Small can be more beautiful: Biz model of SFBs may need to be tweaked

The Reserve Bank of India’s (RBI’s) Report on the Trend and Progress of Banking in India 2020-21 (T&P: 2020-21) says that the primary cash-flows of small finance banks (SFBs) took a hit during the first phase of the pandemic, and that even earlier, structural problems had beset the sector.

Many of these banks have concentration risk on both sides of their balance sheets. On the liabilities side, they have low savings and current accounts, and rely heavily on bulk deposits and term-deposits from co-operative banks. On the assets side, the share of unsecured microfinance loans is disproportionately large. From the perspective of sound risk management, SFBs need to diversify both asset and liability profiles.

The sum and essence of this observation — and contrary to what SFBs may say on-record — is that their business model may require major tweaks, even if this last aspect is not explicitly mentioned. Their cost of deposits is higher than it is for universal commercial banks; and the fact that they have to lend to the more vulnerable sections of society makes their task difficult.

Given this backdrop, it’s a bit surprising that six new entities have lined up at the RBI’s on-tap window for SFB licences — Cosmea Financial Holdings, Tally Solutions, VSoft Technologies, Calicut City Service Co-operative Bank, Akhil Kumar Gupta, and Dvara Kshetriya Gramin Financial Services. And then there is Unity SFB.

This, though, is a slightly different case, as it was tasked with gathering the pieces of the Punjab and Maha­rashtra Urban Co-operative Bank (PMC Bank), which has been amalgamated with Unity SFB, in which Ce­n­trum Finance and BharatPe are shareholders. But the question won’t go away: is the SFB model workable?

“I am confident that the SFB model is workable, as evidenced by the likes of AU SFB and Equitas SFB. The way you go about it is what matters,” says Centrum Group Chairman Jaspal Bindra. And how does Unity SFB intend to go about it?

“We will initially roll out a few products, and then continue to build a diversified portfolio over time. We have the erstwhile PMC Bank, Centrum and BharatPe clientele to start with,” he adds. Given the focus on digital, Unity SFB will quickly aim for a pan-India footprint. This is “un­like in the past, where only branches dictated how you serviced customers and the pace of the rollout.”

Adds R Baskar Babu, managing director and chief executive officer of Suryoday SFB: “Our core mission for the next three years will be to build financial robustness for our inclusive finance customers, using digital channels, which is simple, easy to operate and gives them holistic product options for wealth creation and superior user experience.” He has big dreams: “We aim to create at least a million millionaires from our customer base, and are pursuing this dream relentlessly.”

Are tweaks needed at all?

SFBs have been around for nearly five years now, but no study has yet mapped their story so far. The closest was a paper, ‘Performance of SFBs: An Early Reflection’ in the RBI Bulletin of August 2021.

Authored by Nitin Kumar (from the central bank’s Department of Statistics and Information Management) and Sarita Sharma (from the Department of Economic and Policy Research), it noted that empirical results show micro factors like efficiency, leverage, liquidity and banking business are important in determining SFBs’ profitability early on during their operations.

The outcome could be because SFBs are established with the goal of serving a niche segment of the under-privileged, rather than as a purely profit-making intermediary.

“Due to the limited time span available, the outcome of the analysis may be considered as indicative at this stage and needs to be substantiated with greater data, going forward”. The paper carried the rider that these views were those of the authors and did not necessarily represent the RBI’s views.

An issue that has cropped up in discussions between the RBI and SFBs is recommendation 31 of the Internal Working Group (IWG) on the existing guidelines on the ownership and corporate structure of private banks. It said: “Whenever a new licensing guideline is issued, if new rules are more relaxed, benefits should be given to existing banks immediately. If new rules are tougher, legacy banks should also conform to new tighter regulations, but a transition path may be finalised in consultation with affected banks to ensure compliance with new norms in a non-disruptive manner.”

Especially interesting is the IWG’s recommendation 27 on ‘SFBs to be set up in future’. This said: “Such banks should be listed ‘within six years from the date of reaching a net-worth equivalent to prevalent entry capital requirement prescribed for universal banks’, or ‘ten years from the date of commencement of operations’, whichever is earlier.”

The RBI accepted this with the modification for ‘SFBs to be set up in future’. It said, “Such banks should be listed within ‘eight years from the date of commencement of operations’.” On the cap of eight years for mandatory listing for these banks, the RBI reasoned that this has been stipulated considering the importance of listing and to provide sufficient time to these banks for stabilisation, consolidation of operations and to gain investors’ confidence.”

Asks a senior official at an SFB: “Recommendation 31 is for equal treatment for newly minted and existing SFBs. But when it comes to listing, the new players have to do so only in eight years, while it was six year for us. And RBI’s reasons are to give time for them to settle down.”

This angst is understandable: the existing ten SFBs faced the worst possible start in life — demonetisation in 2016, and even as its effects lingered, the pandemic in 2020. “Of these six years, just how many were good?” asks the SFB official.

This has not halted Capital SFB — the first to roll-out operations in 2016 — in its effort to get listed: it has filed a draft prospectus. It has the most diversified portfolio, with a sizable book in multiple asset classes, compared to other SFBs, with the highest proportion of secured lending of 99 per cent in FY21.

Worse, urban co-operative banks (UCBs) that aspire to become SFBs have lobbied the RBI and the ministry of finance with their own views on entry norms, arguing that the RBI need not equate UCBs with SFBs, as the entry-point norms, permitted activities, and rural branch requirements for each are different.

Small can be more beautiful, but with out-of-the-box thinking.