Policy Brief: RBI releases “Guidelines for ‘on tap’ Licensing of Small Finance Banks in the Private Sector”

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Policy Brief: RBI releases “Guidelines for ‘on tap’ Licensing of Small Finance Banks in the Private Sector”

Komal Gupta

@Komal

December 6, 2019

Public Policy

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Context

On 5 December, the Reserve Bank of India (RBI) issued guidelines for ‘on tap’ licensing of small finance banks in the private sector. The move comes after a review of the performance of the existing small finance banks, which were granted in-principle approval in 2015.

The draft guidelines was placed for public comments on 13 September 2019. According to the Central Bank, the final guidelines have been readied after taking into consideration the responses received on the draft version.

RBI had issued the Guidelines for Licensing of “Small Finance Banks” in the Private Sector on November 27, 2014. It was notified in these guidelines that after gaining experience in dealing with these banks, the Reserve Bank would consider ‘on tap’ licensing of these banks.

Key highlights of the guidelines:

The small finance bank shall be registered as a public limited company under the Companies Act, 2013. It will be given scheduled bank status once they commence their operations.
The objectives of setting up of small finance banks will be for furthering financial inclusion by:

provision of savings vehicles primarily to unserved and underserved sections of the population,
supply of credit to small business units; small and marginal farmers; micro and small industries;
other unorganised sector entities, through high technology-low cost operations.

Eligibility Criteria:

Resident individuals/professionals (Indian citizens), singly or jointly, each having at least 10 years of experience in banking and finance at a senior level; and Companies and Societies in the private sector, that are owned and controlled by residents (as defined in FEMA Regulations, as amended from time to time), and having successful track record of running their businesses for at least a period of five years, will be eligible as promoters to set up small finance banks.
Existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) in the private sector, that are controlled by residents (as defined in FEMA Regulations, as amended from time to time), and having successful track record of running their businesses for at least a period of five years, can also opt for conversion into small finance banks after complying with all legal and regulatory requirements of various authorities and if they conform to these guidelines.
However, joint ventures by different promoter groups for setting up small finance banks would not be permitted.
As local focus and the ability to serve smaller customers will be the key criteria in licensing such banks, this may be a more appropriate vehicle for local players or players who are focused on lending to unserved / underserved sections of the society. Accordingly, proposals from public sector entities and large industrial house / business groups, including from NBFCs promoted by them, autonomous boards / bodies set up under enactment of a State legislature, state financial corporations, subsidiaries of development financial institutions, will not be entertained.
For the purpose of these guidelines, a Group with assets of Rs.5,000 crore or more with the non-financial business of the group accounting for 40 per cent or more in terms of total assets / gross income, will be treated as a large industrial house / business groups. (In taking a view on whether the companies, as either promoters or investors, belong to a large industrial house or to a company connected to a large industrial house, the decision of the RBI will be final).
Primary (Urban) Co-operative Banks (UCBs) applying for transiting to small finance bank or obtaining in-principle approval for such transition (under the above referred scheme), will be required to ensure compliance with these ‘on tap’ licensing guidelines from the date of commencement of business as small finance bank except the guideline on minimum capital. The minimum net worth of such small finance banks shall be Rs.100 crore from the date of commencement of business. However, they will have to increase their minimum net worth to Rs.200 crore within five years from the date of commencement of business.

Capital Requirement:The minimum paid-up voting equity capital for small finance banks shall be Rs.200 crore, except for such small finance banks which are:
- transited from UCBs for which the capital requirement will be as prescribed in paragraph 3 (a) of the guidelines.
- converted from NBFC/MFI/LAB/PB for which the capital requirement will be as prescribed in paragraph 10 of the guidelines.
In view of the inherent risk of a small finance bank, it shall be required to maintain a minimum capital adequacy ratio of 15 per cent of its risk-weighted assets (RWA) on a continuous basis, subject to any higher percentage as may be prescribed by RBI from time to time. Tier I capital should be at least 7.5 per cent of RWAs. Tier II capital should be limited to a maximum of 100 per cent of total Tier I capital. Basel II norms will be generally applicable to the small finance banks, unless stipulated otherwise.
The applicants for small finance bank licenses will be required to furnish their business plans along with project reports with their applications. The business plan will have to address how the bank proposes to achieve the objectives behind setting up of small finance banks and in the case of an NBFC / MFI applicant, how the existing business of NBFC / MFI will fold into the bank or divested / disposed of. The business plan submitted by the applicant should be realistic and viable. In case of deviation from the stated business plan after issue of license, RBI may consider restricting the bank’s expansion, effecting change in management and imposing other penal / regulatory measures as may be necessary.
Other conditions:

