September 16, 2015 marked a curious turn in the banking regulator’s policy trajectory. Ten entities were granted in-principle approval to set up Small Finance Banks.
SFBs have been in the news since. A number of them have grown considerably large, complete with sizeable loan books and branch networks. Even a casual observer will notice how visible SFBs have become these days, thanks to new branches that are
rapidly coming up in all sorts of neighbourhoods. This actually prompts me to view these banks from a different angle — the fact that large-scale and quick expansion will inevitably invite risks that are inherent in other, more institutionalised, sections of the banking space. SFBs may now need to deal with normal stress in terms of asset quality and similar metrics. There will also be costs stemming from quick expansion and technology-related programmes. Furthermore, any shift by SFB managements from their initial mission — greater financial inclusion — to value-added retail and wholesale lending will have to be justified.
The SFB segment is now clearly poised to enter a phase of consolidation. A few of the leading entities seem like what mid-level private banks resembled some years ago. There are also a clutch of smaller ones that are yet to acquire the right scale and size. However, all of them must face systematic risks.
At this stage, we must recall why the SFB regimen was deemed necessary.
These banks delivered an institutional base for sections that were historically served by small, non-banking financial services, firms, and micro credit organisations. Local money lenders formed unorganised credit mechanisms and a new generation of banks was needed to address critical issues derived from these circumstances. Mobilisation of small deposits and provision of collateral-light micro credit were significant objectives.
Have SFBs succeeded? To answer this question, it is necessary to understand the need for small loans, especially for suburban markets. Also, we must appreciate the fact that ‘emerging’ and ‘aspirational’ India needs digital access to modern banking services. A number of SFBs have mobilised fairly large quantities of retail money, including CASA (current and savings accounts) and term deposits. Their presence has prompted newer categories of retail customers to move into the formal banking fold. Their financial savings are increasingly held by regulated institutions. Retail clients are by and large satisfied with their deposit rates. Branch networks are expanding too.
The next stage of growth will surely see some of the smarter SFBs turn into universal banking enterprises. The regulator has already outlined a transition path under Draft SFB Guidelines, 2019. Universal banking will help SFBs become more efficient.
But observers will do well to keep the matters of cost and profit in mind. Any sequential dip in profit will lead to an inevitable conclusion: the presence of
systemic stress in the segment. Some would want to keep an eye on asset quality as well. The key question here — are loans being repaid? — is absolutely vital in a country that has seen many rounds of loan write-offs. It will also be interesting to see how gross NPA figures are morphing in the SFB space. There is also the question of return on assets: any decline on this front will act as a headwind. This is extremely relevant; SFBs are expected to list their shares on stock exchanges in the foreseeable future.
Entities in the listed space will be subject to far greater scrutiny in the future. Investors who are willing to zero in on their stocks and hold them for probable capital gains will undoubtedly look at news headlines emanating from the SFB spectrum in the days to come. A new generation of players led by fintech companies is driving transactions and credit deliveries. Legacy banking, especially what is represented by giant public and private sector banks, is being challenged by newbies. SFBs will need to find their feet in these competitive circumstances.
Nilanjan Dey is a partner, Wishlist Capital
