SFBs ready with systems, governance to become universal banks: MDs & CEOs

Small Finance Banks (SFBs) are emerging as key players, driving growth by catering to under served segments. A panel discussion titled ‘Small Finance Banks, can they go big?’ at the Business Standard BFSI Insight Summit 2024, brought together managing directors (MDs) and chief executive officers (CEOs) of four prominent SFBs – Ajay Kanwal of Jana Small Finance Bank, Govind Singh of Utkarsh Small Finance Bank, K Paul Thomas of ESAF Small Finance Bank, and R Baskar Babu of Suryoday Small Finance Bank. They dwelled on the pros and cons of becoming universal banks and the road ahead. Edited excerpts: 

What are the benefits of becoming a universal bank from a small finance bank? 

K Paul Thomas: We already have become big - big small finance banks. When the licences were given, the then RBI (Reserve Bank of India) Governor Raghuram Rajan had said that these banks are big banks for small people. If you look at the last seven years of growth of the small finance banks, we all have exceeded the growth rate of commercial banks. One major benefit of becoming a universal bank is that public perception will change. Otherwise, we can do everything that a universal bank does. The main thing is that the word small finance will go away. We will be treated equally to universal banks. Number two is, the minimum capital adequacy for universal banks is slightly less. 

Govind Singh: If you look at the number of clients, employees, and the network of branches, many small finance banks may be bigger than several universal banks. 

Perception is important, especially when we go to newer geographies. Each small finance bank will have its own core geography. Sometimes it becomes difficult in newer geographies to explain what a small finance bank is. They might ask whether you are a small corporate bank. If you get ‘small’ removed from the name, either through regulations or by becoming a universal bank, it is going to help us. Otherwise, in terms of impact and overall footprints, we are big and can do all types of activities that normal banks can do. 

Ajay Kanwal: We don't have to become big. We're already growing pretty fast, and growing too fast may have its own risks. We'd rather grow at a measured pace. One big aspect we do have is a small finance bank risk premium because it is seen as a riskier organisation versus universal banks. We all tend to pay anything between 25 to 50 basis points extra on our deposits. Both the pace of deposit growth, and the cost of deposits will come down when the small finance tag changes, which will be directly measurable. In a macro picture, SFBs becoming universal will encourage a lot of other NBFCs to apply for SFBs. 

R Baskar Babu: Becoming a universal bank might impact the cost of funds, but not necessarily. Each of us has created a niche and reputation for small finance banks in our respective regions. If the name changes to Suryoday Bank Limited, it doesn’t mean my pricing will suddenly drop by 25 basis points, and deposits will continue as they are. The change will come from size. Currently, in the SFB space, the smallest loan book size is Rs 2,500 crore, and the largest is Rs 97,000 crore. It will help in potentially opening up more opportunities like co-lending. 

Other than that, there isn’t any specific advantage. Initially, many of us wanted to apply, but I am very clear I would not even give it a shot for the next three years. 

Are you ready to become a universal bank, what is the level of preparedness? 

  Thomas: We are not in a hurry to become a universal bank as we are more of an impact-focused institution. ESAF started as an NGO. We wanted to make an impact in the community. I can make an impact in society as a small finance bank. I can attract NRI deposits. I can do whatever a universal bank does, and we have tried to convince individual markets that we are a differentiated bank, but we are a scheduled commercial bank, like any other bank. So, I am not in a hurry. The RBI prescribed criteria to become a universal bank. ESAF will be eligible in a few quarters, one or two years, definitely. 

Singh: The bigger work right now is the reverse merger of our holding company. The process is on and normally takes around a year or so. Once it is completely over, we will look at the next step to become a universal bank. It is not going to make much difference. We will not be in a hurry to become a universal bank. 

Kanwal: If somebody would drop the name small finance today, I will take it. We are 90 per cent plus in the priority sector. To me, becoming universal does not stop me from the priority sector. What it does is it gives employees, investors, and depositors a better feeling that they are not going to a differentiated bank. I have one criterion to meet, which is that net non-performing assets (NPAs) have to be less than one per cent for two years. If I meet it, I will certainly like to put up my proposal to the regulator next year.  

We are a scheduled commercial bank and all policies, regulations have been applied to small finance banks since our inception. There is nothing new to do to become universal. We have all the systems from cyber security to a Core Banking System (CBS) to whatever else is required to be a universal bank. I don't have to spend extra money to be a universal bank. I will have only one cost, to change the branding. 

