Small Finance Banks (SFBs)
Small finance banks have emerged as an innovative banking model in India to promote financial inclusion. They aim to cater to the needs of underserved sections like small businesses, low-income households and farmers. This article discusses the concept of small finance banks, their key features and objectives, criteria for setting up and transitioning to a universal bank. It explains the difference between universal banks and small finance banks in a simple manner.
What is a small finance bank?
A small finance bank is a type of banking license granted by the Reserve Bank of India to extend affordable and customized banking services to unserved and underserved sections of society. They were conceptualized to fill the gap between commercial banks and microfinance institutions by providing basic banking facilities to communities with limited means.
Small finance banks focus on serving small business units, small and marginal farmers, micro and small industries, and other unorganized sector entities through high-technology, low-cost operations. They offer a range of simple financial products like small loans, savings accounts, payment/remittance services, and other transactional banking services to customers with modest means.
What Are The Objectives Of Small Finance Banks?
The main aims and goals of setting up small finance banks in India are:
- To provide basic banking services like savings accounts, payments, remittance and small loans to unserved sections of society. This will promote financial inclusion across the country.
- To specifically cater to the needs of small business owners, low income households, small and marginal farmers who usually do not have access to formal banking.The main aims and goals of setting up small finance banks in India are:
- To extend credit access through small value loans to small traders, entrepreneurs and businesses in rural regions to help them grow. This boosts rural economy and local employment.
- To teach people the importance of savings by introducing simple deposit instruments and digital transaction solutions. Regular savings can help people meet their future needs.
- To use the latest technology to keep costs low and offer banking at customers’ doorsteps in easy affordable ways without needing to visit branches often.
- To act as a bridge between self-help groups (SHGs) and commercial banks by providing organized group financing and linkage to mainstream credit.
- To aggregate small savings through micro-deposits and recycle those funds as micro-loans for productive purposes, thereby deepening financial inclusion.
Guidelines for Licencing of Small Finance Banks
The Reserve Bank of India recognized the need for banking services targeted at unserved communities. In 2015, it granted preliminary approval to 10 applicants to set up Small Finance Banks (SFBs). However, only regular applications were invited then. This limited banking expansion.
Later, RBI announced an ‘On Tap’ licensing policy. This means SFB licenses can be applied for throughout the year instead of waiting for specific windows. This promotes continuous availability of affordable banking.
Some key guidelines for ‘On Tap’ licensing are:
- Minimum paid-up capital: The capital required is ₹200 crores. For existing Urban Co-op Banks transitioning, initial capital can be ₹100 crores to be raised to ₹200 crores in 5 years.
- Immediate Scheduled Bank status: New SFBs get an important Scheduled Bank tag allowing financial operations from day 1.
- Branch access from start: SFBs can freely open branches all over without delays.
- Pathway for Payments Banks: Such banks can apply as SFBs after 5 years if eligible.
- Primary focus areas: SFBs mainly accept deposits and provide loans to farmers, small shops, industries and unserved people.
- Offer basic financial services too: With approval, SFBs can distribute mutual funds, insurance, pension products etc.
- Priority to weaker sections: Minimum 25% branches in rural areas. 75% loans to priority sectors like farmers and small businesses. 50% loans below ₹25 lakhs.
- Prudent lending limits: No large loans. Single exposure capped at 10% of capital, group exposure at 15%.
- Promoter shareholding reduced over time: From initial 40% to be brought down to 40% in 5 years.
- CRR and SLR compliance: SFBs must maintain part of deposits as cash reserves (CRR) and liquid assets (SLR).
This ‘On Tap’ scheme facilitates continuous expansion of financial access through SFBs meeting needs of unserved communities all over India.
Difference Between and Small Finance Banks (SFBs) and Universal Banks (UBs)
| Basis of Differences | Small Finance Banks | Universal Banks |
| Definition | Smaller banks focused on serving underprivileged segments, primarily in rural and semi-urban areas | Large, full-fledged banks offering a wide range of financial services |
| Ownership Structure | Primarily owned by Indian promoters, with a minimum of 40% public shareholding. | Can be public, private, or foreign-owned |
| Branch Network | Limited branch network, usually located in rural and semi-urban areas | Large branch network across the country. |
| Product Portfolio | Focused product portfolio primarily on microfinance, small business loans, and deposits | Comprehensive range of products and services, including deposits, loans, investments, insurance, etc. | |
| Customer Base | Primarily serves to underprivileged segments like low-income individuals, small businesses, and farmers | Wider customer base, serving to individuals, businesses, and institutions |
| Regulatory Framework | Subject to less strict regulations than universal banks, allowing for greater flexibility | Subject to stricter regulations by the Reserve Bank of India (RBI) |
| Capital Requirements | Lower capital requirements, enabling easier entry into the market | Higher capital requirements to ensure financial stability |
Criteria for Small Finance Banks (SFBs) to Become Universal Banks
Minimum Net Worth Requirement:
- SFBs aspiring to become universal banks must maintain a minimum net worth of Rs. 1,000 crore. This is as per the guidelines set by the Reserve Bank of India (RBI) for obtaining a universal banking license.
- Maintaining such a high net worth ensures the bank is financially stable and strong enough to offer a wide range of banking services to its customers across India. An example would be major commercial banks with a presence across the nation maintain net worth in thousands of crores to manage operations on such a large scale.
