The Reserve Bank of India's 2024 guidelines for Small Finance Banks (SFBs) to transition into universal banks are proving challenging, with a focus on diversified loan portfolios and robust governance, as seen in the recent rejection of Ujjivan SFB's application.
Key Points
- The RBI's 2024 norms for SFB conversion to universal banks include criteria such as NPAs, net worth, listing status, and a satisfactory five-year track record, with 'diversified loan portfolio' being a key subjective element.
- Ujjivan SFB's application for universal bank conversion was returned by the RBI, citing a need for further improvement in its loan portfolio diversification, despite recent efforts.
- Jana SFB also had its application returned last year, while AU SFB is the only one among the three applicants to have received approval, largely due to its significantly more diversified and secured loan book.
- Many SFBs, originally microfinance institutions, struggle with a high proportion of unsecured loans, making diversification a long-term challenge, as evidenced by Bandhan Bank's multi-year journey to reduce unsecured exposure.
- Beyond diversification, the RBI also considers governance, risk management practices, and the quality of NPA management, with aggressive write-offs not viewed as prudent.
In the last quarter century, only five entities have secured the coveted universal bank licence — two in the early 2000s and another two in 2014.
The fifth was AU Small Finance Bank (SFB), which got it last year.
The licensing structure has changed completely over the past decade, with licences now available on tap.
Earlier, prospective entrants had to wait for the regulator to open a window for applications.
The on-tap regime, however, has seen a lacklustre response.
Not a single large non-banking financial company (NBFC) has applied to convert into a universal bank.
NBFCs owned by corporate houses are not eligible either. Lesser-known entities that applied were turned down by the banking regulator.
RBI's 2024 Norms and SFB Aspirations
Against this backdrop, the Reserve Bank of India’s (RBI’s) 2024 norms on the voluntary conversion of SFBs into universal banks offered a glimmer of hope that more full-service banks would emerge.
For a country aspiring to be a $5 trillion economy, more banks are essential.
That hope has now taken a hit.
On Monday, the RBI returned Ujjivan SFB’s application to transition into a universal bank.
Last year, another Bengaluru-based SFB, Jana, also saw its application returned.
These entities can reapply later if eligible. Of the three banks that met the criteria and applied, only AU SFB received approval.
The 2024 norms laid down eligibility criteria based on non-performing assets (NPAs), net worth, listing status, and a satisfactory track record of at least five years, among others.
The only subjective element in the norms was a “diversified loan portfolio”, without specifying the degree of diversification required.
Ujjivan said that while the regulator had taken note of its recent efforts to diversify its loan portfolio, it believed there was still room for improvement.
“The application for transitioning to a universal bank was submitted as part of the bank’s long-term growth plans,” the SFB said.
“Ujjivan will continue on the path of diversification and will resubmit the application in due course, keeping RBI’s guidance in view.”
Impact on Ujjivan SFB and Industry Trends
Ujjivan’s stock fell 3 per cent on Wednesday to close at Rs 54.53 apiece.
A report by Axis Securities said the development would be sentimentally negative and weigh on the stock price, though performance is expected to improve over the medium term, with better credit costs and lower operational expenditure ratios offsetting net interest margin compression.
“The management had earlier guided to improve the mix of secured businesses to 65–70 per cent by 2029–30, while exiting 2025–26 with a 50:50 mix,” the report said.
Of the 11 operational SFBs, eight were microfinance institutions (MFIs) in their earlier avatar. As a result, unsecured loans form a larger share of their portfolios.
Among the 11, AU, Unity, Capital, and Shivalik — the last to start operations — were not converted from MFIs.
Ujjivan’s unsecured loan book accounted for 52 per cent of its Rs 37,057 crore portfolio as of December 31, 2025.
“The bank’s secured/unsecured (MFI) mix has improved to 49:51 as of the fourth quarter (January–March/Q4) of 2025–26 (FY26), compared with 39:61 at the time of application,” Antique Broking said.
“This is ahead of its guidance to reduce the unsecured mix by 5 per cent annually.
"For reference, Bandhan, a universal bank, has an MFI share of 35 per cent (versus Ujjivan’s 52 per cent) and is expected to remain at similar levels in the near to medium term.”
Diversification Challenges and Success Stories
When AU SFB received in-principle approval for conversion in August 2025, secured loans made up nearly 67 per cent of its Rs 1.18 trillion loan book as of June 30, 2025.
Its acquisition of Fincare SFB, effective April 1, 2024, helped add microlending to its portfolio.
Micro loans are margin-accretive.
During the second quarter (July–September/Q2) of 2024–25 (FY25), Jana SFB reported a 72.5 per cent secured portfolio of its Rs 31,655 crore loan book.
“Secured assets will reach 80 per cent, while unsecured loans under the guarantee programme will be about 15 per cent by March 2027,” the bank had said. Jana’s application was returned in October 2025.
Industry sources say diversification is necessary but not sufficient.
Governance and risk management practices matter just as much.
“One of the eligibility criteria is maintaining net and gross NPA ratios of 1 per cent and 3 per cent, respectively, for two consecutive financial years.
"If a bank resorts to aggressive write-offs merely to meet these thresholds, it is not seen as prudent,” said a senior industry executive.
“Diversification has to be meaningful, not cosmetic,” said another senior banker at an SFB. “Credit costs matter just as much.”
Future Outlook for SFBs
Meaningful diversification will take time, bankers said. Even Bandhan Bank — the only MFI to become a universal bank — took years to reduce its unsecured exposure.
Bandhan, which began operations in 2015, acquired Gruh Finance in 2019, helping expand its secured portfolio.
It was only in the first quarter (April–June/Q1) of FY26 that its secured loans surpassed unsecured ones.
Scale may also be a factor weighing on the regulator’s mind.
The largest SFB, AU, has a loan book of about Rs 1 trillion as of December 2025.
The second-largest is less than half that size. Most SFBs, which began operations seven to eight years ago, are yet to reach meaningful scale.
AU reached scale partly through inorganic growth, acquiring Fincare SFB, making it the only SFB to acquire another lender from within its cohort.
Of the 11 operational SFBs, three are unlisted.
Among the remaining listed ones (excluding AU, Jana, and Ujjivan), most are yet to meet the NPA criteria.
Equitas could qualify if it maintains net and gross NPAs below 1 per cent and 3 per cent in FY26; as of December 31, 2025, its ratios stood at 0.92 per cent and 2.75 per cent.
The others are unlikely to qualify this financial year (2026–27), as their FY25 NPA ratios exceeded one or both thresholds.
In fact, most SFBs still have elevated NPAs and are unlikely to meet the RBI’s criteria in FY26.
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