Regulations for Small Finance Banks: A bit too many?

Yesterday Ira Dugal tweeted about AU Small Finance Bank trading at 7.5 times its Price/Book Ratio, much more than any other Private Bank.  Case of early froth/bubble in valuation of Small Finance Banks? We will get to know soon. Markets hype both ways – upside and downside- very quickly.

Anyways, over the weekend RBI released a document called: “Compendium of Guidelines for Small Finance Banks”.  Compendium is a deceptive word as it means- a collection of concise but detailed information about a particular subject, especially in a book or other publication. Concise yet detailed.

So are RBI’s guidelines for Small Finance Banks:

Objective of a small finance bank
The objective of setting up of small finance banks is to further financial inclusion by, 
a) provision of savings vehicle and primarily to unserved and underserved sections of the population and,
b) supply of credit to small business units, small & marginal farmers; micro and small industries and other unorganised sector entities through high technology & low cost operations

Scope of activities
• The scope of activities of a small finance bank would primarily be to 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.
• SFBs are required to open at least 25% of its branches in unbanked rural centres.
• Further, these banks are required to extend 75% of its ANBC to priority sector. 

Guidelines for SFBs on Financial Inclusion and Development
• Considering the differentiated nature of business and financial focus of the SFBs and taking into account the important role that SFBs can play in the supply of credit to micro and small enterprises, agriculture and banking services the need for a specific compendium of guidelines for SFBs on areas relating to Financial Inclusion and Development have been prepared.
• The provisions of these instructions shall apply to every Small Finance Bank licensed to operate in India by the Reserve Bank of India.

As one goes through the guidelines (read regulations) on SFBs, you realise how stringent they are really. There are just so many laws and regulations that apply to these banks, that compliance cost itself will be quite something. Before discussing specifics, we see this acronym – ANBC which means Adjusted Net Bank Credit. It is computed as:

Bank Credit in India (As prescribed in item No.VI of Form ‘A’ (Special Return as on March 31st) under Section 42 (2) of the RBI Act, 1934. I
Bills Rediscounted with RBI and other approved Financial Institutions + Advances extended in India against the incremental FCNR (B)/NRE deposits, qualifying for exemption from CRR/SLR requirements, till their maturity. II
Net Bank Credit (NBC)* III(I-II)
Bonds/debentures in Non-SLR categories under HTM category + other investments eligible to be treated as priority sector + Outstanding Deposits, as on preceding March 31st, under RIDF, Warehouse Infrastructure Fund, Short term Co-operative Rural Credit Refinance Fund and Short Term RRB Fund with NABARD IV


Now coming back to Guidelines.

For instance, the requirement for 75% of loans going to priority sector. What constitutes priority sector?

i. Agriculture
ii. Micro, Small and Medium Enterprises (MSMEs)
iii. Export Credit
iv. Education
v. Housing
vi. Social Infrastructure
vii. Renewable Energy
viii. Others

Within this 75%, 18% goes to agriculture. Within 18%, 8% is for Small and Marginal farmers. Who are small and marginal farmers?

  • Farmers with landholding of up to 1 hectare are considered as Marginal Farmers. Farmers with a landholding of more than 1 hectares and up to 2 hectares are considered as Small Farmers.
  • Landless agricultural laborers, tenant farmers, oral lessees and share-croppers, whose share of landholding is within the limits prescribed for small and marginal farmers.
  • Loans to Self Help Groups (SHGs) or Joint Liability Groups (JLGs), i.e. groups of individual Small and Marginal farmers directly engaged in Agriculture and Allied Activities provided banks maintain disaggregated data of such loans.
  • Loans to farmers’ producer companies of individual farmers, and co-operatives of farmers directly engaged in Agriculture and Allied Activities, where the membership of Small and Marginal Farmers is not less than 75 per cent by number and whose land-holding share is also not less than 75 per cent of the total land-holding.

The remaining 10% of credit to agriculture is divided into 3 categories:

  • (i) Farm Credit (which will include short-term crop loans and medium/long-term credit to farmers)
  • (ii) Agriculture Infrastructure and
  • (iii) Ancillary Activities.

THen there is an expansion of what constitutes Farm Credit, what constitutes agri infrastructure and so on..(page 4-6).

Likewise, there are definitions for Micro, Small and Medium Enterprises (MSMEs) and so on. Many of these definitions have been developed by respective ministries making the entire thing very complex and cumbersome.

As if these guidelines were not enough, there are common guidelines for all priority sector loans:

SFBs should comply with the following common guidelines for all categories of advances under the priority sector.
i. Rate of interest – The rates on interest on bank loans will be as per directives issued by our Department of Banking Regulation from time to time.
ii. Service charges – No loan related and adhoc service charges/inspection charges should be levied on priority sector loans up to 25,000. In case of eligible priority sector loans to SHGs/JLGs, this limit will be applicable per member and not to the group as a whole.
iii. Receipt, Sanction/Rejection/Disbursement Register – A register/ electronic record should be maintained by the bank, wherein the date of receipt,
sanction/rejection/disbursement with reasons thereof, etc., should be recorded. The register/electronic record should be made available to all inspecting agencies. 
iv. Issue of Acknowledgement of Loan Applications- Banks should provide acknowledgement for loan applications received under priority sector
loans. Bank Boards should prescribe a time limit within which the bank communicates its decision in writing to the applicants.
v. Definitions/Clarifications: a) Contingent liabilities/off-balance sheet items do not form part of priority sector target
achievement. b) The term “all-inclusive interest” includes interest (effective annual interest), processing fees and service charges.
c) Banks should ensure that loans extended under priority sector are for approved purposes and the end use is continuously monitored. The banks should put in place proper internal controls and systems in this regard.
vi. Amendments
These guidelines are subject to any further instructions that may be issued by the RBI from time to time.

These guidelines for Priority sector loan for SFBs differ broadly come from the guidelines for commercial banks. But given the fact that SFBs are much smaller and specialised entities, the regulations for them could have been seen differently. We have seen that these stringent guidelines pushing loans for financial inclusion purposes has its own limitations and the model breaks down eventually.


One Response to “Regulations for Small Finance Banks: A bit too many?”

  1. Linkfest - Kairos Capital Says:

    […] Mostly Economics – Small Finance Banks: too many rules […]

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