Prior to 1991, financial and economic activity in India was heavily regulated; not only did public institutions and enterprises dominate numerous core sectors, but financial sector development was also greatly hindered by “tight control of industrial investment, a highly protective trade regime with a multiplicity of discretionary import licenses, [and] high tariffs and numerous quantitative restrictions.” Access to debt and equity capital without the support of the government was highly difficult and rent-seeking practices were rampant. It is of interest to note how Hanson and Kathuria find that despite these restrictions, the Indian financial system was relatively “deep” in comparison with other low-income countries at the time; for example, during the 1980s, the stock market was “large in terms of number of listings and market capitalisation,” and “in 1980 the ratio of broad money to GDP was 36%, as high as many middle income countries.”
However, growth during the 1980s proved to be unsustainable as it was highly dependent on borrowing for financing the current account deficit. Thus, prompted by a severe balance of payments crisis (during which the country’s foreign reserves were drawn down to two weeks) as well as macroeconomic imbalances in the early 1990s, the Government of India finally decided in 1991 to implement a series of stabilisation and structural reforms. With a view to spur sustainable growth, and reduce poverty at the same time, the financial reforms adopted broadly included the following: 
- Liberalisation of interest rates (gradually, over a period of time)
- Reduction of Cash Reserve and Statutory Liquidity Requirements (SLR)
- Liberalisation of the capital account
- Better regulation and supervision
- Increased competition.
The financial sector at the time was comprised broadly of the following: equity, bond, and commodity markets, and insurance, mutual, and pension funds. In order to enable greater liberal access to – and transparency in – these markets, key institutions such as the Securities and Exchange Board of India (SEBI), an independent regulatory board, and a new stock exchange, the National Stock Exchange of India, were also set up. Together, these financial reforms aimed to increase investment, “to improve resource mobilisation and to allocate credit to its most efficient uses.” 
The Evolution of the Indian Financial Sector
Following the implementation of the above reforms, the role of various financial markets and private players in the banking sector has increased in the Indian economy. The Indian stock market functions largely on two leading national indices, the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE), although in total there exist 22 stock exchanges in the country. The number of listed companies on these two indices has been rising progressively, and stood at 4,921 on the BSE – the highest among all global indices - and 1,402 on the NSE by the end of 2008.
Source: Compiled with data from Reserve Bank of India and Securities Exchange Board of India.
Figures 1 and 2 show how the equity market in India has developed since liberalisation in 1991. It can be seen that the ratio of stock market capitalisation on the BSE to GDP had been quite volatile during the 1990s. With the opening up of the economy, there was a sharp increase in the share of market capitalisation in GDP from 15.9% of GDP in 1990-91 to 49.4% in 991-92; however, the ratio oscillated during the rest of the decade, reflecting, for example, changes in valuation due to the Asian financial crisis in 1997 and the bursting of the information technology bubble after 2000.
It has only been since 2002 that a continued increase in the market capitalisation to GDP ratio has been observed. Figure 2 shows how, as more and more households and enterprises looked to the equity market for funds or as an alternate means of saving, stock market capitalisation rose from 26% of GDP in 2002 and peaked at 108% of GDP at the end of 2007. Following the global recession and the collapse of Lehmann Brothers, however, the share fell considerably to 53.6% of GDP by the end of 2008.
Source: Compiled with data from World Federation of Exchanges and International Monetary Fund.
Furthermore, as the banking sector has liberalised, the role of private banks has also increased. Figure 3 depicts how the private sector credit to GDP increased from just below 30% in 1994-95 to almost 55% in 2007-08. Nonetheless, the degree of financial depth as compared to other countries – including other emerging economies such as Malaysia, Thailand, and Egypt – remains quite low. This is in part due to the fact that several restrictions on the banking sector, the corporate bonds market, and derivatives markets still exist, discouraging lending and trading.
Fig. 2: Financial Depth in India
Source: Prasad and Rajan (2008).
