C. Rangarajan flags fewer regional rural banks as ‘a step in the wrong direction’; urges RBI to incentivise SFBs

Indian Economy & Banking Sector Reforms · 8 September 2026 · Based on The Hindu (original report)

2-minute summary

Former RBI Governor C. Rangarajan has raised critical concerns over the structural shifts in India's rural credit ecosystem. He criticized the progressive consolidation of Regional Rural Banks (RRBs)—which reduced their numbers from 196 to 28 under the 'One State-One RRB' policy by May 2025—arguing that it erodes their essential local and regional character and risks their eventual absorption into universal banks. To address unmet rural credit needs, Rangarajan urged the RBI to incentivize the creation of Small Finance Banks (SFBs), noting that the current 11 SFBs are insufficient because they face the same regulatory burdens as universal banks without matching incentives. Additionally, he cautioned that Self-Help Groups (SHGs) have deviated from their original self-reliance and mutual-guarantee principles, increasingly becoming mere instruments for executing government projects.

Why it's in the news

During an event in September 2026, former RBI Governor C. Rangarajan flagged the consolidation of Regional Rural Banks (RRBs) as a 'step in the wrong direction' and highlighted the dilution of the original mandate of Self-Help Groups (SHGs).

Background and context

Regional Rural Banks (RRBs) were established under the RRB Act, 1976, following the recommendations of the Narasimham Working Group (1975) to provide credit to small farmers, agricultural laborers, and rural artisans. To address issues of low capital base and operational viability, the government initiated phases of amalgamation in 2005, reducing RRBs from 196 to 82 by 2010, and further down to 28 by May 2025 under the 'One State-One RRB' model. Concurrently, Small Finance Banks (SFBs) were introduced in 2014 as differentiated banking entities to further financial inclusion. Self-Help Groups (SHGs) emerged in the early 1990s, supported by the RBI's 1993-94 guidelines allowing banks to lend to unregistered groups on a common guarantee, which laid the foundation for the SHG-Bank Linkage Programme.

Constitutional provisions

• Article 39 — Directive Principles of State Policy (DPSP) directing the State to secure an economy where ownership and control of material resources subserve the common good and prevent concentration of wealth, underpinning the mandate for financial inclusion and rural credit.

Committees and reports

• Narasimham Working Group on Rural Banks — Recommended the establishment of Regional Rural Banks (RRBs) to combine the local feel of cooperatives with the professionalism of commercial banks.
• Nachiket Mor Committee on Comprehensive Financial Services for Small Businesses and Low Income Households — Recommended the introduction of specialized, differentiated banks, which led to the creation of Small Finance Banks (SFBs) and Payments Banks.

Government schemes

• SHG-Bank Linkage Programme (SBLP) — An initiative to connect informal SHGs with formal banking channels, which C. Rangarajan supported via regulatory relaxations in 1993-94.
• Deendayal Antyodaya Yojana - National Rural Livelihoods Mission (DAY-NRLM) — A poverty alleviation scheme structured around promoting and leveraging self-managed SHGs, which critics argue has turned SHGs into implementation tools for state projects.

Previous UPSC questions on this theme

• Prelims GS-1 2017 — What is the purpose of setting up of Small Finance Banks (SFBs) in India? 1. To supply credit to small business units 2. To supply credit to small and marginal farmers 3. To encourage young entrepreneurs to set up business particularly in rural areas. (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3
• Mains GS-2 2020 — "Micro-Finance as an anti-poverty vaccine, is aimed at asset creation and income security of the rural poor in India". Evaluate the role of the Self Help Groups in achieving the twin objectives along with empowering women in rural India.

Mains practice: The consolidation of Regional Rural Banks (RRBs) presents a conflict between financial viability and localized credit delivery. Critically analyze the impact of RRB amalgamation on last-mile financial inclusion in India.

Regional Rural Banks (RRBs) were established under the RRB Act, 1976, to combine the local familiarity of cooperatives with the professional credit-handling capacity of commercial banks. To address structural inefficiencies and high overhead costs, the government consolidated RRBs from 196 in 2005 to 28 by May 2025 under the 'One State-One RRB' policy. While this consolidation has improved financial metrics, it poses significant challenges to the core mandate of rural credit delivery.

