Guidelines for setting up Small Banks in India

It may be mentioned that India did experiment with small banks following an announcement made by then Finance Minister in the Union Budget in August 1996 and the RBI issued guidelines for setting up of Local Area Banks (LABs) vide its Press Release dated August 24, 1996. The LABs were conceived as low cost structures which would provide efficient and competitive financial intermediation services in a limited area of operation, i.e., primarily in rural and semi-urban areas. LABs were required to have a minimum capital of Rs. 5 crore and an area of operation comprising three contiguous districts. Presently, four LABs are functioning satisfactorily.


Taking into account the above and that small local banks can play an important role in the supply of credit to micro and small enterprises, agriculture and banking services in unbanked and under-banked regions in the country, the RBI has decided to allow new “small banks” in the private sector. While permitting small banks, however, the issues relating to their size, capital requirements, area of operations, exposure norms, regulatory prescriptions, corporate governance and resolution need to be suitably addressed in the light of experience gained.

Guidelines

Registration, licensing and regulations


The small 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, other relevant Statutes and the Directives, Prudential Regulations and other Guidelines/Instructions issued by RBI and other regulators from time to time, including the regulations of SEBI regarding public issues and other guidelines applicable to listed banking companies.

Eligible promoters

Resident individuals/professionals with 10 years of experience in banking and finance, Companies and Societies will be eligible as promoters to set up small banks. Existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and LABs can also opt for conversion into small banks after complying with all legal and regulatory requirements from various authorities if they conform to these guidelines. Preference will be given to professionals from banking / financial sector, NBFCs and MFIs to set up small banks, if they meet the “fit and proper” criteria. Local focus and the ability to serve smaller customers will be a key criterion in licensing such banks. Thus this may be a more appropriate vehicle for local players.


Promoters/ Promoter Groups as defined in the SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009 should be ‘fit and proper’ in order to be eligible to promote small 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 running their businesses, etc. for at least a period of five years.

Scope of activities

The area of operations of the small bank will normally be restricted to contiguous districts in a homogenous cluster of States/Union Territories so that the bank has the “local feel” and culture. However, if considered necessary, the bank will be allowed to expand its area of operations beyond contiguous districts in one or more States with reasonable geographical proximity. Its branch expansion plan for the initial three years would need prior approval of RBI after which, based on experience, RBI may consider relaxing this condition.

In the initial five years, the small bank shall further the objectives for which it is set up. Therefore, the small bank shall primarily undertake basic banking activities of acceptance of deposits and lending to small farmers, small businesses, micro and small industries and unorganised sector entities. It can also undertake other simple financial services activities with the prior approval of the RBI. It cannot set up subsidiaries to undertake non-banking financial services activities.


The other financial and non-financial services activities of the promoters, if any, should be kept distinctly ring-fenced and not comingled with the banking business. After the initial stabilisation period of five years, and after a review, RBI may liberalize the scope of activities of the small banks.

Capital requirement

The minimum paid up voting equity capital for small banks shall be Rs. 100 crore. Any additional voting equity capital to be brought in will depend on the business plan of the promoters. In view of the inherent risk of a small bank, it shall be required to maintain a minimum capital adequacy ratio of 15 per cent 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. However, as small banks are not expected to deal with sophisticated products, the capital adequacy ratio will be computed under simplified Basel I standards.

Promoter's contribution

The promoters’ minimum initial contribution to the paid up voting equity capital of such small bank shall at least be 40 per cent which shall be locked in for a period of five years from the date of commencement of business of the bank. Shareholding by promoters in the bank in excess of 40 per cent shall be brought down to 40 per cent within three years from the date of commencement of business of the bank. Further, the promoter’s stake should be brought down to 30 per cent of the paid-up voting equity capital of the bank within a period of 10 years, and to 26 per cent within 12 years from the date of commencement of business of the bank. Proposals having diversified shareholding and a time frame for listing of the bank will be preferred.

Source: Reserve Bank of India