Small finance banks paid more for FCNR(B) deposits but captured less than 1% of inflows

Small finance banks (SFBs) struggled to attract a meaningful share of foreign currency non-resident (bank), or FCNR(B), deposits despite offering interest rates 50–100 basis points higher than those offered by universal banks, highlighting the funding challenges faced by smaller lenders, according to Crisil Ratings.

SFBs accounted for less than 1% of total FCNR(B) deposits mobilised during the recent deposit mobilisation drive, with universal banks benefiting from their larger scale, broader product offerings and established overseas franchises.

The development underscores the limitations of relying on higher deposit rates to compete for funds, particularly as SFBs seek to diversify their loan portfolios and protect profitability amid intense competition for deposits.

Scale and overseas reach favour larger banks

SFBs have traditionally built their deposit franchises by offering relatively attractive interest rates, helping them establish sizeable retail deposit bases. Retail deposits now account for more than 70% of their total deposits, according to Crisil Ratings.

However, the recent FCNR(B) mobilisation drive demonstrated that competitive pricing alone may not be enough to attract funds from non-resident Indians.

Universal banks were better positioned to mobilise these deposits because of their scale, wider product suites and established international presence. SFBs, by contrast, largely competed by offering higher rates, but this failed to translate into a meaningful share of the inflows.

The outcome points to a structural disadvantage for smaller lenders seeking to expand their funding sources beyond conventional domestic deposits.

Higher funding costs could pressure margins

The challenge has implications for profitability as SFBs gradually diversify beyond microfinance into secured and relatively lower-yielding asset classes.

According to Crisil Ratings, the sector's net interest margins (NIMs) are expected to recover to 7.1–7.3% in FY2027, from around 6.2% in FY2026, supported by easing microfinance stress and lower interest income reversals.

However, sustaining these margins will depend partly on how efficiently banks manage their liabilities, or the cost of the funds they raise.

Offering higher deposit rates can help lenders attract customers, but it also increases funding costs and can erode the benefits of improving asset quality. This becomes particularly important when banks are shifting towards loans that generally generate lower yields than microfinance advances.

Crisil Ratings said SFBs need to develop a more sustainable and cost-efficient liability strategy to compete for deposits and offset the structural moderation in portfolio yields as their asset mix changes.

Sustainable funding strategy becomes critical

The rating agency said the sector's next phase will depend less on the immediate recovery in earnings and more on its ability to sustain profitability through credit cycles.

For SFBs, this means building deposit franchises that rely on more than interest-rate competition. Improving funding efficiency will be essential as lenders balance deposit mobilisation, portfolio diversification and asset quality.

The FCNR(B) experience highlights the challenge: smaller banks may offer better rates, but competing with universal banks requires scale, broader products and access to established overseas customer networks.