Differentiated Banks, Types, Structure, Payments Banks, SFB, LAB

Differentiated Banks in India, such as Payments Banks and Small Finance Banks (SFBs), represent a major shift in the country’s financial architecture. Unlike universal banks, these institutions are designed with specific objectives to serve niche customer segments, extend credit to underserved groups, and deepen financial inclusion. By offering customized banking solutions for low-income households, small businesses, and rural populations, differentiated banks have become vital instruments in bridging the gap between formal banking and the unbanked population.

Differentiated Banks

Differentiated Banks under the Indian Banking System are institutions created to serve specific segments of customers rather than the general public. The idea was introduced by the Reserve Bank of India (RBI) on the recommendations of the Nachiket Mor Committee (2013), whi ch emphasized the need for banks that could deliver specialized services and products modifies to particular sectors of the economy. These banks focus on financial inclusion by addressing the needs of groups often left out of the traditional banking framework, such as small businesses, low-income households, and rural populations.

Differentiated Banks Vs Universal Banks

Differentiated Banks stand apart from Universal Banks in terms of capital requirements, scope of activities, and area of operations. While Universal Banks are designed to provide a wide spectrum of financial services from retail banking and corporate loans to investment products, Differentiated Banks function as niche banks.

They focus on specific customer segments and align their operations with the unique needs of those groups. Instead of offering every financial product, these banks restrict themselves to a limited range of services that directly address their target market. For example, a Payments Bank is limited to small savings accounts and remittances, while a Small Finance Bank primarily caters to small borrowers and businesses.

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Differentiated Banks Structure

Based on their conception and objectives, Differentiated Banks in India are classified into the following categories:

• Payments Banks:
  • Established to promote financial inclusion by providing small savings accounts and payments/remittance services to low-income households, migrant workers, and small businesses.
  • They cannot issue credit or loans but play a crucial role in last-mile connectivity.
• Small Finance Banks (SFBs)
  • Created to extend credit facilities to unserved and underserved sections such as small businesses, marginal farmers, and low-income households.
  • They can perform basic banking functions like accepting deposits and lending, but their focus is on priority sector lending.
• Local Area Banks (LABs)
  • Introduced to provide efficient and localized financial intermediation in smaller areas.
  • They focus on credit and savings facilities within a limited geographical boundary.

Small Finance Banks (SFBs)

Small Finance Banks (SFBs) are a category of differentiated banks in India designed to provide a full range of basic banking services but within a limited operational area. In simple terms, they perform almost all functions of a commercial bank, yet their scale, reach, and focus remain narrower. They are:

• Registered as public limited companies under the Companies Act, 2013.
• Licensed under the Banking Regulation Act, 1949.
• Regulated by the RBI Act, 1934.

Their primary role is to extend credit and financial services to underserved sections such as small businesses, marginal farmers, and low-income households.

Examples: Capital Small Finance Bank, Ujjivan Small Finance Bank, Equitas Small Finance Bank, AU Small Finance Bank, among others.

Small Finance Banks Features

• Deposit Acceptance – SFBs can accept all types of deposits just like commercial banks, including savings, current, fixed, and recurring deposits.
• Credit Services – They can extend loans using depositor’s money, but their lending is restricted to a smaller geographical area.
• Additional Financial Services – They can engage in non-risk sharing activities such as distribution of mutual funds, insurance products, and pension schemes.
• Target Customers – Their services are primarily directed towards small business units, marginal and small farmers, micro and small industries, and entities in the unorganized sector.
• Operational Focus – Their main emphasis remains on deposit mobilization and lending.

Small Finance Banks Objectives

• Expanding Financial Access – The primary aim is to extend banking facilities to rural and semi-urban areas, where penetration of commercial banks is limited.
• Promoting Basic Banking Services – To provide essential banking functions such as deposit mobilization and credit facilities to underserved and unbanked segments of society.
• Offering an Alternative Option – To act as an alternative to traditional institutions by catering to unserved and diverse customer groups, thereby strengthening the vision of financial inclusion.

Small Finance Banks Guidelines

• Eligible Promoters – Resident individuals/professionals with at least 10 years of banking/finance experience, or companies owned and controlled by them.
• Capital Requirement – Minimum paid-up equity capital of ₹100 crore at commencement, to be raised to ₹200 crore within five years.
• Regulatory Norms – Subject to RBI’s prudential norms applicable to commercial banks, including CRR and SLR requirements.
• Capital Adequacy – Must maintain a minimum CRAR of 15% of risk-weighted assets on a continuous basis.
• Branch Distribution – At least 25% of branches in rural areas.
• Business Activities – Restricted mainly to acceptance of deposits and lending to underserved segments.
• Priority Sector Lending – 75% of total loans must be to priority sectors.
• MSME Lending – 50% of total loans should be directed to the MSME sector.
• Loan Size Restriction – At least 50% of loans and advances must be up to ₹25 lakh.

