Growing scope of small finance banks

Growing scope of small finance banks

In an era where inclusion (of all sorts), digitisation and low cost options for service delivery are buzz words, the entrance of Small Finance Banks (SFB) into an arena hitherto dominated by the ubiquitous universal bank is being looked forward to.

As a new entity focusing on a specifically targeted client base which has been marginalised in the whole financial inclusion conversation they are expected to play a more granular role in the area of financial inclusion.

On July 17, 2014, the Reserve Bank of India (RBI) released the draft guidelines for SFB, and on October 6, the operational guidelines for SFBs were issued. The new kid on the block is pretty much on its way to coming into being. Of the 10 licensees, one is an existing local area bank, one a NBFC and eight are Non-Banking Financial Companies (NBFC) Micro Finance Institutions (MFIs), which are regulated by the RBI. The local area bank and one NBFC MFI have already transformed into SFBs, a second NBFC MFI has received its license and is on it’s way and the rest are waiting in the wings to unfurl as D-Day draws closer.

Growing talk

Over the last several months, every conference, seminar and financial discussion forum have debated the role of the differentiated banks and the likely impact they will have on the financial services ecosystem going forward. More so, the SFBs as they have been poised to play the role of funding what has been a largely unfunded and neglected segment.

Micro-enterprise, unorganised sectors, small and marginal farmers, entities who at best can provide fuzzy collateral have remained largely unfunded due to the discomfort of the universal bank in providing funds to this segment. This thinking underlies the creation of differentiated banks and the structure of lending reflects this philosophy.

As part of their lending model, 50% of SFB lending is limited to a loan size of Rs 25 lakh and below and 75% of the lending must be Priority Sector Lending. This does create challenges but considering the nature of the majority of the transforming entities, it is a step-up model from the current microfinance lending model. The difference, however, is now the need to raise deposits.

NBFC MFIs can lend but not take deposits. And the traditional MFI client is not the base that is likely to provide a large part of these deposits. But Bandhan, the other MFI that became a universal bank over a year ago has managed to cross that bridge which demonstrates that this is something which is doable. Ideally, SFBs they should focus on retail deposits and not go after a model of institutional deposits and retail clients.

The transformation

The question that commonly comes up is how the transformation of MFIs to SFBs is likely to impact the MFI sector. With the eight SFBs moving out, almost 50% of the existing Gross Loan Portfolio (GLP) of the NBFC MFI sector will move out. The MFI crisis of 2010 led to the RBI bringing in specific regulations on NBFCs doing microfinance lending and creation of the NBFC subset NBFC MFI. Currently, not more than two NBFC MFIs can lend to a single client and the Joint Lending Group ticket size has been voluntarily capped at Rs 60,000 by MFIN although the RBI permits a loan size of Rs 1,00,000 to an MFI client.

With the sector recovering steadily from the 2010 crisis (69% growth on a Year-on-Year basis in 2014-15 and 84% in 2015-16), there are a host of other agencies that have started providing credit to the low income MFI segment.

This includes banks (directly and through Business Correspondence - BCs), NBFCs, Section 8 companies to name major players. Today, of a total microfinance segment lending of almost Rs 1.5 lakh crore, NBFC MFIs represent about 34% and banks (including BCs) represent 22%. The transforming SFBs will also become a player in the banking segment and considering the largest part of their current asset base is the MFI client, this will certainly have an impact on lending to the segment.

The fact that SFBs can open accounts without a wet signature and through digital signatures and electronic verification will make on-boarding of customers easy for geographically distant places which will effectively address the traditional ‘feet on street’ model of microfinance which provided door step services to clients wary of brick and mortar structures. To address this, Microfinance Institutions Network (MFIN) is in the process of initiating a conversation between all lenders to the sector to come together and arrive at an understanding as to how best serve the MFI segment responsibly due to the vulnerable income groups they represent. The SFBs are equally keen to ensure responsible and sustainable lending and are keen to be a part of this conversation. This will address to a large extent the questions in the air about the impact of MFI lending by SFBs.

The clientile

Going forward, the SFB client will either be MFI clients who transcend that level and are no longer MFI clients, and this will be a negligible number at best, or the next level of client seeking a ticket size of more than five lakh. This is the niche where the SFBs will focus on in the long term and the NBFC MFIs will carry on providing credit to the MFI segment. In a country like ours with a diverse population, different segments access finance through different models.

Hence there is place for different entities that formally provide credit. While obviously, the industry will see a churn as neither payments banks nor SFBs are tried and tested models and have no comparators even outside the country the shape of things to come will lead to a more tailored approach to financial inclusion as opposed to the existing model of one size fits all.

(The author is Chief Executive Officer of Microfinance Institutions Network)

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