India's state-run banks dominate the sector and inefficient practices and bloated workforces have brought calls for more private sector capital to reinvigorate the industry and expand its reach.
Under the central bank's proposals, companies would need a "successful financial track record of at least 10 years" to be eligible to set up new banks, the Reserve Bank of India said in a statement.
Real estate construction and brokerage companies would be barred from obtaining banking licences.
New banks would be set up through a holding company while foreign shareholdings in the new banks would be limited to 49 percent for the first five years.
A number of corporate houses, including the Aditya Birla group have expressed interest in obtaining banking licences.
Some micro-finance institutions, which lend money to India's poorest, are also reported to be interested in obtaining formal banking licences.
New lenders would have to sell shares within two years and set up at le