Small Finance Banks (SFBs)

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Context:

• The RBI rejected applications received from Dvara Kshetriya Gramin Financial Services Pvt Ltd and Tally Solutions Pvt Ltd to start SFBs in the private sector.
• These entities had applied for SFB licenses in 2021 under the on-tap licensing guidelines.

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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, as per the Reserve Bank of India (RBI) on-tap licensing norms.

What is On Tap licence? On-tap licensing means that the window for getting a bank license from RBI is open throughout the year. Earlier, RBI used to invite applications for giving bank licenses, and prospective players submitted their applications within a fixed time-frame as prescribed by RBI.

Scheduled Status and Track Record:

• To qualify, SFBs must have scheduled status and a satisfactory performance track record for at least five years.
• The shares of the bank should have been listed on a recognized stock exchange, according to the RBI circular.

Financial Performance Criteria:

• SFBs aiming for universal bank status must demonstrate a net profit in the last two financial years.
• Additionally, they should maintain gross non-performing assets (GNPA) and net non-performing assets (NNPA) of less than or equal to three percent and one percent, respectively, over the same period, as per RBI requirements.

Promoter Requirements for Transition to Universal Bank:

• The RBI circular clarifies that eligible SFBs do not require a mandatory identified promoter.
• However, if existing promoters exist, they must continue as promoters during the transition to a universal bank.
• The addition of new promoters or changes in the existing ones will not be permitted during this transition phase.
• Furthermore, there will be no new mandatory lock-in requirement for minimum shareholding of existing promoters in the transitioned universal bank.

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Difference Between Universal Banks (UBs) and Small Finance Banks (SFBs):

Universal Banks (UBs):

• UBs encompass a wide range of financial entities such as commercial banks, financial institutions, NBFCs, etc.
• They engage in diverse financial transactions, including lending, deposits, investments, and other financial services.

Small Finance Banks (SFBs):

• SFBs are focused financial institutions registered as public limited companies.
• They primarily serve unserved and unbanked regions of the country, catering to marginalized segments like marginal farmers, MSMEs, and other underserved populations.
• SFBs also engage in non-risk sharing financial activities with prior approval from the RBI.

Origins and Mandates:

Universal Banks (UBs):

• UBs were conceptualized as development financial institutions (DFIs) by the Narsimham committee.

Small Finance Banks (SFBs):

• The concept of SFBs was introduced in the recommendations of the Raghuram Rajan Committee.

Licensing Process:

On-Tap Bank Licensing:

• The on-tap bank licensing facility allows entities to apply for bank licenses throughout the year directly to the RBI.
• Introduced in 2016, this initiative aims to promote financial inclusion and the creation of more financing institutions.

Previous Licensing Procedure:

• Before the introduction of on-tap licensing, banking licenses were granted through invitation of applications by the RBI.
• The last round of UB licenses was granted in 2015 to Bandhan Bank and IDFC Bank.

Eligibility Criteria for UB, SFB, and UCB Licenses:

Universal Banks (UBs):

Individual/Entity Requirements:

• Minimum 10 years of senior-level experience in banking and finance or a successful track record of 10 years for private entities.
• Assets of Rs. 5,000 crore or above.
• Required net worth of Rs. 500 crore, to be maintained at all times.

Restrictions on Large Industrial Houses:

• Large industrial houses limited to investing up to 10% only in UBs.

Small Finance Banks (SFBs):

Individual/Entity Requirements:

• Minimum 10 years of experience in the BFSI sector at senior levels for individuals.
• Corporate entities must have a successful track record of at least 5 years.
• Eligible entities include NBFCs, microfinance institutions, local banks, and cooperative banks.

Minimum Paid-up Voting Equity Capital or Net Worth:

• 200 crore for SFB applicants.

Urban Cooperative Banks (UCBs) Transitioning to SFBs:

UCBs voluntarily transitioning to SFBs:

• Initial net worth requirement of Rs. 100 crore, to be increased to Rs. 200 crores within five years.
• Conversion model entails challenges regarding promoter identification, investment plans, and capital infusion by promoter groups.

Key Aspects for Fulfilment:

• Financial Inclusiveness.
• Soundness of Business & Technological Model.
• Strong Management Track Record.
• Sustainable Governance.
• Adequate Capital Structure.

READ ALL ABOUT SMALL FINANCE BANKS: https://www.iasgyan.in/daily-current-affairs/small-finance-banks

Read:

Microfinance Institutions:

https://www.iasgyan.in/daily-current-affairs/microfinance-institutions-mfis

Cooperative Banks:

https://www.iasgyan.in/blogs/all-about-cooperative-banks-in-india#:~:text=Cooperatives%20Banks%20are%20registered%20under,Cooperative%20Societies)%20Act%2C%201965.

Performance of Small Finance Banks in India

Challenges in CASA Base Development:

• Despite offering higher interest rates, SFBs face competition from established commercial banks in building a stable Current Account and Savings Account (CASA) base.

