How’s the structural shift impacting microfinance?

From the customer’s point of view, banks and small finance banks are able to offer a more comprehensive product basket

After the demonetisation shock, the growth in the microfinance industry is back on track. Given that microfinance has traditionally been a good product for small finance banks, the diversification into other products is likely to be slow and steady over the next five to seven years, says Rajeev Yadav, MD & CEO, Fincare Small Finance Bank. Excerpts:

Over the past year, we have seen small finance banks and MFI players grappling with the after-effects of demonetisation and reporting high NPAs. Is the worst behind us?

I think the worst is definitely behind us. The gross NPAs of the microfinance industry have started declining over the last two to three quarters. MFIs typically have 24 month loans and, therefore, their delinquency position arising on account of demonetisation would have been crystallised over the last nine to 12 months. The industry is now clearly seeing a downward trend by way of collecting, reserving or writing off the pool of the de-monetisation impacted portfolio.

The collection efficiencies of our microfinance portfolio are now back to pre-demonetisation levels. The new portfolio that has been created after demonetisation has good collection efficiencies of over 99.8 per cent. Growth is also back on track to pre-demonetisation levels.

After the merger of Bharat Financial Inclusion (BFIL) — the largest microfinance institution (MFI) with IndusInd Bank, Bandhan becoming a universal bank and eight MFIs transitioning into small finance banks —- banks, through the BC model or acquisition, constitute over 70 per cent of the MFI industry. How does this structural change impact the industry?

If you look at it from the microfinance customer’s point of view, banks are in a position to offer the customer a more comprehensive product basket, comprising savings accounts, payments solutions, including debit cards and other individual credit products of higher ticket sizes such as loan against gold, two-wheeler loans, affordable housing loans, based on the needs of customer. So the relationship with a bank is more wholesome, compared with an NBFC-MFI that helps customers with a small initial loan and then loses them when they graduate to bigger loans. Therefore, the stickiness and stability of the customer with the institution increases, which also positively impacts the portfolio quality because the customer will not see it as a one-off loan relationship with the institution.

Further, banks are more deeply regulated compared to NBFCs and, therefore, more respected and trusted by the customer.

On the flip side, the regulations that were framed around borrowing limits, ticket size limits and number of loans were framed for NBFC-MFIs and do not apply to the bank-led models of microfinance. Therefore, with a significant share of the MFI book transitioning to banks and SFBs, the credit-lending framework has become a lot more discretionary at the institutional level. Banks are expected to put in appropriate, self-designed guidelines for ensuring good underwriting of the customers, rather than the guidelines coming from the regulator itself. There is a potential risk of over-leveraging of borrowers that could arise because of this, if the lending guidelines are not appropriately designed.

Have small finance banks managed to diversify from the core joint lending group model? Have they been successful in expanding their asset base into newer segments?

All small finance banks are on a journey to diversify over the next five to seven years. The diversification has to be in products that are well-tested, and synergistic with the SFBs’ existing capabilities, and should create a sustainable value proposition for the customer segments they cater to and the institutions themselves. Microfinance has traditionally been a good product for the SFBs on which they have built solid expertise over the years. Therefore, they should not have to lose out on the opportunity that this portfolio offers by its natural design, just in order to meet a diversification percentage as quickly as possible.

Given this, I expect the diversification to be slow and steady over the next 5-7 years. For Fincare Small Finance Bank non-MFI portfolio currently constitutes 15 per cent of the overall loan portfolio and we will directionally increase the share of new, secured product lines over the next few years, through our loans against property, loans against gold, institutional finance, as well as new products such as two-wheeler loans and affordable housing loans.

MFI players, given their lean cost structure and high return ratios, remain an attractive acquisition target for traditional banks. Do you see more MFI acquisitions? Are small finance banks such as yours also looking at the inorganic route for expansion?

MFI players have been attractive for various reasons. We have seen a lot of acquisitions of good NBFC-MFIs by banks. There exists an opportunity for some of the other good NBFC-MFIs to be an attractive proposition for banks or bigger NBFCs in the future.

SFBs have traditionally been good at building portfolios that are designed for the base of pyramid, and microfinance is a core business for us. We do not foresee a need for acquiring any NBFC-MFIs in the near future, and would focus on continuing to build the microfinance book organically.

With the costs of meeting regulatory requirements and branch roll-out, profitability for small finance banks has moderated. For Fincare, how has the transition been so far?

The banking transition has definitely entailed a relatively higher degree of cost on branches, technology systems, on people and capacity-building for new lines of businesses and raising retail liabilities. This was anticipated in the business plan, and Fincare SFB has transitioned reasonably well, with no surprises. Fincare has adopted a gradual approach to expanding our branch network in line with business growth, and is converting a lot of our old asset offices into different grades of banking outlets with only a reasonable cost increase.

Therefore, we don’t foresee a significant cost increase on account of branch expansion. On technology, we have adopted extremely cost-effective solutions, and are aggressively pursuing digital banking solutions that help reduce costs of opening accounts and doing transactions, improve turnaround time for customers, and productivity of our sales teams. Therefore, our IT costs have only gone up incrementally vis-à-vis our NBFC era spends.

However, our cost-to-income ratios have seen a continuous improvement in the last few quarters, closing Q1 FY19 at 65 per cent, and we expect this trajectory to continue. We also expect to benefit from reducing cost of funds over time, and this would balance the higher cost of banking business, leading to reasonable RoA and RoE for the bank.

Have you been able to mobilise deposits?

On the liability side, we have made good progress, and have mobilised ₹1,200 crore worth of deposits to date. We have seen good growth in our retail deposits, and these constitute about 35 per cent of our total deposits. The deposit build up has been in line with the business plan we had made.

We have started opening savings accounts for all our microfinance customers, and over a period of time, expect this to contribute significantly to our liabilities base. We offer amongst the best interest rates in the industry, going up to 7 per cent p.a. on savings accounts, and 9 per cent p.a. on FDs with an additional 0.5 per cent for senior citizens, and are able to service customers at their doorstep.

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