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Contacts:

Karthik Srinivasan
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karthiks@icraindia.com

RBI’s Operating Guidelines for Kalpesh Gada

+91 22 6114 3445

Small Finance Banks kalpesh@icraindia.com

Rohit Inamdar
+91 124 4545 847

Guidelines likely to enable smooth transition rohit.inamdar@icraindia.com

Supreeta Nijjar
+91 124 4545 324
supreetan@icraindia.com

Abhijeet Jhunjhunwala
+91 33 7150 1132
abhijeet.jhunjhunwala@icraindia.c
om

1
ICRA – Small Finance Banks
Two entities commenced
operations as SFBs; various
entities received or applied for
final licence from RBI
Overall capital requirement high;
however, release of capital and
lower common equity on account
of lower risk weights for retail
portfolio
ICRA Research
In October 2016, the Reserve Bank of India (RBI) issued the operating guidelines for small finance banks (SFBs) following the ten
in-principle licences issued in September 2015. Of the ten licensees, two entities have already commenced operations as SFBs,
while various entities have either applied for or received the final licence. The guidelines provide greater clarity on a number of
operational issues including capital requirements, inter-bank borrowing limits, inclusions and exclusions for adjusted net
banking credit (ANBC) for priority sector lending. This ICRA Research note discusses the guidelines in detail. Overall, the
guidelines are positive for the sector and should enable a smoother transition of the licensees into SFBs.
Chart 1: Capital requirement for SFBs and SCBs Unlike scheduled commercial Banks (SCBs)
which have already migrated to the Basel
10 20 III norms, SFBs would be required to
follow the Basel II standardised approach
8
15 for credit risk. However, they have a
6 higher overall capital adequacy
in %
in %
10 requirement of 15%, with a minimum of
4
7.5% Tier I. The SFBs would also have to
5 maintain a minimum of 6% of Common
2
Equity Tier I (CET1) till FY2019, and a
0 0
minimum of 7% subsequently. There
March 31, 2017 March 31, 2018 March 31, 2019
could however be some capital relief for
SFB : CET 1 + CCB SCB: CET 1 + CCB
SFBs with the risk weight for retail loan
SFB: (incl. CCB) Total Capital (RHS) SCB: (incl. CCB) Total Capital (RHS)
portfolios being lower at 75% for them.
Further, home loan portfolios could get
Source: RBI, ICRA research additional relief owing to the even lower
risk weights on home loans (35%-50% for loans upto Rs. 7.5 million) vis-a-vis 100% for NBFCs and NBFC-MFIs. This, would
however be partly negated by the additional capital requirement (for SFBs) in respect of operational and market risk for which
guidelines will be issued separately. SFBs are also being allowed to raise Additional Tier 1 Capital, although investor appetite for
the same remains to be seen. Nevertheless, given that most SFB licensees have been able to raise substantial capital (Rs. 25
billion YTD FY2017) and intend to maintain significantly higher capitalisation levels than regulatory requirements over the next
two to three years, in ICRA’s opinion, they should be able to meet these capitalisation requirements.
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ICRA – Small Finance Banks
Grandfathering of existing bank
borrowings to support liquidity
Lending banks to continue to
enjoy PSL status for existing
borrowings; ANBC computation
provides relief on PSL
requirements
Governance, branch authorisation
to be similar to private sector
banks
ICRA Research
In its earlier note on Small Finance Banks in October 2015, ICRA had highlighted that building a retail deposit franchise would be
a key challenge for SFBs and that during the interim period; SFBs would be dependent on other sources like inter-bank
borrowings, refinance from SIDBI, NABARD and MUDRA. The operating guidelines provide significant relief for SFBs and
licensees with legacy borrowings being exempted from the inter-bank borrowing limits of upto 200%/300 % of networth, till the
legacy borrowings run down or three years of commencement of SFB operations, whichever is earlier. With only the loans
availed after conversion to SFBs being subject to inter-bank borrowing limits (as applicable to SCBs) for the first three years, the
guidelines provide the banks time to develop a deposit base, and focus on establishing systems and operations, apart from
supporting their liquidity profile.
As for priority sector lending (PSL) benefits, the lending banks —providers of existing debt which will be grandfathered—will be
permitted to classify the grandfathered loans as PSL, as long as the underlying assets are PSL eligible. This facility will be
extended till these bank loans are repaid by the SFBs. Further, the assets financed from these loans would neither be classified
as PSL for SFBs nor would be recognized as part of Adjusted Net Banking Credit for the purpose of priority sector calculation for
the SFBs. Hence, double counting of PSL benefit would be avoided and the SFBs’ PSL requirement will be significantly lower on
the incremental portfolios, till such time these borrowings continue on their books.
Most of the guidelines for SCBs would be applicable for SFBs as well. The SFBs would be required to have 25% of their branches
in unbanked rural centres within one year from the date of commencement of operations. The governance structure for private
banks would be applicable for SFBs as well. However, while the guidelines are silent on treatment for the existing branches of
some NBFC-MFIs which are converting to SFBs, as per the recommendations of the Report on the Internal Working group
(IWG) on rationalisation of Branch Authorisation policy , NBFC/NBFC-MFIs may be given a time period of 3 years to close or
convert their existing branches into ‘banking outlets’. During this period, the existing structures may continue, and these would
be treated as ‘banking outlets’ though not reckoned for the 25 per cent norm. Therefore, the SFBs would get time for
rationalisation/upgradation of branch network so as to meet the norm of having opened 25 per cent of their total Banking
Outlets in unbanked rural centres.
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ICRA – Small Finance Banks

The detailed report comprises of the following:

1. Comparison of key parameters between SFBs and Banks:

 Capital Adequacy Framework
 Borrowing and Liquidity profile
 Priority Sector Lending (PSL) Requirements
 Branch Authorisation Policy
 Credit Risk Transfer and Portfolio Sale or Purchase
 Para-banking Activities

2. Key Challenges during Transition; Progress So Far

3. Comparison of SFBs, new Universal banks & NBFC-MFIs

ICRA Research Page 4

ICRA – Small Finance Banks

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ICRA Research Page 5