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ROUND TABLE

Small finance banks: Challenges

Jayadev M *, Himanshu Singh, Pawan Kumar

Indian Institute of Management Bangalore, Bangalore, Karnataka, India

Received 27 December 2016; revised 19 April 2017; accepted 11 October 2017; available online 19 October 2017

KEYWORDS Abstract A recent innovation in the Indian banking structure has been the formation of a new
Small banks; banking institution—small finance banks (SFBs). These banks are expected to penetrate into fi-
Financial inclusion; nancial inclusion by providing basic banking and credit services with a differentiated banking model
Differentiated banking; to the larger population. In this context the new SFBs have multiple challenges in coming out
Banking technology with a new, differentiated business model. The challenges include building low cost liability port-
folio, technology management, and balancing the regulatory compliances. This paper also pres-
ents the top of mind views of three senior executives of new small finance banks.
© 2017 Production and hosting by Elsevier Ltd on behalf of Indian Institute of Management
Bangalore. This is an open access article under the CC BY-NC-ND license (http://
creativecommons.org/licenses/by-nc-nd/4.0/).

Introduction nationalisation which led to ownership and control by the Gov-

ernment of India of 14 major banks in 1969 and 6 more banks
Academic literature on intermediation and growth (Cameron, in 1980. One of the key objectives of such bank nationalisation
1967; Goldsmith, 1969; McKinnon, 1973; Patrick, 1966; Shaw, was to spread banking activities by opening branches in un-
1973) establishes that financial intermediation, both in the banked areas. The post nationalisation decades witnessed
form of financial institutions such as banks and insurance com- rapid expansion of bank branches, especially in rural areas
panies as well as financial markets (equity, bond and deriva- and so did banking scale and complexity (Gandhi, 2015). Public
tive markets), exerts a powerful influence on economic sector banks, holding substantial market share, contributed
development by reducing poverty and stabilising econo- significantly by providing credit to finance agriculture and gov-
mies. More recent evidence also supports this (Bencivenga & ernment designed credit-based poverty alleviation pro-
Smith, 1991; Levine, 1997; World Bank, 1989). grammes. The existing banking structure (Tables 1 and 2) in
In the Indian context, the banking sector plays a signifi- India has evolved over several decades, is elaborate, and has
cant role in financial intermediation, more so since helped to serve the credit and banking services needs of the
economy. Further, there are multiple layers to cater to the
specific and varied requirements of different customers and
* Corresponding author. Tel.: +91 80 26993450. borrowers. Undoubtedly, India’s banks have played a major
E-mail address: [email protected] (J. M). role in the mobilisation of savings and have promoted eco-
Peer-review under responsibility of Indian Institute of Management nomic development (Reserve Bank of India, 2013a, 2013b).
Bangalore. There has also been a substantial increase in banking business
https://doi.org/10.1016/j.iimb.2017.10.001
0970-3896 © 2017 Production and hosting by Elsevier Ltd on behalf of Indian Institute of Management Bangalore. This is an open access article
under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
312 J. M et al.

Table 1 Deposits, advances and branches of scheduled commercial banks in India as at end of March 2015.
No of banks Deposits Advances and investments
(Rs in billions) (Rs in billions)
State Bank of India (SBI) and associates 6 20179 21% 19198 21%
Nationalised banks 21 46935 49% 44613 48%
Private sector banks 20 19145 20% 18769 20%
Foreign banks 44 4766 5% 5348 6%
Regional rural banks 56 2699 3% 2354 3%
State cooperative banks 17 811 1% 1271 1%
Urban cooperative banks 50 1661 2% 1484 2%
96197 93038
Source: Basic Statistical Returns, RBI.

Table 2 Geographical presence of scheduled commercial banks—March 2009 (Number of bank branches).
Rural Semi-urban Urban Metropolitan Total
SBI and associates 5560 4835 3043 2624 16062
Nationalised banks 13381 8669 8951 8375 39376
Foreign banks 4 4 52 233 293
Regional rural banks 11626 2746 667 88 15127
Other scheduled commercial banks 1113 2638 2715 2411 8877
Total 31684 18892 15428 13731 79735
Source: Branch Banking Statistics, Reserve Bank of India, September 1, 2010.

over the years, captured by the ratio of banking business Urban cooperative banks (UCBs)
(credit plus deposits) to GDP; commercial bank credit as per
cent of GDP has steadily increased from 5.8% in 1951 to 56.5 Credit cooperatives were created to meet the financing,
% by 2012. The population per bank branch came down from processing and marketing needs of small and marginal
64,000 in 1969 to 12,300 in 2012 (Reserve Bank of India, 2013a, farmers. Cooperatives expanded in urban and semi-urban
2013b). areas in the form of UCBs to meet banking and credit
A key feature that distinguishes the Indian banking sector requirements of people with smaller means. Urban coopera-
from banking sectors in many other countries is the foster- tive banks started as early as the 19th century after similar
ing of different types of institutions that cater to the diver- banking attempts became successful in England and Germany.
gent banking needs of various sectors of the economy. Mutual help, democratic decision making and open member-
Promotion and development of industrial finance institu- ship form the core principles on which these societies
tions (such as Industrial Finance Corporation of India—IFCI, work.1
Industrial Development Bank of India—IDBI), finance for small The earliest known cooperative society was Anyonya
industries (Small Industries Development Bank of India—SIDBI) Sahakari Mandali set up in Baroda (which was a princely state)
and specialised sectors of infrastructure (Power Finance, In- in 1889. From the very beginning, these societies have con-
frastructure Development Finance Company—IDFC, etc.) are tinued to channelise savings from relatively more affluent sec-
classic examples. Similarly, urban cooperative banks (UCBs), tions of society and extended loans to other members who
regional rural banks (RRBs) and local area banks (LABs) are belong to poorer sections of society. The number of coop-
institutions encouraged by the Reserve Bank of India (RBI) for eratives grew rapidly after the Cooperative Credit Societies
meeting banking requirements of small customers, espe- Act of 1904 was passed. With effect from 1966, in order to
cially located in rural and semi-urban areas. Further, there improve professionalism, banks with more than rupees one
has been a parallel growth of non-banking finance compa- lakh2 paid up capital have been covered under the supervi-
nies (NBFCs) providing leasing and hire purchase services, sion of the RBI (Sinha, 2012). Although urban cooperative banks
vehicle finance, loans against gold, and micro-finance, etc. have shown growth on a year on year basis (as the share of
Although regulatory frameworks are different for these in-
stitutions, all serve the financing requirements of various cus-
tomer segments. 1
Brief History of Urban Cooperative Banks in India, https://
Among these financial intermediaries, UCBs, RRBs and LABs www.rbi.org.in/SCRIPTs/fun_urban.aspx.
are small size banks (see Table 3) established to cater to the 2
In the Indian context one million equals ten lakhs and one crore is
financing requirements of small customers. ten million.
Small finance banks 313

Table 3 Existing small banking structure

Urban cooperative banks (UCBs) Regional rural banks (RRB’s) Local area banks (LABs)
Commencement and growth Started in 1889 with the spirit Started in 1976 following the Started in 1996
of the cooperative recommendations of the
movement Narasimham committee
Ownership Cooperative structure, Public sector banks, Private individuals
mostly community respective State
dominated Government and
Government of India
Number of banksa 1574 56 3
Geographical area of Higher concentration in a few Restricted to a few districts Restricted to one or two
operations districts and nominal of a state districts
Regulatory reserve ratios Applicable Applicable Applicable
Prudential norms of capital Applicable Applicable Capital adequacy ratio of 15%
adequacy
Advances to priority sector 40%, similar to other
specified by the regulator commercial banks, out of
which 25% should be for
weaker sections
Market share in the banking 3.5% as on March 31, 2010 Insignificant portion
sector
Customer clientele Targetting specific Rural customers Middle and lower middle
communities Middle and lower middle income groups
Mostly from semi-urban and income groups
urban areas
Middle and lower middle class
customers
Credit Low amount for productive Agriculture credit Small entrepreneurs
purpose Low amount for small
Small entrepreneurs (for entrepreneurs
example three wheeler
rickshaw drivers)
Systems, processes and Moderate Replication of public sector Customised systems and
controls commercial banks processes
Political interference High level Only through Government No interference
channel

Main problems High non-performing assets High NPAs Moderate NPAs

(NPAs)
Restructuring and Many UCBs closed and RBI initiated reforms and One bank closed due to
consolidation merged with public sector merged all the loss making irregularities and another
banks due to capital RRBs in a phased manner merged with a public
erosion, frauds and poor sector bank
quality of management
Supervision Reserve Bank of India (RBI) National Bank for Agriculture Reserve Bank of India (RBI)
and Rural Development
(NABARD)
a
Number of Urban Cooperative banks and Local Area banks are reported in Trend and Progress of Banking in India 2016 and Regional Rural
Banks as per NABARD Annual report 2016–2017.

