licensing of Small Finance Banks in the private sector Draft Guidelines for “on tap”

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Regulatory Insights

from India Tax & Regulatory Services

www.pwc.in

Draft Guidelines for “on tap”

licensing of Small Finance Banks in the private sector

September 19, 2019

In brief

In November 2014, the Reserve Bank of India (RBI) first issued guidelines on Licensing of “Small Finance Banks” in the private sector and subsequently, ten small finance banks (SFBs) were licensed and set-up. After gaining experience in dealing with these banks, review of their performance, and to encourage competition, the RBI has now issued draft guidelines¹ for “on-tap” licensing of SFBs.

The draft guidelines have been formulated for continuous authorisation and covers eligible promoters, scope of activities, capital requirements, prudential norms, licensing process, etc. The RBI has invited comments and suggestions on the draft guidelines by 12 October 2019.

In detail

Eligible promoters (and entities)

 Resident individuals/

professionals (Indian citizens), singly or jointly, each having at least ten years of experience in banking and finance at a senior level.

 Companies and societies that are owned and controlled by residents (as defined in FEMA²

regulations) with

successful track record of running their businesses for at least five years.

 Existing NBFCs, MFIs and LABs³ in the private sector

1 RBI Press Release dated 13 September 2019

2 FEMA – Foreign Exchange Management Act, 1999

3 NBFC – Non-Banking Financial Company; MFI – Micro Finance Institution; LAB – Local Area Bank

4 UCB – Primary Urban Co-operative Banks

5 Converting under Scheme on voluntary transition of Urban Co-operative Bank into an SFB - Circular reference no.

DCBR.CO.LS.PCB. Cir.No.5/07.01.000/2018-19 dated 27 September, 2018

6 A group with assets of INR 50bn 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 group.

that are controlled by residents (as defined in FEMA regulations) and having a successful track record of running their businesses for at least five years - can opt for

conversion into SFB after complying with the necessary legal and regulatory requirements.

 UCBs⁴ desirous of converting to SFB may convert⁵ to SFB after ensuring compliance with the guidelines.

 Existing payments bank can also opt for conversion into SFB, subject to

compliance with the guidelines.

 Joint ventures by different promoter groups for setting up an SFB are not eligible.

 Public sector entities and large industrial houses/

business groups⁶, including NBFCs promoted by them, autonomous boards/

bodies set up under enactment of a state legislature, state financial corporations, subsidiaries of development financial institutions are not eligible.

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Regulatory Insights

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Corporate structure

 SFBs may be set up as a standalone entity or under a holding company, acting as a promoting entity of SFB.

 Any intermediate company between SFB and its promoting entity will be a non-operative finance holding company (NOFHC).

The NOFHC will conform to all requirements specified for an NOFHC under the

guidelines for “on-tap”

licensing of Universal Banks in the private sector dated 1 August 2016.

 If it is desired to set up the SFB under a holding company structure, without an NOFHC, the holding company/ promoting entity will be registered as an NBFC-CIC with the RBI.

 If a promoter of a payments bank desires to set up an SFB, both the banks should be under the NOFHC structure.

Fit and proper criteria

 Promoter/ Promoter Groups (as defined in the guidelines) should meet “Fit and Proper”

criteria.

 The RBI will examine

applicants based on their past record of sound credentials and integrity; financial soundness and successful track record of running their business, etc., for at least a period of five years.

 Local focus and ability to serve smaller customers will be a key criterion in licensing such banks.

 Preference will be given to those applicants who, in the initial phase, set up the bank in a cluster of under-banked

7 SLR – Statutory Liquidity Ratio; CRR – Cash Reserve Ratio

States/ districts, such as in the North-East, East and Central regions of the country.

 Preference will also be given to proposals having

diversified ownership subject to meeting minimum

shareholding of promoters as prescribed in the guidelines.

Capital requirement

 Minimum paid-up voting equity capital - INR 2000 mn except for UCBs/ NBFCs/

MFIs/ LABs converting to SFBs.

 For UCBs converting to SFBs - minimum net worth will be INR 1000 mn from the date of commencement and which should be increased to INR 2000 mn within five years of commencing operations as an SFB.

 For NBFCs/ MFIs/ LABs converting to SFBs – minimum net worth will be INR 2000 mn or it will infuse additional paid up voting equity capital to achieve this net-worth within 18 months from the date of in-principle approval or as on the date of commencement of

operations, whichever is earlier.

 Foreign shareholding in the bank should be as per extant foreign direct investment policy.

