Meeting with Small finance banks representatives with banking regulator

With merely 8 months remaining to start operations, small finance banks are facing headwinds to open 25% of their total branches in unbanked areas as it will impact their profitability. Hence, in a recent meeting with the banking regulator, the small finance bank representatives have requested the regulator to give them three years to comply with the norms.

Concerns:

• According to them, the cost of opening or converting the present microfinance institutions branches into full-fledged bank branches is higher. Therefore, one year will be very challenging from the profitability point of view for these institutions.
• The other issue that is posing a hurdle is that compliance with the Basel norms. According to the guidelines for small finance banks, RBI had said as small finance banks are not expected to deal with sophisticated products, the capital adequacy ratio will be computed under Basel Committee’s standardised approaches. 

Background:

The Reserve Bank of India (RBI) has mandated that the small finance banks have to open at least 25% of their branches in unbanked rural areas within one year of their operations. Unbanked rural areas are the centres having a population less than 9,999 as per latest census.

In September 2015, RBI granted in-principle licences to 10 entities to start small finance banks. These entities will have to start operations within 18 months, else the licences will lapse. Out of the 10, nine entities were predominantly involved in microlending. Only one entity, out of 10 that received licences, has commenced operations – Jalandhar headquartered Capital Small Finance Bank, which was a local area bank earlier.

What are small finance banks?

The small finance bank will primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized sector entities.

What they can do:

• Take small deposits and disburse loans.
• Distribute mutual funds, insurance products and other simple third-party financial products.
• Lend 75% of their total adjusted net bank credit to priority sector.
• Maximum loan size would be 10% of capital funds to single borrower, 15% to a group.
• Minimum 50% of loans should be up to 25 lakhs.

What they cannot do:

• Lend to big corporates and groups.
• Cannot open branches without  prior RBI approval for first five years.
• Other financial activities of the promoter must not mingle with the bank.
• It cannot set up subsidiaries to undertake non-banking financial services activities.
• Cannot be a business correspondent of any bank.

The guidelines they need to follow:

• Promoter must contribute minimum 40% equity capital and should be brought down to 30% in 10 years.
• Minimum paid-up capital would be Rs 100 cr.
• Capital adequacy ratio should be 15% of risk weighted assets, Tier-I should be 7.5%.
• Foreign shareholding capped at 74% of paid capital, FPIs cannot hold more than 24%.
• Priority sector lending requirement of 75% of total adjusted net bank credit.
• 50% of loans must be up to Rs 25 lakh.