When the Reserve Bank of India (RBI) first issued guidelines for the new category of Small Finance Banks (SFBs) in 2014, it had indicated a possible transition to universal banks once they demonstrated a track record. The dozen or so SFBs that sprang up have now completed over five years of operation and have been knocking at RBI’s doors for a glide-path to become universal banks.

This appears to be the main reason for the RBI circular last week laying down terms and conditions for SFBs to apply for a universal banking licence. However, the high financial bar that the RBI has set for SFBs and its ultra-conservative stance on issuing universal banking licences to other categories of applicants, suggest that aspiring SFBs have their task cut out. SFBs are keen to upgrade to universal banks to take advantage of three regulatory relaxations. RBI regulations require SFBs to deploy at least 75 per cent of their loan books towards priority sector credit, while universal banks have only a 40 per cent obligation. SFBs need to extend 50 per cent of their loans to small-ticket customers borrowing up to ₹25 lakh, while universal banks have no such requirement. SFBs are also required to maintain a higher capital adequacy ratio of 15 per cent against 11.5 per cent for commercial banks. SFBs believe that the ‘small’ tag makes depositors wary of parking large sums with them, pegging up their cost of funds.

However, RBI’s circumspect stance on allowing SFBs to upgrade to universal banks is reflected in the stringent conditions. SFBs will need to have a scheduled status, a five-year track record and be listed on stock exchanges. They must be profitable for the previous two years, meet a ₹1,000 crore net worth norm and maintain capital adequacy of 15 per cent. Many of the listed SFBs do fulfil these criteria. But one condition that may trip up most of them (except for one) is the requirement of Gross and Net NPA (non-performing asset) ratios below 3 and 1 per cent, respectively, in the last two years. With a spike in small-borrower delinquencies during Covid, most SFBs are only now recovering from elevated GNPA ratios of 4-5 per cent. RBI has indicated that SFBs must demonstrate diversified loan books. This is a hard ask, as most of the current crop of SFBs were microfinance NBFCs in their earlier avatar, and therefore have geographically concentrated exposures.

SFBs have, however, been catering to under-banked segments such as agriculture, services and trade, by overachieving on their priority sector targets. Except for the Covid period, they have also operated with high capital buffers and manageable NPAs, generating good shareholder returns. They have offered healthy competition to mainstream banks by wooing depositors with attractive rates. Therefore, in the interim till they turn eligible to become universal banks, RBI can perhaps offer seasoned SFBs leeway on the 50 per cent small-ticket lending norm to allow them to explore lucrative opportunities.