Why small finance banks are in no hurry to become universal banks

The fear of rejection is real. Many of the SFBs are listed on the exchanges. They are aware that no new universal bank licence has been granted in the last 10 years

After the onset of economic liberalisation in 1991, a new generation of private sector banks took shape. The most prominent among them are ICICI Bank and HDFC Bank, both of which were incorporated in 1994. However, it has been a story of fits and starts, while the Reserve Bank of India (RBI) has taken its time to issue universal bank licences.

Till the middle of the last decade, aspiring entrants had to wait for the RBI to open the licensing window. One could only apply when the window opened, which it did once in the early 2000s, when Kotak Mahindra Bank and Yes Bank received licences, and again in the last decade, when Bandhan and IDFC became banks.

On August 1, 2016, the banking regulator decided to put the licensing process on tap. Later, the licensing of small finance banks (SFBs) was also made on tap. One no longer had to wait for the opening of the window and could apply whenever.

This promised to change much. But there is a catch. Or two. Or three.

Since the licensing process was put on tap, not a single universal bank licence has been granted. There have been only six applications, five of which were not found suitable. The sixth applicant is Bhubaneswar-based Annapurna Finance. Some experts point out that it is the lesser-known, smaller entities that are showing interest in universal bank licenses.

Therefore, the second catch.

In June 2020, an internal working group was formed by the RBI to review ownership and corporate structure of private banks in India. The group suggested that large corporate or industrial houses be allowed as promoters of banks. The regulator has not accepted this yet. So, as of now, the Ambanis, Adanis, Birlas, and Mahindras of the world are not allowed to promote a commercial bank.

Against this backdrop, on April 28 this year, the RBI announced new rules for voluntary conversion of SFBs into universal banks, rekindling hopes. 

SFBs, their track records, governance, and promoters are known to the regulator. Of the private universal banking licences issued so far, only Yes Bank was a greenfield bank. All others were already financial entities known to the RBI one way or another. 

And that brings us to the third catch.

Known and unknown

Small finance banks, or SFBs, are meant to serve the marginalised sections of society, such as small businesses and low-income households, through basic banking services, including savings accounts, fixed deposits, recurring deposits, digital banking, and debit cards. Unlike universal banks, SFBs cannot provide wealth management, corporate banking, credit cards, and other high-end services.

Ten in-principle SFB licences were issued in 2015. Of the 10, Fincare merged with AU SFB, which is the largest SFB in the country. Later, another two entities received fresh licences to become SFBs – Unity and Shivalik -- taking the number of SFBs to 11.

Most SFBs have done well to fulfil their mandate so far, despite the challenges presented by the demonetisation and Covid-19 pandemic, which were harsh on the bottom-of-the-pyramid segment served by SFBs.

“The geographical concentration of SFBs – measured by the Herfindahl-Hirschman Index (HHI) – has been coming down in terms of both number of reporting offices as well as credit and deposits. This indicates progressive diversification and increasing outreach of SFBs in line with their mandate of serving the marginalised sections,” the RBI Trend and Progress report of 2022-23 said.

Many believe the SFBs are best placed to become universal banks. The RBI’s recent glide path norms for SFBs' voluntary conversion should be seen in this light, according to the CEO of a small finance bank.

But it is not that simple. The first criterion for an SFB to become a universal bank, according to the recent norms, is “satisfactory track record of performance for a minimum period of five years.” Only nine of the 11 SFBs have completed five years of operations, of which one was in trouble with capital erosion, prompting merger with a fintech company last year.

Of the remaining eight SFBs, only two are eligible to apply to become a universal bank, as of now. This is because the norms say SFBs should have gross non-performing assets (NPA) and net NPA of less than or equal to 3 per cent and 1 per cent, respectively, in the last two financial years.

Two few

Only AU and Ujjivan meet the NPA criteria for FY23 and FY24. Jana, Suryoday, and Urkarsh met the gross and net NPA criteria for one year: FY24. In case they maintain the gross NPA and net NPA below the prescribed marks in the current financial year (FY25), they will become eligible.

Bengaluru-based Jana SFB’s MD & CEO, Ajay Kanwal, says the lender will apply in the next financial year, after it meets the NPA parameters this year.

“We are short by one year. Our net NPA [ratio] this year is 0.5 per cent. We have to keep it at less than 1 per cent for one more year. After that we will apply. We plan to apply in FY26,” Kanwal said in an interaction with Business Standard after the norms were announced.

The two eligible SFBs, AU and Ujjivan, have taken a cautious stance. AU has recently completed a merger with Fincare, and its immediate priority may be to see a smooth integration.

Ujjivan, will see a change of guard next month, as MD and CEO Ittira Davis has decided to take early retirement. Davis told Business Standard last month the bank had just completed the reverse merger and was not in a rush.

“The board will consider the timeframe for a conversion to universal bank during this financial year,” Davis said.

Like Jana, Navi Mumbai-based Suryoday SFB, too, expects to become eligible in FY25. However, its MD & CEO, R Baskar Babu, makes it clear that there is no hurry.

“We have a long way to go even as a small finance bank, both in terms of size, and in terms of fulfilling our aspirations for financial inclusion,” Babu said.

Though the RBI conversion norms are clear -– as it talks about the numbers needed to achieve for becoming eligible -– there is one area where more clarity may be needed.

Into the unknown

“The eligible SFBs having diversified loan portfolios will be preferred,” the norms said.

Eight of the 10 SFBs that received the licence in 2015 were converted from microfinance institutions. As a result, some of these players’ loan book is still tilted toward micro loans -– which are unsecured in nature. The pace of diversification varied from one bank to another.

This unknown element, that is, how much of a diversified loan portfolio the regulator will prefer, is the question many SFBs are asking.

As the chief executive of an SFB puts it: “Everyone is waiting for someone else to apply and see how it goes.”

The fear of rejection is real. Except NE SFB, all the ones who received licences in 2015 are listed on the exchanges. SFBs and payments banks were test cases, the former has succeeded.

However, the regulator cannot take chances with new bank licences. Yes Bank was on the brink of collapse a few years back, prompting the government to intervene and revive it. SFBs are aware that no new universal bank licences have been granted in the last 10 years.

Moreover, there has been a change in approach on how errant entities are to be treated. Monetary penalties are passé. Business restrictions are a reality.

That could be yet another catch.