India’s banking landscape is set to see the entry of a new species: the small finance bank. Licensees for 11 small finance banks, which have so far operated as microfinance institutions (MFIs) or non-banking finance companies (NBFCs), must transform themselves into banks. They will be accepting deposits from the public for the first time, a new experience for them. Human resources and technology issues could also pose challenges to the new entrants, said top industry executives at a discussion at Mint’s annual banking conclave.

At Mint’s 9th Annual Banking Conclave, panellists Samit Ghosh, MD & CEO, Ujjivan Financial Services Ltd; Rajeev Yadav, group CEO of Fincare Business Services, which runs small finance bank licensee Disha Microfin; Govind Singh, MD & CEO, Utkarsh Microfinance; K. Paul Thomas, CMD, ESAF Microfinance; Jiji Mammen, CEO, Mudra Bank; and V. Vaidyanathan, chairman & MD, Capital First, discussed opportunities, challenges and competition facing small finance banks with Mint’s consulting editor Tamal Bandyopadhyay. Edited excerpts:

On competing or collaborating with bigger universal banks

Would you like to compete with bigger banks and take away business from them, as unlike payments banks which cannot take deposits or give loans, there is not too much of restriction, geographical or business, on small banks? Or will you look at collaborating with them? In this context, how do you view the space?

Govind Singh: The kind of space that we operate in and that we plan to operate in for the next five to seven years is MSME (micro, small and medium enterprises) and below; so, in terms of the loan ticket size, that will be below 25 lakh. Even today, there are hundreds of villages around Varanasi, where Utkarsh is headquartered, microfinance institutions are not going, and that is the case in most parts of Uttar Pradesh and Bihar, which are our core geographies. So, in these regions, we do not foresee any challenge from bigger banks. Mainstream banks are not targeting customers of below 25 lakh in lending and below 5 lakh on the liability side. We are not really worried about competition from bigger banks.

Rajeev Yadav: As part of our platform, we are partnering with banks. Of our nearly 1,300-crore loan portfolio, around 400 crore comes from larger banks through our bank partnership model. Through our partnerships, we have seen that there is a very natural co-existence that exists at the bottom of the pyramid. The bigger banks have strength but the last mile connectivity is not the focus, and given our strengths, we find that they are very complementary. So, even after converting to small finance bank, we feel that there are at least 3-4 areas where we can work with the big banks. For example, we don’t need to buy technology, we can work with the big banks for that. We can also look at some of the products—longer-term loans, co-lending etc. We find that there is a collaborative space rather than a competitive space.

Samit Ghosh: The mandate given by the Reserve Bank of India (RBI) to small finance banks is to serve the unserved and the underserved and from that perspective, right now, we don’t see competition from regular universal banks.

On the asset side, we have the group lending products, and we are moving into the slightly higher micro enterprise segment. But that segment too is not penetrated by universal banks; they operate generally in above- 25 lakh-kind of ticket size. On the liability side, we will all be opening savings accounts. So, to that extent, we will be competing with universal banks, Jan Dhan Yojana etc. Universal banks have opened a lot of Jan Dhan accounts and I think they will be quite happy to share that load with us, because those accounts are not really transacted upon by the customers, apart from receiving subsidies.

The real competition for us is that people in the unserved and underserved segments—they don’t save in the formal sector. They save with institutions such as shadow banks, chit funds... Our real challenge will be how to channel those savings into the banking system through the small finance banks.

V. Vaidyanathan: If you look back and see the banking system, in its existence in over a 100 years, has about 650 million bank accounts and not more than 100 million credit accounts. In just 20-25 years, NBFCs have put together close to 30-40 million accounts. MFIs in just 10 years have put together another 20 million accounts. It means that if you depend only on the banking system to lend credit to the small consumer, it would take a long time, probably another 30-35 years. So, the entire ecosystem will have to address the issue of inclusion and passing on credit, and you can’t just depend only on the banks. Secondly, because of their compensation and branch structures, banks are not able to reach to the last mile. For an employee of a large bank, the joining salary is 5 lakh, while the employee at a MFI is working in the same place at around 1.2 lakh. Fundamentally, the structure becomes unviable for banks.

