Small finance banks are likely to witness some margin pressure in the near to medium term (see chart), estimate analysts. This is due to a change in their loan book mix with lower share of micro (small-ticket) loans that attract higher yields on one hand, and garnering deposits at higher rates on the other hand.
Bucking the dismal deposit growth trend of the entire banking system, small finance banks reported a sharp rise in deposits. For the listed small banks – Ujjivan Financial Services, Equitas Holdings and AU Small Finance Bank – deposits jumped by 2-4 times year-on-year as of December 2018. This was in sharp contrast to the entire banking sector deposit growth of 9.5 per cent. High pricing power, mainly through unsecured micro lending, is helping the small finance banks to offer attractive deposit rates.
However, even as small finance banks are offering higher deposit rates, many are now lowering the share of micro loans. Ujjivan’s management, for instance, indicated their targeted annual loan book growth of 30-35 per cent over the next three years would be driven by non-micro book (mainly secured), says a CLSA report.
Already, the share of micro lending in overall loan book of Ujjivan has come down to 87 per cent in December 2018 from 94 per cent a year back, while it fell to 27 per cent from 32 per cent in case of Equitas. AU Small Finance Bank does not deal in micro lending, but it has 81 per cent of its assets under management (AUM) coming in from the secured retail loans segment.
Since secured non-micro book fetch lower yields as compared to the unsecured micro book, it would lower the overall yields of small finance banks. This would, in turn, impact their net interest margin.
Supreeta Nijjar, vice president, financial sector ratings at ICRA, says, overall average yields of small finance banks (listed and non-listed ones) have gone up from 17 per cent in FY18 to 18.3 per cent during April-September 2018 and is likely to come back to 17 per cent levels in near to medium term.
Though a diversified liability franchise should typically offer lower cost of funds, how much benefits can these banks accrue is key to watch given the overall lukewarm scenario of banking deposits. For instance, AU Small Finance Bank has over 62 per cent of its borrowing from deposits, as on December 31, 2018. For Equitas and Ujjivan this figure stood at 65 per cent and 58 per cent, respectively.
“Cost of funds could go up given the expected higher rate of deposits and small finance banks are increasing their deposit base. This along with rising focus on non-micro lending, could lead to margin compression or stagnation in margin,” adds Nijjar who also believes lower operating costs would however, support earnings.
Sanjay Kao, chief business officer, Ujjivan, echoes a similar view. “The net interest margin would decline going ahead with lower yield on loans. However, lower operating expenses should help the bottomline.”
For most small finance banks, a costlier transition to full-fledged banks is almost done. Thus, operating cost is likely to moderate going ahead, though getting right talent or branch expansion in case of some small banks would add to the costs.
While a lower share of micro-book is weighing on yields, this is positive for asset quality. “Given the riskier nature of micro book, diversifying loan book into non-micro secured segment is a good strategy from a long-term perspective. Though there could be some margin pressure in the near term, loan book diversification also improves asset quality outlook,” says Asutosh Mishra, head of research-institutional equity at Ashika Stock Broking. Further, it will also help to improve capital adequacy ratio given the lower risk involved.
Also, with growth levers for retail and micro loan segments such as improving rural outlook as well as overall customer sentiment, loan book growth is likely to be strong for small finance banks. Analysts foresee an over 25 per cent loan book growth each in FY20 and FY21.