Financial sector committee recommends opening of small finance banks

The high-level panel on financial sector reforms managed by Professor Raghuram G Rajan has recommended that the government should liberalize the entry norms for the banks. It said that the minimum norm of Rs 300 crore of capital would mean that only large players could enter. Only foreign institutions or converted domestic financial institutions would be able to enter.

The recommendations of the committee may make many small private banks in the country feel happy. The committee has urged the RBI not to focus excessively on the level of capital. It stated that large quantities of capital quickly degenerate it is the quality of promoters, their management capabilities, their capital adequacy and systems must be considered. It noted that in spite of the plaid record of some small banks, which it attributes to poor governance structures, excessive government and political interference and regulatory unwillingness or inability to take prompt action, there is no link between size and integrity.

In this perspective, the panel has recommended for the creation of small finance banks that resemble the earlier Local Area Bank (LAB) scheme. It feels that no serious efforts were made to reinforce the LAB scheme and that it was prematurely discontinued. According to the panel opening of more small finance banks will help in increasing financial inclusion by reaching out to poorer households and local small and medium enterprises.

The panel reported that there are a number of micro-finance institutions (MFIs) that are small and have a good track record but are forced by their inability to offer the full range of financial products (especially deposits which allow them to lower their cost of funds and commensurately their lending rates).

In its report the panel pointed out that as of March 2007; the total equity base of all the 54 Indian MFIs put together was a shade below the Rs 300 crore capital requirements. It feels that some of these MFIs would benefit from transforming into small finance banks.