SFBs may go all out to raise capital in FY24, say CareEdge Ratings

Small Finance Banks (SFBs) are likely to continue to raise capital in the coming quarters as they strive to comply with regulatory requirements and fund credit growth, CareEdge Ratings has said in a report.

SFBs have to restrict their operations to the unserved and underserved by expanding credit to these sections of the population, thereby enhancing financial inclusion. Their target customers are unorganised workers, small businessmen, small farmers, as well as micro, small and medium enterprises. Commercial banks, on the other hand, do not have restrictions on the customers they need to serve.

Capital raising among these lenders gained momentum in the July-September period, according to the report released on October 31.

During the quarter, SFBs raised equity and Tier II capital aggregating to Rs 3,275 crore, whereas in the preceding quarter, there was not a single instance of fundraising, the report said.

“To achieve a growth rate of 30 percent CAGR during FY23-FY24, most of the SFBs need to mobilise capital,” the rating agency said. “Considering 2 percent cushion over regulatory capital requirement and 30 percent CAGR growth, SFBs would require to raise fresh capital of Rs 4,000 crore during FY23-24,” the CareEdge Ratings analysis said.

Regulations allow SFBs to raise Tier II capital to the extent of 100 percent of Tier I capital. However, the proportion of Tier II capital is significantly lower for the industry currently.

The Tier I capital adequacy ratio (CAR) stood at 18.7 percent for the industry as on March 31 whereas Tier II CAR stood at 1.9 percent, according to CareEdge.

The rating agency noted that capital-raising remains a key challenge for SFBs in the backdrop of the deferment of initial public offerings in FY22 and the April-June quarter this year. This is largely due to the unfavourable equity market sentiment and the moderate performance of SFBs in FY22, it added.

The current level of capital would be adequate to expand the book 15–20 percent for many of the SFBs, the rating agency said. It expects a number of SFBs to report advances growth below the industry level in FY23 unless capitalisation improves.

According to Venkatakrishnan Srinivasan, founder and managing partner of Mumbai-based debt advisory firm Rockfort Fincap, besides mobilisation of fixed deposits and certificates of deposit, SFBs will be “desperate” to raise Tier 1 and Tier 2 capital to fund credit growth. However, capital raising through these instruments may not be a smooth affair due to lacklustre investor demand, Srinivasan said.

“Unfortunately, post Yes Bank and Laxmi Vilas Bank’s Tier 1 and Tier 2 bond writeoffs by the Reserve Bank of India (RBI), investor demand is primarily skewed into the top 8-10 banks’ bond issuances,” said Srinivasan.

“Other private banks are yet to gain investor confidence and investment interest, especially SFBs, which still hold more microfinance portfolios in their books,” he added.

SFBs, according to Srinivasan, will wait for a few investors to back them before testing the waters. It is more likely that these banks will prefer to tap funds through the equity markets first rather than bonds, he said.

Due to the Covid-19 pandemic, most SFBs witnessed an increase in slippages and credit costs amid high loan-loss provisions and writeoffs. The asset quality of SFBs was also impacted over the last two years due as Covid-19 lockdowns exacerbated the slowdown that had already hobbled the economy.

Among the various lenders, besides microfinance institutions (MFIs), SFBs were more severely impacted due to their exposure to the relatively weaker borrower segment. Moreover, SFBs with larger exposure through their unsecured loan book were impacted relatively more severely.

According to the CareEdge report, SFBs’ share of MFI loans declined from 41 percent of advances as on March 2018 to 33 percent as on March 2022 and the share of secured loans increased from 44 percent to 56 percent over the same period. While the percentage of MFI loans is lower at the aggregate level, many SFBs had higher exposure to MFI loans in FY21 and FY22. This had adversely impacted the asset quality and profitability in FY21 & FY22 due to the impact of Covid, the report noted.

“Most SFBs have an MFI-heavy portfolio (relatively weaker and more vulnerable customer franchises), resulting in severe asset quality issues, high credit costs, and elevated stress pools (restructured portfolios),” said Krishnan ASV, institutional research analyst, BFSI, at HDFC Securities.

Krishnan noted that with SFBs’ collective market share at just over 1 percent, there is a tendency to have higher growth aspirations compared to the system. Hence, there will be a simultaneous need for clean-up capital and growth capital, especially at a time when internal accruals are weaker than normal, he said.

SFBs typically do not have a bigger cushion of cheaper current account, savings account (CASA) deposits. Hence, they offer higher rates to mobilise fixed deposits (FDs) to raise funds and meet credit demand.

SFBs will have to continue to offer high FD rates as interest rates are rising and liquidity in the banking system is drying up, bankers and analysts told Moneycontrol.

“SFBs are a niche category within the banking system. We have to offer lucrative rates on deposits and savings accounts, which are much higher compared to mainstream commercial banks, even if we have to take a margin hit,” said the managing director of a small finance bank, requesting anonymity.

Analysts said that SFBs are increasingly looking to diversify into secured longer-tenure assets such as vehicle loans, loans against property and housing loans. Given the impending change in the asset mix that SFBs are driving towards, they may now need to build up longer-term deposits, they added.

“We expect SFBs to face steeper pricing pressure on the deposit side, especially in an environment where there is a scramble for deposits even by larger banks,” said HDFC Securities’ Krishnan.