KEEPING Small Finance Bank (SFBs) AFLOAT

Context- The article explains the Issues related to Small finance banks (SFBs).
What are some facts about Small Finance Banks (SFBs)?

  • They are designed to promote financial inclusion, serve as avenues for savings, and
    provide credit to small businesses, marginalized farmers, and the informal sector
    through technologically advanced, cost-effective operations.
    What are the challenges faced by Small finance banks (SFBs)?
  • Priority sector lending targets- SFBs have a priority sector lending target set at 75
    percent of their loan book, with a significant portion of it being unsecured loans.
    Meeting this target is challenging.
  • Alternative methods to bridge the gap, such as securitization or co-lending with nonbanking financial companies, are not available to them.
  • In contrast, universal banks have a priority sector lending target of 42 percent of their
    loan book.
  • Higher cost of deposits- Another concern is the higher cost of deposits for SFBs
    compared to universal banks. This higher interest expense increases their overall funding
  • Banking license requirements- Many initially saw SFBs as a stepping stone towards
    obtaining a universal banking license. The SFB operating guidelines mentioned their
    eligibility for transitioning to a universal bank after five years of operation. However,
    there is now a demand for a detailed roadmap for the application and conversion.
  • Raising of capital- Several prominent private equity firms have invested in the small
    finance bank sector. However, considering the stock performance of SFBs, raising
    additional capital may not be straightforward.
  • Structural issues- The structural issues had plagued the sector even before the
    pandemic. On the liability side, SFBs had limited savings and current accounts and
    heavily relied on bulk deposits and term deposits from cooperative banks.
  • On the asset side, a disproportionately large portion of their loans consisted of
    unsecured microfinance loans.
    What is the way forward?
  • A paper titled “Performance of SFBs — An Early Reflection” in the RBI’s August 2021
    bulletin suggested that factors such as efficiency, leverage, liquidity, and banking
    business are crucial for SFBs’ profitability.
  • SFBs should also have a 42 percent target priority sector lending target. This change
    would help reduce the risk of concentration.
  • As per Reserve Bank of India’s Internal Working Group (IWG), SFBs should be listed
    “within six years from the date of reaching a net worth equivalent to prevalent entry
    capital requirement prescribed for universal banks,” or “ten years from the date of
    commencement of operations,” whichever comes first.