The Reserve Bank of India has granted in-principle approval to Saharanpur-based Shivalik Mercantile Cooperative Bank to convert into a small finance bank (SFB), making it the first such lender to have opted for the transition. The lender now has 18 months to adhere to all the conditions required to get the final SFB licence from the RBI.

On being satisfied that Shivalik has complied with the conditions, the RBI would consider granting it a licence for the commencement of banking business under Section 22 (1) of the Banking Regulation Act, 1949, as an SFB.

Small finance banks

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.

An experiment with small banks was taken up following an announcement made by the finance minister in the Union Budget in August 1996, and the RBI issued guidelines for setting up of Local Area Banks (LABs).

The LABs were conceived as low-cost structures which would provide efficient and competitive financial intermediation services in a limited area of operation, i.e., primarily in rural and semi-urban areas. LABs were required to have a minimum capital of Rs 5 crore and an area of operation comprising three contiguous districts. Presently, four LABs are functioning satisfactorily.

Taking into account the above and that SFBs can play an important role in the supply of credit to micro and small enterprises, agriculture and banking services in unbanked and under-banked regions, the RBI has decided to give licences to SFBs in the private sector.

While permitting small banks, however, the issues relating to their size, capital requirements, area of operations, exposure norms, regulatory prescriptions, corporate governance and resolution need to be suitably addressed in the light of experience gained. Hence, the RBI has come out with guidelines for licensing of SFBs in the private sector.

The objectives of setting up of SFBs 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.

Who is eligible to apply for an SFB licence?

The business model of SFBs is such that they are aimed to serve small borrowers. Due to this, the RBI has shut the door on big business houses from entering the business of SFBs.

According to RBI guidelines, the eligible entities / persons to apply for SFBs include…

* Resident individuals / professionals with 10 years of experience in banking and finance. Companies and societies owned and controlled by such individuals.

* Further, NBFCs, microfinance institutions and LABs owned and controlled by residents can also opt for conversion into SFBs.

* The RBI has also stipulated the ‘fit and proper’ criteria for such persons and groups. They must have a sound track record of professional experience or of running their businesses for at least five years.

* Applicants with a business plan to serve under-banked regions and Northeastern states will be preferred for the licence, and they will be permitted to expand nationally after a few years.

Scope of activities

The RBI has not put any restrictions on the operations of SFBs. They are meant to provide basic banking facilities to small businesses.

Minimum paid-up equity capital

SFBs should have a minimum capital of Rs 100 crore and maintain a capital adequacy of 15 per cent. Further, minimum initial contribution of the promoter to the paid-up capital shall be 40 per cent and they can bring down their holding to 26 per cent in 12 years from start. The RBI makes listing mandatory once the net worth reaches Rs 500 crore.

Prudential norms

SFBs will be subject to all prudential norms and regulations of the RBI as applicable to other commercial banks.

Business model

The SFB model is for local or niche players. Since the objective behind the establishment of such banks is to serve unbanked and marginal customers, they have been mandated to extend 75 per cent of their credit to priority sector lending. Further, at least half of these loans should be below Rs 25 lakh.

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