A promoter will not be granted licenses for both universal bank and small finance bank even if the proposal is to set them up under the NOFHC structure.
If a promoter of a payments bank desires to set up a small finance bank, both the banks should be under NOFHC structure.
Individuals (including relatives) and entities other than the promoters will not be permitted to have shareholding in excess of 10 per cent of the paid-up voting equity capital of the bank. In case of existing NBFCs/MFIs/LABs converting into small finance bank, where there is shareholding in excess of 10 per cent of the paid-up voting equity capital by entities other than the promoters (including private equity funds), RBI may consider providing time up to 3 years from the date of the ‘in principle’ approval for the shareholding to be brought down to a maximum of 10 per cent.
The small finance bank cannot be a Business Correspondent (BC) for another bank. However, it can have its own BC network.
The operations of the bank should be technology driven from the beginning, conforming to generally accepted standards and norms; while new approaches (such as for data storage, security and real time data updation) are encouraged, a detailed technology plan for the same should be furnished to RBI.
The bank should have a high-powered Customer Grievances Cell to handle customer complaints. The small finance banks will come under the purview of RBI’s Banking Ombudsman Scheme, 2006, as amended from time to time.
The compliance of terms and conditions laid down by RBI is an essential condition of grant of license. Any non-compliance will attract penal measures or regulatory actions including cancellation of license of the bank.

Procedure for Application- In terms of Rule 11 of the Banking Regulation (Companies) Rules, 1949, applications shall be submitted in the prescribed form (Form III). In addition, the applicants should furnish the business plan as per paragraph 11 of the guidelines and other requisite information as per the Annex II.
Procedure for RBI decisions-

At the first stage, the applications will be screened by RBI to assess the eligibility of the applicants, vis-à-vis the criteria laid down in these guidelines. RBI may apply additional criteria to determine the suitability of applications, in addition to the ‘fit and proper’ criteria. Thereafter, the applications will be referred to a Standing External Advisory Committee (SEAC) to be set up by RBI.
The SEAC will comprise of eminent persons with experience in banking, financial sector and other relevant areas. The tenure of the SEAC will be for three years.
The SEAC will set up its own procedures for screening the applications. The SEAC will meet periodically, as and when required. The Committee will reserve the right to call for more information as well as have discussions with any applicant/s and seek clarification on any issue as may be required by it. The Committee will submit its recommendations to RBI for consideration.
The Internal Screening Committee (ISC), consisting of the Governor and the Deputy Governors will examine all the applications. The ISC will also deliberate on the rationale of the recommendations made by the SEAC and then submit its recommendations to the Committee of the Central Board (CCB) of RBI for the final decision to issue ‘in-principle approval’.
The validity of the ‘in-principle approval’ issued by RBI will be 18 months from the date of granting ‘in-principle approval’ and would thereafter lapse automatically. Therefore, the -applicant will have to obtain the license within a period of 18 months of granting the ‘in-principle approval’.
After issue of the ‘in-principle approval’ for setting up of a small finance bank, if any adverse features are noticed regarding the Promoters or the companies / entities with which the Promoters are associated and the group in which they have interest, the RBI may impose additional conditions and if warranted, may withdraw the ‘in-principle approval’.
The names of applicants that are found suitable for grant of in-principle approval will also be placed on the RBI website.
An applicant who has not been found suitable for issue of license will be advised of the Reserve Bank’s decision. Such applicants will not be eligible to make an application for a banking license for a period of three years from the date of that decision.
Applicants aggrieved by the decision of the Committee of the Central Board can prefer an appeal against the decision to the Central Board of Directors, within one month from the date of receipt of communication from RBI relating to the application not being considered.

We are still reviewing the final guidelines and will update the blog accordingly. If you have any inputs/suggestions, please write to us at komal@nasscom.in.

NASSCOM RBI small finance banks on tap payments bank

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Komal Gupta

Policy Analyst

Policy Professional| Former Tech and Business Journalist|

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