A Decade of Small Finance Banks: Survival Success, Inclusion Questions

Ten years after India announced the licensing of Small Finance Banks (SFBs), one conclusion is hard to dispute: among new banking categories created by the Reserve Bank of India, SFBs have shown the strongest staying power. In an ecosystem where earlier experiments with universal banks, local area banks and payments banks produced mixed — often disappointing — results, SFBs stand out for their stability. But survival alone was never the goal. The deeper question is whether SFBs have meaningfully advanced financial inclusion beyond what microfinance institutions (MFIs) were already doing.

Why SFBs look different from earlier banking experiments

India’s post-1991 banking liberalisation saw multiple licensing waves. Of the 14 universal bank licences issued across three tranches, several banks were merged and at least one collapsed under governance failures. Local Area Banks, announced in the 1996 Budget, fared worse: only two survived in any meaningful form. Payments banks too have struggled, with most licences either surrendered or lying dormant.

Against this backdrop, SFBs appear unusually resilient. All in-principle licences were operationalised, none faced an existential crisis, and consolidation — such as the voluntary merger of Fincare SFB with AU Small Finance Bank — happened without regulatory firefighting. For a regulator often criticised for either excess caution or late intervention, this is no small achievement.

How the original vision of SFBs evolved

The initial draft guidelines issued by the “Reserve Bank of India” in July 2014 envisaged “small” banks with geographically contiguous operations, rooted in local contexts and aimed squarely at deepening inclusion in under-banked regions. By the time the final guidelines were issued in November 2014, this vision had shifted.

“Small” banks became small “finance” banks, geographic restrictions were lifted, and regional focus was diluted into a preference rather than a mandate. This shift reflected feedback from the microfinance sector, many of whose players already operated across states and sought the stability and legitimacy of a banking licence. In effect, viability and profitability began to trump the original developmental design.

On credit, inclusion targets have largely been met

Measured against their stated credit objectives, SFBs have delivered — and then some. Over 99% of their loan accounts fall below ₹25 lakh, and roughly 92% have ticket sizes under ₹2 lakh. In fact, average loan sizes at SFBs are even smaller than those of “Regional Rural Banks”, underscoring their deep engagement with low-income borrowers.

Geographically too, SFBs have done better than the banking system average in central, eastern and especially northeastern India. Their performance in the Northeast — aided by at least one locally rooted licensee — raises a tantalising counterfactual: would the original model of regionally anchored “small” banks have produced even stronger outcomes?

The paradox lies on the deposit side

If the asset side tells a story of successful credit inclusion, the liability side tells a more complicated one. Nearly 45% of SFB deposits come from institutions, including financial institutions. Household savings — the cornerstone of inclusive banking — form a much smaller share.

This contrasts sharply with Regional Rural Banks, which source over 90% of their deposits from households. Even within household deposits, SFBs lag on inclusion: deposits from women are significantly lower than in RRBs and resemble patterns seen in public sector banks rather than community-focused institutions.

In effect, SFBs have replaced bulk borrowing from banks (as MFIs once did) with bulk — and often expensive — institutional deposits. The result is a paradoxical balance sheet: deeply inclusive on lending, but far less so on savings.

How different are SFBs from their MFI past?

This raises an uncomfortable but necessary question. Eight of the ten original SFBs emerged from MFIs, and on the credit side, their practices have not changed dramatically. Loan pricing remains broadly similar, and there has been no major breakthrough in mobilising small savings, particularly from women — a group that MFIs historically engaged closely.

If savings inclusion was meant to be the transformative leap from microfinance to banking, that leap appears incomplete.

Regulatory signals and the future direction

Recent regulatory changes add another layer to the debate. The RBI’s decision to reduce priority sector lending requirements for SFBs from 75% to 60% of adjusted net bank credit could be read as nudging them closer to universal banks rather than pushing them deeper into inclusion.

The regulator’s caution on the savings side is understandable — deposit stability is a non-negotiable. But the absence of stronger nudges on inclusive savings raises doubts about whether the SFB model is being allowed, or encouraged, to drift from its original purpose.

A success story — but an unfinished one

There is no denying that Small Finance Banks have succeeded where other new banking categories faltered: they are solvent, stable, and operationally sound. But success on survival does not automatically translate into success on inclusion.

A decade on, SFBs appear to have perfected inclusive lending without cracking inclusive savings. Whether that represents a transitional phase or a structural limitation of the model is the real question policymakers and regulators must now confront.