A Look at Small Finance Banks of India and Their Major Problems

Shares of Ujjivan Small Finance Bank Ltd., AU Small Finance Bank Ltd. and Suryodaya Small Finance Bank Ltd. were the biggest losers in FY22. Shares have lost 34%, 7.4% and 21%, respectively, since April. Equitas Small Finance Bank Ltd shares have remained largely flat, barring any missteps on governance.

AU Small Finance Bank and Ujjivan Small Finance Bank are under the scanner over governance concerns. The quick exit of key executives from management has left investors uneasy, especially when there are expectations that the stress on the balance sheet will only increase. In the former case, the chief risk officer’s exit raised eyebrows. Last month, Ujjivan Small Finance Bank CEO Nitin Chugh resigned after several other mid-level exits. Chugh’s exit came at a time when the bank was grappling with a surge in bad loans in the wake of the pandemic.

In a note dated 23 August, analysts at Emkay Global Financial Services Ltd said: “In our view, apart from the poor performance of the bank, there are some minor problems with the old management and their inconsistent newness in the still MFI-dominated old school bank.” The management style of the era, could have contributed to the resignation as well.”

While these concerns are valid, the big trouble for lenders is the sharp fall in credit growth since the pandemic hit last year. “These banks are in a tight spot due to the pandemic. The pressure to grow the balance sheet is immense, but at the same time, high attrition levels are certainly a big concern,” said an analyst requesting anonymity.

As the attached chart shows, small finance banks have seen a sharp decline in credit growth over the past few quarters as compared to the broader performance of the industry. The pain on asset quality has made it worse.

For example, Ujjivan’s stressed loan book, which includes bad and restructured loans, accounts for about 30% of its total book. AU Small Finance Bank’s gross bad loan ratio rose to 4.3% as of June. Suryoday Small Finance Bank’s default loan was 9.52% of its book. Analysts said that given that lenders serve the most vulnerable sections of borrowers, the tension is unlikely to ease immediately.

This brings us to the strategies for the development of small finance banks. Most lenders have capital ratios far higher than regulatory requirements and therefore may not require a fundraising exercise. That said, small finance banks are looking at various alliances and avenues to boost growth.

According to media reports, Suryoday Small Finance Bank is exploring the possibility of merger with non-banking financial company Clix Capital. The immediate result of the merger is an increase in the size of the balance sheet for Sunrise and expansion in non-micro loans. Another benefit would be a reduction in the gross bad debt ratio to the current 9.5%. A 20 per cent jump in the bank’s shares on Monday indicates that investors consider the merger profitable.

Since organic growth seems to be a slow and difficult path, the inorganic route may seem beneficial. For now, driving valuations from business growth seems like a longstanding question.