While small finance banks (SFBs) have been building their deposit base by providing relatively higher interest rates, building up 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 as against a CAGR of 11% for banking sector deposits. SFBs deposit share of the overall banking industry has improved over the past few years although the proportion is relatively smaller.
The strong focus on building a liability franchise comparable to that of universal banks and the relatively higher rate of interest offered to depositors have resulted in SFB deposits growing faster than the banking industry.
With the credit cost worries behind and access to capital, the SFBs are poised for a strong growth period.
CareEdge Ratings expects SFB advances and deposits growth of 22-25% and report stable profitability with return on total assets (ROTA) in the range of 2.1% to 2.4% for FY24.
Whle the sector has recently witnessed announcements of a couple of mergers for inorganic growth, these are event specific and CareEdge Ratings do not envisage any major consolidation in the industry.
Deposit mobilsation
As most of the SFBs transitioned from being NBFCs, SFBs faced the challenge of mobilisation of deposits; however, SFBs have done a commendable job of building their deposit franchise by setting up liabilities-focused branches.
The Credit to Deposit (C/D) ratio has fallen over a period of time as SFBs replaced borrowings with deposits. The CASA deposit ratio for SFBs continues to trail behind the banking sector.
As of September 30, 2023, certain small finance banks exhibited notably 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 been expanding their franchise continuously with a number of branches growing at a CAGR of 29% since March 2018. The branches are well spread out 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 larger exposure to unsecured loan books were more severely impacted 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 credit cost was highest as SFBs undertook write-offs with all SFBs posting a fall of profits with few even reporting losses. With the resumption of economic activity post Covid the situation started improving in FY23 with all SFBs showing improved net interest margin (NIM) thanks to rate hikes announced by RBI (FY23: 7.5% vs FY22: 6.9%) and lower credit costs as the asset quality showed improvement (FY23: 1.3% vs FY22: 2.4%) with fall in incremental delinquencies translating into superior ROTA.
The improvements continue even in FY24 (YTD) for SFBs with NIMs holding up despite an increase in deposit rates, fall in credit cost and ROTA improvement as demonstrated in H1FY24 results.
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