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RBI releases draft guidelines for 'on tap' Licensing of Small Finance Banks
(09:15, 14 Sep 2019)
As announced in the Second Bi-monthly Monetary Policy Statement, 2019-20 dated 06 June 2019, the Reserve Bank of India has released draft guidelines for 'on tap' licensing of small finance banks.

The small finance bank shall be registered as a public limited company under the Companies Act, 2013. It will be licensed under Section 22 of the Banking Regulation Act, 1949 and governed by the provisions of the Banking Regulation Act, 1949; Reserve Bank of India Act, 1934; Foreign Exchange Management Act, 1999; Payment and Settlement Systems Act, 2007; Credit Information Companies (Regulation) Act, 2005; Deposit Insurance and Credit Guarantee Corporation Act, 1961; other relevant Statutes and the Directives, Prudential Regulations and other Guidelines/ Instructions issued by Reserve Bank of India (RBI) and other regulators from time to time. The small finance banks will be given scheduled bank status once they commence their operations.

The objectives of setting up of small finance banks will be for furthering financial inclusion by (i) provision of savings vehicles primarily to unserved and underserved sections of the population, and (ii) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations.

Resident individuals/professionals (Indian citizens), singly or jointly, each having at least 10 years of experience in banking and finance at a senior level; and Companies and Societies in the private sector, that are owned and controlled by residents (as defined in FEMA Regulations, as amended from time to time), and having successful track record of running their businesses for at least a period of five years, will be eligible as promoters to set up small finance banks.

Existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) in the private sector, that are controlled by residents (as defined in FEMA Regulations, as amended from time to time), and having successful track record of running their businesses for at least a period of five years, can also opt for conversion into small finance banks after complying with all legal and regulatory requirements of various authorities and if they conform to these guidelines.

However, joint ventures by different promoter groups for the purpose of setting up small finance banks would not be permitted. As local focus and the ability to serve smaller customers will be the key criteria in licensing such banks, this may be a more appropriate vehicle for local players or players who are focused on lending to unserved / underserved sections of the society. Accordingly, proposals from public sector entities and large industrial house / business groups, including from NBFCs promoted by them, autonomous boards / bodies set up under enactment of a State legislature, state financial corporations, subsidiaries of development financial institutions, will not be entertained.

For the purpose of these guidelines, a Group with assets of Rs 5,000 crore or more with the non-financial business of the group accounting for 40% or more in terms of total assets / gross income, will be treated as a large industrial house / business groups.

Primary (Urban) Co-operative Banks (UCBs), which are desirous of voluntarily converting into small finance bank, may refer to Scheme on voluntary transition of Urban Co-operative Bank into a Small Finance Bank. UCBs applying for transiting to small finance bank or obtaining in-principle approval for such transition (under the above referred scheme), will be required to ensure compliance with these 'on tap' licensing guidelines from the date of commencement of business as small finance bank except the guideline on minimum capital. The minimum net worth of such small finance banks shall be Rs.100 crore from the date of commencement of business. However they will have to increase their minimum net worth to Rs 200 crore within five years from the date of commencement of business.

Promoters / Promoter Groups1 should be 'fit and proper' in order to be eligible to promote small finance banks. RBI would assess the 'fit and proper' status of the applicants on the basis of their past record of sound credentials and integrity; financial soundness and successful track record of professional experience or of running their businesses, etc. for at least a period of five years.

The promoters / promoter group may choose to set up the small finance bank either as a standalone entity or under a holding company, which shall act as the promoting entity of the bank. However, if there is an intermediate company between the small finance bank and its promoting entity, it should be a Non-Operative Financial Holding Company (NOFHC). If the promoters desire to set up the small finance bank under a holding company structure, without an NOFHC, the holding company / the promoting entity shall be registered as an NBFC - CIC with the Reserve Bank. In case the small finance bank is set up under an NOFHC, the NOFHC would be required to conform to all requirements relating to NOFHC stipulated under paragraph 2 (C) II of the Guidelines for 'on tap' Licensing of Universal Banks in the Private Sector dated 1 August 2016. The general principle for reorganisation of the activities in the group is that all activities permitted to a bank under Section 6 (a) to (o) of Banking Regulation Act, 1949 shall be carried out from the bank. However, if the Promoters desire to continue existing specialized activities from a separate entity proposed to be held under the NOFHC, prior approval from RBI would be required and it should be ensured that similar activities are not conducted through the bank. Further, the activities not permitted to the bank would also not be permitted to the group i.e. entities under the NOFHC would not be permitted to engage in activities that the bank is not permitted to engage in. However, small finance banks will not be allowed to set up any subsidiaries.

The minimum paid-up voting equity capital for small finance banks shall be Rs 200 crore, except for such small finance banks which are converted from UCBs for which the capital requirement will be as prescribed in paragraph 3(a) above.

