Will Small Banks Make A Difference?

<div><strong>Raghu Mohan</strong><br><br>The Reserve Bank of India (RBI) has issued “in-principle” approval to ten applicants to set up small finance banks (SFBs) to bolster financial inclusion to cover the vast swathes of the unbanked. The idea is akin to the move to set up local area banks (LABs) in the mid-90s which was an unqualified flop. Will its new avatar work?</div><div>&nbsp;</div><div>In the current context where size is everything, it remains to be seen how these SFBs fare. While they are designed to be small, in just about every other aspect of regulation, they are to be seen as your regular bank. Again, operationally, it’s anybody’s guess as to what kind of cost advantage they can have – rentals (office and branches) will be on a par with any other bank; as for salaries, just what kind of talent can they attract if it not aligned with the market?</div><div>&nbsp;</div><div>Let us also not lose sight of the fact that some of the bigger state-run and private banks have now started to target (in an aggressive manner) the very same audience that the proposed SFBs aspire to cater to, albeit at the top of this pyramid.</div><div>&nbsp;</div><div><img alt="" src="http://bw-image.s3.amazonaws.com/small-beautiful.jpg" style="width: 640px; height: 248px; margin: 1px;"></div><div>&nbsp;</div><div>&nbsp;</div><div>&nbsp;</div><div>On paper, the idea is laudable. It was the Committee on Financial Sector Reforms (Chairman: Dr. Raghuram G. Rajan; 2009) which opined on the need to set them up; that the sufficient change (in the environment) warranted experimentation with well-governed deposit-taking SFBs. And to offset their higher risk from being geographically focussed, it was for higher capital, a strict prohibition on related party transactions, and lower allowable concentration norms. It was seconded by the report on `<em>Banking Structure: The Way Forward</em>’ (27th August 2013).</div><div>&nbsp;</div><div><img alt="" src="http://bw-image.s3.amazonaws.com/licensees-lrg.jpg" style="width: 640px; height: 286px; margin: 1px;"></div><div>&nbsp;</div><div>&nbsp;</div><div><strong>Will It Fire?</strong></div><div>To flashback. In his “Dream Budget of 1997”, then finance minister P Chidambaram made a case for LABs to provide organised finance for rural India – not very different from SFBs.</div><div>&nbsp;</div><div>In August 1997, Mint Road allowed them entry -- Manipal LAB (Manipal; Karnataka); Priyadarshini LAB (Aurangabad, Maharashtra)) and Krishna Bhima Samruddhji LAB (in Karnataka and Andhra Pradesh). Later, an “in-principle” nod was given to five more -- Capital LAB (Nakodar, Punjab); Coastal LAB (Vijayawada, Andhra Pradesh); LAB of Kongunadu Ltd (Salem, Tamil Nadu); Central Gujarat LAB (Dabhoi, Gujarat); and Vinayak LAB (Sikar, Rajasthan).</div><div>&nbsp;</div><div>The last time we got a full report on the functioning of these banks was from `The Review Group on The Working of LAB Scheme’ (1st September 2002) under the chairmanship of G Ramachandran (Former Finance Secretary). It was critical; and its major findings were: that in their catchment areas, they had a limited footprint, and they were swamped by commercial banks.</div><div>&nbsp;</div><div>&nbsp;</div><div><img alt="" src="http://bw-image.s3.amazonaws.com/working-lab.jpg" style="width: 640px; height: 542px; margin: 1px;"><br><br>&nbsp;</div><div>&nbsp;</div><div>The Committee concluded that “we are strongly of the view that whether it is rural banking or any other segment of the financial sector, size, whether in terms of capital base or totality of operations as reflected in the balance sheets, is of critical importance. It is size which inspires and retains the confidence of depositors and borrowers alike. It is size of capital which enables a financial entity to cope with unexpected adverse trends in its business and overcome threats to its survival from any panic reaction on the part of its investors”.</div>