SMALL FINANCE

BANKS
Introduction, Current Scenario, Challenges, RBI
guidelines and Licenses granted
Introduction
Small Finance Banks is a crying need of the Rural India. Due to the lack of banking
facilities / credit supply, most of the petty traders in Rural India are funded by loan
sharks and end up in financial slavery due to the methods adopted by these sharks and
levying of exorbitant interest and penal interest. Like the traders, even the farmers too
are caught in this debt trap and we are aware of numerous instances of their suicides.

Small Banks are RBIs most recent initiative to further financial inclusion by creating
new banking models. Their purpose, apart from mobilizing deposits, is to provide
credit to sections currently unable to access it sufficiently from the big commercial
banks - small business units, small and micro industries, small and marginal farmers,
self-employed individuals, especially those in semi-urban and rural areas.

Small Banks are different from payment banks which is merely a vehicle for savings.
Small finance banks will also lend - although only to specified sections - and sell
mutual funds, insurance and pension products.

With a minimum capital of INR 100 crore, they will have to direct 75 per cent of their
credit to the priority sector - primarily agriculture, small industry, small business,
micro credit, education and housing. The sector's ambit may be widened to include
agri-infrastructure, agri-processing, health care, sanitation, drinking water and
renewable energy.

The central bank has also stipulated that 50 per cent of the small banks' credit
portfolio must comprise loans of INR 25 lakh or less, so that small borrowers become
a priority. Which means, these banks will now be able to provide secured and legal
loans to MSMEs and SMEs, bringing them under the ambit of the financial system.

The Banking Industry

Competition will be fierce as the number and types of players in the financial services
space expands. SFBs will be facing competition from existing banks and non-bank
financial companies (NBFCs) who may be looking to extend their reach to serve the
unbanked and under-banked, especially in semi-urban and rural areas. For example,
Mahindra Finance, an NBFC that focuses on rural and semi-urban populations, is
targeting its lending to farmers and non-salaried workers.
SFBs will also be competing with the Micro Units Development and Refinance
Agency (MUDRA), a government initiative launched in September, 2015 that targets
the loan segment for up to INR 1 million (around $15,000). While SFBs are permitted
to disburse loans of up to INR 2.5 million ($38,000), some have indicated that they
will not start out by disbursing loans of this size.
In addition to this, SFBs will also face challenges as they transition from their current
profile as MFIs to newly minted SFBs.

SFBs will be required to adhere to the same strict norms and regulations
applicable to commercial banks. Nine of the 10 licensed small finance banks
are required to raise INR 40 billion (about $613 million) from domestic
shareholders in order to bring the foreign ownership down to 49% before they
start operations.
Previously functioning as MFIs, the SFBs have not handled deposits before.
They will need to invest in the infrastructure that enables them to mobilize
deposits through establishing a physical branch network, business
correspondent network, ATM network, and partnering with banks. Given the
non-existent track record in mobilizing deposits, it could be difficult to inspire
the trust and confidence among consumers required to attract deposits.
Finally, SFBs may face difficulties acquiring and retaining top talent. MFIs
typically have a large number of low skilled people coming from and working
in the communities in which they lend and very few people in corporate
positions who are classic bankers. In order for SFBs to scale, they will have to
address the human resources side of their operations.
SFBs need to build their strength using technology and digital solutions to
extend their reach in a cost-effective and efficient manner.
One issue facing SFBs is how to raising debt financing for the new entity. A
key assumption while converting from an NBFC is that SFBs will have a
competitive advantage as they will be deposit-taking entities and can raise
low cost funds by way of current and savings accounts (CASA).
NBFCs that convert to SFBs will face restrictions on inter-bank borrowings.
But they have new borrowing instruments like CDs and inter-bank deposits.

The success of SFBs depends on how well they are able to mobilize cheaper deposits
from public to reduce their costs of funds. It will also depend on their ability to attract,
retain and grow customers by attractive pricing of loans. The loans need to be priced
lower without impacting the business model negatively.

Regulations as proposed by RBI.

Every small finance bank must have the words -- small finance bank -- in its name.
They cannot set up subsidiaries to undertake non-banking financial service
activities.
75% of its Adjusted Net Bank Credit (ANBC) should be advanced to the priority
sector as categorized by RBI.
Maximum loan size to a single person cannot exceed 10% of total capital funds;
cannot exceed 15% in the case of a group.
 At least 50% of its loans should constitute loans and advances of up to 25 lacs.
Small banks can undertake financial services like distribution of mutual fund units,
insurance products, pension products, and so on, but not without prior approval
from the RBI.
Small finance banks will be subject to all prudential norms and regulations of the
RBI as applicable to existing commercial banks. This will include maintaining
cash reserve ratio (CRR) or the percentage of deposits that must be kept aside as a
reserve; and statutory liquid ratio (SLR) or the percentage of deposits that must be
invested in government securities.
Minimum paid-up equity capital requirement of INR 100 crore. The promoter's
minimum initial contribution to the paid-up equity capital of such small finance
bank shall at least be 40% which can be gradually brought down to 26% within 12
years from the date of commencement of operations.
A small bank can transform into a full-fledged bank, but only after RBI's approval.
A fundamental requirement is that it must have 25% of its branches set up in
unbanked areas.

