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Tata Capital > Blog > Generic > What Is a Small Finance Bank? How Is It Different From a Commercial Bank?

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What Is a Small Finance Bank? How Is It Different From a Commercial Bank?

What Is a Small Finance Bank? How Is It Different From a Commercial Bank?

India has a vast and well-organised financial system with commercial banks and NBFCs at the centre. Both these institutions are prominent in India’s financial landscape, offering a range of services from savings and investing avenues to loan facilities.

However, over the years, a new category of banks has emerged as banking alternative in the country. Scheduled small finance banks, or SFB banks, have gained massive popularity for their higher FD interest rates.

Moreover, this category of banks is not limited to their higher interest rate offerings. Instead, they serve a greater goal of fostering financial inclusivity. Read on as we explore the numerous features, objectives, and significance of small finance banks.

What is a Small Finance Bank?

Small finance banks are a niche banking segment in the financial industry that cater to the financial needs of certain segments of population, including small businesses and low-income households. The first small finance bank, Capital Small Finance Bank, was established fairly recently in the year 2016. The primary of this category of banks is to foster India’s goal of enhanced financial inclusion among the population.

These banks have been established in most of the remote parts of India, where standard commercial banking systems are scarce. With small finance banks, the government aims to extend basic banking services to the unbanked and under-banked segment of the population.

Apart from this, small finance banks also offer microloan facilities to small business units, marginal farmers, and low-income families.

Difference Between SFB Bank and Commercial Bank

There are a few differences that help in distinguishing between an SFB bank and a commercial bank, these are as follows:

Comparison ParameterSmall Finance BankCommercial Bank
Services OfferedThey offer basic banking services like savings accounts, fixed deposits, recurring deposits, digital banking, debit cards, and so on.Apart from basic banking services, commercial banks offer a wide range of financial services including credit cards, wealth management, corporate banking services, etc.
Capital RequirementTo set up an SFB bank, the minimum capital required is ₹200 crores.To set up a commercial bank, the minimum capital required is ₹500 crores.
Loan ProductsSmall finance bank loans include microfinance loans, small personal loans, micro-business loans, and loans to marginal farmers and industries.A broader range of loan products can be accessed, including large corporate loans, housing loans, personal loans, etc.
Target CustomerSmall finance banks target the underserved and unbanked segments of the population, like small businesses, MSMEs, and marginal farmers.These banks cater to a wider consumer base including large corporates, SMEs, and retail customers.

Objectives of Small Finance Bank

The primary objectives of a scheduled small finance bank are as follows:

1. Promoting Financial Inclusion: SFB banks focus on granting access to essential financial services and products to the segment of the population that has been overlooked or underserved by commercial banks. With wider reach in remote parts of the country, these banks are improving India’s financial inclusion.

2. Offering Basic Banking Services: Small finance banks strive to deliver basic banking services to the individuals who traditionally lack access to these facilities. Savings accounts, fixed deposits, and microloans are some of the products offered by these banks.

3. Contributing to Poverty Reduction: Through their efforts to promote financial inclusivity, SFBs aid in poverty alleviation. They provide vital financial services and products to low-income groups, supporting equal economic opportunities across the country.

4. Facilitating Microfinance: A key mandate for SFBs is to offer microfinance services. It includes extending small-scale loans to micro-enterprises and households with limited income. This helps in fostering small-scale entrepreneurship and financial stability among the underserved segment.

5. Supporting Agricultural Financing: These banks also play a crucial role in addressing the financing needs of the agricultural sector. They extend credit and other services to marginal farmers and rural households. This helps in supporting the agricultural community along with the rural economy.

RBI Guidelines

As the regulatory body for India’s SFB banks, the Reserve Bank of India (RBI) has established specific guidelines for their proper functioning and adherence to regulatory standards:

1. Scheduled Bank Status: Post-establishment and upon meeting specific criteria under Section 42 of the RBI Act, 1934, SFBs are accorded scheduled bank status.

2. Emphasis on Financial Inclusion: SFBs have the primary objective of providing financial services to unbanked and underbanked populations, including small businesses, low-income households, and farmers, in line with the broader financial inclusion agenda.

3. Minimum CRAR: CRAR or Capital to Risk-Weighted Assets Ratio is a tool that measures the bank’s capital to its risk exposure. The RBI guidelines require SFBs to maintain a minimum CRAR of 15% to ensure stability and robustness.

4. Priority Sector Lending Commitment: SFBs are obligated to allocate 75% of their Adjusted Net Bank Credit to prioritise lending to essential sectors like agriculture, MSMEs, and other similar areas.

5. Rural Branch Expansion: The RBI has provided a strict mandate for SFBs to establish at least 25% of their branches in unbanked rural areas to enhance banking service outreach.

6. Capital Requirements: SFBs are required to have a minimum paid-up voting equity capital of Rs. 200 crores. This reinforces their financial robustness and stability.

7. Microfinance Portfolio Obligations: According to the RBI, SFBs need to ensure that at least 50% of their loan portfolio comprises microfinance, with advances capped at Rs. 25,00,000. This underscores SFB's commitment to microfinance and small-scale borrowers.

8. Adherence to Prudential Norms: They must comply with various prudential norms and regulations concerning income recognition, asset classification, and provisioning. This move helps in safeguarding their operational integrity.

9. Technological Integration: To effectively reach the targeted clientele, RBI has encouraged SFBs to embrace technological advancements. It ensures enhanced operational efficiency while aligning with India’s digital transformation initiatives.

To Sum Up

Scheduled small finance banks have played a crucial role in connecting the dots within the Indian financial landscape. They have complemented the existing banking system by reaching out to society's unbanked and underbanked segments.

As the number of entities in the small finance banking sector increases, we can expect to reach greater heights of financial inclusivity. This expansion can prove to be a monumental step in fostering India’s economic growth and prosperity.

For more information regarding small finance banks and other trending financial topics, head on to Tata Capital Blogs.

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