Last Updated : Nov 28, 2018 05:18 PM IST | Source:

RBI listing diktat: Should you avoid or buy small finance banks?

Both Equitas and Ujjivan are at a vantage position to capitalise on the weak competitive environment due to the comatose state of most public sector banks and the challenging funding environment for non-banking finance companies.

Madhuchanda Dey

Equitas Holdings and Ujjivan Financial Services, the erstwhile microfinance lenders that got converted into small finance banks (SFB), had a rocky start to their innings post-demonetisation as bad loans soared. Just when they were emerging out of this mess, sentiment took a big knock with the Reserve Bank of India (RBI) refusing to waive-off key licensing norms warranting them to list their SFBs.

What spooked the market about these stocks?

The central bank has asked Equitas and Ujjivan to comply with its small bank licence norms, which require them to list banking subsidiaries within three years and maintain minimum promoter shareholding in the bank (at least 40 percent) for a period of five years from the date of commencement of their business.

As a result, Equitas’ SFB has to be listed by September 4, 2019 and 40 percent promoter shareholding will have to be maintained till September 4, 2021. Ujjivan will have to list its SFB by January 31, 2020 and maintain promoter shareholding until January 31, 2022.

While this restriction is indeed disappointing for shareholders of the holding company, which has no business of its own, both entities are working at ways to protect the interest of investors. This could be partially mitigated by distributing up to 60 percent shares of the SFB to existing shareholders of the holding company.

In the past six months, Equitas and Ujjivan stocks have corrected close to 33 percent and 44 percent, respectively, at a time when the operating environment was improving.

Strong Q2 FY19 performance

In the quarter gone by, Equitas’ profits grew 4.6 times to Rs 49.7 crore, driven by a 22 percent growth in net interest income, strong surge in fees and well contained costs. For Ujjivan, the profit picture was encouraging too, with the company reporting an after-tax profit of Rs 44.3 crore as against a loss in the year-ago quarter on the back of healthy 41 percent growth in net interest income and a steep decline in provisions.

Robust business growth

The superlative performance was backed by strong business growth. For Equitas, assets under management grew 36 percent to Rs 9,980 crore, led by a 55 percent growth in non-micro finance portfolio that now stands at 73 percent. While the non-microfinance portfolio grew 2 percent YoY, sequential growth in this portfolio has picked up. In Q3, disbursements grew 56 percent to Rs 2,171 crore.


Ujjivan saw a 25 percent growth in AUM to Rs 8,317 crore on the back of a 15 percent growth in microfinance and 252 percent surge in non-microfinance book (which constitutes 12 percent of its total portfolio). Disbursements grew 22 percent to Rs 2,383 crore driven by the non-MFI book, which is a conscious diversification strategy by the management.


Asset quality improving

The asset quality pain that had aggravated post-demonetisation has been showing signs of improvement. For Equitas, asset quality norms was changed to daily as against the erstwhile practice of month-end recognition. Without this change, gross non-performing assets (NPA) improved sequentially to 2.73 percent from 2.84 percent. However, on a daily basis it rose to 3.36 percent. Ujjivan saw its gross NPA decline to 1.9 percent from 2.7 percent QoQ, while net NPA was stable.

Protecting interest margin

Both Equitas and Ujjivan managed to improve their interest margin sequentially: Equitas to 7.77 percent from 7.2 percent, whereas for Ujjivan it rose to 11 percent from 10.7 percent. The improvement in liability profile is key to an improvement in interest margin.

Changing liability mix – the key to profitable growth

For Equitas, deposits form 49 percent of total borrowings, with share of low cost current and savings account (CASA) at 35 percent. Compared to the year ago quarter, while yield on advances has fallen, despite rise in cost of borrowings in the system, cost of funds has declined.

For Ujjivan, the share of deposits in total borrowings stood at 49 percent, with the share of core deposits (excluding Certificate of Deposits) at 36 percent and low cost deposits at 12.5 percent. Consequently, the cost of borrowing has declined YoY.


The diversified funding profile of these small finance banks, with increasingly lower reliance on wholesale funding, should insulate these entities in the prevailing difficult funding environment. Both the entities are well capitalised as well.

Better sweating of assets should pare down the cost-to-income ratio

Equitas is almost at the fag end of its network expansion. In the future, as it continues to sweat its assets, a moderation in the C/I ratio should be expected. Ujjivan is still on an expansion spree and expects drastic reduction in C/I ratio on the back of its aggressive growth plans (over 30 percent).


While RBI’s insistence on listing the SFB would remain a medium term dampener, we see improvement in the operating environment and hence earnings traction. Both Equitas and Ujjivan are at a vantage position to capitalise on the weak competitive environment due to the comatose state of most public sector banks and the challenging funding environment for non-banking finance companies. We see long term value in the stock prices in the current depressed sentiment towards these stocks. Long term investors can gradually accumulate these stocks.


First Published on Nov 28, 2018 03:34 pm
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