While small finance banks (SFBs) have built their deposit base by providing relatively higher interest rates, building a stable Current Account and Savings Account (CASA) base will continue to remain a challenge with stiff competition from established commercial banks.
Deposits of SFBs grew at a CAGR of 32% during the period from FY20 to FY23 against a CAGR of 11% for banking sector deposits. The SFB deposit of the total banking industry has improved over the past few years although the ratio is relatively smaller.
The strong focus on building a liability franchise comparable to that of universal banks and the relatively higher rate offered to depositors resulted in SFB deposits growing faster than the banking industry.
With the cost of credit concerns behind and access to capital, the SFBs are poised for a period of strong growth.
CareEdge Ratings expects SFB advances and deposits to grow by 22-25% and reports stable profitability with return on total assets (ROTA) in the range of 2.1% to 2.4% for FY24.
While the sector has recently witnessed announcements of a number of mergers for inorganic growth, these are specific events and CareEdge Ratings does not foresee any major consolidation in the industry.
Warehouse mobilization
As most of the SFBs transitioned from being NBFCs, SFBs faced the challenge of mobilizing deposits; however, SFBs have done a commendable job of building their deposit franchise by setting up liability-focused branches.
The Credit to Deposit (C/D) ratio fell over a period of time as SFBs replaced borrowings with deposits. The CASA deposit ratio for SFBs continues to lag behind the banking sector.
As of September 30, 2023, certain small finance banks exhibited particularly high CD ratios, with Suryoday Small Finance Bank at 108%, and IDFC First Bank, Equitas Small Finance Bank, and Utkarsh Small Finance Bank at 102%, 101%, and 100.8 %, respectively.
SFBs have expanded their franchise continuously with number of branches growing at a CAGR of 29% since March 2018. The branches are well spread all over India with South India having the highest number of branches at 28% followed by the western region contributing. 20%
Improvement in asset quality
During Covid-19, SFBs especially those with greater exposure to unsecured loan books were more severely affected due to exposure to a relatively weaker borrower segment. SFBs saw a jump in their NPAs, contributing to higher credit costs.
The impact of Covid-19 peaked in FY22 when the cost of credit was highest as SFBs undertook ramp-ups with all SFBs posting a drop in profits with few even reporting losses. With the resumption of economic activity post-Covid, the situation started to improve in FY23 with all SFBs showing improved net interest margin (NIM) thanks to rates announced by RBI (FY23: 7.5% vs FY22: 6.9%) and lower credit costs as the asset. quality showed an improvement (FY23: 1.3% vs FY22: 2.4%) with a drop in incremental crimes translating to superior ROTA.
The improvements continue even in FY24 (YTD) for SFBs with NIMs holding despite rise in deposit rates, fall in credit cost and ROTA improvement as evidenced in H1FY24 results.
ETBFSI now has its WhatsApp channel. Subscribe for all the latest updates.