RBI should allow large and profitable fintechs to become small finance banks

Fintechs are pioneers in technology which can help further the cause of financial inclusion especially in geographical areas where it is difficult to open branches and reach out to customers.

In the month of October, there was an interesting development in the field of banking and fintech. The Reserve Bank of India (RBI) gave a no-objection certificate (NOC) to the Bengaluru-based fintech player named Slice to merge with North East Small Finance Bank (NESFB), a Guwahati-based small finance bank (SFB). The developments in the SFB space over the last few years have led to discussions not related to the functioning of SFBs but to mergers and acquisitions.

In 2014, the RBI agreed to license differentiated banks to achieve specific objectives. The central bank zeroed on two kinds of differentiated banks: small finance banks and payment banks. The objective of SFBs was to further financial inclusion by providing savings vehicles and supply of credit to small enterprises and the unorganised sector. The objective of the payment banks was to provide payment solutions to the public but they were barred from giving any loans.

In 2015, the RBI had licenced ten SFBs from a list of 72 applicants. Of the 10 licensees, the majority were existing microfinance institutions (MFI) that had applied for the SFB licence. One such MFI was Guwahati-based RGVN (North East) Microfinance which established the NESFB. The RGVN started as a society in 1990 to provide financial inclusion of the poor especially the women of the north-eastern region and North Bengal. The society converted itself into an NBFC in 2010. In 2015, the MFI successfully received the RBI licence for establishing an SFB, a big milestone for the institution.

An Unusual Merger

The merger of NESFB and Slice leads to three observations.

First, the merger is between two loss-making entities. The financial data for the NESFB shows that the bank had incurred large losses in 2021-22. The bank’s annual report (2021-22) identified two factors for the high losses — (a) during the pandemic the RBI had asked banks to restructure loans and lower monthly instalments and (b) the Assam government’s microfinance incentive and relief scheme also provided relief to borrowers. Both these schemes led to high non-performing assets (NPA) for the NESFB, which pushed the bank to increase provisions forcing it to make large losses in 2021-22.

Unlike the NESFB which made losses only in 2021-22, Slice has been making losses every year since 2016-17, the year from which the entity’s financial data is available. It is odd to see the RBI agreeing to merge two loss-making entities. Ideally, the RBI allows a merger of a profit-making entity and a loss-making one, as seen in previous mergers of banks such as Yes Bank and Laxmi Vilas Bank.

Second, this is the second instance of a merger of a weak/failed company with an SFB. In 2022, the defunct Punjab and Maharashtra Cooperative Bank was amalgamated by Unity SFB. Unity SFB was established in 2021 and its key promoters are Centrum Financial Services and BharatPe. While Centrum is a leading company in equity markets, BharatPe is a leading fintech company which gave India its first interoperable QR codes enabling payments.

Third, the two mergers point towards the potential for high synergy between SFBs and fintechs. Both SFBs and many fintechs operate in the space of financial inclusion. The SFBs by virtue of a licence to run a bank have access to retail deposits which usually are a cheaper source of funds. They also have branches for better customer outreach. Fintechs, on the other hand, are pioneers in technology which can help further the cause of financial inclusion especially in geographical areas where it is difficult to open branches and reach out to customers.

Guidelines Need to Change

The RBI should encourage more of these mergers and tieups between fintechs and SFBs. Currently, the RBI permits individuals/ professionals with 10 years of experience, existing non-banking finance companies, microfinance institutions, and local area banks to set up SFBs. Later, the RBI allowed urban cooperative banks to transition to SFBs. Shivalik Urban Cooperative Bank became an SFB in 2021. The fintechs that have registered with the RBI are classified as NBFC. The larger profitable fintechs should be encouraged to become SFBs.

The RBI needs to revisit its guidelines for SFBs and make them more open and inclusive. After the first phase of licencing SFBs, there have just been two more new licensees (Unity and Shivalik), taking the number of SFBs to twelve. There is room to give more licences to SFBs, starting by encouraging large and profitable registered fintechs to consider becoming a small finance bank.

Amol Agrawal teaches at Ahmedabad University, and is the author of 'History of Private Banking in South Canara district (1906-69)’. Views are personal, and do not represent the stand of this publication.