This small finance bank might be the next AU SFB

Here's how Equitas SFB transitioned from a microfinance institution into a diversified bank

Equitas SFB: This small finance bank might be the next AU SFB

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From starting out as a microfinance lender in 2007 to now being the second-largest small finance bank (SFB) by market cap, Equitas Small Finance Bank 's journey hasn't been a one-way street. Before the company obtained a licence in FY17 to operate as an SFB in India's highly regulated banking sector, it faced many hiccups, including the microfinance crisis of 2010.

The crisis engulfed the industry as a result of over-indebtedness, poor loan recovery practices and subsequent suicides of borrowers in Andhra Pradesh. The upheaval forced Equitas SFB to diversify its loan book. It gradually ventured into small business loans and vehicle and housing finance.

Later, its transition from an NBFC to an SFB proved to be a shot in the arm, allowing the company to offer customers a wide range of products, an advantage not available to traditional microfinance institutions.

Cut to the present day, in terms of business fundamentals, the company is now close to joining ranks with the only large-cap SFB in India— AU SFB — thanks to its sharp downsizing of unsecured assets (microfinance loans).

Let's dig deeper and find out what has changed for Equitas since becoming a small finance bank.

Rising pie of safer loans

Nearly all existing SFBs in India, which previously operated as microfinance institutions, continue to have significant exposure to microfinance loans that, albeit, earn higher yields (i.e., net interest margin) but carry equally higher risks. (high bad loans during economic downturns).

Lending on thin ice

SFBs and their exposure to microfinance and unsecured loans

SFBs Microfinance exposure (%) Total unsecured exposure (%)
Top Tier:
AU SFB 0 9
Capital SFB 0 0.15
Equitas SFB 18 18
Bottom Tier:
Ujjivan SFB 57 73
Utkarsh SFB 63 66
Suryoday SFB 59 59
Jana SFB 43 43
ESAF SFB 74 74

However, Equitas has become an industry outlier thanks to its consistent reduction of microfinance loans over many years. In FY15, microfinance comprised 53 per cent of Equitas's total loan book. This has sharply fallen to 19 per cent as of Q3 FY24 as the lender doubles down on diversifying its books.

Joining the top guns

We believe that Equitas has joined the club of a handful of SFBs, like AU and Capital Small Finance Bank, with higher-secured assets and stable health. Incidentally, when the microfinance sector experienced a downturn during FY21-22 due to Covid-19, AU SFB and Equitas were the only players in the industry that managed to keep their return on assets and gross NPA ratios steady.

On all measures like loan growth, asset quality, growth and profitability, Equitas SFB is only moving closer to AU SFB. However, there remains a significant gap in the valuations of the two.

Healthy low-cost deposits

Equitas' growth as an SFB has also been due to its access to low-cost funds in the form of CASA (current account and savings account). This gave it an edge over NBFCs, which cannot raise deposits. The lender's advances and deposits have grown at an annual growth rate of 28 and 35 per cent, respectively, from FY18 to FY23. Its retail deposits, especially, were boosted due to digital initiatives taken by Kotak Mahindra Bank veteran Murli Vaidyanathan, whom Equitas poached as Country Head - Branch Banking - Liabilities.

A word of caution

While the company's growth fundamentals are on an upswing, investors should take note of the risks involved in the business.

  • Heat from large banks: With its large base of advances and deposits, the company competes not only with SFBs but also with large commercial banks, which have significantly lower costs of funds than SFBs.
  • Geographical concentration : The bank is highly dependent on Tamil Nadu, with 50 per cent of its loan portfolio coming from this state alone as of Q3FY24. As a result, its NPAs have also slightly increased owing to the heavy floods in the state.

Also, this is not a stock recommendation. Do the due diligence before investing.

Also read: What drove the recent recovery of small finance banks?

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