SFBs: The canter on a chequered terrain as deposit challenges loom

Segmental and geographical expansion, undergirded by strong and increasing presence in semi-urban and rural markets with large untapped potential, will help small finance banks (SFBs) clock robust 25-27 per cent growth in advances this financial year, just shy of 28 per cent in the previous year.

 

Net interest margins (NIMs) could, however, contract 15 basis points (bps) year-on-year as SFBs continue to diversify into secured asset classes that fetch lower yields.

 

Also, with credit cost expected to increase 40 bps amid rising delinquencies in the unsecured segments (including microfinance), the return on assets is likely to decline nearly 40 bps to 1.7 per cent this financial year.

 

Growth in credit will be split across traditional and new segments, with the latter set to achieve nearly 40 per cent growth. New asset classes chosen by SFBs may vary in line with their initial segment focus but would typically entail secured segments. With sharper focus, the share of secured lending is slated to rise to 65 per cent by financial year 2025 (FY25) from 62 per cent in FY24. However, NIMs could compress to 7.2 per cent as yields on secured loans are typically 6-7 percentage points lower than on unsecured loans.

 

To combat this and achieve balanced credit growth, the funding side is crucial.

 

At 30 per cent for FY24, deposit growth has outpaced credit growth for SFBs, in contrast to the overall banking sector. However, this has come at a higher cost: the share of the relatively more expensive bulk term deposits rose 7 percentage points to almost 30 per cent of total deposits as of FY24. Correspondingly, the share of current and savings account deposits dropped to 28 per cent from 35 per cent; and that of retail term-deposits also fell.

 

Amid challenges in deposit mobilisation, SFBs will need to explore alternative, non-deposit funding routes at a competitive cost. 

 

Securitisation is gaining currency: transactions have increased to Rs 9,000 crore in FY24 from Rs 6,300 crore in FY23. As an additional channel, SFBs will seek more refinancing lines from financial institutions. Cost of deposits will remain structurally higher for SFBs than for universal banks as they offer a 50-250 bps premium in interest rates across similar deposit categories. Diversification into alternative funding avenues should lend stability to cost of funding.

 

The pre-provisioning profitability of SFBs could dip 10 bps to 3.5 per cent this fiscal because of NIM compression and flat operating expenses. 

 

Meanwhile, gross non-performing assets (GNPA) are likely to rise to 2.9 per cent in FY25, from 2.3 per cent in FY24. This is due to early signs of stress stemming from borrower overleveraging, particularly in microfinance and unsecured personal loans. Sub-segments within secured asset classes that cater in part to a similar customer segment could also see delinquencies increase.

 

As seen in the aftermath of the pandemic, SFBs with more diverse and secured portfolios will be more resilient. Amid their evolving asset-liability model and its impact on earnings, SFBs remain well-capitalised. They have raised equity of over Rs 8,000 crore in the past three financial years, including almost Rs 2,700 crore raised by a few via initial public offerings, to meet their licensing requirements.

 

All said, growth prospects for SFBs remain buoyant, anchored by comfortable capitalisation and ever-increasing presence in underpenetrated markets. It will also be propelled by systemic emphasis on financial inclusion and universal banking aspirations. The latter may take time to materialise though given the stringent eligibility criteria for application and ultimate licensing being subject to regulatory due diligence. Until then, SFBs shall continue to co-exist as a niche segment alongside traditional universal banks, that largely cater to the peripheral customer segment of the formal financial system. In the milieu, the ability of SFBs to ramp up their low-cost, retail deposit franchise, while organically transitioning to newer asset classes and maintaining asset quality in the process, will bear watching.

 

(The writer is chief ratings officer, CRISIL Ratings)