Perspectives

Small Finance Banks : New

Category of Differentiated Banks
by Kamal Kishore
Abstract
In September 2015, Reserve Bank of India (RBI) announced in principle approval to ten entities for setting up yet
another category of differentiated banks, named as Small Finance Banks. Eight out of ten successful candidates are
already working as Micro Financing Institutions (MFIs). The primary objective of setting up of small finance banks is
to further promote financial inclusion by provision of savings and credit to small business units, small and marginal
farmers, and other unorganised sector entities, through high technology-low cost operations. The small finance
banks will have minimum paid-up equity capital of Rs. 100 crore with minimum initial promoter's contribution of
40% of paid-up equity capital of banks and locked in for a period of five years. Unlike Payment Banks earlier
announced a month ago, these banks are permitted to engage in lending activities and are subject to Reserve Bank of
India's (RBI) regulatory frame work for other universal banks. The entities granted approval for setting up new banks
have shown successful performance as MFIs, but will be faced with significant challenges while functioning in the new
role of small finance banks with different asset and liability products but have the potential to seize the opportunity
opened before them. The paper analyses various nuances of new kind of differentiated banks opened by RBI.

Keywords
Differentiated Banks, Financial Inclusion, Microfinance Institutions, Payment Banks, Small Finance Banks, Universal
Banks.

Introduction
On 16th September, 2015, Reserve Bank of India (RBI) announced in principle approval to ten entities for setting
up yet another category of differentiated banks, named as Small Finance Banks (RBI Press Release 1). This was a sequel to
earlier announcement by RBI on 19th August, 2015 granting in principle approval for setting up “Payment Banks” to eleven
entities. The primary objective of setting up of small finance banks is to further financial inclusion by (a) provision of
savings vehicles, 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-low cost operations (RBI, Guidelines 2014). Small Finance
Banks are in addition to two universal banks earlier licensed by RBI, viz. IDFC Bank and Bandhan Bank.
Differentiated banks are distinct from universal banks as they function in a niche segment. The differentiation
could be on account of capital requirement, scope of activities or area of operations (Gandhi, 2015). A Differentiated
Licensing Procedure for banks is an accepted practice internationally.
It is interesting to note that earlier also RBI did an experiment in 1996 with small banks by announcing setting up of
Local Area Banks (LABs). These banks were conceived as low cost structures, to provide efficient and competitive financial
intermediation services in a limited area of operation, i.e., primarily in rural and semi-urban areas, generally in three
contiguous districts. Presently, only four LABs are functioning.
The introduction of new category of niche banks followed the announcement made by the Finance Minister in the
first budget of new Government in July 2014 that “RBI will create a framework for licensing small banks and other
differentiated banks. Differentiated banks serving niche interests, local area banks, payment banks etc. are contemplated to
meet credit and remittance needs of small businesses, unorganized sector, low income households, farmers and migrant
work force”. Accordingly, keeping in view that small finance banks 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 in the country, RBI has
decided to license new “small finance banks” in the private sector.

