Small banks are the last bricks in the wall of financial inclusion that has been cemented by the Reserve Bank of India (RBI) and comes close on the permission to entities to set up payments banks. Small banks are a concept where the entity is allowed to collect deposits and use the funds for specific purposes with a focus on priority sector lending.
RBI has maintained a minimum paid-up capital of Rs 100 crore. Surprisingly, as of March 2014, there were 10 banks in the public and private sector that had capital of less than this level, which includes four associate banks of SBI, Lakshmi Vilas Bank, Nainital Bank, City Union Bank, J&K Bank, Catholic Syrian and Tamilnad Mercantile Bank. Hence, in terms of size, these small banks could compare well with the existing banks.
Further, assuming that the small bank starts with a capital of Rs 100 crore, the equivalent amount for an existing bank in FY14 would be Karur Vysya Bank, which had a balance sheet size of around Rs 51,000 crore, of which total advances were Rs 34,000 crore. Intuitively, one can visualise the potential scale that can be built on this size of capital over a period of time.
The basic concept involves a certain matrix in terms of lending. In fact, 75% of adjusted bank credit has to be for the priority sector that includes small farmers, micro units, etc. Further, there is a clause which says that 50% of total loans should be going to borrowers where credit is up to Rs 25 lakh. In addition, the prudential norms of CRR and SLR have to be met. Hence, for every Rs 100 of deposits collected, Rs 25.5 would be set aside for pre-emptions. Of the Rs 74.5 left, Rs 56 has to be to the priority sector (assuming adjusted bank credit is the base). Further, Rs 37.25 of total loans has to be less than Rs 25 lakh.
A look at the structure of credit in the banking system, as of 2014, shows that loans of size of up to Rs 25 lakh totalled Rs 16.71 lakh crore, out of a sum of Rs 62.8 lakh crore, with a share of slightly more than 25%. However, in terms of number of accounts, there were 137.1 million accounts with loans of each less than Rs 25 lakh, out of a total of 138.7 million accounts—share of 99%. Quite clearly, there is a large market in terms of number of accounts that can be targeted by these new banks. Intuitively, these banks can focus also on rural home loans to retail segment that would qualify under these stipulations.
The concept is again novel and with 10 applications being given an in-principle nod, there would be another ring of players in the market. The approvals are to eight microfinance institutions (MFIs), and one Local Area Bank (LAB) and Non-Banking Financial Company (NBFC). They are well distributed across the country with only two entities based in Chennai. They would be allowed to operate across the country with no restrictions. This appears to be a good enough experiment which is being tested before other players are allowed to join the fray.
The interesting thing about these small banks is that all of them are already in the financial business and hence do not have to start afresh. There are CRR and SLR norms to adhere to, which becomes important to ring-fence them from the risk associated with priority sector lending. However, the issue really is that priority sector loans tend to become vulnerable to becoming non-performing assets (NPAs) with the propensity being higher for them. In the past, the NPA ratio for priority sector loans has ranged from 4-5% while that of non-priority sector has been around 3%, with the number increasing to 4% in 2014 due to the problems in the infrastructure space.
The challenge would be to control NPAs here, as an unfavourable monsoon would have an impact on farm loans. Similarly, any slowdown in the industrial sector is first felt on the small and medium-sized enterprises (SMEs), which have payments problems. Therefore, on both scores, they would be at a disadvantage compared with the commercial banking system. Banks are able to diversify their portfolio by lending to all sectors which includes retail, services and manufacturing, while these banks would be left with dealing with the smaller ones only. Besides, given that these accounts would be small and well dispersed, the cost of monitoring would also be higher for them.
To the advantage of the licensees, their experience on this front would help them overcome this challenge as they already have relationships with customers in this area and only have to scale up. The rules allow them to open branches across geographies, though they have to be in unbanked areas. While this is an opportunity, the accompanying risk of focusing on the hitherto unbanked section would be a challenge. On the positive side, they would be able to garner deposits from the public, which will help the system to bring in more deposit holders as well as provide funding to these banks.
Two questions that come up are the following. The first is whether these banks will be able to add a ‘delta’ to the overall level of lending? This is pertinent here because these organisations already exist and are involved in lending. This portfolio, which hitherto was not part of the system, would get added to the bank credit level. But for the system as a whole, the incremental growth would be important.
The second question is whether these banks would also be treated like commercial banks in terms of having access to the money market and the RBI repo window. With them being subjected to the CRR and SLR stipulations, they should be part of the banking system and also be allowed to do treasury operations to manage their balance sheets.
While the concept of both payments banks and small banks will be tested over time, the small banks, being already in the business of lending, would have a distinct certainty in their operations. However, the fact that they will now be regulated and have to lend to the more vulnerable sections will ensure that they have to constantly be on guard when balancing their loan portfolios.
The author is chief economist, CARE Ratings. Views are personal