Small Finance Bank

Small Finance Banks (SFBs) were established to give impetus to financial inclusion in India. SFBs serve the customer base that is unserved, such as Micro, Small, and Medium Enterprises (MSMEs), and other small borrowers. They provide limited facilities to their customers and hence fall under specialised or niche banking. They were introduced on the basis of the recommendation of the Nachiket Mor Committee on Financial Inclusion, constituted by the RBI in 2013. The RBI regulates SFBs under the RBI Act of 1934 and the Banking Regulation Act of 1949. Since their introduction, SFBs have enjoyed significant success and growth and fulfilled their objective of financial inclusion. As of March 2024, there are 12 SFBs operating in India.

Since 2005, India has focused its attention on financial inclusion. To realise this vision, the RBI has introduced various measures, such as the opening of bank branches in previously unbanked areas, introducing banking correspondents, etc. to ensure the last mile connectivity of banking services. In 2013, the RBI, under Governor Raghuram Rajan, constituted a committee headed by Nachiket Mor with the objective of financial inclusion in India. Among other recommendations, the committee recommended the introduction of specialised banking that could serve the unserved and unbanked areas. These banks should have low entry barriers and regulatory requirements for relatively easy approval. Hence, based on these recommendations, Small Finance Banks (SFBs) were introduced. The first SFB started its operation in 2016, and since then, 12 other SFBs have received RBI nods.

SFBs were introduced and set up primarily in the private sector with a specific mandate.

Mandate of SFBs

• To provide saving vehicles.
• To provide finance to MSMEs, small industries and business units, other unorganised sectors, low income groups, and migrant workers.
• Use of technology to keep the operation cost low.

SFBs are regulated by the RBI under the RBI Act of 1934 and the Banking Regulation Act of 1949. A SFB is established as a private limited company under the Companies Act of 2013. Following are the guidelines issued by the RBI regarding SFBs:

• Promoter requirement:
  • Setting up: Any resident individuals/professionals (Indian citizens), singly or jointly, each having at least 10 years of experience in banking and finance at a senior level; and Companies and Societies in the private sector, that are owned and controlled by residents (as defined in FEMA Regulations) and having successful track record of running their businesses for at least a period of five years.
  • Conversion: Existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) in the private sector, that are controlled by residents (as defined in FEMA Regulations) and having successful track record of running their businesses for at least a period of five years can also apply to convert to a SFB.
• Minimum paid up equity capital: Requirement of INR 200 crores, except for SFBs converted from Urban Cooperative Banks that require only INR 100 crore.
• SFBs are subject to all other regulatory and prudential norms the same as Scheduled Commercial Banks (SCBs), such as the Statutory Liquidity Ratio (SLR), Cash Reserve Ratio (CRR), etc.
• At least 75% of the Adjusted Net Bank Credit (ANBC) to be allocated towards the priority sector lending (PSL).
• At least 50% of the loan portfolio must be small ticket loans of up to INR 25 lakhs.
• At least 25% of the branches must be in unbanked rural areas.
• No restriction on the area of operation, but priority will be given to those who set up bank branches (in the initial phase) in unbanked areas of North-East, East, and Central India.
• Mandatory public listing within 3 years of SFB reaching a net worth of INR 500 crores. Below this threshold, public listing is only voluntary.
• FDI is allowed, subject to regulatory norms for private banks.

• A large section of the population is unserved or underserved as far as banking is concerned. Hence, the SFBs have a unique opportunity for growth and can provide tailored banking solutions to this section of the population.
• Low Non Performing Assets (NPAs) and better management driving efficiency.
• Thrust on Digital Banking and technology infusion: There is an increased focus on keeping the operational cost of banking relatively low. So the infusion of technology in providing digital banking is greater as compared to traditional commercial banks. This will foster innovation in the banking industry.
• Financial inclusion: SFBs offer low cost banking services and low account maintenance charges. This enables the underprivileged to open and maintain bank accounts and participate in the formal banking system.
• Focus priority sector lending: Since 75% of the loans are to be disbursed according to the PSL norms, SFB caters to the unique credit requirement of the priority sector such as MSMEs, small borrowers, etc. Hence contributes to inclusive economic growth.

• There is intense competition in the market due to SCBs, NBFCs, and other micro finance institutes (MFIs) which will hurt the credit growth of SFBs.
• SCBs have the unique advantage of brand recognition among the masses. Hence, they can leverage this position in order to increase deposit growth. This presents a challenge for SFBs in getting deposits for credit growth. This ultimately hurts profitability.
• SFBs have targeted the semi-urban population until now. But there is now a renewed focus from the SCBs on targeting rural and semi urban populations to increase their credit growth. Therefore, SFBs will be under pressure in their core area of operations.

Small Finance Banks were introduced to cater to the underserved population. Within a decade of their introduction, SFBs have shown tremendous growth and the promise of financial inclusion in the country. SFBs provide a differentiated banking solution for their customers and are not weighted down by legacy issues of the banking industry such as high NPAs. With better management, low NPAs and high asset quality SFBs have a unique opportunity for driving growth in the banking industry.