RBI’s Lending Relaxation: A Turning Point for India’s Small Finance Banks (SFBs)

In a major policy move that could significantly shift the business dynamics of small finance banks (SFBs), the Reserve Bank of India (RBI) has reduced its mandatory lending requirement to the priority sector from 75% to 60% of Adjusted Net Bank Credit (ANBC). 

Announced on June 20, 2025, this reform is being seen as a critical enabler for SFBs to recalibrate their lending portfolios, improve book quality, and take another step closer toward becoming universal banks.

This isn’t just another regulatory adjustment. For SFBs, which have historically operated under tight guidelines with a large focus on microfinance and rural lending, this relaxation opens up a new realm of opportunity. 

Understanding the Shift in Lending Requirements

Previously, SFBs were mandated to allocate at least 75% of their ANBC or Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher, to priority sector lending (PSL). These sectors include agriculture, micro and small enterprises, and weaker segments of society.

With new guidelines, this requirement has been reduced to 60%. While the core PSL target of 40% remains unchanged—aligned with the requirement for universal banks—the additional component of 35% has been brought down to 20%. This change provides SFBs more discretion in choosing which PSL segments they want to serve within the flexible 20% buffer.

What this essentially means is that SFBs now have more control over how they want to manage their lending portfolios. They can continue supporting high-impact sectors while also exploring areas with better risk-return trade-offs.

Source: Business Standard

Why This is a Big Deal

This revision reflects the RBI’s intention to support the evolution of SFBs into more versatile financial institutions. There are several reasons behind this policy shift.

• The move offers operational flexibility. By reducing the high PSL exposure requirement, SFBs can allocate a greater portion of their portfolio to non-PSL segments such as secured personal loans, affordable housing, vehicle finance, and select MSME loans. These sectors often offer better yields and more predictable repayment behavior compared to high-concentration PSL portfolios.
  
• The change brings SFBs a step closer to achieving regulatory parity with universal banks. Currently, universal banks are required to maintain only 40% of their ANBC in PSL. While SFBs still remain above that threshold, the 15% reduction narrows the gap and aligns their operational framework more closely with the universal banking model.
  
• This shift supports scalability. SFBs have often struggled with concentrated exposure to microfinance loans, which are vulnerable to regional disruptions and socio-political events. The ability to diversify into new asset classes provides SFBs with a strategic tool to balance their portfolio risks and improve overall book quality.

Source: Money Control

What SFBs Can Do Differently Now

To navigate this transition effectively, SFBs will need to follow a structured plan of action. Here are key steps they are likely to undertake:

1. Reassess the current loan book
   SFBs will start by reviewing their existing lending mix to understand how far they are from the revised 60% PSL target.
   
2. Identify growth-friendly PSL segments
   While the mandatory PSL percentage is reduced, banks may choose to stay strong in specific PSL areas where they have a market advantage—such as microfinance or small business lending.
   
3. Expand into non-PSL sectors
   This is where the real transformation lies. SFBs will now be in a position to enter lending categories like small-ticket housing loans, vehicle finance, or even low-risk personal loans with a structured underwriting approach.
   
4. Enhance risk and compliance systems
   Entering newer segments means updating credit models, underwriting policies, and risk management frameworks to ensure portfolio stability.
   
5. Train internal teams
   Lending to new customer segments requires capability-building within sales, credit, and operations functions.

The Bigger Picture: Gearing Up for a Universal Banking License

This regulatory easing has another crucial layer. It aligns well with the long-term goal of several SFBs to transition into universal banks. Under the RBI’s “on-tap” licensing guidelines, SFBs with strong track records and a minimum net worth of Rs 1,000 crore are eligible to apply for a universal bank license.

While AU Small Finance Bank has already filed for a license, several banks like Ujjivan Small Finance Bank, Equitas SFB, and Jana SFB have already expressed interest in this transformation. 

The latest PSL relaxation offers them more strategic flexibility to meet the eligibility and operational benchmarks required for a full-fledged banking license.

Furthermore, it allows these banks to develop capabilities in areas such as treasury operations, current accounts, forex services, and digital banking products—core functions of universal banks that are limited under the SFB structure.

Source: RBI Universal Bank Licensing Guidelines

Conclusion

Reacting to the above news, most of the small finance banks in India have seen a decent rise in their stock prices today.

Equitas SFB, Jana SFB, Ujjivan SFB rallied 4-6% in intraday trade on 23 June 2025.

As we watch how SFBs implement these changes over the next few quarters, the sector seems poised for a redefinition—from a regulatory-driven model to a more market-responsive, innovation-led approach.

Happy Investing.

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