Q.) What are small finance banks? Discuss the challenges associated with it?

(400 Words)

Small Finance Banks (SFBs) are a type differentiated or niche banks introduced by the RBI in 2014.
The primary aim of the bank is to deepen the financial inclusion in the underserved and unserved
regions of our country, where universal banks is insufficient.

SFBs have been instrumental in providing last mile services and increasing the financial inclusion
score to 60.1 as on March 2023, as envisaged in the Financial Inclusion Index by RBI . However,
there are certain challenges due to which they haven’t reach the heights of success that they should
have been. Some of the major challenges are listed below:

1. Low Deposit Growth: The prefix “Small” is one of the biggest hurdle in mobilizing the low
cost deposits. Prospective depositors are worried about depositing their money in these
banks due to presence of word “Small” in it. They might feel that their money isn’t safe here,
as compared to nationalized banks.

2. High Cost of Deposits: As depositors are reluctant to park money in the small finance banks,
they often have to give higher interest rates on the deposits as compared to universal banks.
This has to be done to attract the depositors. The cost of funds can come down by 20 basis
points by just removing the name of “small” before such banks

3. Tight Liquidity (High CRAR): The RBI has put tighter capital requirements on SFBs, as the
money deposited in such banks are mostly of the lower or middle income groups. Higher
capital requirement i.e. CRAR of 15% of risk weighted assets has to be maintained, which is
the reason behind the tight liquidity.

4. Major Focus on Priority Lending Sectors: As SFBs have a total priority sector lending target of
75% of ANBC or CEOBE whichever is higher against the universal banks of 40%, it doesn’t
allow SFBs to better manage its loan portfolio.

5. Restriction on opening subsidiaries: SFBs cannot set up any subsidiary that offers non-
banking financial services like life insurance companies, asset management companies, stock
broking companies and amongst others. Less diversification of the business restricts its
profitability.

The challenge faced by the Small Finance Banks can be observed very evidently in an
economy. High low cost deposit growth, diversification of loans, loose liquidity restrictions
and step up by RBI in granting these banks a universal bank status are some of the ways to
mitigate the challenges.

Written By: Rahul Kopulwar

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