Small Finance Banks: Differentiated Banking Or Just Small Large Banks?

India has a number of scheduled commercial banks. Barring differences in service standards and minor variations in interest rates offered and charged, these banks are near clones of each other. They offer similar products to similar clients in similar markets, leaving a large part of India unbanked, or at least, under-banked.

Raghuram Rajan, former governor of the Reserve Bank of India, sought to break that pattern three years ago when he announced that the regulator would give out differentiated banking licences to small finance banks and payment banks. The former was intended to cater to small businesses while the latter was to focus on the remittance business.

In-principle approvals for both were given out in September 2015 and the launches are now beginning to roll out.

Over the past five months, four entities have started operating as small finance banks (SFBs) –Suryoday Small Finance Bank, Utkarsh Small Finance Bank, Equitas Small Finance Bank and, most recently, Ujjivan Small Finance Bank. Capital Small Finance Bank was the first to launch its operations in April last year.

A first look at the strategy being followed by SFBs suggests that interest rate is being used as the key differentiator so far. A majority of the SFBs have chosen to offer higher rates on both savings accounts and fixed deposits. To be sure, this is also a necessity as SFBs need to build a deposit base.

The highest savings rate is currently being offered by Suryoday, at 6.25 percent for deposits up to Rs 1 lakh, 7.25 percent for Rs 1-10 lakh, and 7 percent for those above Rs 10 lakh.

Only slightly lower, Equitas’ savings deposit rate is at 6 percent for deposits up to Rs 1 lakh, 6.5 percent for Rs 1-50 lakh, 7.0 percent for Rs 50 lakh-10 crore, and 7.5 percent for those above Rs 10 crore.

Utkarsh has set its savings bank rate at 6 percent. Capital Small Finance Bank and Ujjivan have both chosen a more conservative approach and are offering 4 percent on savings account, on par with what is offered by large banks.

On fixed deposits, most SFBs are offering rates which are at least a percent higher than what is offered by large banks.

Samit Ghosh, founder and managing director of Ujjivan Financial Services, which launched its SFB on Monday explained that flows into fixed deposits tend to be more sensitive to interest rates. This is borne out by the fact that while small private banks started offering higher savings deposit rates, large banks have stuck to offering 4 percent.

Will The Rate Differentiator Sustain?

Besides, higher rates may not be sustainable in the long run even if they help draw in deposits in the early days of operations.

Suryoday Small Finance Bank, which is currently offering the highest rates on fixed deposits, has clarified that the current rates are not going to be offered forever.

In an interview with BloombergQuint last week, R Baskar Babu, managing director and chief operating officer of the bank, said interest rates are likely to stabilise at levels around 50 basis points higher than what large banks are offering. The differential between rates offered by Suryoday and SBI in the same tenor is currently as high as 2.05-2.10 percentage points.

Govind Singh, managing director and chief executive office of Utkarsh Micro Finance is also of the view that the higher rates are unlikely to be sustainable in the medium term.

“When I have to compete with them (large banks) I have to take care of the service part and the technology part. The third piece is interest rates, where I will be giving 100-125 basis points more than the established PSBs (public sector banks). We will review this in September,” Singh told BloombergQuint in a phone conversation.

That is not to say that the rates differential will go away entirely.

Gautam Chhugani, director and senior analyst for Indian financial institutions at Sanford C Bernstein, told BloombergQuint in a phone conversation that rates offered by SFBs will settle but will remain higher than those offered by scheduled commercial banks. He adds that some of the SFBs have seen early success in gathering deposits.

Sticking To Core Strengths

On the lending side, the SFBs are all choosing to stick to the business and the demographics that they know best. Functioning as a bank, however, will allow them to increase the scale of lending.

The 10 entities that were given in-priniciple approval to launch SFBs were already operating either as microfinance firms or as local area banks. This means that they are familiar with the small business segment that they are expected to cater to.

Some of them, however, may choose to expand selectively either to meet regulatory requirement or make in-roads into newer markets.

The largest, Ujjivan Financial Services, will add over 60 branches in the remainder of the financial year to meet the requirement of having 25 percent of its presence in unbanked and rural areas, Ghosh said. Beyond that, he is in no rush to drastically expand geographical presence.

Ujjivan’s current lending strategy centres around lending to repeat customers, which suggests that the bank will stick to the tried and tested. It may increase the ticket size limit on group lending and microfinance to Rs 1 lakh from the current Rs 60,000 after six months, once the turbulence caused by demonetisation settles, said Ghosh.

Suryoday, too, plans to keep its branch network at the minimum to keep costs in control. It will hit 90 branches by March 2018. The focus will be to provide additional banking services to the bank’s existing 7.6 lakh customers, said Babu.

Utkarsh Micro Finance, which currently has around 75 percent of its client base and branches in Uttar Pradesh and Bihar, also intends to expand only selectively. Some expansion in the product offering is likely but Singh says that the differentiator will lie in the attention paid to catering to rural and small business clients, which are often add-ons for large commercial banks.

Like Suryoday and Ujjivan, Utkarsh will also grow business by increasing disbursements to existing customers. The small finance bank plans to increase the ticket size of loans in the affordable housing sector to around Rs 25 lakh from the current average of Rs 5 lakh.

This is where the competitiveness for small finance banks lies, said Chhugani. Small finance banks will be able to tap markets where private banks have remained tentative, thus providing healthy competition to the industry, he said.

And, as these new age banks attract deposits at lower rates, the eventual benefit should flow to the small borrower, Chhugani added.

“Higher lending yield is giving small finance banks power to price deposits attractively. 6.5 to 7 percent is an attractive savings account proposition to the urban saver. Small finance banks operate at 10-11 percent cost of funds currently. As funding cost goes further down driven by retail deposits, they will pass on the benefit to the borrowers,” he said.