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The Evolution of Small Financial Banks in India

An article recently published in the Reserve Bank of India’s August bulletin has brought the maturing concept of Small Finance Banks in India under the spotlight. Typically understood as an improved version of Microfinance Institutions (MFIs), the small finance banks are a type of Differential Bank set up by the RBI to cater to the demands of a specific demographic group and swiftly fulfill the purpose of financial inclusion. But have SFBs been effective in serving their purpose so far, or are they just another dime a dozen? Let’s find out!

Different types of Banks

SFBs: Meaning and Objectives Small Finance Banks (SFBs) is a niche banking financial institution established to extend financial services to the un-served and under-served areas of the country. Like commercial banks, SFBs engage in the primary banking functions of accepting deposits and lending loans. They also engage in non-risk sharing financial activities like insurance and mutual funds. However, they are required to focus on the marginalized sections of the economy to bring about financial inclusion by:

  • Providing saving vehicles, and

  • Supplying credit to small business units, small and marginal farmers, micro and small industries, and other unorganized sector entities; through high technology, low-cost operations.

Registration and Licensing Requirements SFBs need to:

  • be registered as a Public Limited Company under the Companies Act, 2013, and

  • obtain a license under section 22 of the Banking Regulation Act, 1949.

As they commence operations, SFBs acquire the status of Scheduled Banks and have to use the words “Small Finance Bank” in their names. Ever since RBI introduced these licensing guidelines in 2015, 12 SFBs have come into existence. The first two SFBs, Capital Small Finance Bank and Equitas Small Finance Bank, started operations in 2016. 2017 saw the establishment of seven new SFBs, and 2018, one. 8 out of these 10 SFBs were originally Microfinance NBFCs that reiterated RBI’s agenda of financial inclusion. The latest one is the Uttar Pradesh-based Shivalik Mercantile Co-operative Bank Limited that transitioned into an SFB in April 2021.

How are SFBs different from Commercial Banks?

The chief differences between commercial banks and SFBs can be summarized as follows:

As per the RBI guidelines, the word ‘small’ in SFBs refers to the importance given to the objective of serving the underprivileged section that is excluded, not the size of the bank. Also, at least 50% of their loan portfolio should comprise loans up to Rs. 25 lakhs.

The growth of SFBs: Inception to Present

SFBs have witnessed a rapid growth in the number of branches since inception. By the end of March 2020, there were 4,307 branches of SFBs. They have successfully made their presence felt in some under-served states like Madhya Pradesh (7% of total branches) and Rajasthan (8%). Apart from these states, stats reveal that the rapid growth of SFBs was mainly witnessed in Urban and Semi-Urban Areas. As of March 2020, about 39% of the total branches- were in semi-urban areas, followed by 26% in urban areas. Therefore, most of the branches are present in relatively well-banked regions or states. The study also reveals that SFBs penetration in the North-Eastern region, which is known to be the least banked region, remains low.

Source: RBI Bulletin