Small Finance Banks (SFBs) have been granted licenses by RBI for furthering financial inclusion by providing savings vehicles primarily to unserved and underserved sections of the population and supply of credit to small business units, small and marginal farmers; micro and small industries etc., through high technology and low-cost operations. These banks have to extend 75% of loans to the priority sector (versus 40% for commercial banks). However, the area of operations of these banks would be limited.
For these banks, minimum paid-up voting equity capital/net worth requirement shall be Rs. 200 crores. For the initial five years, these banks would be required to open at least 25 per cent of the branches in unbanked rural centres. All of these restrictions pose challenges to the working of SFBs. However, most of these banks have converted to SFB from microfinance institutions and do not feel handicapped by these challenges. Rather, they see them as opportunities.
Most of the areas in which Small Finance Banks operate are not even served by microfinance institutions, leave alone commercial banks. Also, the average ticket size of loans by these banks are on an average less than Rs. 25 lakhs and are mostly to MSMEs. Most of the commercial banks are not looking at loan ticket sizes of less than Rs. 25 lakhs, and hence, competition for Small Finance Banks is less.
However, most of these banks feel that they can collaborate, rather than compete with bigger banks. Despite a tough operating environment, the total asset base for SFBs crossed Rs. 90,000 crores as on March 31, 2019 while managed advances growth crossed Rs. 67,000 crores with a growth of 41% in FY 2019 (5% growth in FY 2018), according to a report by rating agency ICRA.
Major challenges confronting SFBs
However, human resources (HR) and technology are two major issues facing these banks. First, on the HR challenge. For most of the SFBs which have converted from microfinance institutions (MFI), coming out of MFI mould would be a challenge and would require a change in mindset.
While hiring experienced commercial bankers can be a solution, these bankers would come with a different mindset on what would work and what would not. Hence, change in mindset would be required if these experienced bankers were to serve hitherto unserved or under-served segments, which would require a cultural shift on their part.
Hiring new employees is another big challenge. Skill development and training of new and existing employees would require herculean efforts. Thus, recruitment of the right kind of manpower would remain a challenge. So also, training & development, employee engagement and retaining talent would remain challenges.
With a large number of transactions, particularly collections from customers being cash-based, SFBs are exposed to the risks of loss, fraud, misappropriation, theft, assault and unauthorized transactions by employees. For example, in FY 2018-19, Equitas SFB reported 22 cases of fraud to RBI, which involved Rs. 2.43 crores. While the amount involved might be low in comparison to commercial banks, there might be several such instances which might have gone unnoticed. Such instances might also adversely affect the goodwill, business prospects and future financial performance.
Also, employees of SFBs have expertise in micro-lending operations but have limited exposure to market deposit, insurance or pension products. Further, credit teams in SFBs do not possess the credit assessment skills of the commercial bank staff.
Treasury management is also one of the major challenges facing SFBs. As erstwhile MFIs, these banks do not have the human resources trained in treasury functions and they need to start from scratch. Risk management and compliance are other big challenges. In all these areas, they need to hire people from commercial banking space and may have to pay higher remunerations to attract the right talent.
These banks’ hardware and software systems are also potentially vulnerable to data security breaches. These are further compounded by the fact that these banks undertake a high volume of transactions, including internet and mobile and tab banking and the employees of these banks also relatively lack experience with the newer information technology systems. Given the lower compensation structure vis-à-vis larger commercial banks, they may not be able to attract the best talent available. This is also a challenge in the human resources front.
Technology as an enabler versus up-gradation costs
On the technology front, most of the SFBs are using multiple channels like branch, ATMs, Internet and Mobile Banking and call centres. Also, many of the banks have provided the field staff with tablets for account opening, cash deposit, EMI payments and for E-KYC. However, since SFBs are concentrated in rural and semirural areas, technology adoption remains a challenge due to infrastructural issues like lack of electricity and broadband connectivity.
Most of the commercial banks are pushing their customers towards net banking and mobile banking to reduce the cost of branch banking. However, as the target clients of the SFBs do not have the awareness to use such channels, SFBs will need to rely more on traditional branches to service these clients, while focusing on innovative channels such as tab banking to reach their customers.
Some of the banks like Fincare Small Finance Bank have transformed WhatsApp banking from a menu-driven service to a multi-lingual Natural Language System (NLP) bot, where the customers can type in free text in English, Hindi and ‘Hinglish’ and the bot provides secure and accurate responses. However, while the investments on technology are yielding handsome benefits to these banks, the cost incurred for technology up-gradation is a concern for them.
Digitalizing banking delivery and other operations to source and deliver cost-effective solutions would remain a challenge in the near term. Further, given the rapidness with newer technologies are emerging and older technologies are becoming obsolete, there is the need for constant innovation, up-gradation etc. which would result in substantial technology costs. Additionally, with a rise in cybercrimes, these banks need to invest in robust cybersecurity systems, which would substantially enhance their cost of operations.
In conclusion, we may say that while challenges remain for SFBs, they have done well in the last five years. With the last mile connectivity for rural areas still remaining a concern, a significant portion of India’s population still remains devoid of access to even basic formal credit facilities, SFBs can grow hand in hand with commercial banks.
About the Author
Rajan Sundaram is a banker with more than 3 decades of experience with Canara Bank. Earlier, he was a faculty with Canara Bank, specializing in the area of Credit, Risk Management and Legal & Recovery. He has also been AVP (Credit Analyst) with Wells Fargo.
A holder of MBA (Finance) and PG Diploma in Human Resources Management from IGNOU, Rajan Sundaram has been Academic counsellor for the MBA Program at IGNOU and guided students for their MBA projects. He has taught papers on Statistics for Management and HR for IGNOU. Sundaram has also taught papers on Trade Finance and Quality Management at B Schools. Apart from academic teachings, he is a freelance trainer on credit and soft skills programs.
Furthermore, he contributed articles to Canara Bank House Magazine and Vinimaya a publication from NIBM Pune. He has presented research papers at Management Development Institute (MDI), Gurgaon and other colleges. Currently, he is serving as a faculty of Banking in Manipal Global Academy of BFSI.