Strained Small Finance Banks Prepare For Extended Period Of Stress

Gross bad loans for three listed small banks — AU Small Finance Bank Ltd., Ujjivan Small Finance Bank Ltd., and Equitas Small Finance Bank Ltd. — worsened anywhere between 100 and 600 basis points over the last financial year. Ujjivan saw the sharpest jump in bad loans, with gross non-performing assets at 7%.

In addition to loans already classified as non-performing, each of the lenders had a relatively high level of loans and accounts which were overdue as on March 31.

• AU Small Finance Bank had a 16.2% of customer accounts overdue by 1-90 days, it said in its presentation. Around 2.8% of accounts were between 61 and 90 days overdue, suggesting greater risk of turning bad.
• For Ujjivan, 7.9% of its portfolio is overdue, with 2% overdue by 61-90 days.
• In case of Equitas, the bank in its analyst call disclosed that 5.4% of customers are overdue. It did not specify the days these accounts were overdue by.

Banks are not required to make standardised disclosures apart from accounts that are overdue by more than 90 days and classified as non-performing assets.

Where Is The Stress Coming From?

For AU Small Finance Bank, 47% of its gross bad loans emanated from the vehicle finance segment, while nearly 40% of it came from its small business loans segment. Both rural and semi-urban areas contributed to the stress.

For Equitas, most of its bad loans emerged from the microfinance, small business and vehicle loans portfolio. In each of these segments, about 3% of gross advances had turned bad. Together, these three segments formed close to 90% of the bank’s gross advances.

For Ujjivan, maximum stress came from micro and small enterprise loan segment that saw 23.2% of its portfolio at risk, followed by micro and rural banking that had 15.8% of its portfolio at risk. As of March, micro-banking formed over 70% of its total advances, while loans to small business formed another 8%.

Second Wave Will Add To The Strain

These pain points could worsen amid the second wave. Already, officials at these lenders spoke of rising stress while reporting fourth-quarter earnings.

Nitin Chugh, chief executive officer at Ujjivan Small Finance Bank, said collection efficiency had dropped to 88% in April from 94% in March. “...largely the impact has been in the second fortnight of April. The first fortnight, while we were experiencing difficulties, but larger difficulties have started to come only after the end of April,” Chugh told analysts. “We do intend to add more people to our collections organisation, which will benefit us in the medium term.”

There will be some impact, said PN Vasudevan, chief executive at Equitas Small Finance Bank. “I think that’s fairly clear. So the first quarter I think it’s going to have an impact. Second quarter, how strong it will come back, we have to wait and see.”

What may worsen the asset quality picture for the next few quarters is the fact that the Reserve Bank of India has not announced a repayment moratorium this time, even though it has permitted restructuring for small business and retail loans.

During the first Covid-19 wave, small finance banks used the moratorium provision widely.

Vasudevan suggested the RBI should consider giving small finance banks the option to either reschedule or extend moratorium based on the customers’ needs, unlike last year when blanket regulations were announced as the impact of lockdowns was uniform. “So, that way a customised approach may be better this year simply because the impact of all this second wave is not uniform; it is different,” he said.

Apart from announcing a restructuring relief for all banks, the RBI has also opened a special financing window for small finance banks of up to Rs 10,000 crore to meet any liquidity requirements.

Analysts, too, are building in worsening asset quality for these lenders.

“The impact of the second Covid wave is expected to be a greater drag on the asset quality of small finance banks compared to other lenders as they have a higher exposure to unsecured micro-credit, small business loans, and vehicle financing,” said Darpin Shah, analyst at brokerage Haitong Securities India.

To cope with these challenges, small banks would need to diversify their portfolios to spread risk as evenly as possible, said Siji Phillip, senior analyst at Axis Securities.

“Diversification, both in terms of loan portfolio and geography, will be key in terms of hedging against the risks posed by the Covid second wave,” she said. “That said, small finance banks with greater concentration of microfinance loans and towards states that announced lockdowns will be the worst affected.”