Scheduled Status and Track Record:
- To qualify for the universal banking license, SFBs must hold a scheduled bank status for at least 5 years.
- They should also have a satisfactory performance record during this time period.
- Additionally, shares of the bank need to be listed on a recognized stock exchange for greater transparency as per RBI rules. This boosts investor confidence in the bank.
Financial Performance Criteria:
- SFBs aiming to become universal banks must demonstrate a net profit in their financial reports for the last two years.
- They are also expected to maintain gross non-performing assets (GNPA) and net non-performing assets (NNPA) below or equal to 3% and 1% respectively over the same two year period. This ensures asset quality is managed prudently.
Promoter Requirements for Transition to Universal Bank:
- RBI has clarified that eligible SFBs do not mandatorily require an identified promoter to transition to a universal bank license.
- However, if existing promoters are there already, they need to continue as promoters during the transition phase.
- Additionally, no new promoters can be added or changes done to the existing ones during this transition time according to RBI rules. This brings continuity and stability to bank operations.
Performance of Small Finance Banks in India
Challenges in CASA Base Development
- Despite offering higher interest rates on deposits, SFBs face stiff competition from established commercial banks in developing a stable base of low-cost Current and Savings accounts (CASA).
Deposit Growth Trends
- SFBs have grown deposits at an impressive average annual rate of 32% between FY20-FY23, outpacing the overall banking sector growth of 11%.
- However, their share of total banking deposits remains relatively small even though it is improving over the years.
Factors Driving Deposit Growth
- SFBs focus on building a large deposit base comparable to universal banks through higher deposit rates and expanding access to underserved areas. Their approach of attracting customers through innovative products and regional outreach is allowing deposit growth to surge.
Projected Growth and Profitability
- Ratings agency CareEdge expects SFB advances and deposits to grow at a healthy 22-25% for FY24 while maintaining stable profitability with return on total assets (ROTA) between 2.1-2.4%. This reflects their growing scale and prudent approach.
Deposit Mobilization Strategies
- SFBs have effectively addressed the challenge of mobilizing deposits by establishing dedicated liability-focused branches across India to transition from their previous NBFC model. Their Credit to Deposit ratio has reduced as reliance on borrowing decreased but CASA ratio is still lower than other banks.
Branch Expansion and Geographic Spread
- To gain scale, SFBs have expanded their network rapidly with branches growing at an annual rate of 29% since March 2018. Their branches are strategically located across various regions of the country with the highest presence in South India (28%) followed by Western states (20%).
Asset Quality Challenges during Covid-19
- During the pandemic induced economic slowdown, SFBs faced significant hardships, especially those with larger exposure to unsecured loans. This resulted in higher non-performing assets and elevated credit costs as weaker borrowers defaulted on repayments.
Impact and Recovery Post Covid-19
- The economic after-effects were most severe for SFBs in FY22 as seen through highest credit costs and reduced profits with some even incurring losses. However, the improving macroeconomy aided their asset quality and recovery with declining credit costs and better profitability metrics like ROTA in FY23.
Continued Improvement in FY24
- In the current fiscal year so far, SFBs have sustained healthy net interest margins despite rate hikes while witnessing a drop in provisioning costs leading to increased returns on assets – as evidenced from many leading players’ strong first half FY24 results indicating the recovery is ongoing.
The Growth of Small Finance Banks in India
Swift Expansion and Market Reach
- SFBs have rapidly grown their physical presence since 2016, especially in rural and semi-urban regions traditionally lacking adequate banking facilities.
- Their focus on financial inclusion has helped effectively tap unbanked and underserved communities, broadening the customer base and enabling better access to lending and banking services.
Targeting the Unbanked and Underbanked
- Central to SFB operations is catering to needs of marginalized segments.
- Leveraging digital technologies and simplified procedures, these banks have transcended geographical barriers to deliver banking at people’s doorsteps through initiatives like mobile and internet banking.
Innovations in Product Offerings
- SFBs have introduced innovative, need-based solutions like microloans for entrepreneurs, financing for small businesses, and affordable housing loans.
- By customizing offerings to various customer segments and providing flexibility, SFBs have supported marginalized groups in catalyzing self-employment and business activities.
Embracing Digital Transformation
- To enhance efficiencies and experience, SFBs have fully embraced digitalization in processes and services.
- Advanced technologies have streamlined back-end while services like mobile/internet banking have made banking more accessible for customers across all regions.
Future Prospects and Economic Impact
- As SFBs continue expanding outreach while leveraging innovations, their contributions are projected to rise significantly.
- By catering to needs of underserved segments, SFBs can boost consumption, entrepreneurship and employment, thereby facilitating balanced regional growth.
- Improved access to formal banking will empower individuals and MSMEs, with positive spill-overs on the wider economy.
Conclusion
The small finance bank model was introduced to bring basic but much needed banking services to the masses who does not have access to banking services through an improved financial inclusion ecosystem. These niche banks complement universal banks and microfinance institutions. Over a period, as they stabilize their operations and achieve scale, it is possible for good performing SFBs to transition into universal banks and expand their range of services. This innovative approach has sparked nationwide financial empowerment and supported entrepreneurial capacities across India.