India in the wake of the 2007-09 Financial Crisis
While the Indian real economy as a whole has shown considerable resilience following the recent global financial crisis, maintaining a moderate GDP growth rate of 6.7 %, the financial sector suffered from greater adverse shocks, principally following the collapse of Lehman Brothers in September 2008. The various market segments displayed higher volatility as foreign investors pulled funds and net capital inflows declined. Stock prices suffered, and the BSE index, the Sensex, for example, witnessed substantial volatility, falling by almost 61% between January 2008 (when it peaked) and March 2009; this resulted in a corresponding 63% decrease in market capitalisation during the same period. The adverse effects of these developments were felt in the form of increased pressure on the foreign exchange markets, as well as greater liquidity pressure on mutual funds and non-bank financial corporations. However, as signs of a global recovery arise, interest in Indian markets has again augmented, as evident by increasing foreign investment. Thus, to ensure greater efficiency and stability as the sector becomes more integrated with global markets, its regulation and reform has once again become a top priority for the Reserve Bank of India (RBI), the country’s central bank.
While it can be argued that the RBI has, in fact, been too prudent in its policies in the past, it is also true that this prudence has enabled the financial sector to weather the crisis better than might have otherwise been the case. It is largely due to domestic saving that investment during the past two years was sustained and the effects of the crisis were mitigated. The fact that the completely liberal current account has been accompanied by only a gradual freeing up of the capital account and that interest rates still need to be liberalised further, penetration of the financial markets is still limited in India. The role of private banks has increased over the years; yet much can be done to increase competition, limiting the role of government institutions, and thus improving not only access to the banking and financial sectors, but also generating more innovations that would result in greater efficiency.
India, along with other emerging market economies, represents a booming economic environment in a world currently replete with aversion to risk. While this global interest lasts, it is up to India to make the most of the opportunity by ensuring that its financial institutions are as transparent and efficient as possible in order to sustain long-term economic growth.
Dun & Bradstreet India. “Indian Scenario.” India’s Leading Equity Broking Houses 2007. <http://www.dnb.co.in/ EquityBroking/Indian%20Scenario.asp>. 2007.
Hanson, James A. and Sanjay Kathuria. “India’s Financial System: The Challenges of Reform.” World Bank Working Paper No. 28753. 26 Jun 2000.
Kaushik, Surendra K. “India's Evolving Economic Model: A Perspective on Economic and Financial Reforms.” American Journal of Economics and Sociology. Vol.56, No.1. Jan 1997.
Prasad, Eswar S. and Raghuram G. Rajan. “Next Generation Financial Reforms for India.” Finance and Development. Vol. 45, No. 3. Sep 2008. <http://www.imf.org/external/pubs/ ft/fandd/2008/09/prasad.htm>.
Reserve Bank of India. Annual Report 2008-09. 27 Aug 2009.
“India and capital flows: A world apart.” The Economist. <http://www.economist.com/ research/articlesBySubject/displaystory.cfm?subjectid=6899464&story_id=14745085>. 29 Oct 2009.
World Bank. “India – Financial Sector Development.” Staff Appraisal Report No. 13740. Feb 24, 1995.
World Federation of Exchanges.”WFE - Member Exchanges.” <www.world-exchanges.org/member-exchanges>.
 Prasad, Eswar S. and Raghuram G. Rajan. “Next Generation Financial Reforms for India.” Finance and Development. Vol. 45, No. 3. Sep 2008. <http://www.imf.org/external/pubs/ft/fandd/2008/09/prasad.htm.>.
 World Bank. “India – Financial Sector Development.” Staff Appraisal Report No. 13740. Feb 24, 1995. pp.1-2.
 Hanson, James A. and Sanjay Kathuria. “India’s Financial System: The Challenges of Reform.” World Bank Working Paper No. 28753. 26 Jun 26 2000. p. 6.
 Kaushik, Surendra K. “India's Evolving Economic Model: A Perspective on Economic and Financial
Reforms.” American Journal of Economics and Sociology. Vol.56, No.1. Jan 1997. p. 77.
 Hanson and Kathuria. pp. 8-9.
 Ibid. p. 7.
 Dun & Bradstreet India. “Indian Scenario.” India’s Leading Equity Broking Houses 2007. <http://www.dnb.co.in/ EquityBroking/Indian%20Scenario.asp>. 2007.
 World Federation of Exchanges.”WFE - Member Exchanges.” <www.world-exchanges.org/member-exchanges>.
 Eswar and Rajan.
 Prasad and Rajan.
 Reserve Bank of India. Annual Report 2008-09. 27 Aug 2009. <http://rbi.org.in/scripts/ AnnualReportPublications.aspx?Id=888>.
 Reserve Bank of India.
 “India and capital flows: A world apart.” The Economist. <http://www.economist.com/research/ articlesBySubject/displaystory.cfm?subjectid=6899464&story_id=14745085>. 29 Oct 2009.
 Reserve Bank of India.