Financial Inclusion in India and Its Challenges

[op-ed snap] Small and inclusive

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Small Finance Banks

Mains level : Financial Inclusion

Context

INDIA’S central bank has been criticized for being conservative in lifting entry barriers for new players in the banking sector.

On tap licensing

  • It has been three years after the RBI approved licenses to 10 small finance banks.
  • It has now issued the final guidelines for licensing such banks throughout the year or on tap.

Guidelines

  • The bar has been raised for new entrants in terms of higher capital requirements — Rs 200 crore from Rs 100 crore earlier.
  • Stiffer prudential norms on a continuing basis.
  • Mandatory requirement to list after three years when the net worth tops Rs 500 crore.

Benefits

  • The new approach to granting differentiated licenses to small finance banks and payment banks is welcome.
  • In the current context, established full-service large banks are scaling back their franchises to reduce expenditure.
  • There is also the impact of the planned mergers of some of the state-owned banks.

Small banks

  • Small finance banks have the potential to provide an alternative to some of the existing institutions.
  • Their mandated focus on small and medium businesses, the informal sector, small and marginal farmers will increase financial inclusion.
  • It also serves a variety of unserved clients in the hinterland and tier three and four cities and towns.

Performance of SFBs

  • The RBI’s review of the performance of small finance banks shows that they have achieved their priority sector targets and attained the mandate for furthering financial inclusion.
  • These banks account for less than 0.5% of total deposits and less than 1% of total advances.
  • Many of them have been growing their loan books at a good clip. 

Limitations

  • Their challenge is in building a franchise.
  • There are also the challenges of ensuring relatively low-cost operations by diversifying their loan portfolios and lowering the old legacy loan stock and wholesale deposits. All these can get costly. 
  • They need to put in place robust technology platforms and modern risk management systems.

Way ahead

  • Experience has shown that a competitive banking system can help foster a more inclusive financial sector. 
  • Small finance banks could occupy the space being gradually vacated by some of the bigger banks.
  • They can complement them in segments such as micro and small businesses and the informal sector.
  • Their success will depend on asset quality, the level, and standards of governance and regulatory oversight.

Back2Basics

Small Finance Banks

  • The small finance bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized sector entities.
  • There will not be any restriction in the area of operations of small finance banks.
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