FIIB Business Review. Volume 4, Issue 4, October - December 2015 13

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Literature Review
A Committee on Financial Sector Reforms,
headed by Dr. Raghuram G. Rajan, Governor, RBI, in 2009
had examined the relevance of small banks in the Indian
context. The Committee had opined that there was
sufficient change in the environment to warrant
experimentation with licensing of small banks. It
recommended allowing more entry to private well-
governed deposit-taking small finance banks (SFBs)
offsetting their higher risk from being geographically
focused by requiring higher capital, a strict prohibition
on related party transactions, and lower allowable
concentration norms (Rajan, 2009). Further, Nachiket
Mor Committee, on Comprehensive Financial Services
for Small Businesses and Low-Income Households,
suggested two broad designs for differentiated banks in
India - the Horizontally Differentiated Banking System
(HDBS) and the Vertically Differentiated Banking System
(VDBS) based on the functional building blocks of
payments, deposits and credit (More et al., 2014). This
initiated setting up of differentiated banks in the country.
The differentiated banks offer many advantages like
providing niche banking through differentiated
licensing, risk rationalization of specialized entities
operating in specialized areas (Gandhi, 2015). A good
reason for establishment of such banks was suggested as
- with Differentiated Banking Licenses, we will have
banks that do not face boom and bust at the same time.
Reduced correlations between banks will give lower
systemic risk. The presence of such banks will make the
system less monolithic and hence better placed to face
economic cycles (Kainth, 2014). But with the
introduction of differentiated bank licenses, newer
dimensions of banking would emerge and whether this
initiative would be able to fulfill the broader objective of
financial inclusion or is the idea of a differentiated bank a
little premature is a matter of discussion (Jain, 2014).
Objective of Study
The concept of differentiated banks, more so of
Small Finance Banks is new in India. Reserve Bank of
India (RBI), after lot of deliberations at various fora, has
taken lead in establishment of these banks and
announced regulatory guidelines for such banks and also
issued in principle approval to specified entities. The
objective of this study is to explore the concept of Small
Finance Banks as initiated in India as a category of
differentiated banks and its regulatory framework along
with financial and other credentials of entities granted
approval for this purpose.
FIIB Business Review. Volume 4, Issue 4, October - December 2015
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Perspectives
Data and Methodology
For the purpose of study, data and information
has been culled from various reports of Committees set
up by Government of India, Reserve Bank of India (RBI)
and other agencies. The regulatory nuances and details of
approved entities have been obtained from notifications
issued by RBI. The financial details of entities to be
granted licenses are as available on respective web sites.
Differentiated Banks
Differentiated banks are different from
universal banks which serve financial needs – payment,
deposit and credit- of all sectors. Differentiated banks
provide niche banking services in select verticals.
However, in a country like India, there is huge deficit of
financial inclusion and this has created need for
establishing differentiated banks catering to needs of
specially demarcated sectors in unbanked areas and
small businesses. In countries like USA, Australia,
Singapore, Hong Kong, Brazil, and Indonesia, differe-
ntiated banks system has prevailed for long time and
these banks are issued licenses for carrying out specific
activities. Some other “niche and specialised institutions
are the South Korean Post Office Bank (only payments
and deposits), GE Capital (credit and payments),
MasterCard and Visa (only payments)” (Gandhi, 2015).
The differentiated licensing policy is followed in
countries like Malaysia and Brazil even though financial
inclusion agenda is not important thrust area there. In
India, some initiative was taken in differentiated category
of banks in the form of Regional Rural Banks (RRB) and
Local Area Banks (LAB) aimed at serving the vital needs
of financial inclusion but it did not achieve desired results
and massive area of financial exclusion in India remains
unsatiated. This created a dire need to provide
accelerated impetus for aggressive financial inclusion
and starting banking institutions focused on such niche
segments. The result has been in principle licensing of
Small Finance Banks by RBI. The salient characteristics of
these banks in India, as announced by RBI, have been
delineated below.
Key Features of Small Finance Banks
These banks will be required to use the word
“Small Finance Banks” in their name to differentiate them
from other banks. Some of important features of small
finance banks are as under:
Incorporation
These banks will be registered as a public limited
company under the Companies Act, 2013 and will be

