Can Small Finance Banks make it big?

After reeling under the demonetisation shock, loan growth and asset quality are slowly returning to normalcy. However, garnering low-cost deposits and improving profitability remain a challenge

For Uma Chandra, who does tailoring at home, the loan offered by Ujjivan Small Finance Bank has helped fund her children’s education. From not having a bank account (not even the Centre’s much-hyped Jan Dhan account), Uma now has an account for managing her loan and savings transactions — a giant leap forward from her regular dealings with money-lenders, who charge exorbitant interest rates.

For many low-income earners and small businesses, often underserved by traditional commercial banks, the new format small finance banks (SFBs), have made basic banking services more accessible.

But how has the journey been for these SFBs, with a chunk of them transitioning from being a microfinance institution (MFI)? Undoubtedly bumpy and challenging.

Of the 10 players which have been granted SFB licence by the RBI, eight were MFIs.

The demonetisation shocker brought in a whole set of unexpected challenges for these fledgling ‘banks’. The massive cash crunch led to sharp rise in delinquencies, put growth and branch expansion plans on the back-burner and threw earnings forecasts out of whack. Very recently, the RBI staying its ground on listing norms has once again unnerved investors.

Is the worst over for the SFBs? Will the wheels of fortune turn? To find out the answer, we trace the journey of these SFBs over the past two to three years.

The big picture

Anticipated hiccups: The huge potential for micro-credit in India is evident in the strong growth witnessed by MFIs. Between FY13 and FY15 — before SFBs licences were granted — loan growth for most of these MFI-turned-SFB players (compounded annual growth rate) averaged 40-100 per cent.

But there were several challenges expected in transitioning into SFBs. One, SFBs have to comply with cash reserve (CRR) and statutory liquidity (SLR) requirements, which was expected to impact profitability. Two, garnering low-cost retail deposits was critical to cushion the erosion in profitability. Lastly, asset (loan) diversification was also imperative, but a tough task for players which depend heavily on their MFI business.

The Demo blow: But demonetisation served a hard blow on business growth and earnings. This is because the MFI business depends on cash to a great extent. Hence, limited supply of currency, disruption in borrowers’ cash flows etc. led to slowdown in loan growth and a sharp rise in delinquencies. Unfortunately, what began as a cash-crunch problem, snow-balled into political instigation, misleading borrowers — playing havoc on group repayment behaviour and collections.

Demonetisation-led large write-offs and provisioning continued in FY18, impacting performance.

Signs of recovery: After peaking in the second and third quarter of FY18, GNPAs have been trending down in the first half of FY19. The collection efficiencies of most these banks’ microfinance portfolio are now back to pre-demonetisation levels of 98-99 per cent. Loan growth too is back to pre-demonetisation levels.

Way forward: For all players, loan diversification will be critical, though aggressive growth can hurt profitability and asset quality. The key challenge, however, lies in ramping up low-cost retail deposits to cushion profitability. Most players have been offering high interest rates to draw in deposits and rely heavily on bulk deposits. This is unlikely to change in a hurry. In the current scenario, when deposit growth for traditional banks has also been modest, scaling up low-cost deposits will remain a challenge. A key overhang on players such as Equitas and Ujjivan is the RBI’s norm which requires them to list their banking subsidiary within three years and maintain minimum promoter shareholding in the bank (at least 40 percent) for a period of five years from the date of commencement of their business.

The micro picture

Of the ten SFBs, three players are listed. AU Small Finance was listed in July 2017; the stock has gained over 70 per cent from its listing price.

Equitas Holdings — the holding company of Equitas Small Finance Bank — and Ujjivan Financial Services — the holding company of Ujjivan Small Finance — that listed in April-May 2016, have had a bumpy ride on account of demonetisation. After sky-rocketing 60-100 per cent post listing, their stock prices tumbled after demonetisation. Just as the performance of these banks and stock prices started to recover, the RBI’s clarification this October that small finance banks need to be listed within three years of their operations (discussed later), resulted in stock prices crashing once again.

We do some number crunching on the financial performance of all SFBs over the past few years, and look at their earnings prospect over the next three to five years.

Equitas Holdings

Equitas Holdings began operations in September 2016. Demonetisation led to sharp rise in delinquencies, though the company’s relatively better diversified loan portfolio helped mitigate the risk to some extent.


In FY18, the bank went on to de-risk its portfolio, with MFI loans declining by 30 per cent YoY and constituting about 28 per cent of the portfolio, down from about 53 per cent in FY16. While there has been no overhang of the impacted portfolio (during demonetisation) since the March quarter, the bank’s GNPAs moved up to 3.36 per cent in the September quarter, due to change in recognition of NPAs (from month end to daily). Going ahead, GNPAs should normalise around these levels.

On the loan front, the management expects the share of MFI to come down to about 20 per cent over the next three to five years.

While the bank’s cost-to-income ratio is likely to moderate (as much of the expansion is done), shift towards lower yield portfolio, and dependence on bulk deposits (70 per cent) could impact profitability. How well the bank is able to leverage its branch network to garner low-cost CASA deposits will be critical.

