Small Finance Banks (SFB) are financial institutions that provide financial services to the country's unserved and unbanked areas. According to the Companies Act of 2013, they are incorporated as a public limited company. As per RBI guidelines, they are 'niche' or 'differentiated' banks with the common goal of increasing financial inclusion.

What Small Finance Banks?

• The Small Finance Bank is a private financial institution that primarily undertakes basic banking activities such as deposit acceptance and lending to unserved segments such as small business units, small and marginal farmers, micro and small industries, and unorganised sector entities.
• Unlike RRBs or Local Area Banks, these are private financial institutions with the goal of financial inclusion and without any geographical restrictions.
• They were proposed by the RBI's Nachiket Mor Committee as one of the differentiated banking systems for credit outreach
• Small Finance Banks were established in response to an announcement made in the Union Budget 2014-2015, which was presented on July 10, 2014.
• On November 27, 2014, the RBI issued guidelines for the licencing and regulation of SFBs.
• On September 16, 2015, the RBI decided to grant "in-principle" approval to ten applicants to establish small finance banks in order to advance the financial inclusion agenda.
• The above-mentioned banks were chosen from a pool of 72 applicants. Customers' deposits will be accepted by small finance banks.
• In addition, unlike payments banks, small finance banks will be permitted to lend money to individuals.
• Microfinance institutions make up the majority of those who have received the 'in-principle' approval.
• As a result, the majority of small finance bank customers will be small and medium enterprises and small businesses.
• These banks will now be able to provide MSMEs and SMEs with secured and legal loans, bringing them into the financial system.

Small Finance Banks – Objectives

• To increase financial inclusion by providing savings vehicles to underserved and unserved segments of the population.
• To provide credit to small farmers, micro and small businesses, and other unorganised sector entities through high-tech, low-cost operations.
• Toprovide a full suite of basic banking products, such as deposits and credit supply, but in a limited geographic area.

Small Finance Banks – Important Guidelines

• SFBs will be granted scheduled bank status once they begin operations and are deemed suitable under Section 42 of the Reserve Bank of India Act, 1934.
• Except for small finance banks converted from UCBs, the minimum paid-up voting equity capital for small finance banks shall be Rs.200 crore.
• SFBs must keep a Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR).
• They are required to extend 75% of their Adjusted Net Bank Credit (ANBC) to sectors eligible for priority sector lending as per RBI. At least 50% of its loan portfolio should be made up of loans and advances of up to Rs. 25 lakh.
• SFBs can also transfer to a universal bank if they meet the minimum paid-up capital/net worth requirements of universal banks.
• They are not permitted to work as a Business Correspondent (BC) for another bank. They can, however, have their own BC network.
• They must follow the corporate governance guidelines, including the RBI's 'fit and proper’ criteria for directors.

Small Finance Banks – Significance

• It servesa large population – India has the world's second-largest unbanked population, with more than 200 million people lacking a bank account and relying on cash or informal financing.
• Sincetheir primary focus is on the unserved and underserved segments, SFBs play an important role in the priority sector lending space.
• It promotes financial inclusion for women by providing loans to women. Female customers also have access to full banking services.
• SFBs are now looking beyond the simple metric of "income improvement" to other indicators of positive social impact. SFBs not only provide banking solutions but also empower the socioeconomic progress of their customers.

Small Finance Banks – Limitations

• So far, small banks have not been a roaring success anywhere in the world.
• Small banks have existed in India for a long time, but their impact has been limited.
• Building a retail deposit portfolio is a significant challenge, and existing public and private sector banks have a competitive advantage due to their strong brands.
• The new small finance banks will face fiercecompetition from NBFCs such asMahindra Finance,with revenues of around Rs 5,000 crore and profits of nearly Rs 1,000 crore. Ithas shaped its business model to focus on lending to farmers and the unemployed.
• Some of the older private banks, such as RBL Bank, are also sprucing up their acts, installing cutting-edge technology, luring talent from leading private and foreign banks, and expanding their national footprint. They may also emerge as rivals to the new small banks.
• Even the largest private banks are becoming more interested in non-metros than they were previously. HDFC Bank, for example, is opening 90 per cent of its new branches in semi-urban and rural areas.
• Existing MFIs are also competitors, especially with the Centre establishing the Micro Units Development Refinance Agency (MUDRA) Bank, which will provide MFIs with refinancing support.

Conclusion

With more players competing in the rural financial services landscape, the new small finance banks are likely to reshape India's banking sector. The immediate challenges for these banks are building a liability product portfolio, meeting statutory cash reserve ratio requirements, improving digital connectivity with a large rural customer base, and designing cost-effective banking solutions. These new banks have yet to develop an innovative banking business model that will pave the way for differentiated banking.