given scheduled bank status under provisions of the
Re s e r ve B a n k o f I n d i a Ac t , 1 9 3 4 . Re s i d e n t
individuals/professionals with 10 years of experience in
banking and finance and Companies and Societies owned
and controlled by residents were made eligible as
promoters to set up small finance banks. Existing Non-
Banking Finance Companies (NBFCs), Micro Finance
Institutions (MFIs) and Local Area Banks (LABs) owned
and controlled by residents were also allowed to opt for
conversion into small finance banks after complying with
all legal and regulatory requirements. However, joint
ventures by different promoter groups for the purpose of
setting up small finance banks were not permitted. As
local focus and the ability to serve smaller customers was
the key criteria in licensing such banks, local players or
players focused on lending to unserved/underserved
sections of the society were considered more
appropriate for such banks.
Financial Parameters
The small finance banks will have minimum
paid-up equity capital of Rs. 100 crore. In view of the
inherent risk of such banks, they will have to maintain a
minimum capital adequacy ratio of 15 % of risk weighted
assets (RWA) on a continuous basis, subject to any higher
percentage as may be prescribed by RBI from time to
time. The banks' Tier I capital will have to be at least 7.5
per cent of RWAs and Tier II capital will be limited to a
maximum of 100 per cent of total Tier I capital.
The minimum initial contribution of promoters
has been stipulated at 40% of the paid-up equity capital
of banks which will be locked in for a period of five years.
The promoter's stake has also to be brought down to 30
% in a period of 10 years and to 26 % in 12 years. Listing
for these banks shall be mandatory within three years
after they achieved net worth of Rs.500 crore. Further, as
per Banking Regulations Act, 1949, no shareholder can
have voting rights in excess of 10% and the same applies
to small banks as well. Any acquisition of 5% or more of
paid up share capital in a private sector bank will be
allowed with the prior approval of RBI.
However, it is noticed that International Finance
Corporation, the private investment arm of World Bank
has taken exposure of $114 million (approx Rs. 950
crore) in six of the ten MFIs given licenses of small finance
banks (Narasimhan, 2015). The MFIs include Equitas,
Ujjivan, Suryoday, Utkarsh, AU Financiers, Janakshmi
who got investment through debt and equity during
2010-12. IFC's shareholding in these institutions is in the
range of 15-20%. Combined with other foreign investors
including social investment funds and multilateral
FIIB Business Review. Volume 4, Issue 4, October - December 2015
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Perspectives
institutions, total foreign holding of these MFIs may be
around 70-90% and as per RBI guidelines, they will have
to draw a plan for diluting it to 40% in a time frame of 18
months (Vishwanathan, 2015). The foreign shareholding
in small finance banks can be up to 74% as per existing
guidelines for private sector banks with 49% under
automatic route and balance under approval route.
Scope of Activities
Small Finance Banks have been allowed to carry
on following activities:
acceptance of deposits and lending to unserved and
underserved sections including small business units,
small and marginal farmers, micro and small
industries and unorganised sector entities
other non-risk sharing simple financial services
activities, not requiring any commitment of own
fund, such as distribution of mutual fund units,
insurance products, pension products, etc. with the
prior approval of the RBI
become a Category II authorized dealer in foreign
exchange business for its clients' requirements
set up subsidiaries to undertake nonbanking
financial services activities.
The other financial and non-financial services
activities of the promoters, if any, will be kept distinctly
ring-fenced and not commingled with the banking
business. The operation of these banks will be required to
be technology driven from the beginning conforming to
generally accepted standards and norms. The annual
branch expansion plans of the small finance banks for the
initial five years would need prior approval of RBI. They
will be required to meet the requirement of opening at
least 25 per cent of its branches in unbanked rural
centers (population upto 9,999 as per the latest census).
Corporate Governance
The board of these banks should have majority
of independent directors. Further, these banks must have
a high powered Customer Grievance cell to handle
customer complaints and its operations will come under
the purview of RBI's Ombudsman Scheme.
Area of operation
There will not be any restriction in the area of
