With banking foray, micro finance institutions to dilute foreign ownership

Micro finance companies, which recently received the regulatory nod to float small finance banks (SFBs), may be forced to dilute stake held by foreign firms. They may look at an initial public offering (IPO) route.

According to a senior official of micro finance institutions network (MFIN), small finance banks will need to raise domestic capital. "As non-banking finance companies (NBFCs), 100% foreign direct investment was permissible.

But now, when they comply to become SFBs, they will have to comply with the Reserve Bank of India (RBI) regulations, where they have to peg the foreign shareholding at 60% and domestic promoter shareholding, 40%."

On the other hand, the advantages are that the small finance banks will be scheduled, which means that they can get government business, unlike the Regional Rural Banks (RRBs), which are not allowed to participate in such business. They will also be allowed to diversify their lending to non-rural or the centre of their choice. Considering their expertise in rural lending, spreading to urban centres where commercial banks have a much stronger hold may be a big challenge.

The MFIN official said, "One of the routes these companies may explore may be an IPO to raise domestic capital. To comply with the RBI regulations, they will have to raise massive amounts of capital. They may also float holding companies, which will hold the small finance bank as a subsidiary."

The shareholding of domestic promoter entities is required to be at least 40% (26% if already diluted below 40%). In most of the entities, the promoter holding is already below 26%.

India Ratings said in a report, "They have also issued compulsorily convertible preference shares with variable conversion terms, which could further dilute their holding unless they infuse equity. Thus, the 10 players could be required to replace Rs 20,000 crore of bank loans and at an aggregate net worth of Rs 4,700 crore, they will need to raise equity of Rs 1,500 crore to Rs 2,000 crore and tier 2 capital of around Rs 1,000 crore to Rs 1,500 crore by FY18."

The rating agency expects the most potential SFBs to follow the holding company structure. The SFB, according to India Ratings, could be a subsidiary of the SFB license holder (with the RBI approval). Further, SFBs' NBFC subsidiaries could be merged with the small bank itself.

The other big challenge is to bring down the lending cost from the over 20% they currently charge their customers by at least 100 to 150 basis points, to be on par with the banks. They also have to keep aside about 4% of their capital as cash reserve ratio with the RBI and another 21.5% as statutory liquidity ratio to be invested in government bonds with the start of banking operations.

Religare, a brokerage, said in a report, "The market consensus is that a shift in focus due to the compliance with regulatory norms and building a liability franchise may result in slower growth for licence winners (SFBs), in turn benefiting rival NBFC-MFIs in the short term. However, our interaction with SFBs suggest that they have well-built MIS and technology platforms in place for smooth conversion into a bank. At the same time, most players acknowledged that they cannot replicate the liability franchise enjoyed by private sector banks in India, and hence, they have factored in very reasonable estimates for building a CASA and retail deposit franchise. In addition, it will be difficult for them to slow down loan growth given the large equity dilution required."

The selected entities include eight firms already operating as micro finance institutions, a local area bank and one commercial vehicle financier. SKS Microfinance, the biggest and the only listed MFI, could not secure a license.