Dumka in Jharkhand is scripting an inspiring story for the world. Women in this tribal village have been making bamboo and water hyacinth handicrafts for ages. The task requires special skill sets but used to fetch them just enough to make ends meet. That is now history. Their lives were transformed when ESAF Small Finance Bank reached out to them and offered loans for scaling up the business. Now, among others, they sell to Swedish home-furnishing retailer Ikea, which markets their products to the world. The women, who used to make about ₹50 a day, now earn ₹8,000 a month. “Small loans can transform communities. We believe employment generation is a means of economic empowerment. For example, we trained tribal women in Kerala and gave them small loans to start microenterprises. One of our group entities, CEDAR Retail, has built an entire supply chain for the purpose,” says K. Paul Thomas, MD and CEO of ESAF Small Finance Bank.

Financial inclusion, after all, is not just about opening bank accounts and bank branches in remote areas. It is also about creating an ecosystem for employment generation so that people can start earning and focus on saving and investing. Small finance banks (SFBs), launched half a decade ago, are driving this change in remotest corners of the country.

The Business Case

According to CRISIL Research, rural areas account for about half of India’s gross domestic product but only 9% bank credit and 11% deposits. The numbers were much lower in 2014. The divide between urban and rural India prompted Reserve Bank of India (RBI) under Raghuram Rajan to release guidelines for licensing SFBs.

RBI initially issued 10 SFB licences to mostly microfinance institutions, local area banks and non-banking finance companies (NBFCs). The first two, Capital Small Finance Bank and Equitas Small Finance Bank, started operations in 2016, followed by seven in 2017, and one more in 2018. Shivalik Small Finance Bank was the first co-operative bank to get SFB licence. It started operations in January 2021. RBI also granted Centrum Financial Services approval in principle for setting up a small finance bank after it took over Punjab & Maharashtra Co-Operative Bank Ltd. A banking licence lowers cost of funds by allowing SFBs to raise deposits. According to an ICICI Securities report, cost of funds for SFBs is 100 basis points less than for most NBFCs. Their share of incremental credit was 8% as on September 2021, says the report.

However, SFBs have to meet stringent conditions. They must lend at least 75% funds to priority sector; for scheduled commercial banks, the number is 40%. And at least 50% lending portfolio should have loans of up to ₹25 lakh. “The fact that all banks meet these requirements shows we are touching segments where financial inclusion is needed,” says Murali Vaidyanathan, senior president and country head at Equitas Small Finance Bank.

SFBs have become pioneers in underwriting small loans to self-employed people who do not have enough credit history for assessing their creditworthiness. They reported 42% loan CAGR between FY2018 and September-end 2020 compared to 13% for private banks and 2% for public sector banks. Their overall credit market share was 1% as on September 2021. “Latest data shows that unique MFI borrower base was six crore in March 2021. Assuming 25% customers would be eligible for higher loans (already in 3rd or 4th loan cycle) of up to ₹1 lakh, immediate addressable market for SFBs works out to ₹2.75 lakh crore or 2.5 times their current assets,” says an ICICI Securities report.

Post-Crisis Opportunity

SFBs have been facing several challenges in realising their potential. They had barely recovered from demonetisation when first Covid-19 lockdown hit business and collections. SFBs faced severe asset quality deterioration in FY2021.

The situation is improving now. NPAs are falling and credit growth is impressive. “With economic recovery, we are seeing good growth in SFBs, especially the listed ones. Their credit growth is far better than the rest of the public/private banking system. Asset quality did deteriorate post Covid-19 but is improving,” says Ajit Kabi, equity research analyst (Institutional, Banks & NBFCs) at LKP Securities.

AU Small Finance Bank has maintained collection efficiency of 100%. It reduced its QoQ GNPA ratio from 3.2% to 2.6% in December quarter. “Covid-19 helped us in the sense that it tested our credit model. We increased our communication with customers to build trust. Borrowers started paying back just as businesses revived,” says Uttam Tibrewal, executive director, AU Small Finance Bank.

