New banks: raising low-cost deposits will be a challenge

After being granted ‘in-principle’ approval to set up a bank over a year ago, Bandhan Financial Services received its final approval from the RBI on Wednesday to start operations as a full-fledged bank in August.

Infrastructure Development Finance Company (IDFC), a leading lender in the infrastructure space, the other entity that bagged the banking licence from the RBI, will also transition itself into a bank soon.

The real challenge for these new players lies in raising retail deposits, and not growing their loan book. Here’s why.

The two entities that have been granted licences have niche businesses, catering to a specific segment or customer base. Bandhan, for instance, is the largest microfinance institution in the country. There is a huge potential for MFI business in India.

According to Microfinance Institutions Network (MFIN), the total gross loan portfolio of MFIs stood at a little over ₹40,000 crore, a growth of 61 per cent over the previous year. Bandhan’s market share is over a fifth, and the company grew its loan book by 56 per cent in 2014-15 over the previous year. The company is present in 22 States and has over 2,000 branches, which it plans to ramp up. Given that Bandhan will continue to focus on the micro-lending space for now, growth will not be a challenge.

Further, the company is a key player in West Bengal; the share of the eastern region in the total MFI loan portfolio is about 28 per cent, with West Bengal among the top five States.

The company’s loan ticket size is ₹21,886, which is the highest among other MFIs, barring one. By scaling up its loan size alone, the company will be able to tap additional opportunities with its existing product offerings.

IDFC is also a market leader in the infrastructure space. While challenges in this segment in the last two years have significantly impacted the company’s pipeline of loans, it is well-placed to benefit from an improvement in the investment cycle over the next one to two years. Moreover, after becoming a bank, the company will gradually be able to reduce its reliance on infrastructure.

For growth, therefore, there is scope enough for both new and existing banks. But when it comes to funding, both the new players will have a tougher road.

Take Bandhan. MFIs currently depend on banks for their funding needs, which is an expensive option. Banks lend at 12-13 per cent interest to MFIs, which in turn lend at over 20 per cent to their clients. So, if Bandhan has to lower its lending rate and compete with banks, it will have to quickly ramp up its low-cost retail deposit base.

For IDFC too, the company’s profitability in the near term will be impacted owing to the costs involved in meeting the statutory requirements of a bank and branch expansion. Incremental benefits of low-cost deposits (along with claiming exemptions from regulatory requirements on funds raised for long-term infrastructure projects) can help cushion the erosion in the company’s profitability.

But garnering a slice of the low-cost deposit pie will be a challenge for new players. There is already a scramble for such deposits within the banking sector.

Over the last decade or so, private banks have been able to gain market share in the low-cost CASA (current account, savings account) deposits, eating into the share of public sector banks.

For this reason, new players will find it difficult to scale up their deposit base in the near term. Aggressive branch expansion to widen the deposit base will mean higher costs and lower profitability.

Kotak Bank and YES Bank were awarded licences over a decade earlier and have taken this long to ramp up their CASA deposits to 36 and 23 per cent, respectively. They were also able to take advantage of deregulations in savings deposit rates in October 2011.

In comparison, HDFC Bank and ICICI Bank have CASA ratio of 44-45 per cent.

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