9. Rewiring Financial Architecture: Budget 2026 and the Shift to Market-Based Credit

Summary of Key Highlights • Structural Rebalancing: Budget 2026 initiates a decisive shift to move long-term credit risk away from bank balance sheets and into capital markets through a \'market-making framework\' for corporate bonds.• New Financial Instruments: The introduction of Total Return Swaps (TRS) and Bond-Index Derivatives aims to provide synthetic exposure and hedging tools, enhancing liquidity in the otherwise shallow secondary corporate debt market. • Risk Mitigation Mechanisms: The establishment of an Infrastructure Risk Guarantee Fund seeks to provide partial credit guarantees, reducing the burden on banks for high-risk, long-duration projects like power plants and highways. • Asset Recycling via REITs: Central Public Sector Enterprises (CPSEs) will now use dedicated Real Estate Investment Trusts (REITs) to recycle real estate assets, unlocking capital and creating market-ready investment grade assets. • Correcting Maturity Mismatch: By fostering a deeper bond market, the government aims to address the \'Asset-Liability Mismatch\' where banks use short-term deposits to fund 20-year infrastructure projects. • Enhancing Policy Transmission: A deeper bond market is expected to improve monetary policy transmission, as market yields respond more efficiently to RBI rate changes compared to the sticky lending rates of burdened banks. Key Definitions • Total Return Swaps (TRS): A derivative contract where one party receives the total economic performance (interest plus capital gains/losses) of a reference asset in exchange for a floating rate payment, allowing for risk transfer without shifting ownership. • Market-Making Framework: A system where designated entities (market makers) provide continuous buy and sell quotes for securities, ensuring that investors can enter or exit positions with minimal price impact. • Maturity Transformation: The process by which banks take short-term liabilities (deposits) and turn them into long-term assets (loans), a process that creates systemic fragility when done excessively for infrastructure. Constitutional & Legal Provisions • Article 246 (Seventh Schedule): Banking (Entry 45) and Stock Exchanges/Futures Markets (Entry 48) fall under the Union List, giving the Centre exclusive power to legislate on these financial reforms. • Article 292: Governs the executive power of the Union to borrow upon the security of the Consolidated Fund of India, relevant for the issuance of sovereign guarantees for the new Risk Guarantee Fund. • SEBI Act, 1992 & RBI Act, 1934: The primary legal pillars for the regulation of the proposed bond derivatives and market-making frameworks respectively. • FRBM Act, 2003: The long-term fiscal cost of bank recapitalizations (~₹3.2 lakh crore since 2017) underscores the need for these reforms to adhere to the fiscal deficit targets (target of 4.4% for FY26). Comparative Landscape: Credit Market Architecture (2026)

Important Keypoints for UPSC • The \'Hidden Tax\': Chronic bank recapitalizations act as a hidden tax on the public, as taxpayer money is used to absorb private credit losses landing on public sector bank balance sheets. • Crowding Out Effect: Capital locked in long-term infrastructure loans restricts credit availability for MSMEs and exporters, stifling broader economic growth. • Monetary Policy Lag: The RBI\'s transition to a neutral stance (5.25% repo rate) is often poorly transmitted to the real economy because banks with impaired balance sheets are slow to adjust lending rates. • The Infrastructure Gap: As India targets a $5 trillion+ economy, the annual infrastructure requirement exceeds current banking capacity, making the transition to \'Bond-led Financing\' inevitable. Conclusion Budget 2026 recognizes that for India to achieve global competitiveness, its financial system must evolve from a \'shock absorber of last resort\' (banks) to a \'distributor of risk\' (markets). While the technical tools like TRS and REITs are vital, the ultimate success depends on broadening the investor base beyond a narrow set of institutions to include households and foreign participants, truly \'democratizing\' Indian debt. UPSC Relevance • GS Paper III: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment; Effects of liberalization on the economy; Infrastructure: Energy, Ports, Roads, Airports, Railways etc. • GS Paper II: Government policies and interventions for development in various sectors. • Prelims: Concepts like REITs, Total Return Swaps, Bond yields, and the role of CDSCO/SEBI/RBI in financial regulation.