Not by small banks alone

The Reserve Bank of India recently released guidelines for setting up small, local banks in the private sector. These small banks are expected to be important vehicles for providing essential credit and savings services to micro/small businesses and low income households.

A key point made by the RBI is that India has previously experimented with small, local banks in the private sector and that experience has been satisfactory. Raghuram Rajan actually said in 2008, well before he became overnor, that the concept of small, local area banks had unfortunately not been seriously tried in the country, even though they performed well. (The RBI announced guidelines for local area banks (LABs) in 1996. Though some 230 applications were received, RBI rejected more than 200 and by 2002, licensed only five. Four of them are in operation now).

In his report on the financial sector in 2008, Rajan said the LABs not only served the un-banked segments in rural/semi-urban areas, but were also profitable. Therefore, the RBI’s latest guidelines on small banks can only be taken as a serious second attempt to establish and popularise the concept.

Against this backdrop, the key question is whether small, local banks obviate the need for other kinds of private borrowing and/or lending institutions such as, for example, nonbanking financial companies (NBFCs) focused on the micro/small business segment and low income households?

A study of the aggregate operational performance of LABs in the country would be relevant. While LABs have satisfactory financial performance parameters, they have still made only a minor dent on the problem of financial exclusion of vast numbers of small/micro businesses and low income households.

In the nearly 15 years since their licensing in 2000-2001, the four LABs have built up a total advances portfolio of approximately ₹1,300 crore. They have mobilised nearly ₹1,700 crore of savings in the form of deposits from the public.

Against that, it has been estimated that the recurring, annual credit requirements of small and micro businesses and low income households (across rural, semi-urban and urban areas) in the country is as much as ₹15,00,000 crore. Mainline commercial banks meet only a tenth of this recurring requirement.

It is clear that LABs have made only a marginal impact on the credit and savings deprivation of vast sections of the population. We need hundreds and thousands of LABs, not just three or four.

But, when we are considering thousands of borrowing and lending institutions across the country, can it be optimal to have only one kind of organisation format for such activity, namely, the banking format? It is assumed here that with the advent of new small banks, the RBI is prepared for the likely supervisory challenge.

We also need institutions that can go beyond the geographic limits prescribed for the proposed small banks. Moreover, it is not clear, even in these high inflation times, how many prospective applicants can put up the start-up capital of ₹100 crore — which is the minimum mandated for setting up a small bank under the new guidelines.

The Government should also think in terms of facilitating the growth of the nonbank financial sector in order to complement the efforts on the banking front. There are some 200 nominally deposit-taking NBFCs in operation, catering to micro and small businesses. These NBFCs have capital bases much less than the specified ₹100 crore. But, given their long-standing presence in the market and their experience, they are best placed to serve small businesses and low income households.

In the past couple of decades, these NBFCs have been systematically forced to reduce their operations due to an unfriendly regulatory framework. How can a lending institution do business without adequate borrowing facilities? The retail deposits of such small NBFCs, which formed as much as 10 per cent of the banking sector’s total deposits back in 1996, are now less than 0.5 per cent of the banking deposits. There were also some 13,000 such NBFCs in 1996.

The requirement, then, is to frame a facilitative regulatory environment that can serve the cause of financial inclusion of micro and small businesses and low income households.

The writer is a Chennai-based financial consultant