operations of small finance banks. RBI has, however,
given priority to those applicants who in the initial phase
set up the bank in a cluster of under-banked States/
districts, such as in the North-East, East and Central
regions of the country. These banks are expected to
primarily be responsive to local needs.
15
 Perspectives
Prudential Norms above entities was their proposed reach into unbanked
These new banks have to put in place a robust areas and underserved sections of the population. The
risk management framework. They will be subject to all final selections have been made after extensive
prudential norms and regulations of RBI as applicable to deliberations at various high powered committees. The
existing commercial banks including requirement of selected players have their headquarters based across
maintenance of Cash Reserve Ratio (CRR) and Statutory different regions of the country. There is one institution
Liquidity Ratio (SLR). No forbearance would be provided each from Ahmedabad, Jallandhar, Chennai, Thrissur,
for complying with the statutory provisions. The small Varansi, Guwahati, and two each from Mumbai, and
finance bank will be required to extend 75% of Credit to Bengaluru.
the sectors eligible for classification as priority sector Eight out of ten successful candidates are
lending (PSL) by RBI as against 40% for commercial already working as micro financing institutions (MFIs)
banks. While 40% of its credit will have to be allocated to and have been under supervision of RBI as Non Banking
different sub-sectors under PSL, balance 35% will be for Finance Companies (NBFCs). RBI decision to grant
any one or more sub-sectors under the PSL where it has approval to MFIs to float small banks is a bold step in the
competitive advantage. sense that in 2010, MFIs had seen a crisis particularly in
The maximum loan size and investment limit Andhra Pradesh and they have since then shown
exposure to a single and group would be restricted to performance with their viable business model to win the
10% and 15% of its capital funds, respectively. Further, in confidence of RBI. Many of them have been successful in
order to ensure that the bank extends loans primarily to extending credit to last mile poor villagers where banks
small borrowers, at least 50% of its loan portfolio should were not able to reach or were not successful in their
constitute loans and advances of up to Rs. 25 lakh. The operations. Another successful MFI has already
banks are also precluded from making any exposure to transformed in to a full-fledged universal bank and
their promoters, major share holders (shareholding started operations recently as Bandhan Bank after
more than 10%) and relatives of promoters and the getting license from RBI.
entities in which they have significant control.
MFI Finances
Entities approved for Small Finance Banks The successful business model followed by most
72 applications were received by RBI for setting MFIs attracted large investors, both domestic and
up small finance banks (RBI Press Release 2). On 16th international, to take equity stake in their capital. The
September, 2015, RBI granted in principle approval to International Finance Corporation, (IFC) Washington,
following ten entities to start Small Finance Banks (RBI belonging to the World Bank group, has itself invested in
Press Release 1): many of Indian MFIs showing confidence in their
Au Financiers (India) Ltd., Jaipur activities and business operations. This includes MFIs
Capital Local Area Bank Ltd., Jalandhar who have found favour by RBI in the grant of initial
Disha Microfin Private Ltd., Ahmedabad
Equitas Holdings P Limited, Chennai Table 1 : Performance of MFIs granted approval
ESAF Microfinance and Investments Private Ltd., for setting up Small Finance Banks
Chennai
Janalakshmi Financial Services Private Limited,
Outstanding
No. of Borrowers
S. No. MFI Loan Portfolio
(Rs cr) Branches (lacs)
Bengaluru
RGVN (North East) Microfinance Limited, Guwahati 1 Disha Micro finance 196 106 1.54
Suryoday Micro Finance Private Ltd., Navi Mumbai 2 Equitas Microfinance 2144 361 24.5
Ujjivan Financial Services Private Ltd., Bengaluru 3 Utkarsh Microfinance 978 277 7.85
Utkarsh Micro Finance Private Ltd., Varanasi 4 Suryoday Microfinance 738 166 6.22
The “in-principle” approval granted is valid for 5 Ujjivan Microfinance 3218 423 21.96
18 months to enable the applicants to comply with the
6 Janalakshmi Microfinance 3774 234 23.45
requirements under the Guidelines and fulfill other
conditions stipulated by the RBI where after RBI would 7 ESAF Microfinance 604 160 4.48
consider granting them a license for commencement of 8 RGVN(NE) Microfinance 229 107 2.27
banking business. Source: web sites of respective MFIs
An important factor considered in selection of

