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A Sunrise Sector Coming Out of a Dark Shadow

May 31, 2018

The disruptive impact of notebandi in November 2016 lingered in small towns and villages.

But, the microfinance industry (MFI) reported 27% growth in its loan book in FY18. Among them, Banks and Non-Banking Financial Companies (NBFCs) operating in the microfinance space recorded strong double-digit growth in their microfinance loan portfolios.

However, the newly formed Small Finance Banks (SFBs) have not been lucky. SFBs clocked a mere 3% growth in the loan book at Rs 300 billion.

SFBs, the third largest player in the microfinance industry, have a 27% share. Banks and NBFC-MFIs remain the top two players in the industry with shares of 38% and 28%, respectively. Last financial year was particularly difficult and challenging for SFBs.

Transitioning into the banking format, SFBs were engaged in getting regulatory approvals in place as well as building teams, systems, products, and processes to start their banking journey.

Unfortunately, notebandi induced liquidity crunch and loan waivers in some states, adversely impacted their recovery and collections straining asset quality during this period. Resultantly, the bad loans to advances ratio for a majority of SFBs jumped to 5-6% as compared to 1% in the pre-notebandi era.

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And higher provisioning against these bad loans not only curtailed their earnings but the increased focus on recovery also pulled down the loan growth in FY18.

The redeeming factor is that most of the SFBs have completed their transition into a banking entity. Also, the waning impact of notebandi has led to improved asset quality.

Of the ten SFBs, only three of them are listed. These are Ujjivan Financial Services, Equitas Holdings, and AU Small Finance Bank.

Financial Scorecard of SFBs in FY18

Loan growth (%) Group/Microfinance
Loan share (%)
Cost-to-income ratio (%) Earnings growth (%) CASA ratio (%) Gross bad loans ratio (%)
Ujjivan Small Finance Bank 18.5 84 67.1 13.2 3.7 3.6
Equitas Holding 15 28* 80 -80 15.4 2.7
AU Small Finance Bank 19.6 55.7 4 32 2
Source: Company Presentation
* Equitas Holding is a diversified financial services company

Going ahead, the success of a SBF will depend upon its ability to quickly expand the retail loan book. Presently, micro loans are the mainstay of SBFs, with many having a share of over 80% of the loan book. The erstwhile group lending needs to pave way for individual lending so that the SFBs can sell its banking products and services to clients.

Further, creating a low-cost deposit base (current accounts and savings accounts) for future growth and expansion will not be a simple task.

Relatively late entrants in the banking space - YES Bank and Kotak Mahindra Bank that started operations in 2003-04 - took a long time to build deposits and that too by offering higher rates than peers.

Moreover, SFBs need to have a right strategy in place to expand operations without overtly inflating operating expenses.

A former CEO of Microfinance Institution Network (MFIN) has said that SFBs are at a critical juncture where they need to create breakthrough business models.

An SFB that swiftly builds a profitable asset liability franchise catering to the underserved segment of the population will have an edge in this race.

Warm regards,

Madhu Gupta
Research Analyst, ValuePro

Madhu Gupta

Madhu Gupta (Research Analyst), ValuePro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages.


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1 Responses to "A Sunrise Sector Coming Out of a Dark Shadow"

Harish Priyani

May 31, 2018

Can you help with the difference between Banks, NBFC-MFI and SFB?

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