Small Finance Banks: Licensing, PSL and CASA Building

Small Finance Banks occupy a distinct and increasingly important position in the Indian banking landscape, created by the Reserve Bank of India to deepen financial inclusion among underserved and unserved segments. Born out of the 2014 differentiated banking licence framework, these institutions blend the reach of microfinance with the regulatory discipline of scheduled commercial banking. For IIBF certificate candidates, understanding how Small Finance Banks are licensed, how the 75 percent priority sector lending mandate shapes their balance sheet, and how they painstakingly build a low-cost liability franchise is essential. This article walks through licensing, the inclusion mandate, the MFI transition, PSL obligations, CASA building, and the coveted path to a universal bank licence.

SFB Licensing Guidelines and Eligibility

The Reserve Bank of India issued the Guidelines for Licensing of Small Finance Banks in November 2014, and later moved to an on-tap licensing regime in December 2019, allowing eligible applicants to apply at any time rather than during fixed windows. Small Finance Banks are registered as public limited companies under the Companies Act and licensed under Section 22 of the Banking Regulation Act, 1949.

Key eligibility and structural conditions include:

• Minimum paid-up capital of Rs 200 crore (a higher floor of Rs 300 crore applies to certain urban cooperative banks transitioning to SFB status).
• Promoters with at least 10 years of experience in banking and finance are preferred; resident individuals, professionals, and existing entities such as NBFCs, microfinance institutions, and local area banks are eligible.
• A minimum promoter contribution of 40 percent of paid-up equity, to be progressively diluted to 15 percent over time.
• Foreign shareholding governed by the FDI policy applicable to private sector banks.

Crucially, Small Finance Banks must maintain a Capital to Risk-weighted Assets Ratio (CRAR) of 15 percent, higher than the 9 percent floor for universal banks, reflecting their riskier, granular asset base. They are subject to the full suite of prudential norms including CRR and SLR. Aspirants preparing for these concepts can reinforce their grasp through practice tests and revisit the framework periodically on the blog.

The Target Segment and Financial Inclusion Mandate

The defining purpose of a Small Finance Bank is to further financial inclusion. The RBI explicitly designed these institutions to serve segments that the formal banking system has historically struggled to reach: small and marginal farmers, micro and small enterprises, the unorganised sector, low-income households, and small business units.

To enforce this orientation, the licensing guidelines impose specific structural obligations:

• At least 50 percent of the loan portfolio must consist of loans and advances of up to Rs 25 lakh in ticket size, ensuring the bank stays focused on small-value borrowers rather than drifting toward large corporate lending.
• A mandate to open at least 25 percent of branches in unbanked rural centres (population up to 9,999) to extend physical access where it is most needed.
• No restriction in the area of operations, but a clear expectation that the bank remains rooted in its inclusion mission.

This mandate distinguishes Small Finance Banks from both payments banks, which cannot lend, and universal banks, which face no such ticket-size ceiling. By combining deposit-taking with small-ticket lending, Small Finance Banks become full-service financial intermediaries for the bottom of the pyramid. Candidates can test their understanding of inclusion concepts through the match game and stay current with policy via IIBF news.

MFI to SFB Transition and the 75 Percent PSL Requirement

Many of the most prominent Small Finance Banks began life as microfinance institutions. Entities such as Ujjivan, Equitas, Jana, ESAF, Suryoday, and Utkarsh converted from NBFC-MFI status to SFB status, carrying their deep last-mile distribution networks into the regulated banking fold. This transition brought significant advantages: the ability to raise low-cost public deposits instead of relying on costly wholesale borrowing, and access to the formal payment and settlement system.

The transition, however, came with a defining obligation. Small Finance Banks must extend 75 percent of their Adjusted Net Bank Credit (ANBC) to priority sector lending (PSL) categories, far higher than the 40 percent requirement for universal banks. Within this:

• 40 percent of ANBC must be allocated across the various priority sub-sectors in line with the standard PSL targets.
• The remaining 35 percent can be allocated to one or more sub-sectors where the bank has a competitive advantage, giving it strategic flexibility while keeping the inclusion focus intact.

Because converting MFIs already lend heavily to priority segments such as agriculture and micro-enterprise, meeting the 75 percent PSL floor is often a natural fit rather than a constraint. The challenge lies more on the liability side, as discussed next. Readers tracking lending and rate concepts should bookmark RBI rates for reference.

Building CASA and a Liability Franchise

The single most important strategic challenge for a Small Finance Bank is building a stable, low-cost liability franchise. As former microfinance lenders, these banks inherited strong asset-side capabilities but almost no deposit base. Their early funding leaned heavily on high-cost term deposits and bulk wholesale funds, which kept the cost of funds elevated and compressed net interest margins.

The solution lies in growing CASA — Current Account and Savings Account deposits, the cheapest source of funding for any bank. Strategies Small Finance Banks deploy include:

• Offering higher savings deposit interest rates than large universal banks to attract retail savers.
• Leveraging existing microfinance relationships to cross-sell savings accounts to a captive borrower base.
• Expanding digital banking, mobile apps, and doorstep banking to reduce the cost of acquiring and servicing small deposits.
• Building trust in unbanked areas where the SFB branch is often the first formal financial touchpoint.

A rising CASA ratio directly lowers the cost of funds, widens margins, and reduces dependence on volatile wholesale markets. It is also a marker of franchise maturity that the RBI examines closely. Over time, a healthy CASA base transforms a former MFI into a genuine deposit-led bank, which is the foundation for the next stage of evolution. Strengthen these concepts with focused mock tests.

The Path to a Universal Bank Licence and Conclusion

For a maturing Small Finance Bank, the ultimate goal is often a universal bank licence, which removes the 75 percent PSL ceiling, the 50 percent small-ticket requirement, and the higher 15 percent CRAR, allowing the bank to compete across the full spectrum of banking services.

In April 2024, the RBI laid out the eligibility conditions for SFBs seeking to transition to universal banks. The key criteria include:

• A minimum net worth of Rs 1,000 crore as at the end of the previous quarter.
• Scheduled status with a satisfactory track record of at least five years of operations.
• Shares listed on a recognised stock exchange.
• Gross NPA of 3 percent or less and net NPA of 1 percent or less in each of the last two financial years, plus net profit in those years and the prescribed CRAR.

This pathway rewards disciplined, profitable, inclusion-focused growth and gives Small Finance Banks a credible upgrade route. AU Small Finance Bank, for instance, has been a frontrunner in seeking this transition. For IIBF aspirants, mastering this lifecycle — from licence to inclusion mandate to CASA building to universal status — is a high-value topic. Put your knowledge to the test now with our practice tests and keep learning through the iibf.store blog.