Secured vs unsecured loan debate can't ignore financial inclusion: SFBs

In recent years the small finance bank (SFB) space has witnessed one upheaval after another. Just as the sector had regained its footing after demonetisation, the Covid-19 crisis struck, dealing a blow to asset quality, as non-performing loans piled up. While a transition to a greater share of secured loans is underway, the sector should not lose sight of its original mandate, according to participants at the Business Standard Round Table at the BFSI Insight Summit 2022, titled: Can Small Finance Banks make it big?

The participants included Baskar Babu Ramachandran, co-founder & CEO, Suryoday SFB; Samit Ghosh, founder, Ujjivan SFB; Alok Misra, CEO & Director, Microfinance Institutions Network; Paul Thomas, founder, MD & CEO, ESAF SFB; and P N Vasudevan, MD & CEO, Equitas SFB. Edited excerpts:

Mr Ghosh, can you give us a sense of where we are? Is the Covid pain behind us?

Samit Ghosh: All of us started five-six years ago, and we thought it would be a marathon, because we were going to build a bank. But it turned out like a steeplechase — you’re jumping hurdles. Covid alone wasn’t a big crisis. As soon as we started, we had demonetisation. We went through all this and survived. We grew significantly.

At Ujjivan, we started with a book size of about Rs 7,000 crore. Today it’s about Rs 21,000 crore. We’ve gone through a very tough period, post-Covid losses, etc, but we’ve recovered completely and this year is a record year in terms of profits. Between the last two quarters, we made a net profit of around Rs 500 crore. This year, we hope to maintain that run-rate. We should be able to sprint in the next five to 10 years. You will see spectacular growth among SFBs in the next five to 10 years. 

Alok, you head a self-regulatory organisation. How do you see the SFB space?

Alok Misra: The average vintage of SFBs is six years. Two years went in Covid, so it is four years. In four years, the share of SFBs in the total banking business is close to 2 per cent in both deposits and advances. Take Regional Rural Banks, which are all over India, with a more or less similar mandate as SFBs. In 30 years, their share in total business is 3 per cent. In four years, you are at two per cent, and it is still being said that SFBs are unable to succeed. We have to give them more time.

For lending rates, for cost of funds for SFBs to come closer to mainstream banks, which is at 5.5-6 per cent, it will take another five to six years. Even then, the asset-side challenge for SFBs will continue, because they cannot get into mainstream corporate lending. I am hopeful, but SFBs should not start aping the private banks. They have a special niche and that niche potential is huge. The green shoots are happening in that space. There are 60 million MSMEs, of which 95 per cent are the bonafide clientele of SFBs.

Most SFBs have been in unsecured lending. Mr Ramachandran, is it time to change the model?

Baskar Ramachandran: Earlier, as an MFI, we used to do a cookie-cutter, single product — fast churn, scale, repeatability. SFBs today cater to about 2 per cent in terms of banking assets. But it’s about 7 per cent of Indian households. There are 20 million unique customers. That’s massive. You can’t really rush in to become the largest secured lender quickly. 

Ujjivan and Suryoday are currently at 65:35. Sixty-five is microfinance, which is the profit pool, and then you start building the secured pool. For Equitas it’ll be 80 per cent secured, 15 or 20 per cent unsecured. For ESAF it would be the same. So, the transition is happening, but if we accelerate faster than we can manage, we are building risks in the so-called secured portfolio, which is not manageable. We have experience in managing risks in an unsecured business.

The microfinance customer has also graduated. They require a two-wheeler loan, a commercial vehicle small loan, a micro home loan, and in some cases, a proper home loan. As a sector, we’ve got a grip in terms of where we stand. 

Mr Thomas, your views on revisiting the business model. You can’t just depend on unsecured loans. 

Paul Thomas: I don’t agree that we should completely move out of the unsecured business. At ESAF, we want to continue to work with the low-income segments.

When we started, it was 100 per cent unsecured. Today it is 78 per cent. Over the next two to three years, we want to bring it down to 60 per cent. 

Twenty-five per cent of our micro-loan borrowers create three to five jobs. They have a business, they need high-ticket loans. They may not have colla­te­ral to give, but they have a business, so hypothecation of their assets is possible.

We can work with the government on whether we can have a separate guarantee fund for such things. I believe in continuing to work with these segments, which are below the so-called MSMEs. We will find a way to manage the risk.

Alok, is it a time to change the business model, or let it remain, and get a concession from the government?

Misra: What business model to pursue is up to the institutions. As for a guarantee cover from the government, in all developed economies, MSMEs which have been formalised have that guarantee cover to grow. Banks can take some risk in lending to them. In India also, if some comfort is given by guarantee to a bank lending to a business where a detailed appraisal is required, but the documentation is missing, it will be worthwhile for the policymakers to take it up.

We hear investors are not excited about this space, because of high external risk. Mr Vasudevan?

P N Vasudevan: SFB licences were given by the RBI for the purpose of financial inclusion. That’s the preamble to the licensing guideline itself. They believe we have last-mile connectivity to the borrower. If we become banks, borrowers should benefit.

At Equitas, over 95 per cent of our small business borrowers are new to credit, which means that they are excluded. So, if I am able to give them a loan, it’s good inclusion activity.

The inclusion theme is very important. Within the inclusion theme, how does each organisation balance risk versus inclusion? That’s the crux.