Small Finance Banks (SFBs) have sustained robust growth in both deposits and advances despite persistent challenges in their microfinance portfolios, according to a new report by CareEdge Ratings. The report highlights the sector’s transformation and its growing share in the Indian banking landscape.
Between FY22 and FY25, SFBs recorded a 28 per cent compound annual growth rate (CAGR) in deposits and a 25 per cent CAGR in advances—significantly higher than the industry averages of 12 per cent and 16 per cent, respectively. As of March 2025, deposits stood at Rs 3.2 lakh crore (1.4 per cent share of the system) and advances at Rs 2.7 lakh crore (1.5 per cent share).
The report noted that the SFB sector is gradually diversifying beyond microfinance loans, which once formed its core. The share of microfinance loans declined from 35 per cent in FY22 to 24 per cent in FY25, while lending to micro, small and medium enterprises (MSMEs), vehicle, and housing segments increased. The Reserve Bank of India’s (RBI) decision in June 2025 to lower the priority sector lending (PSL) requirement for SFBs from 75 per cent to 60 per cent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposures is expected to further accelerate this diversification.
Despite these structural improvements, asset quality in the microfinance segment weakened in FY25. Gross Non-Performing Assets (GNPA) for the overall sector rose to 3.8 per cent in FY25 from 2.7 per cent in FY24, largely due to stress in the MFI portfolio, where GNPA increased sharply to 6.8 per cent from 3.2 per cent the previous year.
Deposit Growth Outpaces Industry
The rapid expansion of the SFBs’ branch network—rising 1.3 times between FY22 and FY25 to 7,641 branches—helped deepen their reach, particularly in semi-urban and rural markets. This expansion boosted deposit mobilisation, enabling SFBs to nearly double their deposits from Rs 1.5 lakh crore in FY22 to Rs 3.2 lakh crore in FY25.
CareEdge projects deposit growth to continue at around 21 per cent in FY26, against the banking industry’s average of 12 per cent, with the SFBs’ share of system deposits expected to reach 1.5 per cent. However, the quality of deposits remains a key concern. The current account savings account (CASA) ratio stood at 26.2 per cent as of March 2025, which is modest compared to private and public sector peers. The higher cost of funds—7.3 per cent for SFBs versus 5.3 per cent for the industry—continues to pressure profitability.
Profitability Under Strain
While SFBs continue to outpace the broader industry in credit growth, profitability remains constrained by elevated credit costs, declining yields, and high operating expenses. The Return on Total Assets (ROTA) fell to 1.0 per cent in FY25 from 1.7 per cent in FY23, and CareEdge expects it to moderate further to 0.9 per cent in FY26.
Net Interest Margins (NIMs), which peaked at 7.4 per cent in FY23 and FY24, declined to 6.6 per cent in FY25 as SFBs diversified towards lower-yielding but secured segments such as housing and vehicle finance. Operating expenses, driven by the branch-intensive model and rural presence, stood at 5.5 per cent of assets in FY25 compared to roughly 2 per cent for universal banks.
Asset Quality Trends
Despite fluctuations, SFBs have shown resilience in asset quality recovery since the pandemic. Overall GNPA fell from a high of 7.2 per cent in FY22 to 3.8 per cent in FY25. However, the microfinance book remains volatile, with GNPA levels higher than the broader microfinance industry by 60 basis points. In contrast, secured portfolios such as MSME, vehicle, and housing loans reported improved performance, with GNPA declining to 2.5 per cent in FY25.
CareEdge Ratings expects FY26 to be a stabilisation year for SFBs, as they focus on improving liability efficiency, boosting CASA, and managing MFI-related stress.
“While the pressure on profitability is expected to continue in FY26, the transition to the revised PSL norms will provide more flexibility in lending and allow derisking of portfolios in the medium term,” said Sanjay Agarwal, Senior Director, CareEdge Ratings.
Priyesh Ruparelia, Director, CareEdge Ratings, added that credit costs are likely to stay elevated in the 1.8 to 2.0 per cent range, keeping returns under pressure.
“In the medium to long term, SFBs’ ability to strengthen deposit quality, improve technology adoption, and balance their asset mix will be crucial for sustaining profitability. As they evolve toward universal banking characteristics, they are poised to play a vital role in advancing financial inclusion,” said Dr Sudam Shingade, Associate Director, CareEdge Ratings.
Despite near-term headwinds, the report concludes that SFBs remain well-capitalised, with Tier I capital at 19.7 per cent, and are expected to maintain higher-than-industry growth in both deposits and advances in the coming years. |
