RBI further opens the Small Finance Bank route

Key announcements... why RBI is keen on small finance banks ... and what can be some key questions/ concerns?

On December 5, 2019, The Reserve Bank of India (RBI), issued the final guidelines for On-Tap licencing of Small Finance Banks (SFB).

Who can apply for conversion to a SFB?

  • Payment Banks after 5 years of operations.
  • Primary urban co-operative banks.
  • Resident individuals/professionals, singly or jointly, having at least 10 years of experience in banking and finance at a senior level.
  • Companies and societies in the private sector which are owned and controlled by residents, and having successful track record of running their businesses for at least a period of 5 years.

Other key announcements/ requirements

  • SFBs will be given scheduled bank status immediately and will be allowed to open banking outlets from the date of commencement of operations.
  • Net worth requirement for SFB has been increased from Rs 100 crore to Rs 200 crore. The Rs 200-crore minimum capital requirement norms would not be applicable for SFBs which came into operation after converting from urban cooperative banks, non-banking financial companies, microfinance institutions, local area banks and payment banks.
  • In view of the inherent risk of  SFBs, they shall be required to maintain a minimum capital adequacy ratio of 15 percent of its risk weighted assets. They have to maintain a tier I capital of at least 7.5 percent while the II capital should be limited to a maximum of 100 percent of the tier I capital.
  • Investors (other than promoters) will not be allowed to hold more than 10 percent stake in the SFB. However, in case of NBFCs, micro-finance institutions and local area banks, where non-promoters hold more than 10 percent limit, RBI at its discretion can allow 3 years time to dilute the stake.
  • Promoters should hold a minimum of 40 percent of the paid-up voting equity capital of the bank at all times during the first five years from the date of commencement of business. If initial shareholding by promoters in the bank is in excess of 40 percent, it should be brought down to 40 percent within five years. The promoters’ stake should be brought down to a maximum of 30 percent within 10 years, and to a maximum of 15 percent within 15 years.
  • The listing of SFB will be mandatory within three years after it reaches the net worth of Rs 500 crore for the first time.
Why RBI is keen on SFBs?

SFB is a specific segment of banking created by RBI under the guidance of Government of India with an objective of furthering financial inclusion by primarily undertaking basic banking activities to un-served and under-served sections including small business units, small and marginal farmers, micro and small industries and unorganized entities.

Like other commercial banks, these banks can undertake all basic banking activities including lending and taking deposits. Original guidelines for SFB’s were issued in November 2014. Out of 72 entities who applied for the licence, only 10 were issued licences then.

With yesterday’s announcements, SFB segment has been widely opened for varied entities.

The measures seem to be intended towards consolidating the not so tightly regulated financing activities in India under one umbrella i.e., SFB

This especially became necessary due to the following –

  1. Ongoing NBFC crisis
  2. Recent fraud at PMC (Co-operative) Bank
  3. Demand from Payment Banks given their underlying weak business model
What can be some key questions/ concerns?

RBI’s intention to consolidate financial sector definitely seems to be the right approach. If all goes well, as we move forward, most serious lenders/ financiers will get clubbed first under SFBs and later on as any other commercial bank.

Possibly, entities which don’t opt for conversion into SFB will create doubts in the mind of regulator and would be subject to tighter scrutiny.

However, then comes the key question… Why to allow use of the word ‘bank’ so leniently?

The word connotes trust and faith. SFB’s are allowed to accept deposits from public, who in general associates the word ‘bank’ with utmost safety.

Given the kind of different entities that have been allowed to apply for the SFB, I would presume that lots and lots of applicants would be eyeing to pursue this route to open a ‘bank’ and get access to the low cost public deposits.

Surely, RBI would be having a strict filtering criteria… but still, I am concerned about risk of any lapses.

I continue to ask myself that why do we actually need so many banks? and whether RBI would have the bandwidth to regulate and control so many banks and SFBs?

On one hand we are trying to merge small public sector banks with larger stronger banks and then on the other, allowing SFB route to create smaller banks.

Yes, creating reach and inclusion can be the argument… but then two key questions?

  • Do large existing banks not have the required reach? If not, why don’t we first allow/ ask them to create the required reach or product portfolios? What is that these SFBs will do better compared with the large well established banks?
  • OK, large banks may not be directly interested in those segments… but then won’t it be better to let these potential SFBs work under the direct control of the larger peers and RBI only required to control the limited number of large banks?

My concerns are not on the SFB concept but is more around the kind of entities that can potentially operate as a bank. Maybe, I still have the overhang of an era when getting a banking licence used to be extremely difficult and we still witnessed some significant bank issues/ failures.

I will continue to watch the related developments with utmost attention !

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About the author

Nitin Jain

A finance professional with around 20 years of investing experience in Indian markets both on buy and sell side, equity and debt, private and public with some of the best organizations globally including Goldman Sachs, ICICI Group, ICRA and others. He is a All India Silver Medalist CA by qualification.

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