The Reserve Bank of India (RBI) is learnt to have developed ‘supervisory discomfort’ with a couple of small finance banks (SFBs) due to high concentration risks and rising asset quality stress.

The banking regulator has also told these banks to explore mergers to gain scale and minimise concentration risks, three executives tracking the sector said. “Small finance banks are under the ‘close supervision’ of RBI,” said one of the persons. “Amalgamation between banks is one of the options that have been thought of at the regulatory level to address the concerns.”

The regulator met the management of these lenders a couple of months ago, said another executive. Gaps in corporate governance and succession planning at some of these SFBs were the other areas of concern for the supervisory stakeholders.

RBI did not respond to ET’s request for a comment.


Small finance banks with a higher share of micro loans are in the most challenging situation with the ongoing stress in the microfinance sector, which saw the average gross non-performing assets (NPA) rising to an 18-month high of 11.6% at the end of September 2024.

As a group, these lenders had 15.3% of their cumulative microfinance portfolio as NPAs. Industry-level data till end of December is not available just yet, but the overall sectoral asset quality is likely to worsen, quarterly earnings showed.

Small finance banks face concentration risks in two ways. First, many have high exposure to the microfinance sector, which has been reeling under stress. Second, a few such banks have large exposure to the geographic pockets of higher stress.

These issues could be addressed either by amalgamation of these banks, or merger with bigger entities with a strong capital back-up, said the executives cited above.

"Merger between banks operating in different geographies may make sense and would address the concentration risk," a senior microfinance practitioner said.

GEOGRAPHY, CATEGORY RISKS
ESAF Small Finance Bank, For instance, has 57% of its gross advances in home state Kerala and the neighbouring Tamil Nadu, while 56% of the gross advances are unsecured loans. Similarly, 660 of 916 banking outlets of Utkarsh Small Finance Bank are in five states — Uttar Pradesh, Bihar, Jharkhand, Odisha and Maharashtra — with two-third of the gross loans in the unsecured microfinance category.

The Northeast Small Finance Bank, which got merged with Bengaluru-based fintech company Slice, is largely focused on that region.

In terms of deposit mobilisation, most SFBs reported higher annual growth than the banking industry average. Suryoday leads the pack with 49.7% year-on-year growth to Rs 9,708 crore at the end of December, albeit on a low base of Rs 6,484 crore a year ago.

The bank's gross NPAs rose during the third quarter to 5.5% of total advances of Rs 9,563 crore. Utkarsh reported a 33.5% year-on-year deposit growth to Rs 20,172 crore, while its advances climbed 16% to Rs 19,057 crore.

RBI has created the SFB ecosystem to enhance credit supplies to micro and small enterprises and the farming sector.