The silent rise of Small Finance Banks (SFBs)

Relevance: Financial inclusion and measures taken by RBI

Synopsis: Challenges faced by SFBs and Criticism against them

Background

• SFBs have grown rapidly since RBI first carved out this category half a decade ago in Indian financial system. In Financial Year (FY) 2018 – 2020, SFBs registered a phenomenal growth by doubling the advances and tripling deposit accumulation over the same period.
• At latest, five small finance banks or SFBs are expected to launch an Initial Public offering (IPO) over the next 2 months.
• More, Five years after the experiment on SFBs began, the RBI is now gearing up to issue another set of SFB licences to new players.

Evolution of Small Finance banks

• The idea behind SFBs can be traced back to 2013. An internal group of the RBI recommended that much like microfinance institutions (MFIs), banks should begin viewing the poor as profitable customers.
• The proposal, however, became a reality when Raghuram Rajan became the governor of the RBI, and the term ‘small finance’ was introduced.

Idea behind SFBs

Although share of Indians with bank accounts has swiftly expanded over the past decade, most of these accounts are rarely used. A majority of Indians still remain outside the reach of formal financial institutions. Without assured access to credit, small entrepreneurs can’t flourish, and innovation cannot take root.

This is exactly the problem that these new banks were meant to solve.

Criticism of SFBs

Non-inclusive:

• Most of the branches have been opened in the relatively well-banked regions or states.
• Most of the new small banks operate in urban and semi-urban areas and a large part of their deposit portfolio consists of large borrowers.
• They are only catering to the missing middle-income market.
• For instance, as of March 2020, about 39% of all SFB branches were in semi-urban areas and 26% in urban centres.

High cost for borrowers:

• The lending rate continues to be fairly high despite their transition into a bank.
• According to RBI data, loans had been given at an interest rate of 13% and above. This goes against their very purpose of such institutions, that is to enable enhanced financial inclusion.
• High lending rates also affects SFBs growth negatively. According to RBI data, SFBs have outstanding loans of ₹83,441 crore as of March 2021.

Diversification:

• Many SFBs have diversified into other segments, such as MSME lending.
• In fact, SFBs have been lowering their exposure to microfinance customers to reduce the risk from income shocks, and political and operational risks inherent in the microfinance business.

Challenges faced by SFBs

Weak Deposits:

• The share of current and savings accounts (CASA) in total deposits for SFBs stood at 15% in March 2020, as compared to 41% for banks. This is despite SFBs offering a higher interest rate to attract depositors. Weak Deposits limit their lending capacity and finally a banks’ growth.

Market Risk:

• Over the past four years, SFBs have also had to face two big risk events demonetization and the covid-19 pandemic. These events have resulted in liquidity stress.
• The NPA (non-performing asset) ratio for the sector touched a high of 5% compared to the sub 1% mark earlier.
• A lot of regulations are liberal for universal banks. Becoming a universal bank is less capital intensive. That’s why most of them want to become a universal bank.”

Nomenclature:

• One of the initial challenges that SFBs faced was with the “small finance” byname. Brand acknowledgment among customers was a worry initially. Some people thought SFBs are similar to cooperative banks

Conclusion

As more players enter the SFB space, a stiff competition is expected to break out in the segment alongside a rise in innovation and digitalization. However, the hurriedness shown by Indian SFBs to grow is threatening the financial future of India’s unbanked millions.

Terms to know

• Small Finance Banks (SFBs)