UCBs constitutes just a small market share of 3.5% of the stance, in a period of two years (2011–2013), 31 co-operative
banking sector), such growth has not reflected the growth of banks failed and the Deposit Insurance and Credit Guaran-
the overall banking sector (Sinha, 2012). As cooperative banks tee Corporation (DICGC) paid Rs 437.31 crore as compensa-
work on their own equity funds contributed by members, as tion to deposit holders.3
well as retained profits, these are inadequate to provide suf-
ficient cushion for growth, resulting in resource constraints
and lower growth. Further, due to bad loans and poor loan 3
“13 Co-op banks turned insolvent last fiscal,” The Hindu Business
recovery, many cooperative banks have failed. For in- Line, May 27, 2013.
314 J. M et al.

The ownership and governance structure of UCBs is often Local area banks (LABs)
bent to political influence and there are multiple instances
where loans have been given on the basis of political LABs were introduced in 1996 and are similar to RRBs with a
influence.4 There are conflicting views on the suitability of distinguishing feature of private ownership. Local area banks
the cooperative structure for banking activity as it is seen to were given banking license with a view to bring the private
favour big farmers and landlords who manage the societies, sector’s efficiency and technology based banking services in
leaving small farmers aside (Nagarajapillai, 2008). Thus rural areas. Initially the minimum startup capital was fixed
reaching target small customers has remained a distant goal at Rs 5 Cr7 and one single family’s ownership was restricted
of UCBs. to 40% of equity. Local area banks are restricted from oper-
ating beyond a maximum of three geographically contigu-
ous districts. The rationale behind this is to make banks more
Regional rural banks (RRBs)5 focussed on limited geographical areas and serve local cus-
tomers who are living in the rural parts of the districts. It is
With a view to create a parallel channel for co-operative credit intended to bring more financial inclusion.
societies, RRBs were established in 1975. The objective was Local area banks were directed to focus on financing agro-
to provide banking services in rural areas, help the rural industrial activities, agriculture and allied activities and other
economy in its development and extend credit to rural and similar non-farming sectors. Local area banks have to follow
agricultural sections of the economy. Regional rural banks are all the prudential norms regarding priority sector advances,
promoted by public sector banks in joint ownership with state capital adequacy, income recognition, asset classification and
and central governments. It is expected that the sponsor public provisioning applicable to other mainstream banks.
sector bank will add professionalism and a large resource base Although an encouraging response was received from
to RRBs. private individuals with 227 applications being filed, only 10
Regional rural banks have been restricted in terms of area got the “in-principle” approval from RBI for the establish-
of operations to certain districts in various states. They were ment of LAB and only six licenses8 were issued meeting the
created to bring together the positive feature of equity par- required criteria. Out of these, one bank was shut down by
ticipation of cooperative institutions and professionalism of RBI in January 2002 due to major irregularities and another
commercial banks to specifically address credit needs of back- LAB was merged with a large public sector bank. Currently
ward sections in rural areas. Regional rural banks showed phe- there are four LABs functioning.
nomenal growth in branch expansion, starting with 6 banks In 2002, the Ramachandran Committee studied the per-
and 17 branches covering 12 districts to 196 RRBs with 14,446 formance of LABs and observed that the health of the exist-
branches in 518 districts across the country by the end of 1991. ing LABs was weak. It recommended that no further LAB
Regional rural banks were unable to attract deposits from licenses should be issued. However, in the context of im-
richer sections of society irrespective of the fact that these proving financial inclusion, the Rangarajan Committee9 ob-
banks were as safe as other public sector banks; thus, gradu- served that LABs have huge potential and along with local
ally their funding position has weakened. In the race to expand financial markets, can offer services like savings, credit, re-
their network, RRBs opened branches at places where com- mittances, insurance, etc. It suggested that RBI should relook
mercial and co-operative banking facilities were already avail- into the possibility of issuing new licenses for LABs, strength-
able, thus not serving the basic function of providing banking ening the view of the Raghuram Rajan Committee.10
services to larger sections of society. Since the RRBs contin- At this juncture one more institution needs to be men-
ued several old practices of public sector banks, customers tioned, i.e. microfinance institutions, although for a long time
were discouraged by the many formalities, which cost them these have not been regulated by the RBI.
a lot of time and delays in getting timely credit. Small bor-
rowers continued with informal and indigenous sources of
finance such as moneylenders. Regional rural banks failed to
innovate any new business model to reach out to customers Microfinance
deprived of financial services.
Also, there is no effective link between farmers’ societ- Overcoming the structural weaknesses of RRBs, cooperative
ies and RRBs, which could have promoted loans in rural areas. societies and urban cooperative banks, the microfinance move-
The want of local involvement from the staff has hindered ment has a significant presence in the Indian credit market.
their growth and failed to attract rural credit to these banks. Microfinance in India is a combination of two models; a con-
Many RRBs have reported huge losses and capital erosion, tractual structure of joint liability group (JLG) or popularly,
leading to RBI intervention in 2006 and 2008 for closure and self-help group (SHG), and the second one is for-profit
consolidation, thus reducing their number to 61.6 microfinance institutions (MFIs). Both these models have made
significant progress in improving credit access to rural indi-
4
viduals. Microfinance has evolved as a people’s movement and
“Politicians should be barred from running district cooperative
banks,” Times of India, Shishir Arya, July 21, 2013.
5 7
Consolidated Review of Performance of Regional Rural Banks, RBI, “Guidelines for Setting up of Local Area Banks in the Private
http://financialservices.gov.in/sites/default/files/Consolidated Sector,” 1996.
8
%20Review%20RRB_1.pdf. (RBI, Report of The Review Group on The Working of The Local Area
6
Speech by Deepali Pant Joshi at Conference of Principal Code Com- Bank Scheme, 2002).
9
pliance Officers and Chairmen of RRBs on July 15, 2013. https:// Report of the Committee on Financial Inclusion, 2008.
10
rbi.org.in/scripts/BS_SpeechesView.aspx?Id=820. Report of the Committee on Financial Sector Reforms, 2009.
Small finance banks 315

