The landscape of India’s financial sector is changing rapidly. In April 2015, two commercial bank licenses were announced, followed by 11 payments bank licenses in August 2015. Most recently, on September 15, 2015, RBI awarded 10 small finance bank (SFB) licenses, mostly to institutions known for specializing in microfinance. Small finance banks, which are designed to offer the whole suite of financial services offered by a commercial bank, but on a smaller scale, must meet several criteria:
- SFBs must allocate 75% of their lending to a priority sector, such as agriculture, small business, micro credit, education, or housing.
- 50% of an SFB’s lending must be comprised of loans less than INR 2.5 million (around $38,000) to ensure credit is reaching currently underserved sections of the market.
- The bank’s total lending to a single borrower is capped at 10%, and for a group it is capped at 15% of capital funds.
Competition will be fierce as the number and types of players in the financial services space expands. SFBs will be facing competition from existing banks and non-bank financial companies (NBFCs) who may be looking to extend their reach to serve the unbanked and underbanked, especially in semi-urban and rural areas. For example, Mahindra Finance, an NBFC that focuses on rural and semi-urban populations, is targeting its lending to farmers and non-salaried workers. Some existing banks are relying on their brand along with technology to enter into semi-urban and rural areas to fill the gap. It will be interesting to see how SFBs rise to the challenge of differentiating themselves from the other players in this changing landscape.
They will also be competing with the Micro Units Development and Refinance Agency (MUDRA), a government initiative launched in September, 2015 that targets the loan segment for up to INR 1 million (around $15,000). While SFBs are permitted to disburse loans of up to INR 2.5 million ($38,000), some have indicated that they will not start out by disbursing loans of this size.
In addition to the competition element, SFBs will encounter specific challenges as they transition from their current profile of MFIs to the newly minted SFBs.
- SFBs will be required to adhere to the same strict norms and regulations applicable to commercial banks. This will be a big change for the SFBs, as these additional regulations will likely seem rigorous compared to what MFIs have been used to. Nine of the 10 licensed small finance banks are required to raise INR 40 billion (about $613 million) from domestic shareholders in order to bring the foreign ownership down to 49% before they start operations.
- Previously functioning as MFIs, the SFBs have not handled deposits before. They will need to invest in the infrastructure that enables them to mobilize deposits through establishing a physical branch network, business correspondent network, ATM network, and partnering with banks. Given the non-existent track record in mobilizing deposits, it could be difficult to inspire the trust and confidence among consumers required to attract deposits. Their competitors are existing banks with a track record of handling customers’ deposits, SFBs need to be creative in developing strategies in order to mobilize deposits.
- Finally, SFBs may face difficulties acquiring and retaining top talent. MFIs typically have a large number of low skilled people coming from and working in the communities in which they lend and very few people in corporate positions who are classic bankers. In order for SFBs to scale, they will have to address the human resources side of their operations.
All this said, SFBs have been in the business of providing financial services to the underserved and providing low-value loans to a large volume of people and businesses. They will build on this strength using technology and digital solutions to extend their reach in a cost-effective and efficient manner. How well they are able to do this may ultimately determine their success or failure.
The business case for SFBs depends on how well they are able to mobilize cheaper deposits from the public to reduce their costs of funds. It will also depend on their ability to attract, retain, and grow customers by attractively pricing their loans. That is, their loans will need to be priced lower than the existing rates without negatively impacting the business model.
The quest for survival will hopefully spur innovation which in turn will lead to solutions that will enable quicker, cheaper, and more effective deployment of financial services and products. The licensing of SFBs as a differentiated banking approach to further financial inclusion is a fitting step. Enabling MFIs to accept deposits is a good move. However, it is not clear whether or not a business case truly exists for them and how they will fare in light of all the competition they will be facing.
You correctly identify many areas of concern for SFBs as there is nothing much to differentiate them from other institutions operating in their space. Implied government guarantee which PSB and RRB deposits carry is a strong magnet for rural and semi urban depositors. Size of Rs 25 lakh for loan will make better profitable clients especially in trade and professional services beyond their reach.( It may become a classic case of a weak institution having weaker clients.) Recent data that smaller companies are growing slowly may be a pointer in this direction. One is also worried from the news reports that they are just thing of massive scale by leveraging technologies and adopting marketing approach, may be forgetting in the process that they need to establish themselves as a reliable bank first. There appears to be some negative vibes for engaging PSB experienced staff in SFBs.
SFB promoters need tradional bankers to co-head their various verticals along with youth.
Only advice one can give them is that firstly they should try to become a bank, rest will just fall in place.
There is enough business in this starved land of financial opportunities.
* ex General Manager PNB, Chairman Gramin Bank