Current Affairs

Small finance banks

Small finance banks

News

Reserve Bank of India has accorded “in-principal” approval for 10 small finance banks that will focus on small geographies for operations but with a strong capital base.

Analysis

In 2009, a Committee on Financial Sector Reforms under Raghuram Rajan, now the RBI governor, had examined the relevance of small banks in the Indian context. The panel felt there was sufficient change in the environment to experiment with small banks.

It recommended the entry of private well-governed deposit-taking small finance banks to offset their higher risk from being geographically focused, by requiring a higher capital and strict norms.

Objective

The objectives of setting up of small finance banks will be to further financial inclusion by

  • provision of savings vehicles, and
  • Supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations.

Scope of activities :

  1. The small finance bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganised sector entities.
  2. There will not be any restriction in the area of operations of small finance banks.

Capital requirement:

The minimum paid-up equity capital for small finance banks shall be Rs. 100 crore.

Need for Small finance banks

  • Unlike the payments banks, which can take deposits but not provide credit except to the government, the small finance banks are essentially scaled down versions of commercial banks, with both deposit-taking and loan-making functions.
  • SFBs are required to provide at least 75 per cent of their loans to borrowers classified as priority sector and at least 50 per cent of their loans must be below Rs 75 lakh.
  • Unlike the licensees for the payments banks, which was quite a heterogeneous group comprising telecom companies and prepaid instrument providers among others, this group is relatively homogeneous, mostly comprising non-banking financial companies in the microfinance sector.
  • Commercial banks are largely interested in funding large and medium corporations, or giving out loans for home and vehicle purchases.
  • It is not easy for diamond cutting and polishing units, job work fabricators or small restaurant owners to get working capital finance support. Lending to them is a specialised affair, which cannot be carried out by commercial banks effectively.
  • These are segments where regular banks have gradually withdrawn, with their place being partly taken by various non-banking financial companies. SFBs can probably do even better in filling the gap.
  • Regional rural and urban cooperative banks have not been effectively providing finance to needy sections due to various reasons like fixed cost, political interference etc.

Issues

  • In the case of the payments banks, the success of the Prime Minister’s Jan Dhan Yojana in achieving virtually full penetration of no-frills accounts may prove to be a constraint in their pursuit of deposit accounts.
  •  For the small finance banks, this will also be a challenge; both groups will have to persuade a large number of potential customers to either switch from commercial banks or open up a second account.
  • Beyond this, on the loan side of the business, as they seek to grow their lending volumes, they will be in direct competition with the priority sector mandates of commercial banks.
  • State-run banks, which used to have dominance in rural areas of the country with their reach, will find competition tougher if the new set of banks hit the market with competitive rates of interest to poach customers. Public banks will have to work harder.

Question:

Recently Reserve Bank of India (RBI) granted 10 entities in-principle licences to open small finance banks (SMB). Critically analyse how SMB will expand access to financial services in rural and semi-urban areas?

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