has managed to exist outside of government schemes, banks Separate banks for financing small firms:
and other interventions by entrepreneurs (Sriram, 2010). justification from academic research
Microfinance has made significant progress in the last two
decades (1993–2012). For instance, in 2008–2009, the number
Equilibrium credit rationing models state that the problems
of bank-linked SHGs stood at around 45 lakh (or about six crore
of moral hazard and adverse selection (Stiglitz & Weiss, 1981)
households, if one assumes an average membership of about
are extremely high for small firms and that small firms may
12 households per SHG) and cumulative bank loans availed
be particularly vulnerable to availability of credit. Due to this,
by SHGs stood at Rs 22,000 crore (Reserve Bank of India, 2009).
large banks tend to provide fewer loans to small and medium
Similarly, CRISIL (2009) shows that the top 50 MFIs together
enterprises (SMEs) (Berger & Udell, 1998). The relatively simple
claimed an outreach of more than 1.2 crore clients and an
organisational structure of small banks is thought to play a
outstanding portfolio worth Rs 7,650 crore in September 2008.
key role; due to the simple organisational structure, there
The data also shows that the strategic focus of microfinance
are fewer agency problems among small banks, and thus, small
seems to have shifted from poor borrowers to profits. Trans-
banks can produce and deliver qualitative information (Berger
formation of MFIs towards such a commercial motive has been
& Udell, 2002; Stein, 2002). Zhang (2002) indicates, based
accompanied by changes in the structure of ownership, control
on the relational theory of organisation, that small banks have
and management, and nature of their stakeholder commit-
advantages in SME lending. A substantial body of empirical
ment (Nair, 2010).
research shows that small banks are more willing to deliver
Thankom and Hulme (2008) state that MFIs increase choices
bank loans to SMEs than large banks (Berger, Kashyap, Scalise,
that millions of near-poor and poor people have to basic fi-
Gertler, & Friedman, 1995; Keeton, 1995). Lee (2002) de-
nancial services i.e., loans. However, the loans provided have
termines that introducing small and medium-sized financial
not always been for productive purposes. Being unregu-
institutions will increase SME credit and increase the welfare
lated institutions, MFIs’ interest rates on loans are also too
of society as a whole as information superiority among small
high. Further, most of the MFIs are concentrated around the
and medium-sized financial institutions is positively related
same towns and rural hinterlands and often serve the same
to the total amount of financing that SMEs receive. Com-
sets of households, encouraging multiple loans, leading to in-
pared to large banks, loan officers in small banks have greater
dividuals being burdened with huge debt. Stringent perfor-
incentive to produce and use soft information on account of
mance indicators used by many MFIs exerted pressure on field
the simple organisational structure, and so small banks have
staff to achieve financial targets by encouraging clients to take
an advantage in offering relationship lending (Stein, 2002).
on large loans and on failure to make payment, the clients
Williamson (1967) proposed the theory of hierarchical
were disgraced in public which caused them psychological and
control to explain operational differences between small and
physical distress, leading to some borrowers committing
large banks. He notes that large banks suffer from an au-
suicide (Hulme & Arun, 2011).
thority problem in the lending process and that to avoid dis-
Thus, all existing banks and financing institutions, UCBs,
tortions caused by their complex organisational structure, they
RRBs, LABs and microfinance institutions have been suffer-
need to standardise their lending process. Berger and Udell
ing from structural weaknesses and there is a need for new
(2002) discover that relationship lending creates agency prob-
small finance banks to extend financial services, especially
lems between companies and bank credit officers, between
to small customers.
credit officers and upper managers, and between manage-
ment teams and shareholders. As bank size increases and the
organisational structure of the bank becomes more complex,
more serious agency problems arise. Compared with large
Small banks: international presence
banks, small banks rely more heavily on soft information from
borrowers based on their pre-existing relationships when de-
The concept of small finance banks is not totally new as such
ciding whether to approve SME loans (Cole, Goldberg, & White,
institutions have been in existence in developed and emerg-
2004). Berger, Miller, Petersen, Rajan, and Stein (2005) have
ing markets as well. In the U.S., there are about 7,000 small
reached similar conclusions. Zhang (2002) has developed an
community banks with an asset size ranging from less than
organisational theory model that reflects the trade-off
U.S. $10 million to U.S. $10 billion or more. They account for
between information costs and agency costs in loan decision-
about 46% of all small loans to businesses and farms and in
making, proving the advantages of small banks in providing
terms of the number, they constitute about 92% of all the
relationship loans.
Federal Deposit Insurance Corporation (FDIC) insured insti-
Based on the financial institutions in Shimane, one of the
tutions (FDIC, 2014). As quoted in the discussion paper on
most underdeveloped areas in Japan, Zhang (2007) finds that
Banking Structure in India,11 Nigeria has set up over 1400 com-
large banks tend to use less expensive loan technologies, in-
munity banks in rural and urban areas. In Indonesia, the
cluding credit scoring and other transaction-based lending
banking system is multifarious, with simultaneous existence
technologies, whereas small regional banks are committed
of commercial banks in big cities and provincial banks (for
to producing soft information about firms and thus provid-
example, Unit Desa of Bank Rakyat Indonesia (BRI)) in small
ing substantial loan packages to customers. DeYoung, Hunter,
towns to meet financing requirements of small customers.
and Udell (2004a, 2004b) demonstrate that the small bank
competitive advantage, with regard to relationship lending
technology, is due to the organisational structure and other
11
Discussion paper on Banking Structure in India –The Way Forward, factors, such as the information traits of relationship lending.
August 27, 2013, Reserve Bank of India. The benefits of organisational and operational efficiencies
316 J. M et al.

support the small bank advantage hypothesis—small banks are farmers; micro and small industries; and other unorganised
able to lend to small businesses at a lower cost than large sector entities, through high technology-low cost opera-
banks (and lend proportionately more to small businesses) tions, where “small” refers to the kind of customer the bank
(Jayaratne & Wolken, 1999). deals with (Rajan, 2016). Small finance banks have the flex-
ibility to operate all over India, against the earlier models
of RRBs and LABs which had geographical restrictions.
Move towards new small finance banks

The High Level Committee on Financial Sector Reforms

Ownership and governance
(Government of India, 2009) headed by Raghuram Rajan in
its report, “A Hundred Small Steps”, emphasised the need for The minimum paid-up capital for an SFB shall be Rs 100 crores
a paradigm shift in the strategy for financial inclusion. It said and minimum capital adequacy ratio of 15% of its total risk
that emphasis should be shifted from the existing public sector weighted assets (RWA) on a continuous basis, with an em-
dominated, large-banking structure to improved efficiency, phasis on quality capital of Tier I capital which should be 7.5%.
innovation, and value for money. Motivated financiers with Small finance banks can be promoted by individuals who have
low cost structure who also have the capacity to make de- at least 10 years of experience / expertise in financial or
cisions quickly are to be encouraged to start banks. It there- banking field or by private sector companies or societies with
fore recommended that entry to private, well-governed, a good track record. The promoter’s minimum initial contri-
deposit-taking small finance banks be allowed. bution to the paid-up equity capital shall at most be 40% and
The RBI discussion paper (Reserve Bank of India, 2013a, can be gradually brought down to 26% within 12 years from
2013b) focussed on “desirability and practicality of having the date of commencement of business of the bank. The guide-
small and localised banks as preferred vehicles for financial lines also facilitate foreign shareholding currently at 49%,
inclusion” among other aspects of banking structure. The which can go up to 74% with the permission of RBI. Also, SFBs
paper emphasised that deepening the engagement of formal with a net worth of more than Rs 500 Cr must get listed within
banking for low income households and providing access to three years while others may choose to go public voluntarily.
the unbanked will require increasingly innovative approaches
(including channels, products, interface, etc.). Such a frame- Prudential norms
work will need to be localised, customised and contextualised
to suit the differing needs of different localities and will need SFBs have to comply with all the prudential norms and regu-
to address issues such as the development of an overarching lations of RBI similar to commercial banks that include the
macro policy environment, long-term financial sustainability fulfilment of requirements for statutory liquidity ratio (SLR)
of microfinance institutions, increasing outreach by capac- and cash reserve ratio (CRR). They need to extend 75% of Ad-
ity building and effective governance, and broad-based re- justed Net Bank Credit to the priority sector; while 40% should
search and monitoring/evaluation. be as per standard priority sector norms, the other 35% can
Following this, the Reserve Bank’s report (2014) on Com- be in any of the priority sectors. Small finance banks will be
prehensive Financial Services for Small Businesses and Low- small sized universal banks. Half of their credit portfolio will
Income Households popularly known as the Nachiket Mor have to be of ticket size of less than Rs 25 lakh. The maximum
Committee Report came up with two broad designs for the loan size or investment limit to single or group obligator has
banking system in the country—the horizontally differenti- to be restricted to 10% and 15% of its capital funds
ated banking system (HDBS) and the vertically differenti- respectively.
ated banking system (VDBS) based on the functional building The operations of the firm should be technology driven and
blocks of payments, deposits and credit. In an HDBS design, a detailed technology plan has to be submitted to RBI.
the basic design element remains a full-service bank that com- Out of the 10 institutes (Table 4) who have obtained the
bines all three building blocks of payments, deposits, and in-principle license for small finance banks, eight are
credit but is differentiated primarily on the dimension of size microfinance institutes whereas one is a LAB (Capital Local
or geography or sectoral focus. This could also be referred Area Bank) and one (Au Financiers) is an NBFC. While giving
to as the institutional design configuration. In a VDBS design, licenses to new private sector banks in April 2014, notwith-
the full-service bank is replaced by banks that specialise in standing the introduction of small finance banks, RBI has fa-
one or more of the building blocks of payments, deposits, and voured Bandhan, a microfinance company, to become a
credit. This could also be referred to as the functional design commercial bank. Bandhan has been working as an MFI for
configuration. In reality, most banking systems would have the past 15 years and will be the first such to be converted
a mix of both designs (Reserve Bank of India, 2014). into a bank in this country. Bandhan Financial Services started
full-fledged commercial banking operations from August 2015,
a clear signal by RBI that there is need for more banks to meet
Policy on small finance banks small customers’ banking requirements.