Some SFBs had to show flexibility and hand-held borrowers. Ujjivan SFB restructured loans, wherever required, to support customers. “We deployed analytics tools to increase efficacy of collection efforts,” says MD & CEO Ittira Davis. GNPA ratio came down from 11.8% in Q2 FY2022 to 9.8% in Q3 FY2022. NNPAs almost halved from 3.3% in Q2 FY2022 to 1.7% in Q3 FY2022.

“We started reaching smaller places via micro-ATMs so that people don’t have to travel,” says Vaidyanathan of Equitas. “We also made sure our savings rates were stable. We offered best rates during Covid-19 when other banks were reducing the rates,” he says.

Embracing Digital

Covid-19 was a challenge but it also accelerated digitisation. While smaller SFBs are yet to catch up, Equitas, AU and Ujjivan are taking a number of digital initiatives. AU Small Finance Bank has launched a super app, AU 0101, which recorded 39% QoQ growth in registrations in December 2021 quarter; 20% of those who registered were non-AU customers. The recent video banking has enhanced customer reach and engagement. Credit card base has reached one lakh. A total of 50,000+ credit cards were issued in December quarter, 53% to first-time users. AU is also the first bank to launch QR soundbox that helps merchants hear notifications about fresh payments.

Ujjivan SFB claims to be the first among SFBs in UPI transactions. In order to cope with the challenges posed by the pandemic, it entered into partnerships with fintechs for loan recovery. “There is sustained focus on robotic process automation; 25 processes are already live. Another 10 are in the pipeline,” says Davis of Ujjivan. “API banking remains a focus area. A total of 169 APIs are live. We continue to witness strong traction in number of transactions through API banking,” he adds. API, or application programming interface, is a piece of software that acts as an intermediary between other pieces of software. This enables banks to provide digital services or integrate with other digital services.

Equitas extended video KYC to NeoBanking partners. One of the partners, NiYo, opened over 10 lakh accounts in a month for the bank. “We can open bank accounts in less than three minutes. Earlier, we would open 20,000 accounts in a month. Now, it is 1.6 lakh a month. More and more digitisation will help us hit bigger milestones,” says Murali of Equitas.

Needed, Easier Regulations

SFBs operate in a tight regulatory environment. They have a steep threshold on priority sector lending and strict limit on loan amounts and asset quality ratios. “We seek support for rationalisation of capital adequacy norms as most SFBs have been into banking for the last four to five years and have acquired considerable expertise. Further, as balance sheets of SFBs are growing, rationalised capital adequacy norms shall enable them to lend to under-served borrower segments and achieve financial inclusion,” says Davis of Ujjivan SFB.

The industry is also seeking regulations to enable them to have strategic alliances with fintech players. “This will help SFBs leverage technological capabilities of fintechs and ensure wider reach and faster delivery of banking products to new segments. This will allow SFBs to reduce operational costs,” he says.

Meanwhile, SFBs have to get listed within three years of net worth reaching ₹500 crore. Five SFBs—Utkarsh Small Finance Bank (₹1,350 crore), Fincare Small Finance Bank (₹1,330 crore), Capital Small Finance Bank (₹1,000 crore), ESAF Small Finance Bank (₹1,000 crore) and Jana Small Finance Bank (₹700 crore)—are slated to launch IPOs. The total addressable credit gap in MSME space is estimated at ₹26 lakh crore. ICICI Securities has projected a cumulative credit opportunity of ₹10 lakh crore for SFBs in three sub-segments—1) cross-selling to existing MFI borrowers, 2) market share gain from banks and NBFCs and 3) ‘new to credit’ opportunity in MSME segment.

Expertise in giving loans on the basis of unstructured data, huge untapped market and government’s thrust on financial inclusion make SFBs well-poised to dominate the small lending space. “Within SFBs, industry leaders (AU and Equitas) are likely to lead growth given their deep distribution networks, competitive rates on the back of lower cost of funds as compared to other SFBs and wide range of products to cater to changing customer needs,” says the ICICI Securities report.

It’s this growth that many people are looking at for creating opportunities for the less privileged.

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