The RBI flagged off its Small Finance Bank (SFB) experiment amid high expectations in 2014, responding partly to the view that India needed a differentiated banking model from the ubiquitous ‘universal’ banks and partly to criticism that it was too frugal with its universal banking licenses. Ten SFB licenses were issued in 2016-18 on the understanding that SFBs could be promoted by entities adhering to less onerous eligibility criteria, with a minimum net worth of ₹100 crore against ₹500 crore. SFBs were expected to deliver on financial inclusion mandates by offering credit to informal enterprises, small and marginal farmers and migrant workers, while deploying 75 per cent of their loans in priority sectors, with 50 per cent in sub-₹25 lakh loans. But a majority of SFBs now seem keen to abandon this niche banking model in favour of becoming universal banks and are terming this transition as the logical next step.

In their limited years of existence, SFBs have made fair progress on delivering credit to under-banked segments, though they could have done much better on their rural footprint. RBI’s January 2021 bulletin noted that while SFBs were still at a fraction of the banking industry’s size, they managed asset growth of 150 per cent between 2017 and 2020 while devoting over 83 per cent of their books to small-ticket loans, with half the loans at sub-₹2 lakh ticket size. Their portfolios were well-differentiated from universal banks too, with over 41 per cent loans going to MSMEs, over 25 per cent to agriculture and 15 per cent each to professional services and trade. Better credit management kept NPA ratios under check (until Covid). Importantly, SFBs have offered savers a better alternative to mainstream banks at a time when real returns have plummeted. Key pain points for SFBs seem to lie in higher capital adequacy norms relative to universal banks (15 per cent versus 9 per cent) and their limited CASA (15 per cent versus 41 per cent), while their branch networks are concentrated in the same urban centres as private banks.

One can see why SFBs are keen to pivot to the universal banking model. A universal bank would be in a better position to woo CASA without offering sky-high rates, while enjoying a freer hand in lending to lower risk segments like retail vehicle and housing loans. The stock market too has rewarded SFBs that have diversified their loan books away from riskier segments with high valuations. But in the interests of both savers and borrowers it is important that the SFB experiment succeeds. RBI must do what it can to narrow the regulatory arbitrage between universal banks and SFBs with a good track record so that the latter do not feel a need to pivot. It must also desist from frequently shifting its regulatory goalposts on minimum net worth and ownership structures for SFBs, so that incumbents can frame long-term business strategies with policy certainty.