Small Finance Banks: The Backbone of India’s MSMEs Revolution and Financial Empowerment

“Every small business is a potential engine for economic growth. Small Finance Banks provide the financial support that fuels the dreams of millions of entrepreneurs.”

Introduction

Small Finance Banks (SFBs) are a new entrant into the Indian banking system, with a unique emphasis on promoting financial inclusion. Small Finance Bank is a type of banking institution conceptualized and regulated by the RBI with aim to deliver essential banking services in areas lacking access to financial facilities. They have witnessed a rapid growth in their branch network and asset base while maintaining a healthy asset quality and generating high return on assets. SFBs have emerged as a popular banking alternative in India, especially among underserved populations such as small businesses, micro-entrepreneurs, and low-income households. SFBs offer a wide variety of banking services, including savings and current accounts, fixed and recurring deposits, loans, and remittance services.

Evolution of Small Finance Banks in India

The concept of Small Finance Banks (SFBs) was introduced in the 2014-15 Union Budget, while the RBI releasing comprehensive guidelines in November 2014 to facilitate the licensing of these banks, primarily aimed at promoting financial inclusion. Post receiving their licenses from the RBI, a total of 12 SFBs have commenced operations in India, while one amalgamated with another. The first two, Capital Small Finance Bank and Equitas Small Finance Bank, began operations in 2016, followed by seven more in 2017, one in 2018, and two in 2021. Currently, as of May 2025, 11 SFBs are operational in India.

Importance of Small Finance Bank in India

India is presently at a pivotal moment in its development journey. Over the past 75 years, we have evolved from an agrarian economy to one driven by industry and services. However, achieving a per capita Gross National Income that is comparable to that of developed economies requires a holistic approach to inclusive and sustainable growth. This will encompass areas such as education, skill development, job creation, and, most importantly, further deepening financial inclusion. The role of Small Finance Banks in this context is far from “small.” In fact, their contribution is highly significant, as they are pivotal in extending financial services to underserved populations, promoting entrepreneurship, and driving inclusive growth, all of which are essential for India’s transition to a high-income economy. Since their inception, SFBs have shown impressive growth, now accounting for 1.18% of total banking assets as of March 2024, up from just 0.44% in March 2018. Over the last five years, the deposit base of SFBs has grown at a compounded annual growth rate (CAGR) of 32%, while net advances have expanded at a CAGR of 26%.

Operational Scope and Activities of Small Finance Banks:

• Primarily focus on basic banking services, including accepting deposits and lending to underserved and unserved sectors, such as small business units, marginal farmers, micro and small industries, and entities in the unorganized sector.
• The bank may also offer non-risk-sharing, simple financial services that do not require commitment of its own funds. These services may include the distribution of mutual fund units, insurance products, pension schemes, etc.
• The small finance bank may also apply to become a Category II Authorized Dealer for foreign exchange business to meet client needs. After operating for at least two years as a Category II Authorized Dealer, it will be eligible to apply for a Category I Authorized Dealer license, subject to fulfilling the eligibility criteria.
• Small finance banks will have general permission to establish banking outlets starting from the commencement of their business, as per the RBI circular. However, at least 25% of their banking outlets must be set up in unbanked rural areas.
• There will be no restrictions on the areas in which small finance banks can operate.
• Small finance banks are prohibited from setting up subsidiaries to engage in non-banking financial services activities.
• The bank must include the term “Small Finance Bank” in its name to distinguish it from other types of banks.

Key regulatory requirements for Small Finance Banks (SFBs):

Path for SFBs to become Universal Banks:

To be eligible for conversion into a Universal Bank, the RBI stipulates some conditions as below:

• Only listed SFBs will qualify.
• Having a minimum net worth of Rs. 1,000 crore as of the end of the previous quarter (audited).
• The SFBs must have a scheduled status
• Satisfactory track record of at least five years.
• Having gross non-performing assets (NPA) and net NPA of less than or equal to 3% and 1%, respectively, in the last two financial years.
• Must have reported a net profit in the last two financial years.
• Must have met the prescribed capital adequacy norms. Minimum Capital Adequacy Ratio (CRAR) at 15% and Tier 1 CRAR at 7.5%.

Small Finance Bank (SFBs) operates in India – As of May 2025:

• Ujjivan SFB and AU SFB has applied to the RBI to seek approval for voluntary transition from a Small Finance Bank to Universal Bank.
• Jana SFB may apply to the RBI to seek approval for voluntary transition from a Small Finance Bank to Universal Bank.

Small Finance Bank Leads the First-Ever Bank Rescue in India:

• Most Small Finance Banks (SFBs) started as NBFCs, but the 12th SFB — Unity Small Finance Bank — stands out as a unique case in Indian banking history. It became the first and only SFB to acquire a financially distressed cooperative bank, the Punjab and Maharashtra Cooperative (PMC) Bank, through a merger.
• This milestone is now seen as a benchmark for resolving banking crises and safeguarding depositor interests in India’s financial sector.

Conclusion

Small Finance Banks, with their strong outreach to rural and semi-urban areas, play a pivotal role in extending credit to individuals, underserved communities, entrepreneurs, Self-Help Groups (SHGs), Joint Liability Groups (JLGs), and MSMEs. These banks are key enablers in India’s journey towards becoming a developed nation. In a growing economy like India, it is crucial for the financial sector—especially Small Finance Banks—to strike a balance between profitability and fulfilling social objectives. By strategically focusing on sectors that yield high social impact, these banks can ensure that their financial growth aligns with the broader goal of inclusive development. Furthermore, to enhance the accessibility of affordable credit, it is essential for Small Finance Banks to actively engage in extending credit under various Government-Sponsored Schemes, supporting vulnerable sections of society and promoting equitable financial access for all.

About Author:

Author CA. Gourav Soni who is a member of The Institute of Chartered Accountant of India and is currently working in the Risk function of a private sector bank in Mumbai. He has authored this article based on his professional background and practical experience in the banking sector.

Author can reach out at Email: gksoni92@gmail.com