Small finance banks likely to witness some margin pressure, say analysts

While rising non-micro book improves asset quality outlook and capital adequacy, it would weigh on overall yields, say analysts

Small finance banks are likely to witness some margin pressure in the near to medium term (see chart), said analysts. 

This is due to a change in their loan book mix with lower share of micro loans that attract higher yields on one hand, and more deposits at higher rates on the other hand.

Bucking the dismal deposit gro­­wth trend of the entire banking system, small finance banks re­­p­­orted a sharp rise in deposits. For the listed small banks —Ujji­v­an Financial Services, Equi­t­as Hol­d­ings and AU Small Fin­ance Ba­nk — deposits jumped by a wh­o­­p­ping 2-4 times year-on-year as of December 2018. This was in sharp contrast to the en­t­i­re banking sector’s deposit gro­w­th of 9 per cent. High pricing po­w­er, mainly through unsecur­e­d micro lending, is helping the sm­a­ll finance banks offer attractive deposit rates.

However, even as small finance banks are offering higher deposit rates, many are now lowering the share of micro loans. Ujjivan’s management, for instance, indicated that its targeted annual loan book growth of 30-35 per cent over the next three years would be driven by the non-micro segment (mainly secured), said a CLSA report.

Already, the share of micro len­ding in the overall loan book of Ujjivan has come down to 87 per cent in December 2018 from 94 per cent a year back, while it fell to 27 per cent from 32 per cent in the case of Equitas. AU Sm­all Finance Bank does not deal in micro lending, and has 81 per cent of its assets under management (AUM) coming in from secured retail loans.

Since secured non-micro loan fetches lower yields as compared to unsecured micro loans, it would lower the overall yields of small finance banks. This would, in turn, impact their net interest margin.

Supreeta Nijjar, vice-president, financial sector ratings at Icra, said overall average yields of small finance banks (listed and non-listed) have gone up from 17 per cent in FY18 to 18.3 per cent during April-Sep­t­e­m­b­er 2018 and is likely to come ba­ck to the 17 per cent levels in near to medium term.

Though a diversified liability franchise should typically offer lower cost of funds, how much benefits these banks can accrue is key to watch, given the overall lukewarm scenario of banking deposits. For instance, AU Small Finance Bank has over 62 per cent of its borrowings from deposits, as on December 31, 2018. For Equitas and Ujjivan, this figure stood at 65 per cent and 58 per cent, respectively.

“Cost of funds could go up given the expected higher rate of deposits and small finance banks are increasing deposit base. This, along with rising focus on non-micro lending, could lead to margin compression,” added Nijjar, who also believes that lower operating costs would support earnings.

Sanjay Kao, chief business officer, Ujjivan, echoes a similar view. “The net interest margin would decline over the next 3-4 years gradually, with lower yield on loans. However, lower operating expenses along with scale expansion will support the bottom line.” For most small finance banks, a costlier transition to full-fledged banks is almost done. Thus, the operating cost is likely to moderate going ahead, though getting the right talent or branch expansion in case of some small banks would add to the costs.

“Given the riskier nature of micro book, diversifying loan book into the non-micro secured se­g­­ment is a good strategy from a long-term perspective,” said As­u­­tosh Mishra, head of research-in­stitutional equity at Ashika St­o­ck Broking. Moreover, it will help improve capital adequacy ratio, given the lower risk involved. Analysts foresee at least 25 per cent loan book growth each in FY20 and FY21 for listed firms.