Small Finance Banks (SFBs) faced significant challenges in attracting Foreign Currency Non-Resident (Bank), or FCNR(B), deposits despite offering interest rates 50-100 basis points higher than those provided by larger universal banks. A recent report by Crisil Ratings indicates that SFBs accounted for less than 1% of the total FCNR(B) deposits mobilised during a recent drive, underscoring the funding difficulties these smaller lenders encounter.
The FCNR(B) Challenge for Smaller Lenders
Traditionally, SFBs have built their deposit bases by providing comparatively attractive interest rates, which has helped them secure a substantial retail deposit presence. Retail deposits now constitute over 70% of their total deposits. However, the recent FCNR(B) mobilisation initiative demonstrated that competitive pricing alone is often insufficient to attract funds from non-resident Indians.
Universal banks were better positioned to mobilise these deposits, leveraging their extensive scale, broader range of product offerings, and well-established international presence. In contrast, SFBs primarily competed by offering elevated rates, a strategy that failed to translate into a meaningful share of the FCNR(B) inflows. This outcome points to a structural disadvantage for smaller lenders as they attempt to diversify their funding sources beyond conventional domestic deposits.
Implications for Profitability and Funding Costs
The struggle to attract cost-efficient foreign deposits has direct implications for the profitability of SFBs, particularly as they gradually shift their portfolios beyond microfinance into secured and generally lower-yielding asset classes. Crisil Ratings projects the sector's net interest margins (NIMs) to recover to 7.1–7.3% in FY2027, up from approximately 6.2% in FY2026, aided by reduced microfinance stress and fewer interest income reversals.
However, sustaining these improved margins hinges on how efficiently banks manage their liabilities, specifically the cost of the funds they raise. While higher deposit rates can attract customers, they also inflate funding costs, potentially eroding the benefits derived from improved asset quality. This becomes critically important as banks transition towards loan types that typically generate lower yields compared to microfinance advances.
Towards a Sustainable Funding Strategy
According to Crisil Ratings, the next phase of growth for the SFB sector will depend less on immediate earnings recovery and more on its capacity to maintain profitability through various credit cycles. For SFBs, this necessitates developing deposit franchises that rely on more than just interest-rate competition.
Improving funding efficiency will be paramount as these lenders strive to balance deposit mobilisation, portfolio diversification, and asset quality. The FCNR(B) experience serves as a clear illustration of this challenge: while smaller banks may offer superior rates, effectively competing with universal banks demands substantial scale, a comprehensive suite of products, and access to established overseas customer networks.