A small kid asked me whether he/she could set up a small finance bank and help his relatives living in a small village in Himachal Pradesh. To answer this question and being a retired senior executive from a nationalized bank who worked in the department dealing with financing small borrowers in late 1970s, I was lucky to come across RBI’s Draft guidelines for ‘on tap’ Licensing of Small Finance Banks in the private sector which was issued on September 13,2019.
The historical reference is Reserve Bank of India’s guidelines for Licensing of Small Finance Banks in the private sector on November 27, 2014. Ten applicants took the bait and gave immense value to the concept which has ushered in licensing on tap for any one. What big and highly bloated private/public banks could not achieve for the smallest borrower, the small banks actually showed the way to serve.
Now let us proceed to answer the questions of the kid who initiated this article.
What is the procedure to get registration, licensing and know the regulations?
The small bank shall be registered as a public limited company under Companies Act 2013. The following acts would be applicable in case of them:
The small finance banks gather steam as scheduled bank after commencement of their operations.
So, what for should I set up this small finance bank?
A simple answer. To develop financial inclusion by provision of savings vehicles primarily to unserved and underserved sections of the population, and to supply credit to small business units, small and marginal farmers, micro and small industries and other unorganized sector entities through high technology-low cost operations.
What are the eligibility criteria?
Resident individuals/professionals with Indian citizenship either singly or jointly with minimum 10 years of experience in banking/finance at a reasonably senior level and Companies/Societies in the private sector owned by residents and having successful track record of running business for at least 5 years will be eligible as promotors of small finance banks. Yes, capacity to serve local people, particularly in unbanked or underserved areas will be the main capability to float these banks. It is a plain truth that big ones, either industrial empires, public sector units or public sector banks or state undertakings fail this test. A big group with assets of Rs. 5000 crore or more with non-financial business accounting for 40 per cent or more in terms of total assets/gross income is automatically qualified as a large industrial house and hence fails the test.
‘Fit and Proper’ criteria
Promotors must be fit and proper as per the definition of RBI which explains it as persons of integrity, past record with impressive credentials and successful track record in business. I presume immense value will be added for promotors free from scandals, bankruptcy or illegal past- activities.
The small bank can survive as a standalone entity or under a holding company which shall work as a promoting entity of the bank.
Scope of activities
One has to answer what will be the scope of activities to be undertaken by the small finance bank. Yes, as the name indicates it should undertake basic banking activities like taking deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized sector entities. How will it look like in real life situation?
After setting up a small physical structure, the bank through its representatives would visit any number of villages, meet the deposit holders, encourage them to save and put the money in the bank. Let us not presume that the villagers did not learn the basics of banking. The recent activities of the central government to directly transfer funds to villagers have enabled them to learn the tricks of the trade. It is equally apt to say that unless the bankers live in the villages, move with them like relatives and do not have any halo around them, the villagers will not believe them.
The credit needs may be met at any time and in any scale within the permissible limits but unlike commercial and large banks who failed to reach the smallest man and catered to his credit requirements.
Laxity has also been given to allow the small finance banks to undertake non-banking service like selling insurance products, pension or mutual funds with the prior approval of RBI and of course, meeting the relevant approval of regulators. However, RBI has totally waived its role by allowing them to work like scheduled commercial banks after three years of successful operation.
They can also become Category 2 authorized dealer in foreign exchange to meet its clients’ requirements.
The banks have blanket approval from RBI to open branches provided at least 25% of its branches will be opened in unbanked rural centers (population up to 9,999 as per the latest census).
It has been stated that the small banks are expected to work in unbanked cluster of places in North-East, East and Central regions though after 5 years of successful functioning they may expand anywhere as the business grows. Expectedly, the name “Small Finance Bank” will distinguish these banks from other scheduled commercial banks.
The minimum paid-up voting equity capital for small finance banks will be Rs.200 Crore except where they are converted from UCBs, the capital requirement may vary.
In view of the inherent risk of a small finance bank, it may be required to maintain a minimum capital adequacy ratio of 15 per cent of its risk weighted assets (RWA) on a continuous basis, subject to any higher requirements by RBI from time to time. Tier I capital should be at least 7.5 per cent of RWAs. Tier II capital should be limited to a maximum of 100 per cent of total Tier I capital. Basel II norms will be generally applicable to the small finance banks. This will strengthen the financial structure of these banks.
The promoters shall hold a minimum of 40 per cent of the paid-up voting equity capital with a lock in period of 5 years from the date of commencement. The promotors are expected to reduce their holding to 30% at the end of 10 years with further reduction to 15% at the end of 15 years.
When the said banks reach a net worth of Rs.500 Crore, listing in stock exchange is compulsory within 3 years of reaching that net worth.
As per the norms prescribed for private sector banks, foreign holding of shares will be as per Foreign Direct Investment guidelines issued by central government.
As per Banking Regulation Act 1949, read with further guidelines from RBI, any shareholders voting rights have been capped at 26% of all shareholders voting rights.
With the past trends noted from the regulatory control exercised by RBI, the small finance banks are expected to maintain all prudential norms such as Cash Reserve Ratio and Statutory Liquidity Ratio.
The maximum loan size and investment limit exposure to a single and group obligor have been restricted to 10% and 15% of capital funds. At least 50% of its loan portfolio would be up to Rs 25 lakh on an ongoing basis. Suitable restrictions for extending loans to its 10% or more share-holders have been stipulated.
It is not unexpected that RBI has insisted on a business plan for the small finance bank to be prepared on a rational basis and also on pure commercial considerations. History has consistently shown that doing business in rural or unbanked areas has not been a pleasant experience for its owners unless the social commitment element is not mixed thereon. RBI may take stringent action if terms of business plan are violated.
Majority of directors of the bank have to be independent directors. Recent evolution of upgradation of the requirements of independent directors and their role would equally apply in the case of small finance banks also. Being a service-oriented industry, the directors may take up the assignments as social service than pure commercial or money- making professions.
Procedure for application
In terms of Rule 11 of the Banking Regulation (Companies) Rules, 1949, applications are expected to be submitted in the prescribed form (Form III). In addition, the applicants should furnish the business plan as per paragraph 11 and other requisite information contained in Annex II. Application for small finance bank may be submitted to the following address:
The Chief General Manager,
Department of Banking Regulation,
Reserve Bank of India, Central Office,
13th Floor, Central Office Building,
Shahid Bhagat Singh Road,
Mumbai – 400001.
Let us look at time span that may be taken by RBI for its customary approval.
The guidelines issued by RBI contain the following detailed forms to be submitted in connection with opening of small finance bank.
Evolution of commercial banks, setting up of regional rural banks and other types of banks have again and again shown that adequate social commitments have not been shown by the central government or state governments to serve the rural areas. With massive resources invested to serve the rural areas, commensurate results could not be shown. Recent deaths among agriculturists and small traders have again forced RBI to bring the concept of Small Finance Banks on tap, explaining a new concept of any time setting up of banks with proper fit and care as they call the promotors or their ideals to serve the poor. The author with his 4 decades of banking/finance experience is delighted with the evolution of relegation of setting up of these banks to private sector rather than the government itself. It will be a fitting tribute to expect great success from Small Finance Banks.
RBI draft guidelines for ‘on tap’ Licensing of Small Finance Banks in the private sector.(dated September13,2019)