India’s banking sector is undergoing a major transformation as new players enter the market and challenge the dominance of the traditional banks. Among them are the small finance banks (SFBs), which are niche institutions that cater to the financial needs of the underserved segments of the society, such as farmers, low-income households, small businesses and unorganised sectors. However, these SFBs are facing a prickly problem of survival and growth amid increasing competition from other banks, fintech companies and non-banking financial companies (NBFCs), as well as regulatory hurdles and operational constraints.
What are SFBs and why are they important?
SFBs are a type of differentiated banks that were introduced by the Reserve Bank of India (RBI) in 2014 as part of its financial inclusion agenda. The primary objective of creating SFBs was to improve financial inclusion through an effective deployment of deposits and extension of credit facilities to micro, small and unorganised entities at low processing costs. SFBs are required to have at least 50 per cent of their loan portfolio comprising loans of up to ₹25 lakh. They are also mandated to have 75 per cent of their adjusted net bank credit (ANBC) in priority sector lending (PSL), which includes agriculture, micro, small and medium enterprises (MSMEs), education, housing, social infrastructure and renewable energy.
SFBs play a crucial role in providing access to formal banking services to the marginalised sections of the society, who are often excluded or underserved by the conventional banking system. SFBs offer a range of products and services, such as savings accounts, fixed deposits, recurring deposits, micro loans, gold loans, vehicle loans, housing loans, business loans, remittances, insurance and mutual funds. SFBs also leverage their local knowledge and expertise to understand the needs and preferences of their customers and offer customised solutions. By doing so, SFBs not only help in improving the financial literacy and inclusion of their customers, but also contribute to their economic empowerment and social development.
What are the challenges faced by SFBs?
Despite their potential and importance, SFBs are facing several challenges that hamper their performance and viability. Some of these challenges are:
- Competition: SFBs face intense competition from other banks, especially public sector banks (PSBs) and private sector banks (PVBs), which have a larger network, customer base and product portfolio. SFBs also compete with fintech companies and NBFCs, which offer similar products and services at lower costs and faster delivery. Moreover, SFBs have to contend with informal sources of finance, such as moneylenders, chit funds and self-help groups (SHGs), which have a strong presence and influence in the rural and semi-urban areas where SFBs operate.
- Regulation: SFBs are subject to the same regulatory framework as other scheduled commercial banks (SCBs), which imposes certain restrictions and obligations on them. For instance, SFBs have to maintain a minimum capital adequacy ratio (CAR) of 15 per cent, a statutory liquidity ratio (SLR) of 18 per cent and a cash reserve ratio (CRR) of 4 per cent. SFBs also have to comply with the RBI’s norms on corporate governance, prudential norms, asset classification, provisioning, income recognition, disclosure requirements and customer protection. These regulations increase the operational costs and compliance burden for SFBs and limit their flexibility and innovation.
- Operational constraints: SFBs face several operational constraints that affect their efficiency and profitability. For example, SFBs have a limited branch network and geographical reach compared to other banks. They also have a high dependence on deposits as a source of funds, which exposes them to liquidity risk and interest rate risk. Furthermore, SFBs have a high cost-to-income ratio due to their low scale of operations, high operating expenses and low fee income. Additionally, SFBs have a high credit risk due to their exposure to low-income segments with low creditworthiness and high delinquency rates.
What are the possible solutions for SFBs?
To overcome these challenges and achieve sustainable growth, SFBs need to adopt some possible solutions such as:
- Diversification: SFBs need to diversify their product portfolio, customer segments and revenue streams to reduce their concentration risk and increase their income stability. They can also explore new avenues such as digital banking, co-lending models, cross-selling opportunities and partnerships with other entities to expand their reach and offerings.
- Digitisation: SFBs need to leverage technology to enhance their operational efficiency, customer experience and competitive edge. They can use digital platforms such as mobile apps, internet banking, biometric authentication, artificial intelligence (AI), blockchain etc., to offer faster, cheaper and more convenient services to their customers. They can also use data analytics, cloud computing, machine learning etc., to improve their risk management, fraud detection and customer segmentation.
- Differentiation: SFBs need to differentiate themselves from their competitors by offering value-added services, customised solutions and personalised interactions to their customers. They can also focus on their core competencies, such as local knowledge, customer relationships and social impact, to create a loyal and satisfied customer base.
- Regulatory support: SFBs need to seek regulatory support from the RBI and the government to ease some of the regulatory constraints and create a conducive environment for their growth. For instance, SFBs can request for a lower SLR and CRR requirement, a higher PSL sub-target, a longer transition period for meeting the CAR norm, a relaxation in the branch licensing policy, a tax exemption for PSL income etc.
SFBs are an important part of India’s banking sector and have a significant role to play in promoting financial inclusion and inclusive growth. However, they face many challenges that threaten their survival and viability. By adopting some of the possible solutions mentioned above, SFBs can overcome these challenges and achieve their potential and objectives.
