RBI's Gamble

The largest number of aspirants recently for a small finance bank licence were from the jittery microfinance industry (MFI). Indeed, out of the 72 applicants, as many as 17 were MFIs. The Reserve Bank of India (RBI) handed out banking licences to eight - of the 10 allotted - of them.

What explains the RBI's bias towards the MFI industry? Experts suggest that the central bank wanted to kill two birds with one stone. The banking platform will not only discipline the MFI industry - notorious for not being transparent, high interest rates and bad corporate governance - but will also bring those at the bottom of the pyramid under a much transparent system with cheaper funding options. "MFIs have mastered the art of lending to the priority sector while traditional bankers always looked at it as a drag on their profitability. They now have a banking platform to scale up their business," says Abizer Diwanji, National Head (financial services ) at E&Y.

Clearly, the RBI is heavily banking on MFIs for achieving its objective of financial inclusion. Last month, Bandhan Bank, a Kolkata-based MFI, kicked off its universal bank operations. MFIs clearly have an ace up their sleeve - they can access low-cost deposits. Ultimately, the interest rate beneficiaries will be small business units, micro industries, small farmers and self-employed individuals in rural and semi-urban areas.

The highly regulated banking platform will also revive confidence in MFIs. As part of the prudential guidelines, these MFI players will have to maintain a minimum cash reserve ratio (CRR), invest a quarter of their deposits in government securities under statutory liquidity ratio (SLR) and also lend 75 per cent of their resources to the priority sector. The priority sector commitment is only 40 per cent for universal banks. "The small finance banks will gradually reduce the burden of traditional banks in the system especially by direct lending to poor," says Diwanji of E&Y.

But there are big challenges ahead. MFIs have a bad past track record- products with no collateral, geographical concentration, cash driven collection and also corporate governance issues. There is also no institutional framework for creating credit history of borrowers. Sceptics say India always had small finance and regional banks serving the poor but the model failed to scale up despite the huge potential. The share of small banks to deposits and advances is less than five per cent of the overall banking system. In addition, all large banks also caters to the poor through priority sector commitments. There are also parallel initiatives like Jan-Dhan Yojana and MUDRA bank, both targeted at the bottom of the pyramid.

Small finance banks, then, are yet another experiment, along with payments banks, with lot of hopes and expectations but they face a daunting task ahead.