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license for establishing Small Finance Banks. IFC
(Washington)'s investment in six of ten entities is to the
tune of $114 million (around Rs 950 crore), made
through debt and equity (Narasimhan, 2015). These
MFIs are also known to have professional management.
The performance of eight MFIs who have been
given in principle approval has been quite encouraging
as shown in Table 1. All the above MFIs have more than
100 branches, one has more than 300 and one even in
excess of 400 signifying their reach to a significant
population of rural population. The MFIs already being in
lending space, the average number of borrowers is at the
level of 11 lacs, not small by any means and three MFIs
have borrowers more than 20 lacs each. The MFIs can
leverage this client base to their business advantage. The
loan portfolio that is outstanding represents good
performance by all MFIs from which they can take their
operations as bank to much higher levels. These MFIs
definitely can have confidence level to transform them to
successful small banks in near future.
Rural Measures Towards Financial Inclusion
In recent times, Government of India has
initiated several measures all aimed at small businesses
and individuals. The first one was launch of MUDRA bank
(Micro Units Development Refinance Agency) earlier in
the year which was slated to provide credit to small
businesses. The commercial banks are already under
obligation to earmark 40 % of credit to priority sector
which generally include small units and individuals.
Similar job has been mandated for Regional Rural Banks,
though they are currently showing distress signals being
unable to perform their basic functions. The Small
Industries Bank of India (SIDBI) has also earmarked good
amount of funds for small units' needs. Amidst these
institutions, have now come another genre of
differentiated banks, Payment Banks and lately Small
Finance Banks, the latter having been permitted to
undertake credit extension to small businesses and
individuals. They have been introduced in private sector
and are expected to compete with existing set up mostly
in public sector.
Prime Minister's Jan Dhan Yojana
Earlier in the year, Government introduced
another scheme in the name of Pradhan Mantri Jan-Dhan
Yojana (PMJDY, 2015), aimed at promoting financial
inclusion. The scheme seeks to provide banking and
financial services to small businesses and individuals in
an affordable manner. The scheme allows opening a bank
account even with zero balance.
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Perspectives
The progress of accounts opened under the scheme
as on 30th December, 2015 is as under:
Table 2 : Status of accounts opened in Jan-
Dhan Yojana
No of Accounts (in cr) Balance in % of Zero
S.
Bank group Accounts Balance
No.
Rural Urban Total (Rs.cr) Accounts
1 Public Sector Banks 8.61 6.93 15.54 23034.86 31.89
2 Rural Regional Bank 3.06 0.51 3.57 5025.66 29.67
3 Private Sector Banks 0.44 0.30 0.74 1165.04 40.57
Total 12.10 7.73 19.83 29225.56 31.81
Source: Prime Minister Jan-Dhan Yojana,
http://www.pmjdy.govt.in/accounts
This Yojana has already mobilised nearly twenty
crore accounts with whopping Rs 29,200 crore deposit
balance and 60% rural component. However, about 38 %
of accounts are zero balance accounts. The substantial
number of rural accounts, largely comprising low
balance, can be exploited by new category of banks,
Payment Banks and Small Finance Banks to tap the
potential of these accounts to their advantage. However,
as PM Jan Dhan Yojana is being channelized through
Public Sector Banks, these PSU banks ceding their
deposits to new niche banks will be difficult proposition
and will require some hard bargain to penetrate.
Other Differentiated Banks
Differentiated banks have been in existence in
many countries. In India, RRBs, LABs, Urban Cooperative
Banks (UCBs) were started as a type of differentiated
banks but they were covered under single licensing
system followed for all commercial banks. However,
these banks did not largely meet the expectations set up
for them. Looking at the need for aggressive steps for
financial inclusion, a conducive environment emerged
for new kind of differentiated banks particularly focused
on financial inclusion and small businesses. As a result, in
a space of one month, RBI has announced two different
categories of differentiated banks, Payment Banks and
Small Finance Banks. It is interesting to draw few points
of distinction between the two:
Both niche bank categories have primary objective to
deepen financial inclusion agenda, there are some
distinctive points to be noted. Both have been
allowed to raise deposits especially from rural areas.
While there is maximum limit of Rs one lac per
customer for Payment Banks, no such limit applies to
Small Finance Banks.
17

