Foreign Shareholding
Foreign investment in Small Finance Banks is permitted according to the Foreign Direct Investment (FDI) policy applicable to private sector banks in India. At present, total foreign investment from all sources can be up to 74 percent of the paid-up capital of the bank. Foreign investment up to 49 percent is allowed through the automatic route, while investment beyond 49 percent and up to 74 percent requires government approval. However, at least 26 percent of the paid-up capital must always remain in the hands of resident Indian shareholders.
In the case of Foreign Institutional Investors (FIIs), Foreign Portfolio Investors (FPIs), and Qualified Foreign Investors (QFIs), an individual investor cannot hold more than 10 percent of the paid-up capital. The combined holding of all such foreign investors cannot exceed 24 percent, although this limit may be increased to 49 percent if approved by the bank’s Board of Directors and shareholders through a special resolution. For Non-Resident Indians (NRIs), individual shareholding is limited to 5 percent, while aggregate NRI shareholding is generally capped at 10 percent. This aggregate limit may be increased to 24 percent with shareholder approval through a special resolution.
Voting Rights and Acquisition of Shares
According to the Banking Regulation Act, 1949, the voting rights of any shareholder in a private sector bank are generally restricted to 10 percent, irrespective of the number of shares held. The RBI may gradually increase this limit up to 26 percent. Furthermore, any person or entity intending to acquire 5 percent or more of the paid-up share capital of a Small Finance Bank must obtain prior approval from the RBI. These provisions help prevent concentration of ownership and ensure proper governance.
Prudential Norms and Risk Management
Small Finance Banks are required to establish a strong and comprehensive risk management framework from the very beginning of their operations. They must comply with all prudential norms applicable to commercial banks, including the maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). The RBI does not provide any relaxation or special treatment in complying with these statutory requirements.
Since the primary objective of Small Finance Banks is financial inclusion, they are required to lend a substantial portion of their funds to priority sectors. At least 75 percent of their Adjusted Net Bank Credit (ANBC) must be directed towards sectors eligible under Priority Sector Lending (PSL). Out of this, 40 percent must be distributed among various priority sectors according to RBI guidelines, while the remaining 35 percent can be allocated to any priority sector where the bank has expertise or a competitive advantage.
To ensure that these banks continue serving small borrowers, at least 50 percent of their loan portfolio must consist of loans and advances up to ₹25 lakh. Exposure to a single borrower is restricted to 10 percent of the bank’s capital funds, while exposure to a group of related borrowers cannot exceed 15 percent. These restrictions help reduce concentration risk and encourage diversified lending.
Additionally, Small Finance Banks are prohibited from granting loans or advances to their promoters, major shareholders holding 10 percent or more equity, relatives of promoters, or entities controlled by them. These restrictions are intended to prevent conflicts of interest and protect depositors’ funds.
Conversion of NBFCs, MFIs and LABs into Small Finance Banks
Existing Non-Banking Financial Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) can apply for conversion into Small Finance Banks if they meet RBI’s eligibility criteria. Such entities must have a minimum net worth of ₹100 crore or infuse additional capital to achieve that level before conversion.
Upon conversion, the NBFC, MFI, or LAB ceases to exist as a separate institution. All activities that can legally be undertaken by a bank must be transferred to the Small Finance Bank, while activities not permitted for banks must be discontinued or sold. Existing branches of the NBFC or MFI must either be converted into bank branches or merged or closed according to the approved business plan. The original institution and the newly formed Small Finance Bank cannot operate simultaneously.
If the converting institution has created floating charges on its assets for secured borrowings, RBI may allow such borrowings to continue until maturity under a grandfathering arrangement. However, the bank may be required to maintain additional capital to safeguard depositors’ interests.
In cases where regulatory requirements have already reduced the promoter’s shareholding below 40 percent but above 26 percent, RBI may grant exemptions from the minimum promoter contribution requirement.
Business Plan Requirements
Applicants seeking a Small Finance Bank licence must submit a detailed business plan and project report to the RBI. The business plan should clearly explain how the proposed bank will achieve the objectives of financial inclusion and serve the target customer segments.
For NBFCs and MFIs seeking conversion, the plan must also explain how the existing business will be integrated into the bank or divested where necessary. The RBI expects the business plan to be practical, realistic, and financially viable. Significant deviation from the approved business plan after licensing may lead to restrictions on expansion, changes in management, or other regulatory actions.
Corporate Governance
Strong corporate governance is a key requirement for Small Finance Banks. The Board of Directors must have a majority of independent directors to ensure transparency and objective decision-making. The bank must comply with all RBI guidelines regarding corporate governance, including the “fit and proper” criteria for directors and senior management personnel.
Good governance practices are essential for maintaining public confidence, protecting depositors, and ensuring the long-term sustainability of the institution.
Other Important Conditions
Promoters wishing to establish both a Small Finance Bank and a Payments Bank must do so through a Non-Operative Financial Holding Company (NOFHC) structure. However, RBI does not permit a promoter to establish both a universal bank and a Small Finance Bank simultaneously.
Individuals or entities other than promoters are generally not allowed to hold more than 10 percent of the paid-up equity capital of the bank. In cases where an NBFC, MFI, or LAB is being converted and existing shareholders exceed this limit, RBI may allow up to three years for compliance.
A Small Finance Bank cannot function as a Business Correspondent (BC) for another bank. However, it may establish and operate its own Business Correspondent network to extend banking services to remote areas.
The bank must adopt technology-driven operations from the beginning and maintain modern systems for data storage, cybersecurity, and real-time transaction processing. A comprehensive technology plan is required as part of the licensing process.
Each Small Finance Bank must establish a customer grievance redressal mechanism and falls under the jurisdiction of the RBI Banking Ombudsman Scheme. Failure to comply with RBI regulations may result in penalties, restrictions, or even cancellation of the banking licence.
Transition to a Universal Bank
A Small Finance Bank may continue operating as a differentiated bank indefinitely. However, if it wishes to become a Universal Bank in the future, it must apply separately to the RBI. Such conversion is not automatic.
The bank must demonstrate a satisfactory track record of operations for at least five years, meet the minimum capital and net worth requirements applicable to Universal Banks, and successfully pass RBI’s due diligence process. Once converted, it will be subject to all regulations applicable to Universal Banks, including any requirements relating to the Non-Operative Financial Holding Company (NOFHC) structure.
Conclusion
The RBI has designed a comprehensive regulatory framework for Small Finance Banks to ensure financial stability, strong governance, and meaningful financial inclusion. Through strict ownership norms, priority sector lending requirements, capital adequacy standards, and customer protection measures, these banks are expected to serve small borrowers and underserved communities while maintaining sound banking practices. Their ability to mobilize savings and provide credit at the grassroots level makes them an important component of India’s inclusive banking system.