Big challenges before small finance banks


Ujjivan Small Finance Bank Ltd, the fifth such bank in India and the largest among the five in terms of their small loan portfolio, will make its formal debut on Monday after running a pilot programme in five of its microfinance branches in Bengaluru. Professor Muhammad Yunus, a microfinance pioneer and founder of the Grameen Bank in Bangladesh, will inaugurate the bank. Like Equitas Small Finance Bank Ltd, which started operations in September, Ujjivan too listed its shares ahead of the bank’s launch to comply with the regulatory norms. Foreign stake in such banks is capped at 49% but most of the entities that have got a licence from the central bank to float small finance banks have higher foreign stakes. One of the ways of restructuring the shareholding pattern is to sell some of the foreign stake in the market to domestic investors. Jaipur-based AU Financiers (India) Ltd, which has got the final licence from the Reserve Bank of India (RBI) to start a small finance bank, too plans to enter the capital market soon.

AU Financiers is one of the two entities which were not into microfinance business among the 10 granted in-principle approval to float such banks by the Reserve Bank of India (RBI) in September 2015. The other is Capital Local Area Bank, the first to take off in April 2016. Since it was into banking activities—albeit in a limited way in five districts of Punjab before becoming a small finance bank—Capital Small Finance Bank Ltd has built expertise for both giving loans as well as raising deposits. This is why it is not offering high interest rates to garner deposits. Its savings bank rate is 4%, on a par with most banks in India.

However, this is not the case with microfinance institutions (MFIs) turning into small finance banks. For instance, Equitas, which has cricketer Ravichandran Ashwin as its brand ambassador, is offering 6% interest on savings bank deposits of up to Rs1 lakh; for higher amount, interest rates progressively go up to as much as 7.5%. For fixed deposits, its highest interest rate is 8.85%.

Two other small finance banks took off in January—Utkarsh Small Finance Bank Ltd and Suryoday small Finance Bank Ltd. Like Equitas and Ujjivan, both were into microfinance business. Utkarsh has 1.2 million borrowers and Suryoday 750,000. Utkarsh is offering 8.25% to 8.4% interest on fixed deposits and 6% on savings bank while Suryoday is offering between 6.25% and 7.25% on savings account, depending on the amount of money kept, and as much as 9% on fixed deposits between one and two years. Clearly, garnering deposits is the biggest challenge before them as they were into giving loans and not collecting deposits. They are offering more than high street banks to woo depositors and they can afford to do so as the cost of borrowing from other banks is even more. They want to replace their high-cost bank borrowings (raised to build their micro-loan portfolio) with deposits as fast as they can. Once that is achieved they will bring down the rate in sync with the requirement to build their loan book. Since higher interest rate alone cannot ensure deposit mobilization, they plan to combine that with superior service. While interest rates will attract depositors, service will create the sticky factor.

Ujjivan, founded by ex-Citibanker Samit Ghosh, however, doesn’t want to pay high rates on savings bank account even as it is willing to offer about 1 percentage point more than larger banks for fixed deposits. It plans to make savings an attractive proposition for its own borrowers—some 3.5 million of them, served by 470 branches—by not having any minimum balance requirement, offering debit card, etc. Many of its borrowers have bank accounts but when it comes to savings, they use the informal sector (chit funds). Ujjivan wants to woo them back to the banking fold, besides reaching out to small traders and other not-so-privileged people.

It will be interesting to watch how the strategy of higher interest rate and superior service plays out for the small finance banks as trust is the critical factor when it comes to garnering deposits. It is built over time and the “small finance” moniker may not be of great help for doing so. Also, MFI employees know how to give money and collect loan repayments but not deposits. If the same set of people is used for deposit raising, they may end up compromising on the credit discipline as they need to invest time in picking up the new skill. The other option is to appoint bankers for deposit mobilization. That leads to the second challenge for the small finance banks—human resource management. They would need to pay relatively more to attract banking talent and this may create resentment among the existing MFI employees who have been with the organization for years.

Yet another challenge will be technology which calls for hefty investment and great understanding. The ideal technology platform should benefit both the customers (ease of transactions) and the bank (reduction in cost) but it’s not easy to achieve this as there aren’t too many bankers who understand the nuances of technology well and there are tech experts who don’t mind taking the bankers for a ride. People and technology will be the two biggest risk factors for these banks.

Finally, demonetization has queered the pitch for the MFIs-turned-small finance banks as cash is the mainstay of their business model and it’s not easy to leap into a cash-less business model for small borrowers who work in the informal sector. On the one hand, there have been delays and defaults in repayment of loans and, on the other, new loan disbursements have slowed considerably. As a result of this, their non-performing assets (NPAs) are bound to rise. Equitas, which has a loan book of little over Rs7,000 crore—out of which roughly half has been microfinance and the rest commercial vehicle finance and loans to medium and small industries—saw its gross NPAs rising to 2.46% of loans in December from 1.33% a year ago even though its net NPAs dropped as the bank set aside more money to provide for bad loans. ESAF Microfinance and Investments Pvt. Ltd will also launch its small finance bank later this month. It will be followed by four more—AU Financiers, Janalakshmi Financial Services Pvt. Ltd, RGVN (North East) Microfinance Ltd and Disha Microfinance Ltd. Barring AU Financiers, none of the others have got the final nod from the RBI yet.

All small finance banks will attempt in their own ways to redefine banking in India—a nation where urban centres are overbanked but in rural pockets bank credit is still a scarce commodity. In the process, all may not thrive. A few will eventually upgrade themselves into universal banks while a few others may not even survive—they will be taken over by other banks for their franchise. The good news is that the fear of failure has not inhibited either these banks or the banking regulator.

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