ADVANCES GROWING SLOWER than deposits! It's a recipe for disaster in a rising interest rate regime, where banks have to offer high interest on deposits, but are unable to earn equal or higher interest income via lending.

That's exactly what happened with small finance banks in FY22 when their collective advances grew 24% even as deposits rose 32%. The 12 SFBs, however, showed resilience and turned around in FY23.

Listed SFBs such as Equitas Small Finance Bank recorded an improvement in gross advances at 35% in FY23, compared with 15% in FY22. Deposits grew at 34%, more than double from 16% in FY22. The bank's credit-deposit (CD) ratio also increased from 102% in FY22 to 110% in FY23. The number is better than most scheduled commercial banks. Even HDFC Bank, the country's largest private sector lender, reported a CD ratio of 85% in FY23 — it means for every ₹100 in deposit, ₹85 is being lent out. While a low CD ratio shows poor credit growth compared to deposits, a high ratio means the bank may not have enough liquidity to meet unforeseen fund requirements.

For AU Small Finance Bank, however, growth in advances and deposits slowed to 32% and 26%, respectively, in FY23, compared with 46% and 33% in FY22. The bank's CD ratio also declined to 84% in FY23 from 88% in FY22. However, MD and CEO Sanjay Agarwal sounded optimistic. "Now that our total assets are reaching ₹1 lakh crore, the advances and deposits growth will be calibrated on a high base," says Agarwal.

Even unlisted SFBs such as Fincare Small Finance Bank and Capital Small Finance Bank maintained higher growth in advances over their deposits in FY22 as well as in FY23. Fincare reported a 26% growth in advances and 24% growth in deposits in FY23. The CD ratio came in at 110%. The CD ratio of Capital SFB improved from 77% in FY22 to 84% in FY23. It reported 17% growth in advances and 8.5% growth in deposits last fiscal.

Ujjivan Small Finance Bank, on the other hand, also recorded an improvement in gross advances at 32% in FY23 (12% in FY22), but deposit growth was higher at 40% in FY23 (39% in FY22). CD ratio, however, improved to 94% from 89%.

Record Performance in FY23

FY22 had its share of challenges in Covid-19, which slowed the credit demand in segments where SFBs lend. But FY23 has been phenomenal for most SFBs. While AU Small Finance Bank reported a 23% year-on-year rise in March-quarter net profit to ₹425 crore backed by a 37% growth in net interest income, Equitas Small Finance Bank earned its highest-ever net profit of ₹190 crore in Q4, a 59% rise year-on-year, aided by a 28% YoY increase in net interest income. Bengaluru-based Ujjivan also recorded its 'best-ever' performance in Q4 by reporting a nearly two-and-a-half fold jump in net profit for the March quarter at ₹310 crore.

Among unlisted SFBs, Fincare reported a 1,068.43% increase in net profit at ₹104 crore in FY23, against ₹9 crore in FY22. ESAF Small Finance Bank posted a 452% rise in net profit to ₹302 crore in FY23, from ₹55 crore in the previous year.

The success lies in pricing the liabilities right. "SFBs are paying 1.6x times in terms of cost of funds at 6.36%, compared with 3.87% in the case of private and 3.98% by public banks. Yet, the average RoA is 2.85%, nearly double of 1.67% for private and 1% for public lenders," says Anil Rego, founder and CEO, Right Horizons, a Sebi-registered financial advisory firm.

Take, for example, Capital SFB. It is a retail-centric deposit franchise. Its current account savings account (CASA) deposit base has been consistently increasing — from 36.3% in FY20 to 41.9% in FY23. "If you raise liability at the right price, it gives you a huge opportunity. You get to lend to the creamy layer, keeping your earnings intact. Around 81.1% of our liabilities originate from deposits, of which 97.9% is retail deposits with a rollover ratio of more than 90%," says Munish Jain, CFO and COO.

In case of AU Small Finance Bank, net advances grew 27% in FY23. For FY24, the management has given a 25-30% guidance, with demand in segments, including MFI, housing, and used commercial and passenger vehicles. Equitas SFB, on the other hand, plans to foray into personal loans and credit cards in H2FY24. "Backed by strong demand and the bank leveraging its existing network, we expect EQSFB to register a healthy advances growth of 28% CAGR over FY23-25E," brokerage Axis Securities says in a note.

When an NBFC converts itself into a bank, it has to make huge investments in setting up branches, branding and tech. "Those initial years of conversion take 5-8 years during which banks will not only need to manage growth but spend a lot. This makes the cost-to-income ratio elevated. With the conversion period now ending, the future is positive," says Farokh Pandole, managing partner at Avestha Fund Management.

Asset Quality Key

Despite catering to the underserved section with a large unsecured loan portfolio, SFBs have been able to maintain a healthy net non-performing asset ratio. Net NPA ratio at the industry level stood at 2% in FY22, compared with 2.2% in PSBs. "Lending should not be seen only from the perspective of NPAs, but also the spreads that the product generates. A product having NPAs may be attractive and profitable if spreads are even more generous to adequately compensate for NPAs," says Pandole. In other words, in case of SFBs, profitability is compensating for NPAs.

Meanwhile, SFBs have been trying to control NPAs by reducing their unsecured portfolio. Fincare Small Finance Bank had a net NPA of 3.6% in FY22, which came down to 1.2% in FY23. "Our loan collections have improved over the last few quarters. That is the reason for NPA reduction every month," says Rajeev Yadav, MD and CEO.

SFBs are also investing aggressively in digital technologies. AU Small Finance, Equitas and Ujjivan have already got it right. Among others, Capital SFB has been trying to use technology to increase cashless banking and deepen automation. The share of digital transactions in non-cash transactions has grown from 34% in FY18 to 81% in FY23 for the bank.

Fincare SFB, meanwhile, prides itself in being a truly digital bank. "We onboard 99% of our customers through digital channels from Day 1... We have built IT capability in-house," says Yadav.

The next leg of growth for SFBs will come from product expansion, aiding a rise in the other income category. The RBI recently granted the Authorized Dealer Category-I licence to AU, Equitas and Capital, allowing them to deal in forex for specified purposes. This will help the SFBs woo foreign customers. Meanwhile, pushing lending through account aggregator platforms will be another watch-out area. "Anyone can lend, but how you determine who to lend, how much to lend, your collection efforts and your ability to cross-sell, are what matters. These parameters will have a great bearing on how well you run your business," concludes Pandole.

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