It is now over four years since the RBI issued licenses to 10 financial institutions to set up Small Finance Banks (SFBs) with the objective to provide financial services to sections of the economy not being served by other banks, such as small business units, small and marginal farmers, micro and small industries and unorganised sector entities. Of the 10, 8 were Microfinance Institutions, most of which have either completed or are close to completing three years of operations as SFBs. For most SFBs however, the portfolio continues to be dominated by microfinance loans and the share of retail liabilities is low. By September this year, all SFBs had been granted scheduled status by the RBI. Meanwhile, the RBI also released the draft guidelines for on tap licensing of SFBs, raising the expectations of MFIs and NBFCs for the next level of transformation into banking institutions.
The session provided an opportunity to review the extent to which this new set of differentiated banks have succeeded in achieving the objective of financial inclusion so far, and discussed operational, structural and regulatory challenges faced by them as they transformed themselves from largely mono- line asset backed revenue businesses to a diversified asset and liability backed profitable businesses. The session discussed various aspects of providing an enabling and supportive framework to SFBs for them to realize the potential of transforming into the bankers to the last mile, and also highlighted lessons learnt for financial institutions aspiring to be SFBs in future.
- The transition journey to SFBs from MFIs was marked with challenges with the highest priority being to build trust among customers, market players and investors that MFIs can indeed be “banks” who have the intent to be in the financial system for long run as true “Banks”.
- Of the various challenges faced, compliance challenge was the most critical as senior management time was primarily devoted to dealing with compliance adherence. Others include developing a truly granular liability franchise and diversifying asset line by venturing into new but related business verticals. On the regulatory front, meeting the requirements of dilution of shareholding and public listing remain an on-going concern.
- SFBs have tackled the challenges of building liability by mobilizing wholesale deposits to begin with, while the intent and long term vision continues to be have retail liability base. Similarly, diversifying to new asset classes required setting up a strong team, integrating the team into the culture and investing in the right technology.
- At a steady state, the liability business built up will be largely retail driven and deposit sizes will be small, however, the volume of transaction will be very high. To manage high volumes on liability side on a base that is built up on smaller deposit size, keeping costs under control while delivering the services is critical. Cost efficiency can be achieved through investment in innovative technology. Strengthening SFB’s readiness to manage volumes and diversity of services will need prudent investment in technology.
- SFBs have emerged as an investible asset class for mainstream capital market investors.
- Investor community has set higher benchmarks for SFBs on metrics to track return on investment compared to the private sector banks. Key strengths that have made SFB a lucrative proposition to invest in is largely driven by high standards of governance, strong grasp and understanding of customer and continued focus on vision of creating impact at scale.
- Quality of service and ability to provide door step service is critical for SFBs to claim and retain market share.
- Compliance adherence is at times, significantly more for SFBs than regular mainstream banks. Increased compliance and regulatory requirements for SFBs helps build trust. Since regulator’s prime responsibility is to protect the interest of depositors, SFBs attracted greater vigil and supervision given that they are new to the system.
- Moreover, it is considered prudent to undergo the rigor of adhering to increased scrutiny and compliance. It builds a culture of trust with the regulator, investors and customers.
- To build a resilient SFB ecosystem, it is important to build trust and building trust will need the effort to build a culture around transparency and highest standards of governance. Compliance helps in achieving those standards till they become part of organizational culture.