Updated Apr 13, 2022

What is Small Finance Bank?

What is Small Finance Bank?

A small finance bank is a financial institution that provides monetary services to the unbanked and unserved regions of the country. They are a public limited company registered under the Companies Act, 2013.

They play an essential role in supplying credit to micro and small enterprises and agriculture and banking services in the unbanked and under-banked regions of the country. While permitting small finance banks, RBI considers the experience gained, size, capital requirements, area of operations, exposure norms, regulatory prescriptions, corporate governance and resolutions.

The objective of a small finance bank

Small Finance Banks serve the following objectives:

1. Basic Banking Services: small finance banks offer essential banking services, accept deposits, and lend money to the underserved section of individuals, small business units, small and marginal farmers, micro and small industries and entities in the unorganised sector.

1. Alternative Institution: Small finance banks act as an alternative to the traditional banks and focus on small and medium businesses, small and marginal farmers, the informal sector etc. They thus serve to increase the financial inclusion of various unserved clients in tier II and tier III cities.

1. Access to Financial Services: small finance banks' primary purpose is to provide financial services in rural and semi-urban areas. They work just as a commercial bank but on a small scale.

List of regulations

Regulations applicable to small finance banks are:

• Reserve Bank of India Act, 1934;
• Banking Regulation Act, 1949;
• Deposit Insurance and Credit Guarantee Corporation Act, 1961;
• Foreign Exchange Management Act, 1999;
• Credit Information Companies (Regulation) Act, 2005;
• Payment and Settlement Systems Act, 2007;
• Other RBI issued relevant Statutes and Directives, Prudential Regulations and Guidelines.

Small Finance Banks, after commencement of their operation, if found suitable as per Section 42 of RBI Act 1934, will be given scheduled bank status.

Who are eligible to obtain small finance bank license?

Following individuals or companies can obtain small finance bank License from RBI:

• Indian residents, individual or professional, individually or in collaboration, having a minimum of ten years of experience in banking and finance at the senior level, are eligible.
• Private Sector companies or societies owned and controlled by residents who have a successful track record of running businesses for at least five years are eligible.
• Existing Private Sector Micro Finance Institutions (MFIs), Non-Banking Finance Companies (NBFCs) or Local Area Banks (LABs) are eligible. Residents controlling such institutions should have a proven track record of five years of running businesses.
• Urban co-operative banks that voluntarily desire to convert to small finance bank are eligible for conversion.
• The minimum net worth of such banks should be Rs 100 crore from the commencement of business as a small finance bank. The small finance banks must increase their minimum net worth to Rs 200 crores within five years.

SFBs Working Norms

The small finance banks should first take up the primary banking activities such as accepting deposits and lending to the unserved and underserved sections like small and marginal farmers, small business units, micro and small industries and unorganised sector entity.

Commencing non-risky simple financial activities such as insurance products, distribution of mutual fund units, pension products etc., is possible only after obtaining approval from RBI and complying with the sectoral regulator's requirement. These activities do not require their funds' commitment.

Three years after the commencement of operations, the SFBs will not require any prior approval from RBI. Instead, the extant norms applied to scheduled commercial banks will govern the working of SFBs.

If their client requires it, the small finance bank can also work as an authorised dealer in foreign exchange.

Small Finance Banks can open banking outlets with the condition of opening 25% outlets in the unbanked rural areas where the population is less than 10,000 (as per the latest census).

RBI does not restrict the area of operations of small finance banks. However, preference for applicants from under-banked states/districts of the North-East, East and Central India is more for setting up a small finance bank. In due course, such banks will not face any hindrance to expanding to other regions.

The small finance bank should primarily respond to the local needs. Five years later, after stabilisation and review, RBI may liberalise the scope of activity.

Conclusion

Small Finance Banks serve the unbanked and underbanked societies of India. They penetrate the market which is out of reach of commercial banks. 75% of their Adjusted Net Bank Credit is extended to the priority lending sectors classified by the RBI. 50% of their loan portfolio comprised loans and advances of up to Rs 25 lakh.