The Reserve Bank has, accordingly, decided to licence dif-

ferentiated banks and guidelines on licensing of small finance Need for discussion
banks (SFBs) and payments banks were issued in November
2014. The objectives of licensing small finance banks were In this context the current round table discussion assumes sig-
stated to be as follows: (a) provision of savings vehicles, and nificance for widening the ambit of banking services to small
(b) supply of credit to small business units; small and marginal businesses and raises the following questions
Small finance banks 317

Table 4 New small finance banks.

Name of the institution Nature of activity
Au Financiers India Au Financiers is an asset finance company incorporated in 1996 as a non-banking
finance company. The main asset portfolio includes vehicle loans, small secured
business loans for MSMEs and housing finance.
Motilal Oswal Private Equity Advisors, ChrysCapital, Kedaara Capital, Warburg Pincus,
and International Finance Corporation have substantial ownership in the company
and have geographical presence across 10 states in northern India.
Capital Local Area Bank Capital LAB is the largest among the surviving local area banks. Set up in January
2000, the bank has been operating in five contiguous districts in Punjab. As of
March 2015, Capital LAB has Rs 1506 Cr of deposits and Rs 926 Cr of advances on its
balance sheet; it has 39 branches and has been consistently profitable.
Disha Microfinance Disha Microfinance started in 2009 offers financial services to rural and semi-urban
areas of Gujarat, Rajasthan, Madhya Pradesh and Karnataka. Along with
microfinance loans, it offers credit linked insurance and retirement solutions. It has
more than Rs 200 Cr of assets under management as of 2014. The company is
backed by equity investors like India Value Fund. As of March 2015, Disha
Microfinance covers close to 8600 villages with 71 branches across 39 districts. A
unique feature of this company is it offers credit to only women borrowers.
Equitas Microfinance Based out of Chennai, Equitas was formed in 2007 as a microfinance institution. Since
then, it has diversified its businesses through a holding company into different
verticals like housing finance and used commercial vehicle financing. Equitas has
operations in 124 districts across seven states with 361 branches, but its main
business still comes from Tamil Nadu.
Evangelical Social Action Forum ESAF society started as an NGO in 1992 in Kerala. Its objectives were to deal with
(ESAF) Microfinance unemployment and poverty. ESAF started its microfinance business in 1995. In
2006, the society acquired Pinnai Finance and Investments. It currently offers
products like micro loans, social security services like insurance and pension and
money transfer. ESAF has operations in Tamil Nadu, Kerala, Madhya Pradesh,
Maharashtra, Chattisgarh, and Jharkhand. ESAF predominantly offers loans to
women borrowers under the joint liability group model of lending.
Janalakshmi Financial Services Janalakshmi Financial Services is the third largest urban MFI of India with more than
Rs 3800 Cr. It has 23 lakh customers served through 233 branches with a presence
across 17 states and in 151 cities. Janalakshmi is backed by investors such as
Michael and Susan Dell Foundation, Lok Capital and Bellwether Microfinance Fund.
Rashtriya Gramin Vikas Nidhi (RGVN) RGVN is a society strated in 1990 and converted into a micro finance institution in
(North East) Microfinance 2010. The society was founded to develop and support NGOs and community based
organisations in the north-eastern part of the country. The company is
headquartered in Guwahati and has presence in five states—Assam, Arunachal
Pradesh, Meghalaya, Nagaland, and Sikkim. The company has more than 2.2 lakh
borrowers who are served through 104 branches.
Suryoday Microfinance Suryoday received license as a microfinance institution in 2009. It has presence in
seven states though its primary business (up to 65%) comes from the states of
Maharashtra and Tamil Nadu. The focus of the firm is on the women borrowers from
the weaker sections of society. As of March 2015, Suryoday has 164 branches
through which it is serving 6.05 lakh customers.
Ujjivan Microfinance Having started operations in 2005, Ujjivan Microfinance is the fourth largest MFI in
the country. It has Rs 3270 Cr of assets under management and serves over 20 lakh
clients through 463 branches. The company was started to provide financial
solutions to the urban poor and is backed by investors such as the CDC Group,
Sequoia Capital, Lok Capital, and International Finance Corporation among others.
Utkarsh Microfinance Utkarsh Microfinance, started in 2009, has a presence in the central and northern
areas of the country. Headquartered in Varanasi, Utkarsh is backed by investors
such as Lok Capital, Norwegian Microfinance initiative, Aavishkaar Goodwell,
International Finance Corporation and Commonwealth Development Corporation.
In a short span of six years, Utkarsh has built a customer base of 600,000 with a
network of 271 branches.
318 J. M et al.