Jiji Mammen: As far as the segment is concerned, the small finance banks are also aiming at the segment which Mudra was started for. We have been formed with a mandate of supporting the small (and) micro enterprises with a loan ticket size of 10 lakh. For small finance banks, the majority of the lending will be of a size less than 25 lakh, and I am sure that 60-70% of this lending would be below 10 lakh. So, there should not be any problem as far as resources are concerned from Mudra and we will be very happy to support the small finance banks.

On challenges facing the small finance bank licensees

Microfinance institutions know how to lend money, but how are you planning towards getting money in terms of liability side? Also, there are other challenges such as human resources, technology etc. What are the challenges that you have to overcome in the next 15 odd months on your way to becoming a small finance bank?

Paul Thomas: We will become a highly regulated entity; so, we will need to have all the systems and processes put up. Human resources (HR) is a major issue. Several bankers have approached us, wanting to be a part of this journey of transformation and to serve the underserved markets. So, I think we will be able to overcome the challenge by getting experienced bankers to join our organizations and also training our existing people. Technology is another area of challenge. But we are seeing that all the major vendors today are ready to work on an opex model, so we don’t have to buy everything. Also, they want to grow with us, so we are getting positive responses from the technology vendors.

Liability side of the business model is another challenge. When we started working on the transformation, we were concerned how we will be able to do it. But the experience of Bandhan Bank shows that we need not worry too much. Bandhan was also an MFI, transformed into a universal bank and they were able to mobilize resources. Also, we have various agencies like Mudra, SIDBI, Nabard etc. for refinancing.

Rajeev Yadav: There are some one-time problems which we will solve in a matter of year or so, but the major challenge is that of creating a long-term solution for the business model on the liability side. There are ways of solving the liability problem for the first 2-3 years, which can be support of various financial institutions, through one-time bank support in some form, but ultimately, just the way MFIs have cracked the business model of doing small-ticket loans in an economical manner, that similar business model has to be sort of worked through and it will be worth the small parts.

Each one of us has to figure last mile solutions to find that answer and in a sense, we are lucky we are living in an age where technology is available, where data is better than what it was 4-5 years back and there is a view that if you can make the job simple and products simple, then we can have people with reasonable cost structures to do the jobs and service our customers. I think the ecosystem is gradually building up but there is lot of work to be done to find the business model on the liability side.

So many of us are working on it, including Bandhan, so in next 2-3-4 years, we will be able to find a solution to that. To build new-age banks, you don’t really need bankers. The problem with hiring bankers is that they come with their own mindset on what works and what does not work. I think people is not the bigger problem. The business model is my bigger challenge.

Govind Singh: One of the major challenges will be treasury management, which is not there today and so will have to be built from scratch. Second, certain things we need to upgrade, such as risk management and the compliance part. The human resources challenge has several parts to it.

First is hiring new employees. Today, we have around 2,600 employees. We need to hire close to 1,700-2,000 employees in the next seven to eight months in order to start the bank sometime in October. Second is the skill development of existing employees and new employees.

But the biggest problem is HR culture part—the cultural shift needed for a small finance bank. For me, the HR culture part is the biggest challenge that needs to be taken care of. I am spending almost 50% of my time on the HR piece right now.

Audience question: How different are small banks from cooperative banks, because cooperative banks were also set up for a specific purpose. Which needs did they not fulfil that we had to bring small finance banks and how will small finance banks overcome the challenges that cooperative banks have faced?

V. Vaidyanathan: Basically, the cooperative banking system got politicized and had terrible corporate governance. Over a period of time, they started lending to friends and relatives and money never came back and we know the non-performing assets situation at cooperative banks. The difference with small banks will be that probably, the sectors that they are dealing with will be the same but the governance will be much better and I think motivation will be different. They will be profit-oriented and so will be more sustainable.

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