Small Finance Banks: Risks and Challenges of Transformations of MFIs/NBFCs

This focus note highlights the key challenges and potential deal breakers that Indian MFIs and non-banking financial companies (NBFCs) are likely to face while graduating into small finance banks (SFBs). The concept of SFBs was introduced in India in November 2014 as a new banking entity to cater to the needs of two target segments: low-income households and micro and small enterprises. The note suggests that transformation to SFB entails changes in the business model, organizational structure, capital structure, product suite, and other characteristics of MFIs/NBFCs which are likely to lead to challenges. Some of these challenges can be deal breakers as many MFIs/NBFCs are not in position to fulfil these requirements. Key challenges highlighted in the note include:

• MFIs/NBFCs will have to bear the incremental cost of infrastructure, human resources, and organizational transformation;
• SFBs will have to compete with established public sector and regional rural banks;
• SFBs will have to make rapid progress in developing their ability to attract and manage savings for their liabilities;
• Guidelines put a cap of 74% foreign ownership in SFBs but many MFIs/NBFCs have more than 75% foreign equity;
• MFIs/NBFCs will have to undergo massive organizational changes requiring comprehensive and efficient change management processes.