Financial inclusion is one of the priorities of the current Government. It has been recognised that inclusion of a large section of the currently unbanked Indian population into the banking mainstream will not only foster growth but will also bring these individuals into the banking system. This will provide them access to savings instruments and also enable them to avail credit facilities hitherto unavailable to them. To this end, the Reserve Bank of India (RBI) has recently released Guidelines to set up of Small Finance Banks (SFBs) and Payments Banks (PBs).
The objective of SFBs is to further financial inclusion by (a) provision of savings vehicles and (b) supply of credit to small and marginal farmers, micro and small industries and other unorganised sector entities through high–technology, low-cost operations. For PBs, the objective is to (a) provide small savings accounts and (b) to provide payments/remittance facilities to migrant labour, small and low income households, unorganised sector entities and other users.
A few key points, which are relevant on a reading of these guidelines, are given below:
The guidelines provide that the SFBs as well as PBs will be constituted as companies. For both of these, one of the criteria for the eligibility to apply for respective licences is that the company must be owned and controlled by Indian residents. According to the prevailing foreign investment guidelines, a company is considered as “owned” by resident Indian citizens if more than 50% of its capital is beneficially owned by resident Indian citizens and/or by Indian companies which are ultimately owned and controlled by Indian citizens. “Control” is understood in the context of having the right to appoint a majority of Directors or to control the management policy decisions by virtue of shareholding or managements’ rights or shareholders’ agreements or voting agreements. This appears to indicate, unless clarified, that a foreign investor or indeed an Indian subsidiary of a foreign investor may not be eligible to set up these types of banks. In addition, for SFBs (but not for PBs) there is a prohibition on joint ventures of two different promoter groups coming together to form the bank.
As noted above, each of these banks has a distinct purpose behind its set up. The areas of operation of each of these banks are therefore, also defined in conformity therewith. For example, PBs cannot accept deposits such that the account balance is not more than INR100,000 per customer; some flexibility is however afforded in accepting and remitting money to and from pool accounts such that the day-end balance does not exceed INR100,000. SFBs have no restriction on the deposits they accept but have certain restrictions on their advances. They are required to extend 75% of their adjusted net bank credit to sectors eligible for classification as priority sectors by the RBI and at least 50% of an SFB’s portfolio must consist of loans and advances up to INR2.5 million.
The minimum capital requirement for each of these banks is mandated to be INR1 billion. These banks are expected to maintain a minimum capital adequacy ratio of 15% of their Risk Weighted Assets (RWAs) at all times. Tier I capital should be at least 7.5% of RWAs and Tier II capital cannot exceed Tier I capital. Moreover, a PB should have a leverage ratio of not less than 3%, i.e., its outside liabilities should not exceed 33.33 times its net worth (share capital plus reserves).
Other permissible activities
Each of these types of banks can carry on non-risk sharing simple financial activities, which does not require any commitment of their own funds such as distribution of mutual fund units, insurance products, pension products etc., with the prior approval of the RBI and after complying with requirements of the sectoral regulator for such products. An SFB, however, cannot be a business correspondent for any other bank but may have its own network of business correspondents. These banks will not be allowed to float subsidiaries for carrying on non-banking financial activities. If the promoters of these banks are carrying on these activities, these will need to be properly ring fenced from the banks’ activities.
High-technology, low-cost operations
Each of these banks is expected to make full use of technology to keep its operating costs as low as possible. In case of PB, however, branch network is as important as offering internet banking services and the guidelines explicitly say that a PB is not expected to be an “internet bank” or a “branchless bank”. The intention clearly is to be able to reach out to the unpenetrated and under penetrated section of the considerable Indian population.
Necessity, it is said, is the mother of invention. Looking at the crying need for a significant section of the Indian population, which currently does not have access to the banking network, the concept of differentiated banks that can reach out to this multitude and offer banking solutions to them is indeed laudable and welcome. It, however, is evidently not going to be a cake walk for players desiring to undertake this. The recipients of the differentiated banks’ services could probably take time to warm up to these players, which may need formidable reserves of patience and deep pockets. However, it promises the gratification of making a real difference to the society and to take the country forward on its growth trajectory. One is hopeful and indeed optimistic that SFBs and PBs can carve out their own distinctive niches in the country’s banking space.