Microlenders' new avatar as small banks can be a game changer for rural customers

As the extended deadline to apply with the Reserve Bank of India (RBI) for small finance banks and payments banks licences expires today (2 February), many non-banking finance companies (NBFCs) are set to throw their hat in the ring. Among the companies that would throw their hat in the ring for small finance bank licences are microlenders SKS Microfinance and Bangalore-based Ujjivan Financial Services Pvt Ltd and housing loan lender, Dewan Housing finance. Some of these companies are likely to walk into the RBI with their applications on the last day. Microlenders will benefit hugely by becoming small finance banks since they can then access public deposits, which would substantially bring down their cost of funds. Under norms, small finance banks can operate in all areas of a commercial bank but in a smaller scale including offering credit, while payments banks cannot offer loans. [caption id=“attachment_2074575” align=“alignleft” width=“380”] The RBI’s extended deadline to submit application for licences to operate small finance banks and payment banks expires this week. Reuters[/caption] Until now, MFIs aren’t allowed to accept deposits. They mainly source funds from commercial banks at 12-14 percent and onlend to the customer at about 26 percent or even at a higher rate. Once they become banks, they can tap public savings and lower their dependence on bank finance. At the same time, converting to small finance banks wouldn’t dilute the character of MFIs since the RBI has clearly stipulated that the mandate of small finance banks will be to operate among the lower end of the customer. At least 75 percent of their total credit must be lend to the priority sector (agriculture, exports, small housing and other economically weaker sections). Microlenders witnessed a phase of crisis in 2010 in the aftermath of a controversial law promulgated by the erstwhile Andhra Pradesh state government. These companies went through a correction phase in the following years. The crisis had forced MFIs to change the way they conducted the business. Some stability returned to the sector after the RBI had come with guidelines to govern such companies. In the aftermath of the crisis, many smaller microlenders had to shut shop, while even some of the big NBFC-MFIs based in Andhra Pradesh had to go for massive loan recasts to stay afloat in the business. Since then, these entities haven’t fully recovered from the impact of the crisis. In this backdrop, becoming a small finance bank is a golden opportunity to access public deposits, by tapping their existing customer base. This will help them significantly lower their borrowing costs, and engage in businesses focused on small and medium enterprises and lower end of the retail customer base. Once these firms enter the banking industry, logically, the bigger commercial banks will face intensified competition in the cheaper deposit and small-value loan market. This, in turn, will be good for the common customers in rural segments since the fresh competition will force banks to offer loan, deposit products at more competitive rates. This time around, it is quite likely that the number of new set of banks will be much higher than the last time when the RBI issued full-service banking licences to IDFC and Bandhan Microfinance, unless the RBI wants to keep the bar very high. Both for the existing banks and for small customers, the entry of new set of banks will certainly be a game changer.