• What is the spirit of differentiation and source of busi- healthy respect for us because they feel that we can disrupt
ness opportunity recognised by prospective small finance the market merely because of our ability to use a very agile
banks? technology platform. There are technology platforms which
• How are these new banks leveraging technology? are 10 to 15 years old, from which we can learn and thus
• How are these new banks building up their liability make a platform which is more robust and at the same time
portfolios? cost effective. Thanks to Aadhaar, thanks to National Pay-
• What are their capital management strategies? ments Corporation of India (NPCI) and thanks to the mobile
• What strategies do these banks envision to face the chal- revolution, we can do banking much more differently from
lenges of a competitive banking landscape? what is being done today. These are the three points which
will help us in being successful in this experiment.
Panellists: Sarvjit Samra (Capital): We are a local area bank, and we
have been operating as a LAB for the last 16 years. The dif-
Sarvjit Samra, CEO Capital Local Area Bank, Jalandhar ference between us and other banks is that we can open
Rajat Singh, Head of Strategy and Planning, Ujjivan Fi- branches in the local areas that we have been assigned. Ac-
nancial Services cording to the RBI guidelines, we could work in three con-
HKN Raghavan, CEO, Equitas Microfinance tiguous districts as the area of operations. For the first 13
years, we worked in the three districts of Jalandhar,
Kapoorthala, and Hoshiarpur and in January 2013 we got per-
mission for expansion into two more districts—Amritsar and
Spirit of differentiation Ludhiana. In terms of small finance banks, there will be no
restriction on the area of operations. We can keep on ex-
Question: RBI has performed a similar experiment earlier by panding. Presently we are not a scheduled bank; once we start
introducing regional rural banks or local area banks. What working as a small finance bank, we will be a scheduled bank.
exactly is the spirit of differentiation as you understand, with A scheduled bank has a number of other advantages. We will
the introduction of small finance banks? be eligible for certain subsidies which the government pro-
Rajat Singh (Ujjivan Financial Services): Three things. vides to scheduled banks, and we can pass them on to mar-
First, allowing small finance banks to operate pan-India. I ginal farmers and others.
would say that is a big differentiator because given the kind HKN Raghavan (Equitas): We always wanted to become
of business we are in, we are always prone to some political a bank. Our vision, from the time we started in 2007, was to
mandate or natural calamity. Having concentrated your busi- become a bank. Our mission is to improve the quality of life
ness in one geographical area makes your business very risky. of our clients in a fair and transparent way and getting the
Both local area banks and regional rural banks are geographi- bank license is a way forward towards it.
cally constrained, and when the small finance bank discus-
sion paper came up, the authorities came up with the same
thought process that SFBs have to be geographically contigu-
ous, and they cannot be pan-India. As an MFI, we tried to Technology
explain to them why it does not make sense to have a geo-
graphically concentrated institution. It has its own chal- Question: The RBI guidelines clearly say that the SFB should
lenges and risks, and it has been tried earlier as well with be a technology driven bank. What are your thoughts on de-
LABs. When the final guidelines came up, they removed this vising technology driven business models? Also, would banks
clause. In the final paper, they did not put a constraint on need differentiated technology to do risk assessment and
geography but on the loan size. Fifty per cent of our loans credit assessment of such a varied customer base?
have to be below Rs 25 lakhs. To that extent, it is a big dif- HKN Raghavan: We were the first MFI to invest heavily in
ference for us. Secondly, from day one they have made it technology. Equitas’ first disbursement was with a central-
very clear that all the regulatory guidelines (prudential norms) ised back office. We invested in core banking software back
will be applicable to small finance banks. Take capital ad- in 2007. Technology is very important. We believe in tech-
equacy ratio (CAR) —it is higher than the requirement for nology on two fronts. One, from the customer perspective,
commercial banks and similar to NBFCs. The RBI also said technology enables ease of operations, and we want to make
that all the CRR and SLR requirements will apply in the same it user-friendly and easily accessible. The other is from the
spirit which makes investors or people who are putting money perspective of internal control—technology enables fraud de-
with the license holders very comfortable. To that extent, I tection, process management, and risk mitigation. Technol-
feel that this initiative—SFB—is a bit different from what RBI ogy and process are interwoven today. Today, we collect
has done earlier with LAB and RRBs. Further, here we are cash from 1.5 lakh clients every day without any fraud. If it
under direct supervision of the RBI, while RRBs were not as were not for the technology, it would be impossible. You
they had their sponsor banks. The RBI cannot go wrong with build technology in such a fashion that your risk is miti-
us in terms of not supervising very closely, so that lends us gated. Coming back to banking—we will be hi-tech and
a lot of credibility in the market. And thirdly, there is an hi-touch.
inflection point in terms of technology so we do not have a Rajat Singh: We take pride in saying that we have one of
lot of the legacy and baggage that traditional banks have. the best technology solutions in the industry. Such technol-
We have the opportunity to start from scratch, and it is a ogy could be common for banks but in microfinance, no one
big advantage. We may not be able to compete with the has invested so much in technology. Many MFIs that have
HDFCs of the world, but there are many banks which have a opened after Ujjivan have learnt about the technology;
Small finance banks 319

however, we were the first to begin using technology in this Grameen 12 to a retail bank. Grameen is good for the front
industry on a larger level. Group lending is our bread and end; it will cut down your front end cost, get the right cus-
butter, where we use Craft Silicon, a Kenyan software. In tomer, and so on, and retail back end ensures that you have
India, back in 2005, there was no software service provider efficiency. So from day one we were very focussed on that.
who was looking at this space actively. It was not a key busi- Over a period of 10 years, it has turned out to be one of the
ness area. When we started, we wondered what we should most efficient processes. For example, our operating cost is
do. We could not start a business without software. Prior to one of the lowest.
us, there were microfinance institutions who started their busi- Sarvjit Samra: At present we are a very technology savvy
ness, but they came from an NGO background. They had a bank. We will be adopting all the channels. We were the first
different mindset and their outlook was very different. They bank to post an ATM in a rural area over 15 years back in
did not focus on risk management, operational efficiency and Punjab. Now we have all those technological channels, and
so on. It was more in the nature of doing a good thing. Our we will be strengthening them. We will be going ahead with
management came from a banking background. These things digital banking.
were ingrained in their DNA. Microfinance was well devel-
oped in African countries, so we brought the Kenyan soft-
ware to India. Today they have many MFIs as customers. For
Liability management
individual lending which is an emerging or growing portfo-
lio, we have a software called SysArc which is provided by Question: Except Capital Local Area Bank, all the license
Lend Perfect, a Chennai based company. Most of the PSU banks holders are NBFCs or microfinance institutions which have asset
are using it as their loan map origination system; it is also a portfolios funded by bank loans and borrowings but not low
software for individual lending. Third is our mobility solu- cost deposits. What are your thoughts on building a liability
tion. Today all our individual loans are app based. We have portfolio and offering a wide range of liability products?
developed a software with the help of a startup where fi- Rajat Singh: It is a big challenge. It will also require a
nancial analysis, credit bureau linkage, customer acquisi- mindset change on our end. Today the only question we ask
tion, etc. happens over the tab and that makes the overall is, “Can I trust you?” but we now have to answer this same
process efficient and faster. But that is done only for indi- question from the borrower. At the level of field officer it re-
vidual loans, which are 12% of our portfolio. For the remain- quires a change of mindset. There could be two opportuni-
ing group loans, we have not automatised the front end ties; if you look at the RBI guidelines carefully, on the asset
process. We are in the process of doing it, and will convert side, they have put a lot of restrictions such as 50% of credit
the front end of group lending process into a paperless process. under Rs 25 lakh, 75% priority sector lending (PSL), that decide
One of the processes is customer onboarding; another is col- where you need to look for the liabilities. But there are no
lecting repayment from our customers which we are doing restrictions on the liabilities side. This makes the whole game
on a door to door basis. Once a month, we have to go to our very different. So depending on the DNA of the organisation,
customers and collect money from them. Initially, this whole different organisations are taking it differently. For example
process was paper driven. Now we have automatised it. We Bandhan has got the full banking license, but they were origi-
have a solution called true cell where field staff can update nally an MFI. What they have done is to create two banks in
repayment. It reflects in real time in our system. This reduces one bank. They are targetting all customers from high net
a lot of paper work because when paper comes into the worth individuals (HNIs) to people at the bottom of the
picture, the process of reconciliation and report generation pyramid. They have two sets of branches. One set of branches
has to be carried out, only after which you come to realise is targetting urban, affluent and HNI and other branches are
that there is some payment that is overdue. Now these things looking after the rest of the people. This also means two dif-
are gone, and you have a very fast, agile and efficient system. ferent sets of teams. They believe that with this approach
So these are some of the efficient actions we have taken. We they will have access to liabilities, current and savings account
have outsourced the database in Mumbai to the people who (CASA), and so on, and they will be able to build liability port-
can manage it best. The whole data centre is managed by IBM. folio very quickly.
These are some of the highlights of our technology. The second approach could be to look at the customer side.
Coming back to our backend technology, for group loan These are the customers whom we know very well. We have
which is not fully automated, it is done on paper; the cus- served these customers for the last 10 years. Our approach
tomer acquisition or loan forms are filled up, and those forms could be to focus on this set of customers so that we can le-
come to the general bank for approval. The process there- verage our existing distribution network, branch network,
after is paperless. When the loan paper comes to us, we scan technology and people. Once you build this base, incremen-
the document and everyone, operations department or cash tally you can go to the next set of customers such as micro
department, works using that image. When forms come here, and small and medium enterprises (MSMEs), and poorly served
they get digitised. So when you go to our operations depart- bank customers from old public and private sector banks. So
ment, you will see that it is like any bank. No papers or docu- the idea is to first go with your customer and then with those
ments are lying around. Everything is fully automated. When who are either underserved or poorly served. The challenge
the processes of my section (operations section) are com- in this strategy is that your market will be smaller, and peo-
pleted, the form will automatically progress to the out- ple’s ability to save is very small. Nobody has profitably served
sourced level. When the outsourced person is done with it, this set of customers from the banking point of view. The core
it goes to the credit queue. When credit is done, it goes to
cash. So it is an automated and highly integrated system. When 12
Grameen is a group based lending model which uses technology
we started, our vision was to integrate the front end of and professional management.
320 J. M et al.

