How poor rural women drove Bandhan Bank’s spectacular stock market debut

Bandhan Bank, established less than three years ago, is one of India’s newest banks. Still, it just completed a highly successful initial public offering, or IPO, which has put it at the forefront of Indian banking.

In the world of financial services, microfinance institutions, which Bandhan was until the other day, are the country cousins of scheduled commercial banks. Commercial banks are city-based, with large offices and well-known corporates as clients. Microfinance institutions, on the other hand, are based in rural areas; they have modest offices and clients who are mostly poor women vending vegetables or working in factories and as housemaids.

At a time when established commercial banks, public and private, are struggling with varying loads of loans gone sour, Bandhan and other microlenders are thriving. Poor women to whom they provide small unsecured loans of a few thousand rupees at a time almost invariably pay them back. This gives Bandhan and other microlenders incredibly low levels of non-performing assets compared to older commercial banks.

In the 2016-’17 financial year, according to data with the Reserve Bank of India, Bandhan chalked up a net non-performing assets to net advances ratio of 0.36%, rubbing shoulders with the 0.33% of the private sector blue chip HDFC Bank. Of course, both figures are far superior to the 3.71% clocked by the largest Indian bank, the public sector behemoth State Bank of India.

Seeing these figures, the investing public queued up for Bandhan shares, making the issue 14.6 times oversubscribed. This positioned the bank as the eighth most valued in the country, ahead of Bank of Baroda and the scam-tainted Punjab National Bank. Currently, Bandhan’s shares are trading at a higher multiple of its book value than HDFC Bank’s. The newly listed shares ended the financial year trading at 4.2 times the book value – based on earnings estimates for the financial year 2020 – compared to three times for HDFC Bank.

The positive investor perception stems from the fact that Bandhan is highly profitable. On the key measure of return on assets, it scores an industry leading 4.46% when even HDFC Bank, the star performer and leader among private banks, scores just 1.88%. As for public banks, which account for 70% of the country’s banking business, the most robust, State Bank of India, scores a lowly 0.41%.

Bandhan’s profitability comes from and is reflected in its net interest margin, which is the difference between the average cost of funds (what it pays depositors) and the average return it earns from borrowers. This stood at a phenomenal 9.62%; HDFC Bank clocked less than half of that at 4.13% and the State Bank of India trailed at 2.44%.

This is partly for historical reasons. Microlenders typically lent at above 20%. This is high for organised businesses, be they small-scale or large, but a boon to poor microborrowers who would otherwise have to go to moneylenders charging usurious rates.

By becoming a bank, Bandhan has also been able to crash its borrowing costs. As a microfinance institution, it was not allowed to accept deposits and had to rely mostly on borrowing from banks, at the interest rate of around 11%, to finance its lending. Now that it can accept deposits, its cost of funds is going down. Banks pay no more than 5%-6% for their total deposit base.

Bandhan has benefited from the way its deposit mobilisation strategy has worked. In its home area, eastern India, the bank has great brand equity and has opened many branches in urban middle class areas as well. So its need to rely on bank borrowing is negligible, or none at all. It ended 2017 with a deposit base of Rs 25,000 crore, borrowings of Rs 1,330 crore and a loan book of Rs 23,000 crore. Thus, it is earning a fat interest margin even as it is reducing lending rates.

Smart strategising and a bit of luck

Having turned into a bank helped Bandhan greatly when demonetisation came. Other lenders that were still regulated as microfinance institutions could not accept banned currency notes, whereas Bandhan could. When microfinance institutions’ recoveries were severely hit because their borrowers were stranded with banned currency notes, Bandhan could accept old notes and so escaped much of demonetisation’s downside.

What has also benefitted Bandhan and other microlenders is that they were able to control costs in the past. After the microfinance crisis in Andhra Pradesh in 2010, the Reserve Bank of India set an overall 12% ceiling on margins, cut further to 10% for large institutions. This forced microlenders into cost-cutting.

Their front line operational staff are often drawn from the same rural communities as their borrowers and they take far lower remuneration than what the city-bred commercial bank staff would consider essential. Additionally, Bandhan and other successful microlenders have extensively used information technology to cut the intrinsically high costs of servicing a large number of small borrowers. As such, Bandhan’s cost of operating expenses to total assets is as high as 4.09%, compared to 2.46% for HDFC Bank and just 1.84% for the State Bank of India.

But Bandhan’s greatest asset is its connection with borrowers and their loyalty. This is why whenever any crisis has hit loan recoveries, the latest being demonetisation, the recovery rates of such microlenders have rebounded to historical levels. In Bandhan’s case, for example, micro loans still account for 88% of its lending. In contrast, public commercial banks are beset by bad debts and even private banks are not beyond the pale of controversy as revelations about a sweetheart deal between Videocon’s Venugopal Dhoot and the family of ICICI Bank chief executive Chanda Kochhar have shown.

Microlenders have already enhanced financial inclusion to a level that public banks could not and the potential for growth is astronomical. If Bandhan grows at its current rate over the next few years and manages to control costs, it would consolidate its position as one of India’s most valued banks. For a newcomer, that would be exceptional – and it would all be thanks to the poor women taking small unsecured loans from it.

As the microfinance pioneer Vijay Mahajan says, “If you treat the poor as customers with dignity, don’t play games with them, don’t trouble them while they are getting a loan, most of them will try their best to maintain their credit with you.”

Bandhan’s success bears this out.

Subir Roy, a senior journalist, is the author of Made in India and the forthcoming Ujjivan: Transforming with Technology.