In view of the inherent risk of a small finance bank, it shall be required to maintain a minimum capital adequacy ratio of 15% of its risk weighted assets (RWA) on a continuous basis, subject to any higher percentage as may be prescribed by RBI from time to time. Tier I capital should be at least 7.5% of RWAs. Tier II capital should be limited to a maximum of 100% of total Tier I capital. Basel II norms will be generally applicable to the small finance banks, unless stipulated otherwise.

The promoters shall hold a minimum of 40% of the paid-up voting equity capital of the bank, which shall be locked-in for a period of five years from the date of commencement of business of the bank. If the initial shareholding by promoters in the bank is in excess of 40% of paid-up voting equity capital, it should be brought down to 40% within a period of five years. Whether a promoter ceases to be a promoter or could exit from the bank, after completing the lock-in period of five years, would depend on the RBI's regulatory and supervisory comfort / discomfort and SEBI regulations in this regard. Further, the promoters' stake should be brought down to a maximum of 30% of the paid-up voting equity capital of the bank within a period of 10 years, and to a maximum of 15% within 15 years from the date of commencement of business of the bank.

Further, in the case of such small finance banks which are converted from UCBs, while the initial lock in period for promoters will be similar to other small finance banks (i.e. 40% of the paid-up voting equity capital of the bank for first five years), the requirement of bringing down the promoters' holding (to 40/30/15% over the period of 5/10/15 years) would commence from the date of reaching net worth of Rs 200 crore (as against from date of commencement of business, for other small finance banks).

Proposals having diversified shareholding, subject to the initial minimum shareholding of promoters, and a time frame for listing of the bank will be preferred. However, after the small finance bank reaches the net worth of Rs 500 crore, listing will be mandatory within three years of reaching that net worth. Small finance banks having net worth of below Rs 500 crore could also get their shares listed voluntarily, subject to fulfillment of the requirements of the capital markets regulator. Any proposed material change in the shareholding pattern in the promoter entity at the time of application and during the period between the application and in-principle approval and even thereafter should be brought to the prior notice of RBI.

In view of the objectives for which small finance banks are set up, the bank will be required to extend 75% of its Adjusted Net Bank Credit (ANBC) to the sectors eligible for classification as priority sector lending (PSL) by RBI. While 40% of its ANBC should be allocated to different sub-sectors under PSL as per the extant PSL prescriptions, the bank can allocate the balance 35% to any one or more sub-sectors under the PSL where it has competitive advantage.

The maximum loan size and investment limit exposure to a single and group obligor would be restricted to 10% and 15% of its capital funds, respectively. Further, in order to ensure that the bank extends loans primarily to small borrowers, at least 50% of its loan portfolio should constitute loans and advances of up to Rs 25 lakh on an ongoing basis. For assessing compliance with this requirement, the entire loan portfolio of the bank, as on the date of commencement of operations, would be considered and not just the fresh loans disbursed after the commencement of operations. Further, the criteria of upper limit of Rs 25 lakh shall be borrower wise.

After the initial stabilization period of five years, and after a review, RBI may relax the above exposure limits.

In addition to the restrictions placed on banks' loans and advances to its directors and the companies in which its directors are interested under Section 20 of the Banking Regulation Act, 1949, the small finance bank is precluded from having any exposure to its promoters, major shareholders (who have shareholding of 10% or more of paid-up voting equity shares in the bank), the relatives [as defined in Section 2 (77) of the Companies Act, 2013 and Rules made there under] of the promoters as also the entities in which they have significant influence or control (as defined under Accounting Standards Ind AS 28 and Ind AS 110).

An existing NBFC/MFI/LAB, if it meets the conditions under these guidelines, could apply to convert itself into a small finance bank, after complying with all legal and approval requirements from various authorities. In such a case, the entity shall have a minimum net worth of Rs 200 crore or it shall infuse additional paid-up voting equity capital to achieve net worth of Rs 200 crore within eighteen months from the date of in-principal approval or as on the date of commencement of operations, whichever is earlier. It may be noted that on conversion into a small finance bank, the NBFC / MFI will cease to exist and all its business which a bank can undertake should fold into the bank and the activities which a bank cannot statutorily undertake be divested / disposed of. Further, the branches of the NBFC / MFI should either be converted into bank branches within a period of three years from the date of commencement of operations or be merged / closed. The small finance bank and the NBFC / MFI cannot co-exist.

Banks are precluded from creating floating charge on their assets. For such NBFCs / MFIs, which succeed in obtaining licenses to convert into small finance banks, if they have created floating charges on their assets for secured borrowings which stand in their balance sheets on the day of conversion into a small finance bank, RBI will permit grandfathering of such borrowings till their maturity, subject to imposition of additional capital charge in order to protect the interest of the depositors.

If the existing NBFCs/MFIs/LABs have diluted the promoters' shareholding to below 40%, but above 26%, due to regulatory requirements or otherwise, RBI may not insist on the promoters' minimum initial contribution as indicated in paragraph 6 of the guidelines. In such cases, the promoters' have to ensure that their holding does not fall below 26% of paid-up voting equity capital during the first five years, from commencement of business of the bank, even if fresh equity is infused.

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