Abstract

Small Finance Banks (SFBs) primarily play the pivotal role in providing basic banking activities of acceptance of deposits and lending to unserved and underserved sections like the unorganised sector, small and marginal farmers, micro-enterprises, and low-income households. As such, they serve as a very crucial cog in the wheel of the Indian financial sector and economy. Although the combined market share of the SFBs is just close to 1 percent of the total assets deposits of the banking system, within the small borrower category (i.e. up to INR 2 Lac), they have a market share of 6 percent in amount and 9 percent in accounts.

In spite of being relatively newer entrants in the banking system, created as part of RBI’s overall strategy to improve differentiated banking in India (with different business orientation and exposure than other SCBs), these banks have so far been a success story, growing at a rapid pace, much higher than other banking groups, with better profitability and asset quality parameters. Their GNPA and NNPA are much lower than mainstream banks, while their Net Interest Margin (spreads) and Return on Assets are higher despite the higher cost of funds. However, the pandemic had posed greater challenges to them as the segment of society they serve had been hit the hardest. These entities have their inherent strengths and close customer connections and provide tech-based affordable financial services to people of smaller means and further financial inclusion. However, there are certain gaps and weaknesses they have to overcome in order to sustain their growth and stay competitive and profitable. If they work towards and improve upon the five ‘P’s, i.e. Planning, Policies, Processes, Prudence and People, the future augurs well for them.

Small finance banks: Brief overview

Reserve Bank of India (RBI) placed on its website on August 27, 2013 a policy discussion paper on Banking Structure in India - The Way Forward. One of the observations in the discussion paper was that in India, where extending banking services to the underserved and unserved sections of the population is a challenge, there is merit in considering access to bank credit and services through the expansion of small banks in unbanked and under-banked regions.

Based on the Nachiket Mor Committee report, RBI released guidelines for licensing small finance banks in the private sector on November 27, 2014. The objective of setting up small finance banks was to further financial inclusion by (i) provision of savings vehicles, primarily to unserved and underserved, and (ii) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology and low-cost operations.

Subsequently, operating guidelines were issued to SFBs on October 06, 2016. Since then, a total of 12 Small Finance Banks (SFBs) have commenced operations pursuant to the issuance of banking licenses to them under Section 22 of the Banking Regulations Act 1949, the latest entrants being Shivalik SFB which got the licence on January 1, 2021 and started its operations as SFB on April 26, 2021, and Unity SFB which got the licence on October 12, 2021 and commenced operations w.e.f. November 1, 2021.