Mumbai: Small finance banks (SFBs) could require up to Rs60,000 crore of non-equity funding by 2019-20 assuming 25% growth in both steady state loans and off-balance sheet loans, according to an India Ratings and Research report released on Wednesday. Off-balance sheet loan portfolio includes pass-through certificates and loans acquired through the business correspondent route. Steady state loans are the ones which the lender gives on its own. Non-equity funding comprises deposits, debentures and warrants.

Small finance banks would initially ramp up their deposits through wholesale funding at rates higher than those of commercial banks and gradually replace them with granular retail deposits, the report noted.

As these banks will offer term deposit rates of 8-10%, they will save nearly 200 basis points (bps) on borrowing cost, because as microfinance companies, their borrowing cost was 10-13%, the agency said.

The savings can be used to cover higher compliance cost and cost of carry for statutory liquidity investments, India Ratings added.

Since most of the deposits raised by small finance banks are of 1-1.5-year tenure, while borrowings are for an average maturity of 1.5-2 years, it will result in a negative short term asset funding gap and increase refinancing pressure in the medium to long term, it said.

However, these banks will find it challenging to raise debt funds from the capital market, the report noted.

Since 98% of the bond market is dominated by instruments rated ‘A1+’ and ‘A+’ and above, small finance banks will find it tough to finance through bonds since most of them are rated ‘A+’ and below, the report noted.

India Ratings expects small finance banks with strong operating and capital buffers, respectable boards, high standards of corporate governance and steady operating strategies to access capital markets with relative ease.

Among non-housing non-banking finance companies (NBFCs), debt mutual funds have invested about Rs12,000 crore (end-July 2016 in same rating categories) and only a part of it may be allocated to microfinance companies, the agency said.

“Although development financial institutions can continue to subscribe to capital instruments of small finance banks and NBFC-MFIs, the potential could be lower than the absolute requirement," India Ratings said.

The rating agency believes small finance banks who are unable to raise adequate deposits or debt capital funding can use priority sector lending certificates to offset the impact. While the certificates may not help in terms of liquidity, they can boost return on assets up to 0.6% of managed assets.

Microfinance Institutions (MFIs) and small finance banks will easily have a 30-40% share of the Rs1 trillion off balance sheet portfolio of scheduled commercial banks by financial year 2020, the rating agency said.

Ten companies received in-principle approval to start small finance banks from the Reserve Bank of India (RBI) in September 2015, with an 18-month deadline to start operations. Out of the ten entities, eight are microfinance institutions. Among them, only Equitas Small Finance Bank has started operations so far.

According to the RBI guidelines issued in November 2014, the objective of a small finance bank is to boost financial inclusion by offering credit to small business units, micro and medium enterprises. The guidelines state that 75% of their loan portfolio must go towards the priority sector and at least half of the loans will be below Rs.25 lakh.

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