The Reserve Bank of India (RBI) has recently become a topic of discussion in the financial world as it has collected applications from two more entities. Following the “on-tap” small finance bank licensing guidelines set in 2019, these institutions aim to provide financial services throughout the year, reaching out to unserved and unbanked areas of the country.
Understanding Small Finance Banks
Small Finance Banks (SFBs) are financial institutions that operate as public limited companies under the Companies Act, 2013. These banks target the unserved and unbanked regions, providing much-needed financial services. As per regulations, SFBs need to ensure that at least 25% of their banking outlets are in unbanked rural centres, extending 75% of their adjusted net bank credit to the Priority Sector Lending (PSL).
Loan and Investment Restrictions
There are certain rules regarding the loan and investment activities of SFBs. The RBI mandates SFBs to distribute 50% of their loan portfolio as loans and advances of up to Rs. 25 lakhs. In addition, they cannot extend large loans, and the maximum size for loans and investment limit exposure for a single and group debtor is restricted to 10% and 15% of capital funds, respectively.
Shareholding and Cash Requirements
When it comes to shareholding, regulations state that if the initial shareholding by promoters in an SFB stands above 40% of paid-up voting equity capital, it must be reduced within 5 years. Banks are required to hold a certain ratio of their deposits as cash reserve ratio (CRR) and Statutory Liquidity Ratio (SLR), determined by the RBI.
Who Can Set Up Small Finance Banks?
Eligibility criteria for setting up SFBs include resident individuals or professionals with banking and finance experience of 10 years. Companies, societies, existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), Local Area Banks (LABs), and payment banks owned and controlled by residents also qualify.
Permitted Activities for Small Finance Banks
SFBs’ primary function is to undertake basic banking activities. These include accepting deposits and lending to underserved sections such as small business units, small and marginal farmers, micro and small industries, and unorganized sector entities. With the RBI’s approval, SFBs may also distribute non-risk sharing financial services like mutual fund units, insurance products, and pension products.
Governing Laws and Regulations
Several acts govern the functioning of SFBs, including the Reserve Bank of India Act, 1934, Banking Regulation Act, 1949, Foreign Exchange Management Act, 1999, Payment and Settlement Systems Act, 2007, and others. The RBI and other regulators issue directives from time to time.
‘On-Tap’ Licensing Guidelines
For an entity to qualify for an ‘on-tap’ license, they must meet a minimum paid-up voting equity capital or net worth requirement of Rs. 200 crores. Those Primary (Urban) Co-operative Banks (UCBs) transitioning into SFBs voluntarily initially require a net worth of Rs. 100 crores, which should reach Rs. 200 crores within five years from the start of business.
Scheduled Bank Status and Payments Banks Conversion
Newly inaugurated SFBs are awarded scheduled bank status immediately. Payment banks can apply for conversion into SFB after operating for five years, provided they meet all the guidelines.
Understanding Scheduled Banks
Scheduled banks are those included in the Reserve Bank of India Act, 1934’s second schedule. To qualify as a scheduled bank, the bank must have a paid-up capital and raised funds of at least Rs. 5 lakh. Membership in clearinghouses and low-interest loans from the RBI are some benefits awarded to scheduled banks, which include all commercial banks such as nationalized, international, cooperative, and regional rural banks.
