9.3 Indian Financial System: Commercial Banks, Small Finance Banks, Payment Banks & NBFCs

The Indian Financial System comprises institutional structures, financial markets, instruments, and services that facilitate the mobilization and allocation of capital. Commercial banks, differentiated banks (Small Finance Banks and Payment Banks), and Non-Banking Financial Companies (NBFCs) form the core of credit delivery. Understanding their regulatory boundaries, capital requirements, and business mandates is essential for the SBI PO exam.

1. Commercial Banks Architecture & Scheduled Status

Commercial banks are financial intermediaries licensed under Section 22 of the Banking Regulation Act, 1949 to accept deposits from the public for the purpose of lending or investment.

Scheduled Banks vs Non-Scheduled Banks

• Scheduled Banks: Banks included in the Second Schedule of the RBI Act, 1934. To qualify, a bank must:
  1. Have paid-up capital and reserves of aggregate value not less than ₹5 Lakh.
  2. Satisfy the RBI that its affairs are not being conducted in a manner detrimental to the interests of depositors.
• Privileges: Scheduled banks are entitled to access refinance facilities, borrow from the RBI at Bank Rate / Repo Rate, and obtain automatic clearinghouse membership.

Categories of Commercial Banks

1. Public Sector Banks (PSBs): Banks in which the Government of India holds a majority stake (exceeding 50%). Following the mega-mergers of 2019–2020, there are 12 Public Sector Banks in India (e.g., State Bank of India, Punjab National Bank, Bank of Baroda).
2. Private Sector Banks: Banks where private shareholders hold majority equity (e.g., HDFC Bank, ICICI Bank, Axis Bank).
3. Foreign Banks: Banks incorporated outside India operating branches within India under RBI regulations (e.g., Citibank, HSBC, Standard Chartered).
4. Regional Rural Banks (RRBs): Established under the Regional Rural Banks Act, 1976 to cater to rural credit needs. RRBs operate under a unique ownership structure:
   • Central Government Equity: 50%
   • State Government Equity: 15%
   • Sponsor Commercial Bank Equity: 35%

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2. Domestic Systemically Important Banks (D-SIBs)

Some financial institutions are deemed "Too Big To Fail" (TBTF) due to their size, cross-jurisdictional activity, complexity, and systemic interconnectedness. Collapse of such banks would cause severe disruption to the domestic financial ecosystem.

D-SIB Framework in India

• RBI initiated the D-SIB framework in 2014.
• D-SIBs are classified into 5 buckets based on systemic importance scores.
• Banks in higher buckets must maintain additional Common Equity Tier 1 (CET1) capital surcharges as a percentage of Risk-Weighted Assets (RWA).
• Current D-SIBs in India: State Bank of India (SBI), ICICI Bank, and HDFC Bank.

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3. Differentiated Banking Licenses: SFBs & Payment Banks

Based on recommendations of the Nachiket Mor Committee (2013), the RBI introduced niche or differentiated banking licenses to expand targeted financial inclusion.

                                ┌──────────────────────────────────────┐
                                │     Differentiated Bank Licenses     │
                                └──────────────────┬───────────────────┘
                                                   │
                      ┌────────────────────────────┴────────────────────────────┐
                      │                                                         │
        ┌─────────────┴─────────────┐                             ┌─────────────┴─────────────┐
        │ Small Finance Banks (SFBs)│                             │       Payment Banks       │
        └─────────────┬─────────────┘                             └─────────────┬─────────────┘
                      │                                                         │
  ┌───────────────────┼───────────────────┐                 ┌───────────────────┼───────────────────┐
  │                   │                   │                 │                   │                   │
┌─┴────────────┐    ┌─┴────────────┐    ┌─┴────────────┐  ┌─┴────────────┐    ┌─┴────────────┐    ┌─┴────────────┐
│Min Capital:  │    │PSL Target:   │    │Loan Cap:     │  │Min Capital:  │    │Max Deposit:  │    │Lending Rule: │
│ ₹200 Crore   │    │  75% ANBC    │    │50% <= ₹25L   │  │ ₹100 Crore   │    │ ₹2 Lakh/cust │    │ NO LENDING   │
└──────────────┘    └──────────────┘    └──────────────┘  └───────────────┘    └───────────────┘    └───────────────┘

A. Small Finance Banks (SFBs)

• Primary Objective: Serve unbanked and underserved segments including small business units, micro industries, unorganized sector entities, and small/marginal farmers.
• Minimum Paid-up Capital: ₹200 Crore (increased from initial ₹100 Crore mandate; for UCBs transitioning to SFB, initial capital of ₹100 Cr increasing to ₹200 Cr within 5 years).
• Priority Sector Lending (PSL) Target: Must allocate 75% of Adjusted Net Bank Credit (ANBC) to Priority Sector Lending (compared to 40% for universal commercial banks).
• Loan Size Mandate: At least 50% of its credit portfolio must comprise loans and advances of value up to ₹25 Lakh.
• Promoter Shareholding: Minimum 40% initial contribution, locked in for 5 years, gradually reduced over 15 years.
• Examples: AU Small Finance Bank, Equitas SFB, Ujjivan SFB, Capital SFB.