Deposit Growth Trends:

• Deposits of SFBs grew at a Compound Annual Growth Rate (CAGR) of 32% from FY20 to FY23, outpacing the banking sector's 11% CAGR.
• SFBs' share of overall banking industry deposits has improved over the years but remains relatively smaller.

Factors Driving Deposit Growth:

• SFBs' focus on building a liability franchise comparable to universal banks and offering higher interest rates has accelerated deposit growth.
• With credit cost concerns alleviated and access to capital, SFBs are positioned for robust growth.

Projected Growth and Profitability:

• CareEdge Ratings forecasts SFB advances and deposits growth at 22-25% for FY24, expecting stable profitability with return on total assets (ROTA) ranging from 2.1% to 2.4%.

Deposit Mobilization Strategies:

• SFBs have effectively addressed the challenge of deposit mobilization, transitioning from NBFCs and establishing liabilities-focused branches.
• Credit to Deposit (C/D) ratio has declined as SFBs replaced borrowings with deposits, but CASA deposit ratio lags behind the banking sector.

Branch Expansion and Geographic Spread:

• SFBs have expanded their franchise rapidly, with branches growing at a CAGR of 29% since March 2018.
• Branches are well-distributed across India, with the highest concentration in South India (28%) followed by the western region (20%).

Asset Quality Challenges during Covid-19:

• SFBs, particularly those with larger exposure to unsecured loan portfolios, faced significant challenges during the Covid-19 pandemic.
• Higher exposure to weaker borrower segments led to a surge in Non-Performing Assets (NPAs) and elevated credit costs.

Impact and Recovery Post Covid-19:

• The peak impact of Covid-19 was witnessed in FY22, marked by the highest credit costs and reduced profits, with some SFBs even reporting losses.
• Post-pandemic economic recovery in FY23 saw improved net interest margins (NIMs) due to RBI rate hikes and better asset quality, resulting in lower credit costs and enhanced Return on Total Assets (ROTA).

Continued Improvement in FY24:

• In FY24 (Year-to-Date), SFBs sustained NIMs despite deposit rate hikes, experienced a decline in credit costs, and showcased ROTA enhancement, evident from H1FY24 results.

The Growth of Small Finance Banks in India

• Recently, Small Finance Banks (SFBs) have become quite important in Indian banking.
• These banks are licensed by the Reserve Bank of India (RBI) and focus on helping people who usually don't get much banking help, like those with low incomes or small businesses.

Swift Expansion and Market Reach

• SFBs have swiftly expanded their footprint since their establishment in 2016.
• Particularly evident is their robust branch network growth, with a notable focus on rural and semi-urban areas, traditionally lacking formal banking access.
• By prioritizing financial inclusion, SFBs have effectively tapped into unbanked and underbanked populations, broadening their customer base and facilitating greater access to credit and financial services.

Targeting the Unbanked and Underbanked

• Central to the mission of SFBs is catering to the financial needs of marginalized segments.
• Leveraging technology and innovative practices, these banks have transcended geographical barriers to extend banking services to previously overlooked regions.
• Through initiatives like mobile banking and simplified account opening processes, SFBs have made banking more accessible, thus empowering individuals and fostering economic growth.

Innovations in Product Offerings

• SFBs have exhibited a commitment to tailoring products to meet diverse customer needs.
• Introducing innovative solutions like microfinance loans, small business financing, and affordable housing loans, these banks have catalyzed entrepreneurship and supported small-scale industries.
• By customizing offerings and offering flexible repayment terms, SFBs have empowered marginalized groups and contributed to inclusive economic development.

Embracing Digital Transformation

• To enhance operational efficiency and customer experience, SFBs have embraced digitalization. Embracing advanced technology has streamlined processes and bolstered security, while digital banking solutions have improved accessibility, especially in remote areas.
• Mobile banking apps, online loan applications, and digital payment systems have become integral components of SFB operations, enhancing convenience and accessibility for customers.

Future Prospects and Economic Impact

• The future outlook for SFBs in India appears promising. As they continue to expand, innovate, and leverage technology, SFBs are poised to make substantial contributions to the economy.
• By catering to the unbanked and underbanked, SFBs can stimulate consumption, drive entrepreneurship, and facilitate job creation. Increased access to credit and banking services will empower individuals and businesses, fostering economic growth across urban and rural landscapes.

In Conclusion

• The ascent of Small Finance Banks in India signals a significant evolution in the banking sector.
• These institutions have not only addressed the financial needs of marginalized populations but have also propelled financial inclusion and economic advancement.
• With their rapid expansion, innovative approaches, and digital transformation, SFBs are primed to shape India's financial landscape.
• By prioritizing underserved segments, SFBs can contribute to a more inclusive and resilient economy, where all individuals and businesses have access to the financial services necessary for prosperity.

PRACTICE QUESTION Q. Analyze the performance of Small Finance Banks (SFBs) in India, emphasizing their contribution to financial inclusion and economic development.

SOURCE: THE INDIAN EXPRESS