GK Update – All You Need to Know about Small Finance Banks

Dear Readers,

Small
Finance Banks have been in the news prominently recently. Hence, this is an
important topic for your upcoming exams.

The
Reserve Bank of India granted “in-principle” approval to ten companies to set them
up, and this article will look at the background of this news, its practical
applications and the companies which got the approval.

Background

In 2009, the Committee on Financial Sector
Reforms had reviewed the importance of small banks in the Indian scenario. This
committee had expressed the opinion that there were some changes taking place
in the financial sector and licensing new, small banks could be experimented
with. It suggested that allowing private and well-managed small finance banks to
set up could counter their risks by concentrating on geographically less
relevant areas. This could be an effective way to expand the RBI’s reach into remote,
unbanked portions without requiring much capital. The basic idea behind this
suggestion was to promote inclusion of smaller financial bodies and borrowers,
and to provide service to rural areas.

In
July 2014, the Finance Minister Arun Jaitley had said, “After making suitable
changes in the current framework, a structure will be put in place for
continuous authorization of universal banks in the private sector in the
current financial year. RBI will create a framework for licensing small banks
and other differentiated banks. Differentiated banks serving niche interests,
local area banks, payment banks etc. are contemplated to meet credit and
remittance needs of small businesses, unorganized sector, low income
households, farmers and migrant work force”.

Selected Banks

The
RBI issued a statement in the third week of September which revealed the names
of the ten enterprises which were selected to set up Small Finance Banks. A
total of 72 applications were received by the RBI. The
selected entities were:

1. Au Financiers (India) Ltd., Jaipur

2. Capital Local Area Bank Ltd.,
Jalandhar

3. Disha Microfin Pvt. Ltd., Ahmedabad

4. Equitas Holding P Limited, Chennai

5. ESAF Microfinance and Investements
Private Ltd., Chennai

6. Janalakshmi Financial Services
Private Limited,  Bengaluru

7. RGVN (North East) Microfinance
Limited, Guwahati

8. Suryoday Micro Finance Private
Ltd., Navi Mumbai

9. Ujjivan Financial Services Private
Ltd., Bengaluru

10. Utkarsh Micro Finance Private Ltd.,
Varanasi

Eight out of the selected ten are microfinance institutions. The two exceptions are Capital Local Area Bank Ltd. (operates in five districts of Punjab) and Au Financiers (give out loans in contiguous districts). Bigger financial services firms like Dewan Housing Finance Ltd., IIFL Holdings Ltd., SKS Microfinance Ltd. and UAE Exchange and Financial Services Ltd were also in the running. None of them, however, could make the cut.

Selection Procedure

1. A
set of guidelines was released by the RBI in November 2014. Three different
committees were set up and the case studies of all the applicants were used to complement
the selection criteria.

2. According
to the guidelines, the applications were to be sent to an External Advisory
Committee (EAC) after clearing the initial prima
facie eligibility. This involved checking their ability to raise the
minimum initial capital, control by residents and the status of ownership.

3. The
EAC then examined the financial plausibility, the proposed business plan and
its proper status. A significant factor was its reach into underserved parts of
the population and areas which were unbanked. The EAC sent its recommendations
to the RBI after this.

4. An
Internal Screening Committee (ISC) then scrutinized the applications and submitted
its recommendations to RBI’s Committee of the Central Board (CCB).

5. On
16th September 2015, the CCB considered the initial recommendations
of EAC and ISC and made the final decision.

6. The
RBI now plans to use the findings from this procedure to make a revised set of
guidelines which will help it issue licenses more often.

What Next for the
Selected Banks

Even
though these organizations have been handpicked by the RBI itself, there will
be some rules and regulations that they will have to follow.

1. The “in-principle” approval will be
valid for eighteen months so that the selected entities are able to comply with
the guidelines provided by the RBI about Small Financial Banks.

2. These SFBs can facilitate fundamental
banking options, for instance, accepting deposits and giving out loans to
unbanked parts of the economy, like small farmers, budding business ventures
and unorganized sectors.

3. There will be no restrictions vis a
vis area for these firms. They will, however, have to have at least half of
their loan portfolio comprised of advances and loans of up to INR 25 lakhs.

4. As per RBI, a SFB is required to
have 75 per cent of its adjusted net bank credit extended to priority sector. It
must also have at least twenty-five branches in unbanked rural areas.

5. They will have to abide by all the
rules set by the RBI, like the commercial banks. Some examples of these would
be their requirements of Cash Reserve Ratio (CRR) and the Statutory Liquidity
Ratio (SLR).

6. The selected banks must be well
networked and technologically updated from the very beginning, and have a well-structured
Customer Grievances department.

7. Their foreign shareholding will
have to follow the Foreign Direct Investment (FDI) policies for private sector
banks.

These
are the relevant details about SFBs. If you understand these points well, you
should be able to answer questions based on this topic.

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