Mumbai: A number of microfinance institutions (MFIs) are keen to apply for a small bank licence, despite lingering concerns over the high cost of banking operations, the difficulty in building a robust base of retail deposits and the need to comply with tougher regulatory norms.
The Reserve Bank of India (RBI) which released final guidelines for small banks on 27 November has sought applications by 16 January from those interested in applying for a small bank licence. While a number of entities ranging from non-banking financing firms to local area banks and individuals with 10 years banking experience are allowed to apply, MFIs are likely to be strong candidates for such licences thanks to their experience in small ticket lending.
Small finance banks are aimed at furthering financial inclusion by providing loans to small business units, small and marginal farmers, micro and small industries and other unorganized sector entities, through high-technology, low-cost operations. These banks will also act as savings vehicles for the financially excluded.
One of the lures of a banking licence for MFIs continues to be the ability to raise deposits, which, in turn, will bring down their cost of funds substantially and allow them to lend at more reasonable rates than they do now.
Most MFIs currently raise funds from banks for on-lending at 12-14%. As per norms issued by RBI in February this year, large microfinance companies, with a loan book of `100 crore and above, are allowed to charge up to a 10% spread on their cost of funds to customers. This ceiling is fixed at 12% for smaller microfinance companies. This means the average interest rate in the microfinance industry is currently 22-24%.
However, if an MFI chooses to convert into a small bank, the cost of funding could come down substantially. “If the fully loaded cost of funds for a small finance bank comes to 10%, with a spread of around 6%, they could offer micro-loans at around 16%, a huge drop over the existing 22-24% levels,” said Alok Prasad, chief executive officer of MFIN, a microfinance industry body. Prasad adds that a significant number of microfinance firms are expected to apply for a small bank licence.
But building a sizeable base of retail deposits may not be easy, as these institutions would be competing with banks which, too, have been expanding into rural and semi-urban areas.
“Getting retail deposits is a time-consuming effort. By the time we get enough retail deposits to make it a viable source of funds, it will be four to five years,” said Samit Ghosh, managing director and chief executive officer of Ujjivan Financial Services. Ujjivan, a Bengaluru-based microfinance firm with `2,554 crore worth of outstanding loans as on 31 October, is keen on getting a small finance bank licence.
According to rating agency ICRA’s estimates, the cost of deposit mobilization for these banks could be 10-12% of the mobilised amount, at ticket sizes of around `1,000 per depositor, with around 2,000-2,500 depositors per branch. This would also mean that net interest margins for such small banks would be low in the initial years.
“If small banks are able to double the depositor base as well as ticket sizes, the cost of deposit mobilization could come down significantly to around 2-3% of the amount mobilized,” said an ICRA report released last Friday.
So, it would be critical for small banks to develop a sizeable retail deposit base (along with current account savings account) at reasonable ticket sizes to keep the cost of deposit mobilization at reasonable levels, to report reasonable returns and would hold the key to profitability, the agency added.
Adding to the cost pressures for small banks will be the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) requirements imposed by RBI, which are on par with the rest of the banking sector.
“When the draft guidelines had come out, we had requested the RBI for some relief in the CRR and SLR requirements, but the regulator seems to be clear in its thinking that a bank must complete all statutory requirements,” said Manoj Kumar Nambiar, managing director and board member, Arohan Financial Services Pvt. Ltd, a Kolkata-based MFI.
Arohan, which is also keen to apply for a small finance bank licence, is in the process of conducting a viability study.
According to Vijay Mahajan, group chief executive officer and chairman, BASIX Group, some clarity may be needed on promoter shareholding if MFIs are to be converted into small banks since a number of them have a diversified shareholder base. BASIX Group is a livelihood promotion institution which has a microfinance company and a local area bank in its fold.
“Most of us who started microfinance companies in the early years, started with a very small corpus and eventually got investors on board. Over time, our shareholding has been diluted as more people invested. There may not be a single shareholder who has a shareholding of over 26% by themselves. Thus, we may need some clarification about the definition of promoter and whether it can be a group,” said Mahajan of BASIX.
Ghosh of Ujjivan adds that the 74% foreign ownership ceiling will also need some adjustment. At present, the company’s foreign ownership stands at 88%.
However, not all microfinance institutions want to become small finance banks.
Padmaja Reddy, promoter of Spandana Sphoorty Financial Ltd, believes the cut in cost of funds due to deposit taking may not be able to compensate for the overall increase in cost.
“Our board will meet shortly and take a call on whether becoming a bank makes sense. However, there is an obvious benefit of choosing to remain a microfinance company. Major banks complete their priority sector lending requirements through microfinance companies. If larger microfinance companies choose to become banks, we will have higher bank business,” said Reddy.
SKS Microfinance Ltd, the country’s only listed microfinance firm, declined to comment on its plans.
Microfinance institutions went through a rough patch after a crisis unfolded in Andhra Pradesh in 2010, leading to large defaults. The crisis itself was a result of unregulated lending to smaller borrowers, with many companies often lending to the same borrower.
Gross non-performing assets of the microfinance industry had gone up to `2,227.06 crore in 2011-12 from nearly `35 crore in 2009-10, Mint had reported on 7 September 2012. The net profit of these companies fell from `474.68 crore in 2009-10 to `284.44 crore in 2010-11, while they incurred a loss of `2,149.26 crore in 2011-12, the report had said. Since then, however, RBI introduced new regulations governing the sector.