The Small Finance Banks have been allowed to
accept all types of deposits like commercial banks,
the Payment Banks have been allowed to confine to
savings and demand deposits only thereby
precluding them from mobilizing term deposits.
While Small Finance Banks have mandate to
undertake lending activities, payment banks are
precluded from the same as well as from issue of
credit cards. The first category of banks will
therefore be subject to prudential norms set by RBI.
However, their mandate is to service the unserved
and underserved sections including small business
units, small and marginal farmers, micro and small
industries and unorganised sector entities.
Both categories require minimum capital of Rs 100
crore. However, while Payment Banks have to retain
40% promoters share in paid up capital for first five
years, Small Banks are mandated to lower it to 26%
in twelve years.
Small Finance Banks and Contribution to
Financial Inclusion
The financial inclusion objective of Government
of India remains largely unmet despite slew of measures
taken in the form of Bank Nationalisation and extension
of their rural network, Regional Rural Banks,
Correspondent Banks and Self Help Groups (SHGs) etc.
The rural poverty in vast areas remains a bane of
independent India. People who are at the bottom of
pyramid need not only bank account but also small credit
facilities to start something for earning their livelihood
on continuous basis. Despite all the efforts of various
entities, to promote financial inclusion, a large section of
poor population remains deprived of normal banking
and payment facilities (Kishore, 2015). The institutional
mechanism has failed to address this desperate need
satisfactorily. Many MFIs have ventured in this area by
giving small loans to needy and surprisingly the credit
record reported by these MFIs inspires a lot of confidence
and may well have prompted to scale up their operations
by conversion to small banks under the new scheme of
RBI.
MFIs business model has been rooted in the very
areas in which they operate. They possess good
knowledge of local population and their needs and
conditions. Their operatives are also drawn from local
masses and they economized their establishment costs
through this. The MFIs selected for establishing new
category of banks have shown sound financial position
through their unique local rooted business model.
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Perspectives
Currently, MFIs have been raising resources
from banks and other borrowings. Some of them have
also garnered finances by raising capital from domestic
and international investors and venture funds. The cost
of deposits to be attracted from local people will
obviously be cheaper but it will be depend on their
capability to create a niche in this area. They will also be
competing with another niche segment announced by
RBI a month ago in the form of Payment banks, who will
face tougher challenge as being not able to be competitive
in deposit rates as their deployment of funds is largely
earmarked for Government securities with limited yield.
Challenges before Small Finance Banks
Setting up of small finance banks by approved
entities will entail many challenges in business front,
capital adequacy, product profile, HR and organisational
issues. Transition to a diversified financial institution
from credit based MFIs has its own ramifications. The
important ones of these challenges are as under:
The MFIs that have been granted approval for small
finance banks have proved themselves by their
successful performance. But in the changed
landscape of niche category of banks with changed
business model and subject to stricter regulatory
regime, it will be a big challenge for them to repeat
the magic of their earlier incarnation.
The range of products offered as MFIs were limited,
but as Small Finance Banks, these entities will be able
to extend their product range in terms of savings,
credit, insurance, remittances etc. and also increase
the ticket size of their offerings including much
untapped micro enterprise sector. In addition, they
will have the freedom to add many new products
with innovation like agricultural finance, affordable
housing and used vehicles-both private and
commercial. Those banks which display a significant
ability to innovate, both on liability and asset side
products, with extensive use of technology will
acquire the edge as a successful niche bank. Many
MFIs are already working on this challenging
domain.
RBI guidelines stipulate that Small Finance Banks
must have promoter shareholding of 40% and
domestic holding of at least 51%. Most of MFIs given
approval for banks have much higher foreign
shareholding in the region of 70-90% from social
investment funds, multilateral investment
institutions and private equity funds (Vishwanathan,
2015). NBFCs in India are allowed 100% Foreign
Direct Investment (FDI) under automatic route.