 Non-promoters (individual and entities) will not be permitted to have a

shareholding in excess of 10%

of the paid-up voting equity capital of SFB. Non-

promoters with shareholding above 10% may be given three years from in-principle

8 RWA – Risk Weighted Assets

approval to reduce their holding to 10%.

Promoter’s contribution

 The Promoter should hold at least 40% of the paid-up voting equity capital, which shall be locked in for five years from the date of commencement of business.

 Shareholding more than 40%

should be reduced to 40%

within five years, to 30%

within 10 years, and to 15%

within 15 years from the date of commencement of

business. For UCBs, this requirement will trigger from the date of reaching net worth of INR 2000 mn.

 For NBFCs/ MFIs/ LABs that have diluted their

shareholding to below 40%

but above 26%, 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 the commencement of business, even if fresh equity is issued.

 Listing will be mandatory after the SFB reaches INR 5000 mn net worth, within three years of reaching this net-worth.

Voting rights and transfer/

acquisition of shares

The voting rights for SFB will be as per norms for private sector banks and will be capped at 26%

of the total voting rights of all the shareholders and any acquisition of 5% or more of paid-up share capital or voting rights therein will require prior approval of the RBI.

SLR, CRR⁷ and capital adequacy

 Minimum capital adequacy ratio – 15% of RWA⁸ on a

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continuous basis; Tier I – 7.5% of RWA and Tier II – limited to a maximum of 100% of total Tier I capital.

 Basel II norms will be applicable to SFBs.

 All other prudential norms and regulations of the RBI as applicable to existing

commercial banks, including the requirement of

maintenance of CRR and SLR will be applicable to SFBs.

Scope of activities

 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 unorganised sector entities.

 Other simple financial services activities, not

requiring commitment of own fund (such as distribution of mutual funds, insurance, etc.), with the prior approval of the RBI.

 Become a Category II Authorised Dealer in foreign exchange business for client requirements.

 Cannot become business correspondents of another bank; and

 Cannot set up any subsidiaries.

In the case of reorganisation of activities within a group, the principle will be that all activities permitted to a bank under section 6(o) of the Banking Regulation Act, 1949 will be carried out only from the SFB. Prior approval from the RBI will be necessary to continue specialised activities

9 As defined in section 277 of the Companies Act, 2013, and Rules thereunder.

from a separate entity proposed to be held under NOFHC, and similar activities cannot be carried out from the SFB.

Activities not permitted to the bank will also not be permitted to the group (i.e. entities under NOFHC). Any financial and non- financial activities of the

promoters should be distinctly ring-fenced and not co-mingled with the banking business.

Prudential norms

 At least 75% of adjusted net bank credit must be towards priority sector loans.

 The maximum loan size and investment limit exposure to single/ group obligor will be restricted to 10% and 15% of its capital funds, respectively.

 To ensure credit flow to smaller borrowers, at least 50% of the bank’s loan book should be towards loans worth up to INR 2.5m.

 Banks’ loans and advances to its directors and the

companies in which its directors are interested will be subject to restrictions specified under section 20 of the Banking Regulation Act, 1949.

 Any exposure to its promoters, major shareholders (with

shareholding of 10% of paid up voting equity shares in the bank), relatives⁹ of the promoters as also the entities in which they have significant influence or control¹⁰ will not be permitted.

Corporate governance

The Board of an SFB should have majority of independent Directors

10 As defined under Ind AS 28 and Ind AS 110

aand the SFB should comply with the corporate governance

guidelines including “fit and proper” criteria for Directors as issued by the RBI from time-to- time.

Other aspects

 At least 25% of the banking outlets of an SFB will have to be opened in unbanked rural centres¹¹.

 The operations of the bank should be technology driven from the beginning.

 The bank should have a high- powered Customer

Grievances Cell to handle customer complaints.

 With the applications for SFB, detailed business plan along with project reports will also have to be submitted.

 SFB licensing procedure will involve various stages of approvals (clearances/

feedback from internal and external committees’ set-up by the RBI).

The takeaways

After the introduction of on-tap licensing regime for Universal Banks in India (in 2016), this is a welcome move by the RBI to have an open licensing policy

framework for SFBs also. Similar to the number of aspiring applicants in the earlier round of licensing, it is expected that several existing NBFCs and other entities may consider applying for SFB license, once the final

guidelines are announced.

However, it will be interesting to see the number of licenses that the RBI will grant for SFB under the on-tap framework over the next three to five years.

11 Population up to 9,999 as per the latest census

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For private circulation only

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwCPL, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of PwCPL, this publication may not be quoted in whole or in part or otherwise referred to in any documents.

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