customer segment is the untested market. They all have Prime leverage the relationship. The third one could be
Minister Jan Dhan Yojana (PMJDY) account, but the ac- securitisation. According to RBI, 75% of our portfolio should
counts are not regularly used. The advantage of this strat- be PSL. Today 100% of the portfolio is PSL, so practically speak-
egy is there is no competition from formal financial service ing I can securitise some of it. The fourth source is commer-
providers whereas in the Bandhan strategy you have to really cial paper (CP) and also, certificate of deposit (CD). So these
fight tooth and nail with established players such as the HDFCs, are some of the sources through which we will try to manage
ICICIs, and AXISes of the world. Our strategy is, not to compete our transition.
when we are setting up our operations initially with those who HKN Raghavan: It will take time for us to build the low-
have invested the last 20 years in establishing their network cost liability side. The existing client base is not going to help
and technology. We will focus on our own customer base. A much. They will contribute close to 15–20% of the liabili-
closer look at the savings habit of our customers reveals that ties. Rest, we have to fight with the “biggies”. Irrespective
it is not that they are not saving. They are saving with dif- of whether we enter into small finance banks or not, one con-
ferent informal segments of society such as chit funds, com- stant endeavour has been to reduce the cost of funds. There
panies like Sahara, Saradha, Rose Valley and so on. When we are many choices available now—commercial papers and non-
go to different parts of the country there are different meth- convertible debentures (NCDs) are two. We have also reduced
odologies. Chit funds have a larger presence in south India. the interest rates to 22.5% in the last six months from the
The amount of money being transacted through chit funds is earlier 23.5%. With the reputation of MFIs having improved
very large. As per our estimate, if we collate this market, there since the Andhra crisis, raising money from the market is not
is a Rs 4 lakh crore liabilities-side market known in these kinds as difficult as it was before. We also have a credit bureau
of institutes. We are not considering the unknown here. If we where we can get information about individuals who have
include Post Office accounts and money in PMJDY accounts taken loans from multiple MFIs. We have put systems and pro-
as well, the size is reasonable, and we are initially targetting cesses in place to make sure that the client is not overlev-
5% of this market in five years. This is similar to the kind of eraged. This has helped us to take a leading decision today.
situation we were in when we started the microfinance busi- The institutions NABARD and SIDBI have been helping MFIs
ness. If we can provide technology and access to our cus- already and with MUDRA, special focus has been on loans in
tomers and we can provide customers courteous service, we the range of Rs 50,000 – Rs 5,00,000. This is the same range
can tap the market. However, such customers are not com- in which SFBs will be working. Hence, refinancing is going to
fortable doing CASA with us. The way to go in this market is be important and will give us some breathing space. The RBI
to start with products such as fixed deposit (FD) and recur- is also supportive of us in delivering objectives expected of
ring deposit (RD). It will increase your cost of funds, but that’s an SFB. I expect the proportion of lending by NABARD, MUDRA,
the only way to actually educate and bring this customer into and SIDBI to increase once SFB operations start in compari-
your fold. The other companies in the informal segment do son to what is being provided to MFIs. However, there might
not do CASA with these customers. They have educated this be internal caps on these institutions.
customer about FD and RD. We can build on that. Once your Sarvjit Samra: On the liability side our risk is well spread.
channels are in place—ATMs, business correspondent, network, From the deposit point of view also, we do not have any bulk
and so on, we can educate them to have CASA. We can also deposit. On CASA, which we have developed, we are paying
digitise their income to a certain extent. As far as people like only 4% unlike leading private commercial banks like Kotak
us are concerned, 90–95% of our transactions are cashless. and Yes. You can have the required quality of loan portfolio
The only reason it is cashless is because our income is cash- when you pay less on deposits and charge less on loans.
less. If we are able to create an ecosystem for our set of cus-
tomers, if we can digitise their income and put in ATMs and
business correspondents (BCs) close by so that they have access Management of statutory liquidity ratio (SLR)
to their income, I think we can win this game. That’s our strat- and cash reserve ratio (CRR)
egy on the liabilities side.
Liability is a long term game while in assets in one year Question: With RBI being strict on not relaxing the CRR and
you can build a huge portfolio because it is all about giving SLR norms for SFBs, how difficult will it be for SFBs to main-
away the money. Later you can worry about your credit cost. tain a good Net Interest Margin (NIM) or lower the cost of
With liabilities—it is very difficult. Liabilities take time to build. funds? Is regulatory cost too big a burden on SFBs?
If you look at banks, it has generally taken 7–10 years to build HKN Raghavan: It is a process. We have to live with it. It
liabilities and CASA. Everybody has started as a corporate bank is in the interest of RBI as well, as it wants SFBs to be suc-
and then shifted to being a commercial bank. I agree with cessful. The RBI has been very sympathetic to the opera-
your point that it will take time to build the liabilities side, tional issue. They have formed a committee only to solve the
say three years. In the transition phase, we have to look for operational problems of setting up a bank. You cannot have
alternate sources of funding. Term loans will go away. We two sets of guidelines for banks.
have to rely on short-term interbank lending which will mean Sarvjit Samra: At present, we are regulated by the same
asset-liability mismatch (ALM). Further, interbank will be only benchmarks as full scheduled banks so the regulatory cost will
10–15% of the liabilities. Second source could be long-term definitely not increase.
loans from financial institutions such as SIDBI, National Housing Rajat Singh: Yes it will be very costly. It is the cost of being
Bank (NHB), National Bank for Agriculture and Rural Devel- a bank. It will bring pressure on our bottom line. Being a bank,
opment (NABARD), and Micro Units Development and Refi- you also need to bring down your net interest margin. Today
nance Agency (MUDRA). We have already established a we enjoy net interest margin of 12% or so. We have to bring
relationship with them, and we have to see how much we can it down to 4% which is a desirable level which our kind of
Small finance banks 321

