Small finance bank label a key hindrance for expansion, say experts

With clearer RBI norms, easing microfinance stress and digital-first models, small finance banks are set for steady growth and deeper reach among underserved customers

With clear regulatory guidance, easing microfinance stress, digital adoption, and careful risk management, small finance banks (SFBs) are well positioned to grow steadily, expand services, and play a key role in providing banking to underserved communities. At a panel discussion moderated by Subrata Panda at the Business Standard BFSI Insight Summit 2025, experts from the SFB industry — Inderjit Camotra, managing director (MD) & chief executive officer (CEO), Unity Small Finance Bank; and R Baskar Babu, MD & CEO, Suryoday Small Finance Bank —  discuss how lending carefully, keeping costs low, and offering new products can help these banks grow steadily and enable greater access to banking services. Edited excerpts:

 

AU Small Finance Bank recently received RBI approval, while Jana Small Finance Bank’s application was returned. Does this create confusion among other SFBs regarding the transition to a universal bank, or are the regulatory norms sufficiently clear? 

Inderjit Camotra: The RBI has been quite clear on the right path to becoming a universal bank. A bank should have five years of good performance, a net worth of ₹1,000 crore, net NPAs of around 1 per cent, gross NPAs of around 3 per cent, and a CRAR of 15 per cent or more. Small is beautiful. We operate in Tier-II, Tier-III, and Tier-IV cities, where we focus on niche products such as MSME lending, microfinance, micro-LAP, and gold loans — both secured and unsecured — which are our strengths. We go directly to customers and manage customer acquisition ourselves. We make small loans, which allow us to earn slightly higher margins than large banks that lend to large corporates. This is important for us because, being relatively small and new, our cost of deposits is also slightly higher. Therefore, net interest margins have to remain healthy. We are young banks trying to become confident, relevant adults in the banking industry in a steady manner, contributing meaningfully to India becoming the third-largest economy in the world. 

R Baskar Babu: Small finance banks are not necessarily small. Taken together across multiple metrics, they are quite significant. For instance, deposits have grown at a compound annual growth rate (CAGR) of around 30 per cent. At the overall banking level, SFBs hold only about 1-1.5 per cent of total deposits and approximately 1.5 per cent of total assets. The workforce accounts for around 8 per cent of banking employees, while branch networks account for about 5 per cent. In terms of reach, even the smallest small finance bank serves around 0.5 per cent of Indian households. The very purpose for which differentiated banks were created was to reach underserved customers. 

One of the key challenges is the “small finance” label, which often becomes a hindrance. Customers ask whether we are regulated, whether we are scheduled banks, and what “small finance bank” really means. We have made representations to the regulator, but regulatory dispensations often come after multiple rounds, as the original purpose needs to be fulfilled first. There is a glide path ahead. Either all of us will become ready over time, or convergence will happen gradually. AU received in-principle approval, and Jana’s application was not rejected — it was asked to return after fulfilling certain criteria. The bank believes it has done so, but the regulator believes the line has not yet been crossed. Banking is a long-haul business. It is not a five-year game — it is a 10-, 20-, or even 25-year journey. It requires patience. 

For SFBs, it has been a baptism of fire — demonetisation, Covid, and now the microfinance crisis. Connecting the dots in hindsight, surviving cycles is what strengthens a bank. If you survive, you win, and we are probably at that phase now. 

 

Does size play a role in this process? Given AU’s loan book of over ₹1 trillion compared to Jana’s ₹30,000-₹40,000 crore, is scale important for RBI approval? 

Camotra: It is not just about size, it is more nuanced than that. It is about diversification and the ability to operate across multiple geographies. The RBI has consistently encouraged all banks — universal, cooperative, and small finance — to broaden their customer base. Recent mergers show that banks with large balance sheets often come together because they complement each other’s strengths. Scale alone is not the deciding factor. One key area for us is greater flexibility in co-lending, which helps diversify portfolios and optimise risk-weighted assets. The RBI has reduced the PSL (priority sector lending) requirement from 75 per cent to 60 per cent, and we are already seeing some impact from that change. We do not replicate legacy models. Small finance banks are digital by design. Most journeys are paperless. Even in microfinance, there is not a single wet signature — everything is Aadhaar-based and fully digital. Rural customers, supported by UPI and smartphone adoption, are increasingly comfortable with digital products, provided banks ensure ease of delivery and strong customer service. This gives us a unique opportunity to leapfrog traditional banking models and move toward lower-cost, deeper-penetration banking. 

Babu: Size matters, but it is not the only factor. Exponential growth today does not come from traditional methods. Technology and public digital infrastructure enable scale. It took us eight years to acquire three lakh digital deposit customers, but only six months to add one lakh fixed-deposit customers digitally through partnerships. Fintechs excel at customer experience and acquisition, and it makes sense to partner with them, rather than replicate those capabilities. If done well, size matters because investment capacity becomes important. However, technological capability has been democratised. 

 

You mentioned the PSL relaxation provided by the RBI. What business segments does this open up? 

Camotra: Capital is scarce, so deployment must be disciplined. There is a clear shift from unsecured to secured lending. Capital freed up by lower PSL requirements is being deployed into micro-LAP loans of ₹7 lakh-₹25 lakh in Tier-III and Tier-IV towns, and gold loans in urban and semi-urban areas. Gold loans, priced at around 11-13 per cent, are a fast and effective source of MSME working capital. We are also expanding into secured credit-builder cards to help customers build credit histories. Across 11 SFBs, we serve about 3.5 crore active customers, touching nearly 14 crore people — around 9 per cent of India’s population. Even small loans can lift families out of debt traps and reduce reliance on informal lenders. The reduction from 75 per cent to 60 per cent mainly provides flexibility. The impact will be felt more meaningfully from next year onward.

 

Does this also open opportunities to sell PSL certificates? 

Babu: Demand for PSLCs is driven mainly by small and marginal farmers and remains unchanged. The reduction is unlikely to generate surplus PSLCs, or incremental profits. 

Camotra: Our bigger objective is to reduce capital adequacy from very high levels. SFBs must maintain 15 per cent, while universal banks operate at around 11.5 per cent. This means we hold significantly more capital. A phased glide path could free up capital and accelerate growth. 

 

Should capital adequacy norms be relaxed further? 

Babu: It depends on the individual bank. For predominantly secured lenders, lower ratios are manageable. For mixed portfolios, higher buffers remain prudent.

 

When will the microfinance stress cycle ease? 

Camotra: The industry recognised over-lending and introduced stricter norms. New loans are performing well, while stress remains in older books that are shrinking over time. Given borrower intent and improved discipline, we are close to an inflection point. Over the next one to two quarters, the sector should largely be out of the woods.

Babu: Sustainable growth is around 15-20 per cent. Pushing to 40 per cent damages the system. This cycle has taught deep lessons, and we must remember them.

 

Will you step up microfinance lending now? 

Camotra: While JLG lending has slowed, other microfinance segments are picking up. Demand remains strong, and careful risk selection is key. 

Babu: The model must evolve. Customers are more digital and discerning. Costs must fall, and banks must return to fundamentals — serving customers, not just lending. Becoming an SFB was about enabling both savings and credit, and that remains the core mission.