Role of Small Finance Banks in Financial Inclusion

Raghvendra Sonker

13 Sep, 2022

In the Union Budget 2014-15, the Government of India announced to establish the Small Finance Banks (SFBs) for the purpose to expand financial services, provide basic banking activities to the underprivileged, and have last-mile connectivity (mainly in rural areas). The role of Small Finance banks will allow micro and small enterprises, small and marginal farmers, and micro and small industries to avail lending services. Financial inclusion helps in reducing poverty and empowers women/marginalised/secluded to make sound financial decisions, further reducing inequality.

What are Small Finance Banks?

Small Finance Banks are specialised finance institutes created with an intention to implement the concept of financial inclusion in India to serve low-income groups. Small Finance Bank is registered under the Companies Act, 2013^[1] as a public limited company in the private sector. Like conventional banks, the functions and role of small finance banks also involves accepting deposits and lending activities.It also aims to strengthen the Indian economy by connecting small businesses with formal financial institutions.

Features of Small Finance Banks

The following important features of a Small Finance Banks are:

• Small Finance Banks (SFBs) can accept all kinds of deposits.
• SFBs can undertake lending activities.
• Prior approval from the Reserve Bank of India is required for branch expansion for the initial three years.
• The major area of operation of Small Finance Banks is in unserved rural areas, and to allocate 75% of loans to propriety sector lending (PSL).
• The primary focus of Small Finance Banks is on the financial inclusion of low-income individuals and small businesses.
• SFBs are not allowed to lend to the large-scale sector like MNCs and large manufacturing units.

RBI guidelines for Small Finance Banks

The Reserve Bank of India has issued broad guidelines which cover the licensing and role of Small Finance Banks. 

• A Small Finance Bank must have a minimum paid-up equity capital of Rs. 200 crores;
• The minimum capital adequacy ratio (CAR) is 15%, with a minimum Tier I capital of 7.5% of Risk Waited Assets;
• the promoter should have experience of 10 years in banking and finance;
• Individuals, corporations, trusts or societies owned and controlled by residents are eligible to set up SFBs;
• Existing NBFCs, Micro Finance Institutions (MFIs), and Local Area Banks that are owned and controlled by residents are also permitted for conversion into small finance banks;
• SFBs are required to extend 75% of their Adjusted Net Bank Credit to Priority Sector Lending. Under this allocation, 40% shall be allocated to different sub-sectors according to the current priority sector norms. The remaining 35% can be allocated to multiple sub-sectors under Priority Sector Lending;
• Diversification in the ownership structure of Small Finance Bank (promotor’s stake brought down);
• A Small Finance Bank shall mandatorily achieve a net worth of ₹500 crores within three years from the date of commencement.

Role of Small Finance Banks in Financial Inclusion

Financial inclusion means a process of ensuring access to banking services and timely and adequate lending services to vulnerable sections of society like low-income households and people in unbanked areas. The role of small finance banks in financial inclusion are:

• The major function of a small finance bank is to deliver essential banking services to low-income group and their businesses;
• Small Finance Banks must open 25% of their branches in unbanked or unserved rural centres, and they also are mandated to allocate 75% of the net credits to the priority sector;
• Small Finance banks have filled the gap of financial services in unbanked and unserved areas, that was created due to the under performance of large banks and cooperative banks;
• Small Finance Banks are likely to bring change to the traditional banking sector in India and overcome challenges faced with regard to the statutory norms of cash reserve ratio (CRR) and framework for cost-effective banking solutions;
• The rise in small loans to businesses and marginal farmers will increase the financial activities in the unbanked areas;
• SFBs have played a major role in the development of the MSME Sector (Micro Small and Medium Enterprises) by providing loans to the small businesses and startups;
• The Government of India and RBI have taken regular efforts to bring weaker sections of the society into financial inclusion programmes like JAM Trinity;
• Microfinance activities of SFBs form a sizeable portion of the loan book and subsequently contribute to keeping the lending rates higher than that of other banks;
• SFBs can be pivotal in scaling up small lending and low-cost deposits in underserved areas;
• SFBs are created to achieve the twin-fold objectives of providing an institutional framework for promoting rural and semi-urban savings and providing lending facilities for the growth of economic activities in unserved areas.

Conclusion

There has to be a structured and multidimensional approach through small finance banks, regional rural banks, NBFCs, digital platforms, infrastructure, and technological innovations to achieve the goal of Financial Inclusion. The role of small financial banks have been instrumental in bringing the underprivileged and unorganised sectors into the mainstream of formal banking activities. By establishing almost all branches in rural and semi-urban areas of the country to serve the lowest-earning strata the society will amplify the pace of financial inclusion and increase economic benefits to unserved areas.

Read our Article: Guiding Principle for Licensing of Small Finance Banks