B. Payment Banks

• Primary Objective: Provide small savings accounts and remittance services to migrant labor workforce, low-income households, and small businesses via high-volume, low-value transactions.
• Minimum Paid-up Capital: ₹100 Crore.
• Maximum Deposit Limit: Can accept demand deposits (savings and current accounts) up to ₹2 Lakh per individual customer (enhanced from initial ₹1 Lakh limit in 2021).
• STRICT PROHIBITION ON LENDING: Payment Banks CANNOT grant loans, advances, or issue credit cards.
• Allowed Activities: Can issue debit cards, ATM cards, offer mobile/internet banking, and distribute third-party non-risk sharing financial products (mutual funds, insurance policies).
• SLR Investment Mandate: Must invest at least 75% of demand deposit balances in Government Treasury Bills and G-Secs with maturity up to 1 year, and maintain up to 25% in operational current/time deposits with scheduled commercial banks.
• Examples: India Post Payments Bank (IPPB), Airtel Payments Bank, Paytm Payments Bank.

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4. Non-Banking Financial Companies (NBFCs) & Scale-Based Regulation

An NBFC is a company registered under the Companies Act, 1956/2013 engaged in the business of loans and advances, acquisition of shares/stocks/bonds, leasing, or hire-purchase.

The 50-50 Rule (Principal Business Criteria)

A company qualifies as an NBFC if its financial assets constitute more than 50% of total assets AND financial income constitutes more than 50% of gross income.

Scale-Based Regulation (SBR) Framework

Effective October 2021/2022, RBI implemented a four-tiered regulatory structure based on asset size and systemic risk exposure:

1. Base Layer (NBFC-BL): Non-deposit taking NBFCs with asset size below ₹1,000 Crore, Peer-to-Peer (P2P) lending platforms, Account Aggregators, and Type-I NBFCs.
2. Middle Layer (NBFC-ML): All deposit-taking NBFCs (NBFC-D) regardless of size, non-deposit taking NBFCs with asset size of ₹1,000 Crore and above, Standalone Primary Dealers, and Housing Finance Companies (HFCs).
3. Upper Layer (NBFC-UL): Top 10 to 15 NBFCs identified by RBI based on quantitative scoring parameters (size, leverage, interconnectedness). They are subject to bank-like capital requirements and governance norms.
4. Top Layer (NBFC-TL): Ideally remains empty. Activated if RBI perceives extreme systemic risk in an Upper Layer NBFC.

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5. Master Institutional Comparison Matrix

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6. Step-by-Step Worked Example: Priority Sector Compliance Calculation

Problem Scenario:

• Bank X (Universal Commercial Bank) has an Adjusted Net Bank Credit (ANBC) of ₹1,00,000 Crore.
• Bank Y (Small Finance Bank) has an ANBC of ₹20,000 Crore.

Calculate their respective Priority Sector Lending (PSL) mandates and loan portfolio restrictions under RBI guidelines.

Step-by-Step Calculation:

1. Bank X (Universal Commercial Bank):

   • PSL Target = 40% * ANBC = 40% * ₹1,00,000 Cr = ₹40,000 Crore
   • Agriculture Sub-target (18%): 18% * ₹1,00,000 Cr = ₹18,000 Crore.
   • Weaker Sections Sub-target (12%): 12% * ₹1,00,000 Cr = ₹12,000 Crore.

2. Bank Y (Small Finance Bank):

   • PSL Target = 75% * ANBC = 75% * ₹20,000 Cr = ₹15,000 Crore
   • Small Loan Portfolio Mandate = 50% of total loans in portfolio value <= ₹25 Lakh
   • If total loan portfolio is ₹20,000 Cr, at least ₹10,000 Crore must consist of loans below ₹25 Lakh individually.

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7. SBI PO Exam Strategy & Common Traps

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|                                 EXAM TRAP ALERT & SUMMARY                               |
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| 1. Payment Banks Lending Prohibition:                                                   |
|    TRAP: Selecting options that claim Payment Banks can issue credit cards or personal loans.|
|    FACT: Payment Banks CANNOT lend money or issue credit cards under any circumstances.   |
|                                                                                         |
| 2. DICGC Coverage on NBFC Deposits:                                                     |
|    TRAP: Assuming deposit-taking NBFCs are covered by DICGC insurance up to ₹5 Lakh.   |
|    FACT: DICGC DOES NOT insure deposits held with NBFCs.                                |
|                                                                                         |
| 3. Regional Rural Banks (RRB) Shareholding Split:                                       |
|    TRAP: Confusing Central Govt (50%), Sponsor Bank (35%), and State Govt (15%) shares.   |
|    FACT: Central Govt has majority 50%, Sponsor Bank has 35%, State Govt has 15%.      |
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