The Reserve Bank of India (RBI) has raised concerns over Small Finance Banks (SFBs) due to increasing asset quality stress and high concentration risks. The central bank has advised these banks to consider mergers as a strategy to achieve greater scale and reduce concentration risks, according to a report by ET, citing three executives familiar with the matter.
“Small Finance Banks are under close scrutiny by the RBI. Mergers between banks are one of the options being considered at the regulatory level to address these concerns,” said one of the sources. The RBI reportedly held a meeting with the management of these lenders a few months ago, where issues such as gaps in corporate governance and succession planning at some SFBs were also highlighted as areas of concern.
SFBs with a significant share of microfinance loans are facing the most challenges, as the microfinance sector has seen a sharp rise in non-performing assets (NPAs). At the end of September 2024, the average gross NPAs in the microfinance sector reached an 18-month high of 11.6%, with SFBs reporting 15.3% of their microfinance portfolios as NPAs. While industry-wide data for December 2024 is not yet available, quarterly earnings suggest that the overall asset quality of the sector is likely to deteriorate further.
The risks to SFBs are twofold:
- High exposure to the stressed microfinance sector.
- Concentration in geographic regions with higher stress levels.
Executives suggest that these challenges could be mitigated through mergers—either between SFBs or with larger entities that have stronger capital backing. “Mergers between banks operating in different geographies could help address concentration risks,” a senior microfinance expert told ET.
Earlier, the RBI had announced the formation of a Standing External Advisory Committee (SEAC) to evaluate applications for Universal Banks and Small Finance Banks. The committee, supported by the RBI’s Department of Regulation, will assess proposals and provide recommendations to the central bank.
The RBI’s push for consolidation reflects its focus on ensuring the stability and sustainability of SFBs, which play a critical role in financial inclusion but are currently grappling with significant operational and financial challenges.
