Early Success Prompts RBI To Put Small Finance Bank Licences On-Tap

Less than three-years after the Reserve Bank of India first approved the launch of 10 small finance banks, the regulator has decided to put such licences on-tap. These lenders, intended to further financial inclusion, have met their objective and there is a case for more players to be allowed in the sector, the RBI said on Thursday.

SFBs are part of an experiment with differentiated bank licences. Back in 2014, the RBI had decided to give out licences to two sets of entities — financial inclusion focused SFBs and remittances-focused payments banks. While the business model of the latter is yet to stabilise, SFBs have seen steady growth since they were licensed.

Final guidelines are on-tap licences for small finance banks are expected by end of August.

Once these rules are in place, non-bank lenders will have the option to transition towards deposit taking entities. The RBI has also allowed urban cooperative banks to voluntarily transition into SFBs.

“Last year the RBI had allowed cooperative banks to convert to SFBs, which would ensure much close regulatory supervision. I feel some of the more successful micro-finance institutions can convert to an SFB in an easier manner once the new guidelines come,” said Samit Ghosh, managing director and chief executive officer, Ujjivan Financial Services Ltd, one of the SFBs currently in operation.

A number of professionals have also been keen to enter the financial services industry in India, said Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services LLP.

While these professionals were earlier looking at the non banking financial company segment, the recent crisis has prompted them to reconsider applications for banking licences. “Now they can set up an SFB with ease, once the RBI begins the ontap license programme,” Parekh said while adding some professionals may also consider acquiring cooperative banks and then convert to SFBs.

Parekh, however, does not see much demand from MFIs to convert.

Not everyone who applies will get a licence as the RBI will continue to be selective in who is allowed to run a deposit-taking franchise.

Karthik Srinivasan, senior vice-president, ICRA Ltd, said that around 70 NBFC-MFIs had applied for a SFB licence in the first round but only 10 licences were given out. “We could see some of those players apply again but whether they get a licence would depend on the final contours of guidelines for the on-tap licence,” he said.

A Short But Good Run

SFBs, most of which were operating as micro finance institutions earlier, are still small relative to the size of the banking system. They account for just 0.2 percent of system-wide deposits and 0.6 percent of system-wide advances, according to the RBI’s Report on Trend and Progress of Banking in India for 2018.

However, these entities have seen strong growth in advances and deposits.

Seven of ten SFBs, for whom data was available, reported advances growth of above 40 percent on average, on a year-on-year. In terms of deposit mobilisation, three SFBs more than doubled the quantum of customer deposits, while the remaining have grown their deposit-base by more 60 percent, on average.

The financial results of Jana Small Finance Bank, Utkarsh Small Finance Bank and North-East Small Finance Banks for FY19 are not yet published and are not included in the analysis.

On the lending side, growth for these small finance banks has come not just from the traditional business of micro finance loans but also small business loans, vehicle financing and affordable-home loan products.

Among the listed small finance banks, Ujjivan SFB, AU SFB and Equitas SFB have succeeded in diversifying their books. The books of remaining seven SFBs remain concentrated in the MFI segment, which still accounts for over 80 percent of their lending book.

In a recent note, rating agency ICRA Ltd said that SFBs will achieve a loan growth of 25-30 percent in FY20, with the share of MFI lending expected to decline to 40 percent by the end of FY20 from 60 percent as at the end of FY17. This diversification into lower risk products has helped SFBs re-balance concentration risks in their loan portfolio, said Supreeta Nijjar, vice-president, financial sector ratings, ICRA Ltd.

Nijjar, however, cautioned that some of the new lending segments these lenders are entering are yet to be tested for asset quality performance.

On the deposit side, retail deposits have been slow to build-up. As such, most SFBs have had to offer higher rates on term deposits to draw institutional deposits, highlighted Kotak Institutional Equities in a note on May 9.

New Entrants Could Face High Costs

Should new SFBs be licensed when on-tap licencing rules are released, these entities will need to be prepared for high start-up costs associated with creating a branch network and putting risk management processes required at deposit-taking entities.

“Adhering to a new regulatory framework, especially the kind of scrutiny that banks undergo, will be difficult for cooperative banks and MFIs to adjust to,” said As­u­­tosh Mishra, head of research- in­stitutional equities at Ashika St­o­ck Broking Ltd.

In addition, raising deposits will be a struggle at the start.

“When we initially started as a SFB, we wanted to replace the high cost of borrowings that we inherited from our MFI days. While most of us have been able to change the borrowing mix with a higher contribution of deposits today, as new institutions come in they will face a higher cost of raising funds than what we had faced in the past,” said Ghosh.