Licenses granted by RBI

The Reserve Bank of India (RBI) gave in-principle licenses to 10 Non-Banking
Financial Companies (NBFCs) to convert to Small Finance Banks (SFBs) in
September 2015. The licenses are spread across the country, with four from the South
(two from Karnataka, and one each from Tamil Nadu and Kerala), three from the
North (one each from Rajasthan, Punjab, and UP), two from the West (one each from
Maharashtra and Gujarat) and one from the North East. One criterion for their
selection was the likelihood of meeting the requirement of minimum 75 per cent
Priority Sector Lending (PSL).
The banking landscape in the country is set for a big change with the recent in-
principle approval to ten entities out of 72 applicants 10 major small banks are
listed below:

Au FINANCIERS (INDIA) LIMITED, Rajasthan

Incorporated in 1996 by Sanjay Agarwal, a chartered accountant and first-generation
entrepreneur in Rajasthan, Au Financiers is a non-banking financial company (NBFC)
registered with the RBI and is present across 10 states in North India. Its providing
loans for new and used vehicles, refinancing and offering loans to micro and small
enterprises and agriculture based SMEs.
It was incorporated as LN Finch Gems Private Limited, but later changed its name to
Au Financiers in 2005. While it initially raised funds from big investors to offer its
financial services in few districts of Rajasthan, it diversified itself by adopting a fee-
based model. The company got its first round of private equity (PE) funding of Rs 20
crore in 2006 and then it started originating loans under its own book. It raised in
excess of Rs 250 crore from institutions. Its net profit crossed Rs 100 crore in 2013-
14.
UTKARSH MICROFINANCE, Uttar Pradesh

The Varanasi-based microfinance institution was formed in 2009 by Govind Singh, a

former business head for micro banking at ICICI Bank. Though it has been in the
business for only around six years, it has built a customer base of 6 lakhs through its
271 branches. Over the last four years its assets under management (AUM) grew at
the rate of 120 per cent to Rs 730 crore and the management is targeting an AUM of
4,200 crores by FY19. It operates in underpenetrated areas across eight states located
in the northern and western regions of the country and now plans to expand operations
in Jharkhand and Chhattisgarh. The company is largely held by foreign institutional
investors (FIIs) who hold more than 49 per cent. The investors include Norwegian
Microfinance Initiative, CDC and Lok Capital.

RGVN (NORTH EAST) MICROFINANCE, Asaam

Promoted by SM Palia, a former executive director at IDBI Bank, in 1990 with an
initial corpus contribution from IDBI and IFCI and later from NABARD and Dorabji
Tata Trust, RGVN Society was started with an aim to develop and nurture NGOs and
community based organizations in Northeast India. It was headquartered in Guwahati.
In 1995, RGVN-Society started microfinance activities under the aegis of credit and
savings programmed with an initial assistance of Rs 1 crore from SIDBI. RGVN (NE)
MFL was established in 2008 and registered to carry out microfinance activities in
North-East. Currently, the company has a network of 104 branches in 5 Northeastern
states Assam, Arunachal Pradesh, Meghalaya, Nagaland and Sikkim and covers
around 2.2 lakh borrowers. The gross loan portfolio amounts to INR 229 crore.

DISHA MICROFIN, Gujarat

Started in 2009, Disha offers credit to under banked households in rural and semi-
urban areas in Gujarat, Rajasthan, Madhya Pradesh and Karnataka. The company was
founded by Sameer Manavati, who had earlier started a financial services distribution
company in Gujarat. The company is also supported by its equity partner, India Value
Fund (IVF) that came on board in October 2010. As of March 2015, it has 71 branches
across 39 districts and covers over 8,600 villages. It has a total of 3,35,426 members
and around 1.76 lakh borrowers. A distinct feature of the company is that it only offers
credit to women borrowers and all its borrowers are women borrowers. It has an AUM
of over Rs 200 crore.