Babu: The regulations for us are the same as for universal banks. We are all compliant. From the preparedness point of view, it is just the cost of changing the signages and branding. Other than that, most of us are on the same platform as far as universal banks are concerned in terms of all other things on regulation. There is nothing that a small finance bank cannot do, which a universal bank can do, except in terms of forex, and co-lending. So we can continue to become large. There are no constraints. If there is a universal bank, whatever we said 90 per cent of PSL (priority sector lending) which we have, 40 per cent requirement, remaining I will be able to encash as Priority Sector Lending Certificates (PSLCs). So, today we leave that money on the table, which would be probably around closer to half a per cent ROA (return on assets) and 2-3 per cent in terms of ROE (return on equity). The rest of it, I think it gives us nimbleness. I open branches with 400 square feet, not really constrained. So, whatever a regular bank will do, I will do it probably with a little more flexibility and nimbleness. I actually don't see any constraints. 

The RBI’s norms prioritise diversification for universal bank conversion, but many small finance banks still have high MFI and unsecured loan proportions. What do you think is an ideal secured-unsecured loan mix to meet regulatory expectations? 

Thomas: Every bank, whether it is universal or small finance, has a legacy. There is a concentration and it takes time for proper diversification. When ESAF started in 2017, it was 100 per cent microfinance. We have diversified. We are at 60 per cent microfinance now. We are continuing the diversification, building our assets in gold loans, MSME, and mortgage, all these books are growing. It is the individual bank's decision. There is no advisory on a specific percentage in each category, but it depends on the geography they operate and on the priorities and capabilities of the bank which decides. We are reducing our microfinance every year by 5 to 6 per cent. 

Singh: I don't have any specific number in mind where it is 50 per cent, 40 per cent. But the way the RBI looks at it, the trajectory or the direction, is to show a 5 to 7 per cent decline in the core product of what we are doing. The basic difference between an NBFC and a bank is that the NBFC will have one large product. Banks are supposed to be much more granular and diversified. So, if the RBI sees that it is diversified, it is happening regularly. The trajectory is there, direction is there. It will be more than comfortable. 

Kanwal: I did not know this criterion would come in a universal bank because there was no criterion in the past. But when we began the bank in 2018, from that day onwards, we are doing two diversifications. One is asset diversification and the second is geographic diversification. Today after September results, we are 65 per cent non-microfinance and also secured in nature because you can also be non-microfinance but you can still be unsecured. We did not do this from a universal perspective. We built that in a model from 2018, thinking as a bank it's good to be prudent. If we sustain that and carry on as it is, we should be fine. 

Babu: Where we have failed is that we presumed our asset customers will also start saving and it will give us a good stickiness. Today, it has just happened by design as well as by how probably the cost of mobilisation is high, our asset customers are extremely different from liability customers. The overlap is very minimal. Again, all financial inclusion by various discussions tends to go back in terms of lending. Lending is only 40 per cent of financial inclusion. The majority, 60, is in terms of everybody needing insurance. We have 10,000 death claims every year of either the customer or the spouse. In every case, we just check with them whether they have a Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY). The answer is that it is very close to zero. That circle of financial inclusion is a large base that is missing. Whichever SFB can do that very meaningfully, I wouldn't even crave to become a universal bank quickly. 

How challenging will it be to achieve 1 per cent and 3 per cent net and gross NPA levels, considering the overall stress in the microfinance sector? 

  Kanwal: As of September results, we are pretty much within the 3 per cent and the 1 per cent. And to my mind, we will stay there for the year. Now that half a year is over, we have some visibility of the next half. So, I don't think that should be the real issue for us. 

Singh: It's not that there is no stress. The guardrails given by MFIN (Microfinance Institutions Network), every microfinance institution (MFI) followed those. So, we have seen that wherever there is an over-leveraged customer, we are seeing some stress. On a medium-term basis, this is going to help the industry, the SFBs and MFIs, and anybody in universal banks who is into the JLG (joint liability group) space. Whatever the number of customers who are over-leveraged, once that is over, the quality of the portfolio should be much, much better for years ahead. 

A regulation introduced last year by the RBI mandates having more than one whole-time member on the boards of banks. It recently observed that many SFBs have only one whole-time member. Do you think there is room to improve the governance structure in SFBs? 

Kanwal: There are two key areas for improvement: one is enhancing transparency, and the other is focusing more on financial education. If we invest more time in financial education, many of the challenges we face could be mitigated. Apart from that, our call centres, complaint resolution rates per thousand customers, and turnaround times are on par with the best in the banking industry. On the governance front, our boards are independent, and we have already appointed two directors as recommended by the RBI, which has definitely added value. While there is always room to do more, I don’t believe there is any significant governance gap that remains unaddressed. 

Babu: I believe the regulator is quite satisfied with the governance standards of SFBs as we meet most of the required benchmarks. One challenge we occasionally face is that the regulator may question how customer complaints are so low, suggesting we might not be recording them properly, which can make the numbers appear artificially low. Deposit customers are generally very satisfied with the service they receive. For asset customers, while we interact with them in the field, they do reach out to us with any complaints as well. As for governance, it would be even more helpful if the guidelines were a bit more prescriptive.