Reserve bank of India has approved private companies to promote small local area banks (LABs). These banks have an area of operations up to three contiguous districts.

This was proposed by the Raghuram Rajan committee, appointed by Planning Commission in its report in 2008. The committee said that these banks could ensure inclusive banking. The Rajan committee felt that these banks would be more effective in reaching out to poorer households and local small and medium enterprises.

The proposed banks would help in narrowing the gap in credit availability and will also offer credit facility in rural and semi urban areas.

These LABs would be allowed in under-banked or unbanked areas. At present the country has nearly 120 revenue blocks with no banking facilities. Some amongst these proposed LABs that manage to perform well and wish to raise their own deposits could later choose to become small finance banks with a capital base below Rs. 300 crore.

However, many feel that these local area banks could endanger the urban co-operative banks. "The move is welcome. But RBI should show similar generosity in granting licenses for existing urban co-operative banks. In the absence of a similar dispensation for co-operatives, LABs can pose existential challenge to urban co-operative banks," Satish Marathe, president of Sahakar Bharati, noted while reacting to the development.

These new banks backed by the private sector will have easy access to capital. Hence adopting RBI guidelines regarding Capital Adequacy Ratio (CAR) would not be a problem for them.

Earlier, the union finance ministry had indicated its willingness to set up greater number of LABs. The local area bank scheme was first introduced in 1996 by the then finance minister P Chidambram. At that time, these banks were allowed to be set up with a modest capital base of Rs 5 crore. Although a couple of banks were since licenced, the central bank decided to discontinue the scheme in 2003.