Synopsis

• The journey of Small Finance Banks (SFBs), which were envisaged as financial inclusion vehicles to provide credit to the non-banked and underbanked population of the country, has been marked by resilience amid numerous obstacles starting from events like demonetisation and its after-effects, GST implementation, NBFC crisis of 2018, private banks fiasco of 2020 affecting deposits and more recently the Covid-19 pandemic.
• Covid-19 hit SFBs hard during FY21 and FY22 due to the exposure to economically weaker borrower profiles causing higher delinquencies and an increase in credit costs impacting profitability. Most SFBs saw a reduction of their profitability with some even incurring losses and many SFBs were looking to raise growth capital during FY22.
• With the improvement in the economic landscape and financial performance of SFBs, there has been an increasing investor interest for the sector in the current year with few players raising equity through their maiden IPOs. During 9MFY24, SFBs raised equity capital aggregating ₹1,527 crore and around ₹1,725 crore is expected to be raised during Q4FY24.
• With the credit cost worries behind and access to capital, the SFBs are poised for a strong growth period. CareEdge Ratings expects SFB advances and deposits growth of 22-25% and report stable profitability with ROTA in the range of 2.1% to 2.4% for FY24.
• The sector has also recently witnessed announcements of a couple of mergers for inorganic growth. However, these are event specific and CareEdge Ratings do not envisage any major consolidation in the industry.

As most of the SFBs transitioned from being NBFCs, SFBs faced the challenge of mobilisation of deposits; however, SFBs have done a commendable job of building their deposit franchise by setting up liabilities-focused branches. The Credit to Deposit (C/D) ratio has fallen over a period of time as SFBs replaced borrowings with deposits. While SFBs have been building their deposit base by providing relatively higher interest rates, building up a stable Current Account and Savings Account (CASA) base will continue to remain a challenge with stiff competition from established commercial banks. The CASA deposit ratio for SFBs continues to trail behind the banking sector.

SFBs have been expanding their franchise continuously with a number of branches growing at a CAGR of 29% since March 2018. The branches are well spread out all over India with South India having the highest number of branches at 28% followed by the western region contributing 20%.

Advances of SFBs grew at a CAGR of 32% during the period from FY20 to FY23 as against a CAGR of 11% for the banking sector. SFBs increased its market share in advances of the overall banking industry over the past few years although the same is relatively marginal.

Eight out of the twelve SFBs were microfinance institutions prior to their conversion into banks, therefore the largest proportion of their loan book continues to be skewed towards microfinance which is unsecured. There has been a gradual diversification of portfolios by SFBs with an increasing share of Secured products like Home Loans, Vehicle Loans, MSME and Gold Loans resulting in the share of microfinance declining from 40% of advances as on March 31, 2020 to 32% as of March 31, 2023 for the SFB industry. The share of SFBs in microfinance loans has also been declining over a period of time.

Excluding AU Small Finance Bank (the largest SFB with no microfinance exposure), the microfinance exposure has reduced from 59% as on March 31, 2020 to 51% as on March 31, 2023.

During Covid-19, SFBs especially those with larger exposure to unsecured loan books were more severely impacted due to exposure to a relatively weaker borrower segment. SFBs saw a jump in their NPAs, contributing to higher credit costs. The impact of Covid-19 peaked in FY22 when the credit cost was highest as SFBs undertook write-offs with all SFBs posting a fall of profits with few even reporting losses. With the resumption of economic activity post covid the situation started improving in FY23 with all SFBs showing improved net interest margin (NIM) thanks to rate hikes announced by RBI (FY23: 7.5% vs FY22: 6.9%) and lower credit costs as the asset quality showed improvement (FY23: 1.3% vs FY22: 2.4%) with fall in incremental delinquencies translating into superior return on total assets (ROTA). The improvements continue even in FY24 (YTD) for SFBs with NIMs holding up despite an increase in deposit rates, fall in credit cost and ROTA improvement as demonstrated in H1FY24 results.