Thus, many MFIs seeking bank transformation will
be required to draw a clear plan of diluting foreign
equity and garner alternative domestic capital
within the time frame of 18 months allowed by RBI.
Maintaining domestic stake to 51% itself, given the
level of foreign equity stake, is a difficult challenge.
Both these aspects are going to be tough task for
most MFIs.
The new banks will also face tough challenge to
comply with capital adequacy and other regulatory
norms relating to SLR and CRR which may pose
pressure on earnings of the banks.
The MFIs have been able to raise equity with promise
of rate of return expected by their equity suppliers
both from India and international agencies as they
were not subjected to many regulatory norms which
will now become applicable to them as banks.
Raising equity with existing rate of return will be
challenge for them.
As MFIs, the new entities were faced with marginal
or no default in loans. Lending defaults and their
managements with gradually increased size of loans
above MFI norms will be a new and daunting
challenge. They will also face issues relating to loan
security and much expanded documentation issues
which were of modest nature in MFI structure.
As MFI, small banks were mainly dealing with
different type of MFI specific products which will
need total shift in banking operations in terms of
mindset and HR policies. New hiring for this purpose
with enhanced salaries will be a difficult proposition
to face. The organizational dynamics and change
management will be key issues for management to
handle.
The size of business products on liability and asset
side will suddenly change for erstwhile MFIs which
had little experience in such dispensation. This will
require a change of business mindset and ability to
transform quickly in the new environment. The new
outfits will have to acquire proficiency in new areas
such as treasury, risk management , NPA
management, core banking solutions, Management
Information systems, strategic management in
banking arena etc.
The new category of banks will also face severe fund
requirements in terms of branch infrastructure,
upgradation of IT/MIS systems, setting up new
departments to deal with risk management, treasury
and investments, new processes staff training etc.
Such large scale changes and consequent
investments will have a break-even time of 3-5 years,
FIIB Business Review. Volume 4, Issue 4, October - December 2015
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Perspectives
depending on the quantum of expenses and revenue
(Singh et. al. 2015).
These banks will have to face competition from
existing players in banking space like public sector
banks which have a wide network of rural branches,
regional rural banks already functioning in this
segment, MUDRA bank and PM Jan Dhan Yojana of
the Government and recent launch of Payment Banks
- both in deposit and lending as well in dispensation
of financial services. The cost of deposits for new
banks is likely to be not cost efficient in the beginning
as ticket size of deposits will be small and
mobilization cost may be stretched.
Like all other banks, small banks will be subject to
regulatory directions of RBI from time to time. The
Central Bank reviews its regulatory stance whenever
warranted in the overall interests of public and
economy of the country. The new banks will have to
learn to adjust them to such regulatory environment
which will be stricter than they have experienced as
MFIs.
Transition to Universal Bank
The Small Finance Banks can have long term
objective to convert themselves to universal banks in due
course of time. The RBI guidelines have set the tone for
such conversion. The conversion will, however, be
permissible after five years of satisfactory track record of
operations as small finance bank and will require RBI
approval.
Conclusion
The introduction of Small Finance Banks is a
giant leap towards financial inclusion to meet the much
cherished objectives of the Government. Despite many
concerns and challenges, these new differentiated banks
along with earlier announced Payment Banks, present a
good strategy to deepen the financial inclusion agenda.
However, looking at the size of the country, ten numbers
of such banks may not be adequate and need to be
expanded substantially if financial inclusion has to get
real and substantial push on a nationwide scale. RBI has
announced its intention to allow more such banks in
future after watching experience of first lot. These banks
can surely add to financial literacy of rural masses and
can target segments that are not already serviced by
existing banks in effective dispensation of banking
products and services at grass root levels. By innovative
use of technology, these entities can provide ease and
convenience to customers in so far excluded areas and
thereby convert the challenges faced by them into
19

opportunities. Even though they may face competition
from existing universal banks, they can pose challenges
to them by chipping away their rural deposits and making
inroads into their priority sector obligations. Most of
these MFIs have shown large reach and can shake up their
micro finance business to exploit the excellent
opportunity sprung up in new format. The selected band
of MFIs now appears to be ready for transformation into
Perspectives
Small Finance Banks to harness the potential
opportunity given to them. Much will, however, depend
on their business plans, products range and their
competence to transform and manage the banking
business with efficiency and in a profitable manner and
in combating many other challenges. In Indian scenario,
looking at past experiences, any financial inclusion
agenda can deliver results only if it is dispensed through a
financially viable business venture.

References and Links
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Author Profile

Prof. Kamal Kishore has held senior executive positions in banks and financial institutions for thirty years. He has been a Director on the Boards of more
than thirty companies and chairman of two companies. After his valuable experience in corporate sector, he joined academics in last ten years and
presently is Professor of Finance in Apeejay School of Management, New Delhi. His areas of interest are banking, project finance, corporate
restructuring and corporate laws. He can be reached at kamalk1951@yahoo.co.in

FIIB Business Review. Volume 4, Issue 4, October - December 2015

Electronic copy available at: https://ssrn.com/abstract=2780286