operation cannot do. When we made five year plans, we we were non-compliant with RBI guidelines. We are compli-
realised that 4% is not a possibility at all. So we came to the ant with all the rest. Domestic holdings for us are around 66–
mid-way point. We have small transactions and not door step 67%. We are not planning an IPO. In the next financial year,
services, which adds to our cost. Our operating cost itself is we are targetting some equity infusion via private place-
7%. In taking the middle way we envisaged that 12% would ments; the IPO plan may be after four or five years; we made
go down to 8% over a period of five years. As we increase our our projection that we do not need additional capital for the
operational efficiency, we will gradually reduce the net in- next four to five years.
terest margin and fortunately, RBI has also understood this
fact, and they are fine with it. They have given the license
and realised that to bring NIM down to 4% is a long term Payments banks
process and cannot be done in the short term. And if it forces
us to do so, probably this experiment will not succeed. We Question: With customers having the option of choosing from
will reduce it further because our funding cost is coming down. multiple e-wallets—be it HDFC PayZapp, ICICI Pockets, SBI
Also, the spread is coming down. Average yield is close to 23%. Buddy or any other, Equitas might need to produce its own
Over a long period, we will be able to reduce it to 18.5%. Over if it wants to compete with these biggies?
the last few years, whenever we have gained operational ef- HKN Raghavan: Yes, absolutely. Wallets are a kind of fi-
ficiency or our cost of funds has come down, we have passed nancial product and the more products you are able to offer
those benefits to our customers. In this way, Ujjivan is a unique to your customers, the more likely they are to stick with you.
organisation; we take the stakeholder approach and pass the We will also explore the possibility of wallets and other fi-
benefit to all the stakeholders, including customers. nancial products.
Question: There are payments banks as well which are
coming up. Are they going to be a competitive segment for
Regulatory credit exposure to priority sector you because RBI has identified a separate set of players for
payments banks altogether?
Rajat Singh: To some extent they will be our competi-
Question: Though Equitas has been lending to the priority
tors because they are doing liability overlay but they have a
sectors, how easy or difficult would it be for Equitas to meet
certain restriction on liability so they can only do CASA; they
prudential norms, i.e. 75% of banking credit to priority sectors?
cannot do term products or loans. Of course, they can tie up
HKN Raghavan: Asset side is not a worry. We have been
with banks and come to some arrangement. Second thing,
lending to priority sectors, so almost 100% of credit is to the
unlike SFBs, their focus will be across the spectrum; if you
priority sector.
look at it, 8 out of 10 SFBs are actually microfinance insti-
tutions. So by orientation or DNA, they try to focus on the
segment of customers who are unserved. Payments banks have
Capital management and foreign holding many such restrictions. Most of them are either technology
or telecom companies. They will be serving both the top end
Question: What are your thoughts on reaching the target as well as the bottom end customers. What we have seen is
capital requirement of Rs 500 crore? that if you have such a huge customer base, you end up serving
HKN Raghavan: Initially, Indian investors did not buy the profitable customers, at least initially. To that extent, they
MFI story. Hence the low equity from domestic investors, and will serve the segment they are most comfortable with. I don’t
most of the MFIs have more than 70% of foreign holdings. These know what priority customers with say, less than 500 rupees,
foreign investors over the world have seen the growth of will have for them. If some of them choose to serve and ac-
microfinance, and they know what they are investing in. So, tively pursue this segment, they would be our competitors,
there are only two options—initial public offerings (IPOs) or because they have to reach out and they are expected to
some foreign investors selling their stakes to Indian inves- provide very agile and fast service to their customers. To that
tors. Initial public offerings will bring down the foreign holding extent, there will be a fight on CASA. But only if they are ac-
below 49%, and we will see from there what the future holds. tively pursuing this segment of customers. The natural pos-
Rajat Singh: Our main reason for going for listing is to bring sibility is that they will start with the middle and affluent
down the foreign holding to 49%. Today we are comfortable classes. Probably later they will come here.
because we have capital adequacy ratio of above 20%. From
that point of view, we don’t need capital, we can still manage
capital. Since we need domestic capital, we are going for Competition and business model
listing. The listing cost will be on the higher side, but at the
same time if you look at it, it is the adjusted premium that Question: How do you see the competition from other players
you will see on our balance sheet. like payment banks and regional rural banks and urban co-
Question: Will listing on the new SME exchange help you operative banks?
or will you go for mainframe? Sarvjit Samra: When we started in 2000, we had the ad-
Rajat Singh: A lot of investors have their own policy of not vantage of being early starters. At that point of time, the pres-
investing in SMEs. So, our strategy is to go for mainframe ence of private players in rural areas and semi-urban areas
listing. was very small but today every other bank is present where
Sarvjit Samra: We have done a rights issue in December we are opening our branches. When we compare the growth
2015, which was around Rs 17.29 Cr. So as on date, our of our new branches with that of the new private sector banks,
networth is Rs 118 Cr. This was the only thing regarding which we are growing at a much better rate. We find that
322 J. M et al.

nationalised banks which open branches in our area of op- only where our branches are. We will not go for the off-
eration, are not doing well. Let me share with you how we premise model because it is an expensive proposition. We do
are planning to continue this growth story. We want to main- not have the luxury to go for that kind of model. We will con-
tain contiguity in our growth story. We don’t want to grow sider it over a period of time. At the same time, we will
in a haphazard way. If you study the models of a few of the provide a debit card to all our customers. So wherever we
post-liberalisation private banks, one such bank, for example, find that the use of debit card is very high, and there are a
is concentrated mainly in south India and focussed on Tamil lot of transactions and people are using debit cards to with-
Nadu. Now they have opened branches in Ludhiana and draw money from other ATMs, we will analyse that data and
Jalandhar. But for them, they will always be strong in Tamil see whether we need to put an ATM there or not. Depend-
Nadu. So when we grow, we will remain clear cut market ing upon the breakeven cost, if transaction cost goes beyond
leaders in the area in which we are operating presently and the limit, we will put an ATM there. We do not have to invest
the adjoining area. We will not face competition from anyone in these things from day one. We have to take a call on re-
because of the brand equity which we have developed over quired basis and then go for it. So ATM will be part of our
the years. Now we want to carry it forward. If contiguity is channel if the customer sees it as an important channel. It
maintained, you can very well carry it forward. This is what also helps in moving a customer from assisted to self-service
we experienced when we expanded from three districts to mode. But it is a kind of journey. It will start at some point
five districts. and move later. From day one, it may not be all across, but
Question: With expansion into new geographies, will the it will be in our branches, and later we will go to off-premise
model of Suvidha centres (brick and mortar BC outlets) ATMs as well. Our most important channel apart from branches
continue? will be the business correspondent, and we are bullish on the
Sarvjit Samra: Suvidha centres will not continue. Suvidha BC. Our surveys suggest that customers do not want to move
centres were opened in unbanked rural areas, about six or beyond one and a half kilometres to do a transaction. That
seven years ago. Now RBI is saying that you open brick and is their comfort zone. We too do not want to move beyond
mortar branches. So with the opening of branches in unbanked one km to enable an ATM transaction. So we will be estab-
areas, Suvidha centre will not work. In fact, the business cor- lishing our BC network, and that will be probably with the
respondent (BC) model, used by many banks has not help of corporate BC. There are several players who already
succeeded. have their BC network. We will ride on one of them and will
Question: Do you think people will come to branches or see how we can provide transaction points to our customers
should branches go to people via BCs? in their neighbourhood. The BC is our key channel in the fore-
Sarvjit Samra: People in the rural areas love to come to seeable future.
branches. It has been our experience, and that is why our Question: Regarding the business correspondent or BC
Suvidha centre was that successful. Other banks which used network, as the customers are rural in nature, will the tech-
BCs are going to doorsteps of people and opening their ac- nology be friendly for them? Second, will BCs be collecting
counts; they have not been very successful in comparison to savings or giving loans to the customer? Will the customers
our Suvidha centres. trust them or not?
Question: Overall, what are the challenges you see once Rajat Singh: For the kind of BC services we are thinking
you convert yourselves into a SFB? of, the customer does not have to be a tech savvy person to
Sarvjit Samra: In the immediate future, I do not see any avail those services. We are talking about leveraging Aadhaar,
challenge. In fact, instead of challenges, there are a lot of OTP, card or SIM where there is a neighbourhood shop, you
opportunities. But, in the longer run, maintaining a higher go there and say you want to withdraw Rs 500. You use your
capital adequacy of 15% will be a challenge. Today my balance thumb for biometric authentication, and you will get your
sheet size is Rs 2000 Cr but in five years’ time, it is going to money. We are not talking about moving them to a self-
cross Rs 8000 Cr and in business terms from Rs 3000 Cr of busi- service mode where you use your own wallet to withdraw or
ness to 12000 Cr in five years’ time. At that level, maintain- lend or transfer money. That is not under our framework for
ing a 15% CAR will be a bit challenging. But we expect that the next two years. Our theory is to move customers from as-
after a couple of years of successful operations, RBI may relax sisted to self-service mode. We see it as a journey. From day
this. For others, CAR is very low, it is around 9%. Same with one, we are not asking them to do things on their own because
priority sector lending. At present, we do not see any chal- of the reason you just stated.
lenge but as size grows, maintaining 75% PSL is also going to The BC is an assisted model where customers will be as-
be a challenge. The RBI is very open and we expect that after sisted by the BC during the transaction. So knowing technol-
the banks stabilise, RBI will definitely relax these norms. ogy is not an important parameter, even when they are dealing
Question: Then there is an opportunity to convert your- with the BC. The element of trust is there. Business corre-
self into a full commercial bank as well… spondents are of two types: static and mobile. We are talking
Sarvjit Samra: Yes, of course. According to the business about static BC, which will be located at some place. They
plan which we have made for ourselves, we plan to cross will probably use a combination of technology and supervi-
around Rs 400 Cr of net worth in five years. Then we are think- sion methodology to make sure the customer gets a seam-
ing of going for an IPO, so we bring in another Rs 300 Cr to less experience. I am not saying it will happen on day one.
Rs 400 Cr of additional capital to our net worth. Then we can It is a human channel and is expected to have a lot of prob-
think of becoming a universal bank. lems. But it will happen with the help of technology and strong
Question: Will you be using your own ATMs? customer education on financial literacy, on what is right and
Rajat Singh: We have two options. We are saying that on what is not so right; and third, by putting a supervisory struc-
day one, we will have on-premise ATMs. So we will have ATMs ture in place. Our idea is to make sure these things minimise
Small finance banks 323

