The Reserve Bank of India (RBI) issued guidelines on Friday for the voluntary conversion of small financing banks (SFBs) into universal banks.

The "Guidelines for 'on-tap' Licensing of SFBs in the Private Sector," dated December 5, 2019, outline a roadmap for SFBs to become universal banks. "Such conversion shall be subject to the SFB's compliance with the minimum paid-up capital/net worth requirement as applicable to universal banks, a satisfactory track record of performance as an SFB for a minimum of five years, and the RBI's due diligence exercise," the banking regulator stated in a release, stating that these instructions are issued in exercise of the powers conferred on the RBI under Section 22 (1) of the Banking Regulation Act, 1949.

Only listed SFBs are eligible for conversion to universal banks, according to the RBI. Those wishing to convert must have a net worth of at least Rs 1,000 crore. Furthermore, SFBs must have a scheduled status and a solid track record of at least five years, with a gross non-performing asset (NPA) of 3% or less and a net NPA of 1% or less in the previous two fiscal years.

Furthermore, interested SFBs must have reported a net profit in the previous two fiscal years and meet the required capital adequacy standards. The RBI requires SFBs to offer a clear explanation for their wish to transition to universal banks. Those with a diversified loan portfolio will be preferred.

"The application for transition from SFB to universal bank shall be assessed in accordance with the Guidelines for 'on tap' Licensing of Universal Banks in the Private Sector dated August 1, 2016, as applicable, and RBI (Acquisition and Holding of Shares or Voting Rights in Banking Companies) Directions, 2023, dated January 16, 2023, as amended from time to time," the Reserve Bank of India (RBI) said.

Furthermore, upon transition, the bank will be subject to all rules, including the NOFHC structure (where applicable), as outlined in the guidelines.

Previously, Business Standard reported that certain SFB CEOs met with the RBI a few weeks ago and demanded a glide route to become universal banks, as most of them are eligible for such a conversion after five years of existence.

According to banking sector sources, AU SFB, the largest of the SFBs, is expected to seek the banking regulator about becoming a universal bank. An executive with an SFB indicated that AU SFB had considered conversion even before Fincare SFB merged with itself. 

AU SFB is larger than a few universal banks, hence it must give a higher interest rate to attract deposits. A transition in SFB status to universal bank would increase their acceptability, allow them to draw liabilities at lower rates, and profit from reduced priority sector lending criteria of 40%, as opposed to the existing 75% for SFBs.

The RBI granted licenses to the first group of SFBs, totaling ten, in 2015, and the majority of them commenced operations in 2016-17. As of the end of June 2023, 12 SFBs with 6,589 domestic branches were functioning throughout the country. With the merger of AU SFB and Fincare, there are now eleven SFBs.

A prominent executive of a publicly traded SFB expressed genuine satisfaction for the decision, noting, "As an association (of SFBs), we have been demanding clarification from the RBI. Now that we have clarity, we will discuss it, assess it, and make an acceptable choice. The circumstances are really reasonable, and we appreciate the decision."

The Reserve Bank of India BI also established shareholding guidelines for SFBs intending to convert to universal banks. The central bank indicated that there is no required necessity for SFBs to have a named promoter. The current promoters, on the other hand, will continue to be promoters when the bank becomes universal. During the changeover period, SFBs will also be unable to add or update their existing promoter list. 

Following the transformation to a universal bank, there will be no new required lock-in obligation for promoters. The promoter stake dilution plan, which has already been approved by the RBI, will not be revised.