In April 2014, when the Reserve Bank of India announced that only two applicants — Bandhan Financial Services and IDFC — would receive banking licences out of more than twenty-five who applied, the question across India's financial sector was not who won, but why so few. The answer reveals something fundamental about how India thinks about banking: not as a market to be opened, but as a system to be deliberately constructed, one licence type at a time.
See also: NBFC Regulation | Financial Inclusion vs. KYC | Regional Rural Banks | Licensing and Branch Authorisation
Why did only two banks get licences in the 2013 round?
The Guidelines for Licensing of New Banks in the Private Sector dated February 22, 2013 set an intentionally high bar. Promoters needed a "successful track record for at least 10 years" and had to be "financially sound" with "sound credentials and integrity." The Universal Banks Licensing Guidelines (Reserve Bank of India (Universal Banks – Licensing) codified the 'fit and proper' criteria that remain the cornerstone of every licensing decision:
"The Promoters / Promoter Groups should be 'fit and proper' in order to be eligible to promote banks. RBI would assess the 'fit and proper' status of the applicants on the basis of the following criteria." Reserve Bank of India (Universal Banks – Licensing) Guidelin...
Why so restrictive? Because the RBI was not simply adding competitors to the banking system — it was selecting institutions that could demonstrate a financial inclusion track record. Bandhan was India's largest microfinance institution. IDFC was a long-established infrastructure finance company. Both had to route their banking operations through a wholly-owned Non-Operative Financial Holding Company (NOFHC), a structure the RBI created specifically for this licensing round. The NOFHC registration circular RBI/2013-14/558 (since withdrawn) made this mandatory — the promoter group holds the bank through the NOFHC, not directly.
When Bandhan later failed to dilute its NOFHC shareholding within the prescribed three years, the RBI penalised it Rs 1 crore Reserve Bank of India imposes monetary penalty on Bandhan Ba.... The message was clear: licensing conditions are not suggestions.
Why did the RBI create differentiated banks?
The 2013 round exposed a structural problem. Universal banking — accepting all deposits, making all loans — was not reaching every segment of the economy. Why? Because universal banks, even newly licensed ones, gravitate toward profitable urban lending. The RBI's response was not to licence more universal banks but to create entirely new bank categories designed for specific gaps.
The first Bi-monthly Monetary Policy Statement 2014-15, announced on April 1, 2014, signalled that the RBI would develop frameworks for both "on tap" licensing and "differentiated bank licences." This was a deliberate architectural choice: instead of one type of bank trying to do everything, specialised banks would serve specific purposes.
Two new categories emerged from the Guidelines dated November 27, 2014: payments banks (deposits and remittances only, no lending) and small finance banks (focused on underserved segments with a mandatory priority sector lending target far higher than regular banks).
What are payments banks — and why can't they lend?
Payments banks were designed to solve a specific problem: hundreds of millions of Indians had no bank account, but many had mobile phones. The Operating Guidelines for Payments Banks RBI/2016-17/80 (since withdrawn) laid out a radically constrained banking model — accept deposits, facilitate remittances, but never lend.
"The prudential regulatory framework for payments banks (PBs) will largely be drawn from the Basel standards. However, given the financial inclusion focus of these banks, it will be suitably calibrated." Operating Guidelines for Payments Banks (since withdrawn)
Why the deposit cap and lending prohibition? Because the eleven entities that received in-principle approvals in 2015 — Airtel, Paytm, India Post, Jio, among others — were technology companies, postal networks, and telecom operators, not traditional banks. Allowing them to lend would expose the financial system to risks from entities with no credit underwriting experience. The RBI's design was precise: let them be the front door to the banking system, deposit money and move it around, but keep the lending risk with institutions that know how to manage it.
The deposit cap (originally Rs 1 lakh, later raised to Rs 2 lakh) and the requirement to invest at least 75% of demand deposits in government securities ensured that even if a payments bank failed, depositor money would be overwhelmingly safe. The penalty imposed on Jio Payments Bank (Reserve Bank of India imposes monetary penalty on) for regulatory non-compliance showed the RBI would hold these new entities to the same standards as traditional banks.
Why do small finance banks have a higher lending target?
The SFB Licensing Guidelines of November 27, 2014 defined their purpose with unusual clarity:
"The objectives of setting up of small finance banks will be for furthering financial inclusion by (i) provision of savings vehicles primarily to unserved and underserved sections of the population, and (ii) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations." Reserve Bank of India (Small Finance Banks – Licensing) Guid...
