High cost of funds, rapid growth stay concerns for SFBs

Small finance institutions’ asset quality has improved significantly over the past few years, and they have succeeded in reducing some of the initial skepticism regarding their business models. Reserve Bank of India (RBI) and investors are unconvinced, however, due to a multitude of issues including high deposit costs, product concentration, and geographical concentration.

“The entire business model (of small finance institutions) is microfinance- or small-ticket loan-heavy, with bank-like cost structures. If you want to make money at the microfinance level, your cost structures must be microfinance-like rather than bank-like, according to Bhavik Hathi, managing director of Alvarez & Marsal.

Hathi added that many of these institutions’ technology upgrades have taken longer than anticipated, and they have been unable to shed their “original microfinance avatar.”

In November 2014, the Reserve Bank of India (RBI) issued guidelines for small finance institutions with the intent of providing financial assistance to the underserved customer segment.

Small finance banks are subject to all RBI regulations applicable to extant commercial banks, including the maintenance of cash reserve and liquidity ratios.

These banks are required to extend 75% of their adjusted net bank credit to sectors designated as priority sector lending by the RBI.

At least fifty percent of these institutions’ loan portfolios must consist of loans and advances of up to Rs. 25 lakh.

According to experts, these restrictions have made it difficult for small finance institutions to diversify their product lines. The cost of deposits at these banks ranges from 7 to 9 percent, and they compensate for this by lending to subprime segments, which can be hazardous.