Is small beautiful?

The final norms on small banks announced by the Reserve Bank of India are stringent and designed to filter out non-serious players. The idea of a small bank that serves the relatively neglected sections of the local population — agriculture, small industry, shopkeepers, individuals, etc — in an effort to bring about financial inclusion is appealing in its simplicity. A whole host of new players are expected to throw their hat into the ring given the size of the opportunity. Notwithstanding the rapid ramping up of the Prime Minister’s Jan Dhan Yojana, millions of Indians remain outside the pale of the organised banking sector.

The new norms draw inspiration from RBI Governor Raghuram Rajan’s strong conviction that the local area bank model (started a couple of years ago and since performing with mixed results) was not given a fair trial. The final guidelines for the small banks therefore reflect an attempt to address some of the issues that may have contributed to limiting the effectiveness of the local area banks. Ergo, you have the relaxation on geographical limits for these banks (as against the earlier proposal of having them in contiguous districts in homogenous States). Some norms may appear constraining, but these will keep the new banks on track. For instance, the requirement that not more than 50 per cent of the loans should be given to those borrowing more than ₹25 lakh will help address the need of smaller borrowers. In the absence of this, the bank would naturally gravitate towards big-ticket borrowers, which is borne out by the track record of many new banking wannabes in the race to acquire size. Similarly, at first glance, the requirement that 75 per cent of loans are given to the priority sector (agriculture, small industry, weaker sections), is harsh, perhaps even a trifle ambitious, considering that existing banks with much larger networks don’t meet a much lower priority sector target (40 per cent). But this requirement may have been imposed to keep the new banks focussed on under-banked customer segments.

The RBI may, however, have to reconsider its decision to apply the same norms on statutory pre-emption ratios (SLR/CRR) as well as NPA recognition norms that it does to existing banks. These could serve to dampen profitability of the new banks. There is probably a case for a bit of flexibility here. Servicing a target clientele with irregular income (poor, unbanked, small enterprises, agriculture) is an onerous responsibility and carries a fair commercial risk. Moreover, the high capital adequacy ratio of 15 per cent to be maintained by successful licensees, along with limits on leverage, will add to the pressure of being profitable. Whether the objective of financial inclusion would be best served thus is a moot issue. The guarded response from industry players reflects an uncertainty about whether they will be able to meet these norms.