Considering the huge unsecured microfinance loans on their books, the small finance banks (SFBs) are in no hurry to become universal banks.

The 11 SFBs that operate in India are not going to rush in with applications for a universal banking licence, bankers say. It may at best take another year for the first application to reach the regulator. 

However, the Reserve Bank of India’s (RBI) latest guidelines that allow on-tap licensing have provided SFBs a road map to transition to a universal bank. 

The industry CEOs say that they would strengthen their balance sheets before progressing on this path. Unless they do this, the regulator would be cagey about them transitioning to a universal bank. This decision to wait is despite them having completed seven years in operation and having a net worth of over Rs 1,000 crore.

“As per the criteria laid out by the RBI, we are eligible. But we have just completed the reverse merger. So, we need to consider the decision to transition to a universal bank carefully. The board will consider the time frame for such a conversion in the current financial year,” Ujjivan SFB managing director and CEO Ittira Davis told www.indianbankingnews.com in an interview.

Technically, Ujjivan SFB is qualified to apply for a universal banking licence. “Our gross and net NPA (non-performing asset) ratios were at 2.1% and 0.3 %, respectively, for the year ended March 2024. For the previous year, these were at 2.6% and O.4 %, respectively,” explained Davis.

Ujjivan, however, would prefer to have a more balanced loan portfolio before becoming a universal bank. The Bengaluru-headquartered SFB is working on bringing down its unsecured loans from 70% to 60%. Since it has a grip on affordable housing loans, the bank believes it can leverage on this to push up the secured loan component from 30% to 40%, along with the help of MSME (micro, small and medium enterprises), vehicle and gold loans.

Many of the SFBs have over 60% of the loans in the microfinance sector which are unsecured. Their plan is to consolidate their balance sheets and bring down the unsecured loans before they transition to the next phase of growth.

“For those SFBs who have not started the journey of bringing down their unsecured loan book, it will take a little bit longer and also get difficult. It took us six years to bring down our microfinance loans to 60% of the total credit book,” Jana Small Finance Bank managing director and CEO Ajay Kanwal told www.indianbankingnews.com.

Suryoday Small Finance Bank has already started the journey in diversifying its loan portfolio. “We have managed to get 60% of our loans in the non-microfinance sector. By next year this book will rise to 65% of our total loans,” said Suryoday SFB managing director and CEO R Bhaskar Babu. 

Some of the SFBs will be technically eligible to voluntarily transition to a universal bank in a year’s time. “By allowing on-tap licensing for SFBs, the RBI has provided a road map for us. If an SFB has kept its gross NPA below 3% or net NPA below 1% for two consecutive years, then it is technically eligible to apply for a universal bank licence,” said Kanwal. 

AU Small Finance Bank meets all the criteria to transition to a universal bank but has held back its plans as it wants to fully focus on a smooth integration with Fincare SFB. Others such as ESAF SFB, Capital SFB and Shivalik SFB don’t meet the RBI’s asset-quality criteria yet.

Though not a single SFB is ready to hop on to a universal bank status immediately, the RBI’s new guidelines has generated a mood of optimism. “The RBI on tap licensing circular is a much-awaited guidebook for the industry. There is now clarity on the milestones we need to achieve before we put in our application. That was needed so that the industry works towards these goal posts,” said Babu.

The focus of most of the SFBs currently is to strengthen their balance sheets and shed some of their unsecured microfinance loans before they become a universal bank. 

As per the RBI's latest report on trends and progress in banking, 11 SFBs with 6,589 domestic branches are operational as of April 2024. The consolidated balance sheet of SFBs has grown faster than that of scheduled commercial banks during FY23, despite some moderation during the year. 

RBI’s conditions and where do SFBs stand

According to the RBI's guidelines, only listed SFBs can qualify for a universal banking licence. The minimum net worth should be Rs 1,000 crore and the SFB should have a scheduled status with a satisfactory track record of at least five years. 

They should also have been profitable, with gross NPA of less than or equal to 3% and net NPA of less than 1% in the last two financial years. They must also meet the prescribed capital adequacy requirements and provide a detailed rationale for their transition.

The RBI will prefer the SFB to have a diversified loan portfolio. Many SFBs like Utkarsh SFB and ESAF have high exposure to microfinance loans.

The asset-quality criteria is also a bottleneck. Equitas SFB has a net NPA of 1.12% as of March 2024 while Shivalik SFB’s stood at 1.2% and Capital SFB’s at 1.40%. The gross NPA of ESAF SFB stood at 4.8% and net NPA at 2.3%.  For the Kerala-based SFB, micro loans account for 70% of their total assets under management (AUM) worth Rs 19,659 crore. This is targeted to fall to 60% by the end of FY27, with agriculture loans accounting for 20% and 20% others, including mortgage, affordable housing loans and gold loans.

Why become a universal bank

By becoming a universal bank, SFBs stand to gain in a number of areas. The cost of funding will be comparatively lower due to customer access. The capital ratio requirement will be lower. 

There will also be no restrictions on lending ticket size, thus allowing access to businesses like corporate banking. 

The SFBs are required to have 50% of their lending to a ticket size below Rs 25 lakh. “This will help us tap into higher ticket size secured loan portfolio,” said Davis.

The priority sector lending requirement for universal banks is at 40% of the net credit, compared to 75% in case of small finance banks.

Though the RBI opened up ‘on-tap’ applications for a banking licence in 2016, not a single one has been given despite five applications being made. On-tap licensing means that the window to submit applications is open throughout the year.