A key overhang on the stock is the RBI’s listing norms which requires it to list Equitas SFB by September 2019 and maintain 40 per cent promoter shareholding till September 2021. The board is considering various options without the need to go in for an IPO, to cushion the blow for existing investors. Equitas Holdings plans to dilute up to 60 per cent of its holdings in the bank in favour of its existing shareholders.

At the current price of ₹118 the stock trades at 1.5 times FY20 book, which is attractive. However, investors can wait for clarity on the SFB listing before investing.

Ujjivan Financial Services

Ujjivan launched its small finance bank in February 2017. At the time of transitioning into an SFB, MFI loans were still a chunk of the (about 98 per cent) of its loans. Demonetisation led to lower collection efficiencies and rise in GNPAs. In FY18, the company’s focus was to contain losses and improve quality of loan book.


Loan growth has scaled up to 24 per cent in the first half of FY19, led by growth in non-MFI segments. While MSE and affordable housing have been ramping up rapidly, new offerings like personal loans, two-wheeler loans, wholesale lending to NBFCs etc. are in a nascent stage.

The bank had deferred rolling out of bank branches on account of demonetisation. It expects to reach 475 branches by end-March 2019; by the end of FY20, the bank expects to convert 48 assets centres into branches and set up another 50-odd new branches.

Cost-to-income ratio shot up to 77 per cent in Q2 of this fiscal and with the proposed branch expansion, this figure may need watching. The management, however, expects cost-to-income to come down to 55 per cent in the next three years.

Overall, the management expects a 30 per cent growth this fiscal and plans to diversify to 50:50 MFI vs non-MFI loans in the next five years. This appears an aggressive target to achieve. Impact on earnings due to lower yields on non-MFI portfoliowill need watching. Also, CASA stood at 9 per cent as of September 2018. This needs to be scaled up significantly to cushion earnings pressure. On the positive side, Ujjivan’s well-spread operations across states mitigates geographic risk.

At the current price of ₹241, the stock trades at 1.3 times FY20 book, which is attractive. However, here too, the SFB listing requirement is a key risk. Management is considering various options.

WATCH: Ujjivan Small Finance Bank - How does a typical branch work?    

Au Small Finance Bank

AU Small Finance Bank (formerly Au Financiers (India)), was the only NBFC that was allowed to set up an SFB. It began its banking operations in April 2017.


Unlike Ujjivan or Equitas that depended on their MFI business, AU Small Finance already had a well-diversified loan book with retail focus — when it became an SFB. Hence, demonetisation had a relatively lower impact on the company. But the bank’s profitability too slipped in FY18 on the back of transitioning into an SFB. In addition, the company was following a 120-day norm to classify bad loans, which was to move to a 90-day norm in FY18. However, the return ratios are well within expected lines, and GNPAs are still a comfortable 2 per cent in FY18.

The bank, quickly ramping up its low-cost deposit base, has also helped mitigate the pressure on profitability. That said, the company’s ability to ramp up deposit base further, while keeping costs under control, will be critical to sustain profitability. Also, the company’s operations are mostly concentrated in Rajasthan, Gujarat, Maharashtra, and Madhya Pradesh.

At the current price of ₹630 the stock trades at 4.5 times FY20 book. Investors with a two-to-three year horizon can invest in the stock.

Fincare Small Finance Bank

Fincare Business Services acts as the holding company for Fincare Small Finance Bank that commenced banking operations in July 2017.


While demonetisation impacted its performance in FY18, most of the issues, have been resolved. Collection efficiency of the new portfolio post April 2017 is at 99.91 per cent. The gross NPAs have started declining over the last two to three quarters. Loan growth has also sprung back in the latest September 2018 quarter.

While the growth has returned in the MFI portfolio, much like other players, Fincare too is looking to diversify its portfolio, though at a calibrated pace. Non-MFI loans include loan against gold and institutional finance. Fincare has also started two-wheeler loans and is looking to get into affordable housing in the beginning of next year, which will take time to scale up.

The bank is looking to diversify only gradually — 70:30 towards MFI: non-MFI loans over the next 12 months. On the funding side, much like other players, chunk of the deposits are bulk and scaling up CASA will be important. That said, a calibrated diversification should keep the pressure on profitability and asset quality at bay.

Capital Small Finance Bank

A local area bank (LAB), operating in five districts of Punjab, Capital Small Finance Bank transitioned into an SFB in April 2016. At the time of transitioning, the bank had 47 branches and 80 per cent of its business in the rural and semi-urban areas. Being an LAB, the bank’s portfolio was already well-diversified. Demonetisation did impact the bank, though the extent was relatively lower than MFI-turned SFB players.


In the two years of operations, the bank has added 59 branches and has started expanding outside of Punjab into Delhi, Haryana and Chandigarh. Majority of the bank’s direct agri credit is under the Kisan Credit Card Scheme. As of September 2018, while the loan growth remained healthy, net profit slipped owing to sharp rise in provisioning.

We have collated the information on other SFBs in the table. There is very limited information on North East Small Finance Bank that started operations in Oct 2017.




WATCH: Top management small finance banks speak to BusinessLine

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