Regulatory Scrutiny Tightens on Small Finance Banks Facing Capital Erosion
The Reserve Bank of India (RBI) is closely monitoring the capital position of small finance banks (SFBs), with concerns rising over deteriorating asset quality and capital buffers. Sources familiar with the matter indicate that at least 3–4 small finance banks may be required to raise additional capital in the next 6–12 months to meet regulatory norms and sustain operations.
Erosion in Capital Buffers Raises Alarm
Several SFBs have reported a significant decline in their Capital to Risk-weighted Assets Ratio (CRAR) over the past financial year. Since FY24, the CRAR of small finance banks has dropped by 60–290 basis points (bps), while their Common Equity Tier-1 (CET-1) capital has eroded by 90–320 bps.
Banks Facing the Most Capital Pressure:
- AU Small Finance Bank
- Jana Small Finance Bank
- Capital Small Finance Bank
- Suryoday Small Finance Bank
- Utkarsh Small Finance Bank
Regulatory Requirement: SFBs must maintain a minimum CRAR of 15% and a Tier-1 capital ratio of 7.5%, including an additional 1.5% Tier-1 buffer as per RBI guidelines.
RBI’s Stance: Strengthen Capital Reserves to Absorb Losses
A senior banking official disclosed that capital consumption has increased significantly due to weak asset quality, compelling the RBI to step in.
“At least 3–4 small finance banks may be forced to raise fresh equity in the next few quarters,” said a source familiar with the developments.
Capital Raising Plans Underway:
In response to RBI’s push, several SFBs have started formulating strategies to raise capital:
- Utkarsh Small Finance Bank has already received board approval to raise ₹750 crore in fresh equity.
- Utkarsh’s CET-1 capital fell from 21.49% in December 2023 to 17.94% in December 2024, signaling a declining capital buffer.
RBI Questions SFBs on Business Strategy & Innovation
At a recent meeting between RBI and SFB executives, the regulator assessed both:
- Capital raising strategies of banks.
- New business plans and product diversification efforts.
Lack of Innovation Concerns RBI
- Most SFBs continue to operate within their original business model (microfinance, vehicle financing).
- Regulators are concerned about the absence of innovation in products or services.
A senior bank executive revealed that RBI officials expressed dissatisfaction over the sector’s failure to explore new revenue streams.
“Most SFBs are just doing what they did before securing an SFB license. The regulator expected greater innovation,” said the executive.
Investor Confidence at Risk: Will Private Equity Firms Stay?
One major concern for the RBI is that many private equity (PE) firms that invested in SFBs are nearing the end of their fund cycles.
- PE-backed capital influx in SFBs was earlier driven by new banking licenses or IPOs.
- Now, many investors may not reinvest, raising questions about follow-on funding.
“The regulator fears that SFBs may struggle to attract capital without a strong business model,” said a CEO of a leading small finance bank.
What Lies Ahead for Small Finance Banks?
- RBI is likely to impose tighter capital adequacy norms for SFBs struggling with asset quality.
- Pressure to raise capital may lead to further equity dilution in some banks.
- Future fundraising rounds may be challenging unless SFBs can differentiate their business models and demonstrate long-term profitability.
SFBs Face a Critical Phase Amid RBI’s Oversight
With capital buffers depleting, the RBI is intensifying its scrutiny of small finance banks to ensure financial stability. While some SFBs have already begun capital-raising measures, the larger question remains: Will investors reinvest in these banks amid regulatory uncertainty and lack of business innovation?
The coming months will be crucial as SFBs navigate capital challenges, regulatory expectations, and investor sentiment.