Mumbai: The chiefs of two small finance banks (SFBs) have stepped down following a central bank order citing their non-compliance with rules on holding shares in a company other than their own.

The Reserve Bank of India (RBI) in May asked Govind Singh, managing director (MD) and chief executive officer (CEO) of Varanasi, Uttar Pradesh-based Utkarsh Small Finance Bank Ltd, and K. Paul Thomas, MD and CEO of Thrissur, Kerala-based Esaf Small Finance Bank Ltd, to step down, citing violation of Section 10 B(4) of the Banking Regulation Act, 1949. Both banks confirmed the development, adding that the bosses would be back once they sell their shares and comply with the rules.

Under the Act, a bank CEO cannot hold shares over 5 lakh, or shares adding up to 10% of the paid-up capital, in any other company. The CEO himself, his spouse or minor child cannot singly, or taken together, cross this threshold.

Both Singh and Thomas continue to be non-executive directors; however, the day-to-day affairs and financial decisions are handled by a committee of directors appointed by the board.

“The committee of directors will take care of the management. A.G. Varghese, executive vice-president at Esaf SFB will be the officer in-charge during the interim period," Thomas said on the phone. He added that after the lock-in period expires in September, he will sell his shares to comply with the regulations.

“The Companies Act requires a three-year lock-in period for the sweat equity in question. It cannot be exited immediately as it would violate the Companies Act," a spokesperson for Utkarsh SFB said. “After the lock-in gets over, the shares will be transferred or sold. In order to ensure full compliance with the regulations and orders of RBI, the CEO has stepped down and is currently serving as a non-executive director."

He, however, said the officer in-charge is yet to be finalized by the committee of directors and should be done in the next couple of weeks.

While Singh holds about 0.5% sweat equity in Utkarsh Micro Finance Ltd, Thomas holds 0.39% in Esaf Microfinance and Investments Pvt Ltd. Both these companies are promoters of their respective SFBs. The sweat equity lock-in period for Singh expires in January 2019 and for Thomas in September this year. Both of them are expected to return to the helm after the transfer of their shares, once the lock-in period is over.

The Banking Regulation Act does not prohibit such shareholding in the banks themselves, but their holding companies. Ostensibly, this is to ensure the CEO focuses on running the bank without the distraction of ownership in another company.

As on 31 March 2018, ESAF SFB had deposits of 2,523 crore and advances worth 3,155 crore. Utkarsh SFB has deposits of 2,194 crore and advances of 3,083 crore.

“Post the Nirav Modi episode, RBI is extremely particular about compliance. The banking regulator is not allowing any bank to deviate from the rulebook," said a banking analyst, who did not wish to be named.

In February, Punjab National Bank (PNB) had lodged a complaint against diamond merchant Nirav Modi and his uncle Mehul Choksi, accusing the two of defrauding the bank of $2 billion. The public sector bank was criticized for not complying with multiple warnings and directives by RBI, asking the banks to link their core banking systems (CBS) with inter-bank messaging platform SWIFT.

The scam at PNB went unnoticed for years, allegedly because unauthorized transactions were made on SWIFT, which was not linked to the bank’s CBS. SWIFT is short for Society for Worldwide Interbank Financial Telecommunication, a worldwide messaging platform for banks.

RBI in September 2015 had granted in-principle licences to 10 entities to float SFBs. The objective was to further financial inclusion by offering basic banking services by accepting deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries, and entities in the unorganized sector.

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