs should be regulated strictly — they already are.
The real question is whether mature institutions that meet the highest standards should be denied a natural evolutionary path.
Excess conservatism can sometimes create the very risk it seeks to avoid. A large NBFC without a stable liability base may pose greater long-term risk than the same institution operating as a regulated bank with deposit diversification and tighter oversight.
Conversion must not be treated as an automatic process; it has to be earned through clearly defined and rigorous standards. Eligibility should be contingent upon a sustained track record of governance integrity, strong capital adequacy, a well-diversified loan portfolio, transparent ownership structures, and a demonstrable culture of compliance. Only the most robust and well-managed institutions should qualify. However, for those that meet these benchmarks, the pathway to conversion must be clearly articulated, time-bound, and supported by policy. In essence, institutional evolution should not hinge on regulatory discretion alone, but be anchored in objective, measurable thresholds.
The butterfly moment
NBFCs have played a transformational role in India’s financial inclusion story. They innovated where banks hesitated. They expanded credit to segments once ignored. They absorbed risk and built expertise.
But when a caterpillar grows large enough, remaining a caterpillar is no longer strength — it becomes constraint.
If the DFS discussions translate into a thoughtful conversion framework, India will not just be granting new bank licences. It will be strengthening the architecture of its financial system.
The question is not whether NBFCs should become banks.
The question is whether India can afford not to let its strongest ones evolve.
This is the butterfly moment.
We should not miss it.
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