Ten applicants received in-principle approval in September 2015 — most converted from microfinance institutions and local area banks. The regulatory bargain was explicit: SFBs must extend 75% of their Adjusted Net Bank Credit to priority sector lending, compared to 40% for regular commercial banks. Why the higher target? Because if SFBs lend like regular banks, they defeat the entire purpose of their existence. They were licensed specifically to fill the credit gaps that universal banks left open.
The June 2025 review RBI/2025-26/61 acknowledged the strain this placed on SFBs and reduced the target from 75% to 60%:
Amendment chain — SFB PSL target:
- November 2014: Original licensing guidelines set 75% ANBC to priority sector
- December 2019: On-tap guidelines maintained 75% target for new SFBs
- June 2025: Priority Sector Lending Directions for SFBs RBI/2025-26/61 reduced additional component from 35% to 20%, bringing overall target to 60%
- November 2025: SFB Licensing Guidelines (Reserve Bank of India (Small Finance Banks – Licen) codified the 60% target in the consolidated SFB licensing guidelines
Why did the RBI move from periodic rounds to on-tap licensing?
The problem with periodic licensing rounds was not just scarcity — it was the lobbying pressure that scarcity creates. As the 2025 Universal Banks Licensing Guidelines (Reserve Bank of India (Universal Banks – Licensing) preamble explained, the RBI's own discussion paper on banking structure acknowledged the need to move away from the "Stop and Go" licensing policy:
"The discussion paper advocated reviewing the prevailing 'Stop and Go' licensing policy and shift towards a policy of 'continuous authorisation' noting that such a framework would increase the level of competition and bring new ideas in the system." Reserve Bank of India (Universal Banks – Licensing) Guidelin...
On August 1, 2016, the RBI released on-tap licensing guidelines for universal banks. On December 5, 2019, on-tap licensing was extended to small finance banks. A Standing External Advisory Committee RBI announces Standing External Advisory Committee for evalu..., chaired by former Deputy Governor Shyamala Gopinath, was constituted to evaluate applications.
Amendment chain — on-tap licensing evolution:
- February 2013: One-time licensing guidelines for universal banks
- August 2016: On-tap licensing framework for universal banks
- December 2019: On-tap licensing framework extended to SFBs
- November 2025: Universal Banks Licensing Guidelines (Reserve Bank of India (Universal Banks – Licensing) consolidated universal bank licensing; SFB Licensing Guidelines (Reserve Bank of India (Small Finance Banks – Licen) consolidated SFB licensing
But on-tap does not mean easy. By May 2022, of the eleven applications received, six were rejected as "not found suitable" (RBI announces decision on six applications receive). By July 2023, three more SFB applicants were rejected (RBI announces Decision on three applications recei). The gate is always open; the bar remains high.
How do banks climb the regulatory ladder?
The most recent development is the conversion pathway — a regulatory ladder that allows institutions to move between licence categories. The Voluntary Transition of SFBs to Universal Banks circular RBI/2024-25/28 (since withdrawn) of April 2024 spelled out the eligibility: scheduled status for five years, listed shares, minimum net worth of Rs 1,000 crore, GNPA of 3% or less, net profit for two consecutive years.
In August 2025, AU Small Finance Bank became the first SFB to receive in-principle approval for universal bank transition (RBI grants ‘In-principle’ Approval to AU Small Fin). In December 2025, Fino Payments Bank received approval to convert into an SFB (RBI grants ‘In-principle’ Approval to Fino Payment) — a payments bank climbing the first rung. Why does this matter? Because it transforms bank licensing from a one-time gate into a graduated system. Start as a payments bank, prove yourself, become an SFB, prove yourself again, become a universal bank.
The on-tap SFB guidelines Reserve Bank of India (Small Finance Banks – Licensing) Guid... explicitly permit existing payments banks that are resident-controlled and have completed five years of operations to apply for SFB conversion. The SFB compendium on financial inclusion RBI/2017-18/14 ensures that even as SFBs grow, their financial inclusion mandate follows them.
What does this system tell us?
India's bank licensing architecture is not a market with free entry. It is a regulatory construction project. Each licence type — universal, payments, small finance — was designed to solve a specific problem that the existing types could not. The deposit cap on payments banks limits systemic risk from non-traditional entrants. The elevated PSL target on SFBs ensures they serve their intended purpose. The on-tap framework eliminates artificial scarcity without lowering standards. And the conversion pathways create incentives for good performance.
The November 2025 consolidation brought the entire framework — universal bank licensing, SFB licensing, branch authorisation — under comprehensive updated guidelines, replacing years of circular-by-circular evolution with structured directions. But the underlying philosophy has not changed since 2013: every bank licence is a privilege, not a right, and the RBI will always choose to license fewer institutions with stronger mandates over more institutions with weaker ones.
Last updated: April 2026