Payment Banks

Payment Banks are non-full service banks under the Indian Banking System. They provide a limited range of banking products, such as accepting demand deposits and facilitating fund transfers. What sets them apart is their wide network of access points, especially in remote and rural areas, through their own branches, Banking Correspondents (BCs), or third-party networks.

The main objective of establishing Payment Banks is to strengthen financial inclusion. They focus on:

• Providing small savings accounts
• Offering payments and remittance services to sections such as migrant workers, low-income households, small businesses, and other unorganized sector entities.

Examples

Some Payment Banks currently operating in India include:

• India Post Payments Bank (IPPB)
• Airtel Payments Bank
• Paytm Payments Bank

Payment Banks Features

• Payment Banks can accept demand deposits, but only up to ₹1 lakh per individual customer. This makes them suitable for small savers.
• Unlike commercial banks, Payment Banks cannot provide loans or credit cards. They can only invest deposits in safe instruments like Government Securities (G-secs).
• Their main focus is to provide fund transfer and remittance services, especially for migrant workers and low-income households who regularly send money home.
• They are permitted to accept utility bill payments, mobile recharges, and similar services to improve convenience for customers.
• While they can’t lend, they are allowed to sell financial products like mutual funds, insurance, and pension schemes.
• Customers can use ATM and debit cards, but credit cards are not issued.
• The primary beneficiaries are poor households, migrants, small businesses, and unorganized workers who need simple banking services.
• They are not permitted to accept NRI deposits, focusing only on domestic customers.

Payment Banks Guidelines

• Entities like Non-Bank Prepaid Payment Instrument (PPI) issuers, mobile telecom companies, and other similar firms can promote Payment Banks.
• At least 40% of the equity capital must come from the promoter, and this stake has to be maintained for the first five years.
• Payment Banks can accept demand deposits but only up to ₹2,00,000 per individual customer. This makes them suitable for low-value transactions and small savers.
• These banks must comply with the same regulatory and supervisory frameworks applicable to Commercial Banks under the RBI.
• Payment Banks must maintain a Cash Reserve Ratio (CRR) with RBI against their outside Demand and Time Liabilities.
• At least 75% of their demand deposit balances must be invested in SLR-eligible Government Securities or Treasury Bills to ensure safety.
• They can hold up to 25% of their deposits in current or fixed deposits with scheduled commercial banks for liquidity management.
• Required to maintain a minimum leverage ratio of 3%, meaning their liabilities should not exceed 33 times their net worth.

Difference between Payment Banks and Small Finance Banks (SFBs)

While both Small Finance Banks (SFBs) and Payment Banks were conceptualized as part of India’s differentiated banking structure to promote financial inclusion, their objectives, scope of activities, and regulatory frameworks are quite different. SFBs operate almost like scaled-down commercial banks with the ability to lend, while Payment Banks focus mainly on accepting small deposits and facilitating remittances, without being allowed to issue loans.

Local Area Banks (LABs)

Local Area Banks (LABs) are small private-sector banks under the Indian Banking System that operate within a restricted geographical area, usually covering a few districts. Their role is to provide financial intermediation services at the local level, primarily targeting rural and semi-urban regions.

The main objective behind establishing LABs was to mobilize rural savings and channel them into productive investments within the same area, thereby promoting local development and financial inclusion. They bridge the gap between large commercial banks and rural cooperatives by offering efficient, low-cost banking services closer to underserved communities.

Examples of LABs in India include:

• Coastal Local Area Bank Limited
• Capital Local Area Bank Limited

Local Area Banks Guidelines

• LABs must have a minimum paid-up capital of ₹5 crores.
• Promoters can include private individuals, corporate entities, trusts, and societies, with at least ₹2 crores as their minimum contribution.
• LABs are restricted to operating in a maximum of three geographically contiguous districts, ensuring they remain localized.
• LABs must allocate 40% of their Net Bank Credit (NBC) towards priority sector lending, such as agriculture, small enterprises, and weaker sections.

Differentiated Banks Role in India

• These banks extend formal financial services to underserved and unbanked sections, ensuring broader participation in the financial system.
• By offering credit facilities to micro and small enterprises (MSEs), they stimulate grassroots economic activity, generating employment and supporting local wealth creation.
• Easy access to deposits, remittance services, and savings accounts nurtures a habit of saving and investing among rural and low-income households.
• Differentiated banks, especially Payment Banks, use mobile technology and digital platforms to deliver secure, convenient, and cost-effective services.
• Their presence creates competition within the banking sector, compelling traditional banks to improve efficiency, expand outreach, and offer better products.