CAPITAL LOCAL AREA BANK, Punjab

Capital Local Area Bank completed 15 years of operations on January 14, 2015. The
firm operated in Jalandhar, Kapurthala and Hoshiarpur in Punjab for its first 13 years.
In January 2013, it was granted the RBI permission to expand its area of operation to
Ludhiana and Amritsar. The bank currently has a total business of Rs 2,640 crore
spread out across its 39 branches. It has more than 3,32,000 accounts and more than
80 per cent of its business is in rural and semi urban areas, with priority sector lending
accounting for 65.26 per cent. The bank extends loans mostly to small borrowers as
almost 60 per cent of the total advances are of ticket size of up to Rs 25 lakh as on
March 31, 2015.

EQUITAS HOLDINGS, Tamil Nadu

Chennai-based Equitas group was founded by PN Vasudevan in 2007 by setting up
Equitas Micro Finance India Private Limited as an NBFC in microfinance activities.
EMFPL is currently operating in 124 districts across seven states, primarily
concentrated in Tamil Nadu which accounts for 65 per cent of AUM as on March 31,
2015. Vasudevan, MD of Equitas Holdings, has been in the financial services business
during his career spanning almost 30 years. Before floating Equitas, he was vice
president and consumer banking head in Development Credit Bank. Disbursements in
2014-15 were Rs 2,129.04 crore while the total outstandings were Rs 7,309.29 crore.
The company has 22.92 lakh customers. The firm also managed to open 361 branches
in 124 districts in seven states and Union Territories.

ESAF MICROFINANCE, Kerala

ESAF Microfinance and Investments is the largest MFI in Kerala with AUM of Rs
1,020 crore as of FY15. The company is targeting a 40 per cent asset growth over next
four years to Rs 3,800 crore-4,000 crore by FY19. Established in 1992 by K Paul
Thomas in Thrissur, Kerala, Evangelical Social Action Forum society commenced its
microfinance operations in 1995. The society then acquired Pinnai Finance and
Investments in 2006 and renamed it as ESAF Microfinance and Investments. The
societys microfinance business was then taken over by ESAF later in April 2008.
ESAF predominantly offers loans to women under the joint liability group model of
lending. It serves five lakh customers through 175 branches but 68 per cent of its
customers and 57 per cent of its branches are based out of Kerala. It is one of the few
financial institutions successfully operating in the Naxalite-affected districts of
Maharashtra, Chhattisgarh and Jharkhand.

JANALAKSHMI FINANCIAL, Karnataka

Janalakshmi Microfinance is Indias largest urban MFI with assets of Rs 3,800 crore,
233 branches and a customer base of 23 lakh. The companys urban focus, particularly
tier I-III cities, is driven by the lower credit and political risk and higher economies of
scale in these areas, says a Religare report. The countrys third largest MFI has a
presence in 151 cities across 17 states. Promoters acquired an NBFC licence in 2008
and the company got PE funding to escalate assets growth almost every year since
FY08 to FY14. The promoter, Ramesh Ramanathan, is a pioneer in urban
microfinance with more than 12 years of experience in this field, and also a part of
various government committees on urban policy formulation. With his holding stake
through Jana Foundation, any returns from the company do not flow back to the
promoter but are used for charity.

SURYODAY MICROFINANCE, Maharashtra

Suryoday Microfinance operates in the towns and metros in seven states, including
Maharashtra and Tamil Nadu which together account for 65 per cent of the portfolio.
Its gross loan book is around Rs 689 crore and the management is targeting a loan
book of Rs 1,000 crore in FY16. The firm has 6.05 lakh customers through a network
of 164 branches as of FY15. Cumulative disbursals amounted to Rs 1,843 crore. It is
now targeting a 70 per cent increase in assets in FY16 along with a 200-plus branch
network. The firm focuses only on women borrowers from weaker sections. R Baskar
Babu, who was associated with Cholamandalam, HDFC Bank and GE Commercial
Finance in various leadership positions, is the promoter and CEO of Suryoday.
Domestic investors hold 32 per cent in the company.

UJJIVAN FINANCIAL, Karnataka

Ujjivan Financial Services is the fourth largest MFI in India with AUM of Rs 3,270
crore as of FY15. It is incrementally focusing on individual loans and aims to increase
its proportion from 10 per cent now to 40 per cent of AUM by FY19. The
management is targeting an AUM of Rs 4,800 crore in FY16, says Religare. The
company is spread across 24 states and Union Territories. It began operations in 2005
and serves over 20 lakh clients through a network of 423 branches.
Samit Ghosh, who is now CEO and MD, founded Ujjivan in 2005 as a microfinance
firm for the urban poor. He has worked in various capacities in banks such as
Citibank, Standard Chartered, Bank Muscat and HDFC Bank. The companys net
profit increased at a 61 per cent annual growth over FY11-FY15 to Rs 75.8 crore.

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