Why Did RBI Establish Small Finance Banks?

The establishment of small finance banks aims to achieve the following objectives:

(a) To advance financial inclusion by providing a savings avenue for the general public.

(b) To maintain the supply of credit for small business units, small and marginal farmers, micro and small industries, and other unorganised sector entities.

Defining Small Finance Banks (SFBs)

Small finance banks are niche banks found predominantly in India. These banks, having obtained the necessary licences, can offer basic banking services such as accepting deposits and lending. They primarily serve sections of the Indian economy that aren't serviced by mainstream nationalised banks. These include small business units, small and marginal farmers, micro and small industries, and unorganised sector entities.

Here's a brief overview of the regulations pertaining to SFBs:

• Existing non-banking financial companies (NBFC), microfinance institutions (MFI) and local area banks (LAB) can apply to become small finance banks.
• They can be promoted by individuals, corporations, trusts, or societies.
• They are established as public limited companies in the private sector under the Companies Act, 2013.
• They are governed by the provisions of Reserve Bank of India Act, 1934, Banking Regulation Act, 1949, and other relevant statutes.
• These banks are not confined to any specific region.
• The banks were established with the dual objectives of promoting rural and semi-urban savings and providing credit for economically viable activities in local areas.
• The promoters need to have 10 years of banking and finance experience. Initially, the promoters' stake in the paid-up equity capital will be at least 40%, but it must be reduced to 26% within 12 years. Joint ventures are not permitted. Foreign shareholding in these banks is allowed as per the rules for Foreign Direct Investment (FDI) in private banks in India.
• If the net worth of the bank is ₹500 crores, listing will be mandatory within three years. Small finance banks with a net worth of less than ₹500 crores can also voluntarily get their shares listed.

Key Insights from the RBI Initiative

• The SFBs are expected to primarily focus on accepting deposits and lending to small business units, small and marginal farmers, micro and small industries, and other unorganised sector entities. These are areas that are currently underserved by regular commercial banks.
• The initiative highlights RBI's efforts to promote niche banking. Commercial banks typically fund large and medium corporations or provide loans for home and vehicle purchases. However, certain sectors like diamond cutting and polishing units, small restaurant owners, or job work fabricators often find it difficult to secure working capital finance support. SFBs are expected to fill this gap.
• The entities that have been granted licences are primarily microfinance institutions that have already reached remote areas. Their transformation into SFBs will enable them to directly accept deposits, reducing their cost of funds and leading to lower interest rates for clients.
• The SFBs might be better equipped to tap into the vast business opportunities in funding small and medium enterprises. The RBI expects these banks to adopt a high technology-low cost approach and bring innovations in service delivery.
• The initiative also reflects a shift in RBI's traditionally conservative image. India needs a more dynamic and flexible banking system, and the establishment of SFBs and payment banks is a positive step in that direction. This will also ensure better monetary transmission, which is crucial for the effectiveness of the RBI’s own interest rate policy actions.

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