The Reserve Bank of India’s decision to allow 10 players to set up small finance banks out of the 72 applicants may seem conservative. But by permitting eight microfinance institutions (MFIs) to set up small banks, the RBI has chosen wisely, keeping in mind the goal of financial inclusion and extending finance to small businesses and low-income households, under-serviced by traditional commercial banks. Having a bank account for the purpose of savings and remittances has always been the central objective behind banking. With more than half the population in India still unable to access such basic services, the need for institutions with greater penetration and wide distribution models has, to some extent, been met with the issue of payments banks licences. But opening of accounts alone does not guarantee financial inclusion. The missing piece is providing credit to poorer sections of society; and this could be well served by MFIs that have been able to reach out to remote hinterlands.

In India, the primary channels to provide microfinance have been self-help groups and MFIs. But the business model and inefficiency of the former has limited its growth. Having built the necessary due diligence processes, MFIs have played a larger role in providing loans to the weaker sections. According to Micro Finance Institutions Network (MFIN), the loan portfolio of the 52 NBFC-MFIs registered under the RBI, accounting for 90 per cent of the country’s microfinance business, stands at a little over ₹42,000 crore — a growth of 69 per cent over the previous year. The door-to-door delivery model of MFIs has also been difficult for banks to replicate for whom the cost of delivering credit in rural areas has been uneconomical. MFIs also have an edge over other applicants in meeting some of the conditions laid down for small finance banks such as that 75 per cent of loans be in priority sector and that at least 50 per cent of loans are below ₹25 lakh; the average ticket size of loans provided by MFIs is about ₹17,000.

As in the case of payments banks, the central bank’s choice of players suggests that it is testing the waters on a differentiated banking model. It has only handpicked large- and medium-sized microfinance players who form almost one-third of total MFI loans. But only time will tell which of these players will prove successful. For now, it is heartening that these players will be able to reach out to the under-served in a more cost effective way. Access to low-cost retail deposits will translate into lower lending rates for small borrowers who are still charged upwards of 20 per cent on their loans from MFIs. After all, financial inclusion can only be achieved in full if financial services in rural and remote areas are offered in a cost-effective manner.