Game-changers? Small finance banks fail to make a dent in banking space

When Ajay Kanwal, says “small finance banks (SFB) are in a fabulous position; it allows us to do financial inclusion in a very commercial context”, you must agree he is an optimist if there ever was one. For four years after the Reserve Bank of India (RBI) issued 10 SFB licences, a rain-check shows little reason to be bullish like Kanwal, chief executive officer (CEO) of Jana Small Finance Bank (Jana SFB).

The latest available RBI consolidated data tells us that in FY18, these banks reported positive earnings before provisions and taxes, but high provisioning on account of the elevated level of dud-loans led to net losses; in H1FY19, the narrative was the same. The objective behind SFBs — many operated as micro finance institutions (MFIs) in their earlier avatars — was to deepen banking in underserved regions. So, what’s their market share after four years at the crease? Just 0.6 per cent and 0.2 per cent of systemic advances and deposits. 

The largest of these, Bharat Financial Inclusion (then known as SKS Microfinance), never got a look-in for technical reasons even as Equitas, Ujjivan, Suryoday, Janalakshmi and AU Financier (the only non-MFI applicant) received Mint Road’s nod to start life as SFBs. They were potential game-changers, especially in rural pockets which don’t have easy access to formal banking channels.

And if they have not yet been able to scale up — which is part-reason why many of them have issues with listing the SFBs even if the holding company (HoldCo) on top has done so — it would not be off-the-mark to say that the time-frame to do with just organic growth is set to become smaller. Size will become critical as investors (especially private equity players) seek to unlock value. 

And it’s set to get crowded as the 10 licensed SFBs so far will soon have to share room with urban co-operative banks (UCBs) — on September 27, 2018, RBI allowed UCBs to opt for voluntary transition into SFBs in line with recommendations of the R Gandhi Committee report. This would help UCBs roll out products currently permissible only to commercial banks and help secure a pan-Indian presence. The threshold for eligibility — a minimum net worth of ₹50 crore and a capital-adequacy ratio of 9 per cent and above. While a granular assessment of specific UCB books is not readily available, it would be reasonable to assume that a few have the heft to take on the SFBs in the game so far; several have a deep footprint in the markets they operate in with legacy relationships to boot. Where does all this leave SFBs as on date?

Running at the same spot

A good majority of SFBs prefer to stay within their comfort zones of the past as MFIs. Barring Equitas SFB and AU SFB, the books of the rest have a heavy skew towards MFI loans at over 80 per cent. While AU is a non-MFI licence holder, Equitas began its diversification well ahead of its peers even when it operated as an MFI. “We started the process of diversification in 2011 when we were permitted to do a little non-MFI loans,” says PN Vasudevan, managing director  (MD) of Equitas SFB, which probably is the most diversified among the lot.

Analysts at Kotak Institutional Equities note that a rise in customer acquisition rate may not be much of a problem for SFBs as they scale up their operations and diversify into newer channels. But an increase in ticket-size may pose asset-quality risks as incomes of borrowers may not grow at a similar pace, resulting in their high indebtedness. This issue may become particularly prominent as SFBs convert more of their rural outlets into banks. Currently, over half of their loan book is driven by business from metros where these banks have been aggressive in setting up new branches; rural advances account for about six per cent of their total advances.

SFBs’ snail-paced advancement in terms of garnering deposits has in a way been a barrier to their diversification strategy. Despite offering interest rates which on an average are 50–100 basis points higher than what most banks offer, they haven’t made an impact yet in the market. Household savings chanellised into deposits are about 42 per cent of total SFB deposits, as against 63 per cent for the industry. “For the person depositing money, the question is whether this bank is here to stay, and can I trust him with my money,” feels Kanwal.

SFBs share of low-cost current and savings accounts, an important factor in pricing assets, is at a dismally low level of sub-30 per cent for the industry. It could be one 

reason why they have to offer high interest rates on deposits from the commencement of banking operations.

Money, money, money

Another factor that doesn’t augur well for the sector is the prohibitive cost-to-income ratio. While the three listed players have over the past two–three years seen this ratio moderate to the 60-75 per cent mark in FY19 from 70-80 per in the preceding fiscal, the rest still grapple with a prohibitive cost-structure at over 80 per cent. 

As the industry is still in the process of rolling out branches, systems and technology with adequate manpower, costs may remain high for three years.

“Conversion from a non-banking financial company (NBFC) to a bank means conversion from a low-cost model of operation to a fairly high-cost operation in terms of technology, infrastructure and people. How to bring the cost-to-income ratio down depends a lot on scaling up and managing your cost very closely,” says Samit Ghosh, MD&CEO of Ujjivan SFB. You get a sense of the urgency to upgrade to a state-of-the-art mass bank — Flipkart’s founder Sachin Bansal joined last week as an independent director; Nitin Chugh, HDFC Bank’s former digital head, will succeed Ghosh in December this year.

Adoption of a tighter regulatory framework is another factor to juggle with. As Ghosh puts it, bringing in the whole compliance culture is quite a task for the system given that NBFCs (he uses the term in a generic way to describe non-banks) have traditionally operated with far fewer compliances. The next two–three years will be crucial in terms of capital market offerings for the industry as SFBs may flood the market to comply with RBI’s mandatory listing requirements. 

To begin with, FY20 will be crucial for both Equitas and Ujjivan as it would require them to list their SFBs in addition to the already listed HoldCo. 

“All of us saw this problem right at the beginning and this HoldCo structure was mainly to comply with the RBI norms. This is an issue for all the MFIs which converted into SFBs,” points out Ghosh.

You need to be a braveheart to be in the financial services business, more so if you are a relative newbie. Perhaps Kanwal and his ilk are more than just optimists.