trust related issues. Today because of facilities such as Bandhan is doing what you are suggesting, not through BC
Aadhaar, the telephone, OTP, and messages, people get but through their staff. Once in a week at a specified time,
updates. So to a great extent, fraud can be avoided. Ten years he comes, and you can withdraw money. According to me,
back, in such a situation, it was very difficult to prevent a it’s an inflexible way of doing things.
fraud; today you can do it. You get an SMS on a mobile phone Question: SFBs can also deliver other services like mutual
after every transaction. A little bit of customer education will funds, etc. How do you see this opportunity?
also help us in preventing all these things. As of now, BCs are Rajat Singh: It is a big opportunity. However, not all cus-
hungry for business and they have established themselves. tomers are ready for it. We have to do this with a lot of cus-
They try to squeeze the transactions that come their way. tomer education. To start with we will go with remittances
Once they realise that a customer is coming in regularly, say and insurance. A mutual fund is not in our framework for the
twice in a month, they will know that they have to conduct next five years. Basic insurance is in our framework because
themselves professionally with the customer, because either we feel that there is a need for such a kind of product as well
he will complain or he will go to some other BC. The BC will in our customer segment. We will tie-up with insurance
also change as will his income over a period of time. His urge providers.
to do wrong things will decrease. The number of the trans- Question: How can SFBs innovate on the technology front
actions in this customer segment may increase. Business cor- or how can they increase the usage of technology among
respondents will earn more than what they earn today. Plus, clients? The question becomes more relevant since the clients
today BCs are largely being used for fund transfer and not for who are currently dealing with MFIs belong to the low-
transactions. Once in a quarter, customers may go to with- income group and fear e-banking.
draw their NREGA payment, or transfer money to somebody HKN Raghavan: I agree with you that it will take time for
else and the transactions are not so frequent. Now even if them to adopt technology. The current generation will adopt
the charge is 40 rupees per transaction, the customer will think with time but the generation which is 40–50 years of age will
that it is better than going to a remote bank and standing there need assistance. One more important development which has
for hours to get money. When you have to do it more fre- taken place is payments banks. They will ensure that people
quently, you will also become more concerned. These are the adopt technology. License holders of payments banks are tech-
hypotheses on which we feel that we will be able to prevent nology and communication companies which will ensure that
or avoid some of the trust issues. Technology should play an their customers adopt and accept the technological changes.
important role. Our supervisory action should be able to help If we take into account the JAM revolution—The Jan Dhan
us to do that. The BC model is not the easy way to go forward, Yojana, Aadhaar, and Mobile—we are looking towards an
but that’s the cheapest way. If you have to serve this segment economy which will be completely cash-free in 10 years.
profitably, then you have to do that. The ATM transaction costs Further, with mobile wallets removing the cash required in
you 15–18 rupees, BC may cost you 5 rupees. If you start individual wallets, this is an exciting time for our country.
putting ATMs everywhere, then your transaction cost and We are all fortunate to be a part of this financial revolution.
maintenance cost will be very high. You cannot really afford
it. To serve this segment, you have to serve through the BC
route knowing fully well that there can be certain pressure Post script
points, and you have to deal with it as you can.
Since you talked about customers’ ability to use technol- Subsequent to the Round Table, two important changes worth
ogy, I would recommend to you a report from China about a discussing in the context of small finance banks are capital
financial service which is an arm of Alibaba. They have pub- funds raised by the two small finance banks (incidentally, they
lished their one-year transaction history and details that are are participants of the round table) and the event of
very insightful. Regions that are most backward, are most using demonetisation announced by the Government of India. A brief
mobile technology. In areas like Tibet and so on 80% of the note on these two is presented here.
transactions are done through mobile. It is lower for people
living in Shanghai as they use multiple avenues for transaction.
Question: Talking about RRBs, they want customers to Capital issues
come to their premises. Don’t you think that with static BCs,
the problem will remain the same? Subsequent to the discussion, the two licensees Equitas and
Rajat Singh: Static BCs are nevertheless in their Ujjivan have gone for IPO to raise capital funds and have raised
neighbourhood. Best is to provide them door step service. The Rs 2170 crore and Rs 885 crore, respectively. Both the com-
question is, Can you afford it? If you can afford to provide door panies’ post issue stock prices are significantly higher than
step service, that’s great. But some balance has to be created issue prices, indicating the stock market welcomed the idea
and our survey suggests that customers are comfortable with of small finance banks.
a 1 or 1.5 km walk; that is, a 15 minute walk is not an issue
for them. We are talking about BC here. It is completely dif-
ferent from RRB which is 5–10 km away from the custom- Demonetisation
er’s home. We are talking about the same village having a
BC presence. You can also have a mobile BC, but it comes with On 8th November 2016 the Prime Minister of India made
many other side effects. It restricts you, in my opinion. Mobile an announcement, nullifying the legal currency (or
BC has fixed timings. They may not meet your requirement demonetisation) with an aim to clean out the cash supply in
all the time. So it is not that flexible. The risk and trust issue black market (black money), corruption, terror funding and
is also more than with static BCs. to declare a war on counterfeit or fake currency. This
324 J. M et al.

demonetisation move completely disrupted the social, po- lenges for these banks are building the liability product
litical, and economic spheres of India for approximately two portfolio, meeting the mandatory norms on statutory norms
months. With the announcement of cancellation of legal of cash reserve ratio, improving the digital connectivity with
money, all Rs 500 and Rs 1,000 rupee notes were instanta- the large scale rural customer base, and designing cost ef-
neously voided, and a 50 day window period (November 10th fective banking solutions. These new banks are yet to come
to December 30th, 2016) ensued where the people were given out with an innovative banking business model to chart a path
the option to redeem their cancelled cash for newly de- for differentiated banking.
signed 500 and 2000 rupee notes or deposit the cancelled cur-
rency in bank accounts.
The financial and business press in India has widely dis- Acknowledgements
cussed and debated the long term and short term implica-
tions of demonetisation for the society, the economy in general We thank Mr. Sarvjit Samra, CEO Capital Local Area Bank,
and the banking sector in particular. Although small finance Jalandhar, Mr. Rajat Singh, Head of Strategy and Planning,
banks are new players, the demonetisation event has rami- Ujjivan Financial Services and Mr. HKN Raghavan, CEO, Equitas
fications on the business of these entities. These are: Microfinance for participating in the discussion. We also thank
Low cost of funds: With a large part of the cash moving the anonymous reviewers and the journal editorial team for
through the banking channels, the banking sector is flooded useful comments and suggestions.
with funds, with liquidity, and this partly helps banks to reduce
cost of funds. Banks started getting a lot of low cost CASA
deposits coming at a huge spread to them. This will benefit References
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