**Positive Impacts of Consolidation (Viability and Scale):**

• **Operational Efficiency:** Amalgamation has helped RRBs leverage economies of scale, reduce overhead expenses, and eliminate redundant administrative layers.

• **Technological Upgrade:** Larger consolidated entities have successfully adopted modern banking technologies, such as Core Banking Solutions (CBS) and digital payments, improving service delivery.

• **Capital Adequacy:** Consolidated banks possess stronger balance sheets, making them more resilient to non-performing assets (NPAs) and better equipped to meet capital adequacy norms.

**Negative Impacts (Erosion of Local Character):**

• **Loss of Local Identity:** As RRBs expand to cover entire states, they lose their localized 'local feel' and soft-information-based credit assessment, which is vital for evaluating informal rural borrowers.

• **Urban Shift:** To maintain commercial viability, consolidated RRBs often shift focus toward semi-urban and urban lending, sidelining small and marginal farmers.

• **Risk of Universalization:** Diluting their regional character increases the risk of RRBs eventually merging with sponsor commercial banks, leaving remote rural areas underbanked.

**Way Forward:**

To balance viability with inclusion, the RBI must incentivize Small Finance Banks (SFBs) to fill the credit gaps left by consolidated RRBs. Furthermore, RRBs should utilize local business correspondents and digital public infrastructure (DPI) to maintain low-cost, high-touch rural outreach without needing physical branch consolidation. While structural viability is necessary, the foundational objective of RRBs—serving the last mile—must not be compromised.

Prelims practice questions

Q1. With reference to Regional Rural Banks (RRBs) in India, consider the following statements: 1. RRBs are statutory bodies established under the Regional Rural Banks Act, 1976. 2. The equity of an RRB is held jointly by the Central Government, the concerned State Government, and the Sponsor Bank in a 50:15:35 ratio. 3. The 'One State-One RRB' policy has consolidated the total number of RRBs to fewer than 30. Which of the statements given above are correct?

1. 1 and 2 only
2. 2 and 3 only
3. 1 and 3 only
4. 1, 2 and 3

Answer: D. All three statements are correct. RRBs are statutory bodies (RRB Act, 1976). Their shareholding pattern is Central Government (50%), Sponsor Bank (35%), and State Government (15%). Under the 'One State-One RRB' consolidation phase effective May 1, 2025, the number of RRBs was reduced from 43 to 28.

Q2. Which of the following committees recommended the establishment of 'differentiated banks' such as Small Finance Banks (SFBs) in India?

1. Nachiket Mor Committee
2. Bimal Jalan Committee
3. Urjit Patel Committee
4. Narasimham Committee-I

Answer: A. The Committee on Comprehensive Financial Services for Small Businesses and Low Income Households, chaired by Dr. Nachiket Mor, recommended the introduction of specialized, differentiated banks (Payments Banks and Small Finance Banks) in 2013.

Q3. In the context of Indian financial inclusion, what was the significance of the RBI's regulatory intervention regarding Self-Help Groups (SHGs) in 1993-94?

1. It established NABARD as the sole regulatory authority for microfinance institutions.
2. It mandated that 18% of all commercial bank lending must go directly to registered SHGs.
3. It merged the SHG-Bank Linkage Programme with the Priority Sector Lending guidelines.
4. It permitted banks to advance credit to unregistered SHGs on a common/group guarantee.

Answer: D. As noted by C. Rangarajan, the landmark 1993-94 RBI circular allowed banks to extend credit to unregistered SHGs on a informal, common guarantee basis, resolving the initial hesitation of commercial banks to lend to unregistered entities.

Revision flashcards

• What is the shareholding pattern of Regional Rural Banks (RRBs) in India? Central Government: 50%, Sponsor Bank: 35%, State Government: 15%.
• Which working group recommended the creation of RRBs, and in which year? The Narasimham Working Group on Rural Banks in 1975.
• What is the Priority Sector Lending (PSL) target for Small Finance Banks (SFBs) in India? 75% of their Adjusted Net Bank Credit (ANBC), compared to 40% for universal commercial banks.
• How many RRBs remain in India after the 'One State-One RRB' consolidation phase effective May 2025? The number of RRBs was reduced from 43 to 28.
• What criticism did C. Rangarajan level against the current role of Self-Help Groups (SHGs)? He cautioned that SHGs have deviated from their original self-reliance model to become mere instruments for executing government projects.