India , October, 12 2016 - The rapid growth in the microfinance space seems to have caught the attention of private sector banks, which have lately been getting aggressive in tapping the opportunity at the bottom of the pyramid, either through acquisition of microfinance firms or by buying minority stakes in them.

On 30 September, Mint reported Utkarsh Micro Finance Pvt. Ltd raised Rs395 crore from domestic institutional investors, as the firm prepares to make a transition to a small finance bank. One of the key investors in the investment round was private sector bank RBL Bank Ltd, which picked up a 10% stake in the company.

Also on 30 September, private sector lender Kotak Mahindra Bank Ltd said it had acquired BSS Microfinance Pvt. Ltd for Rs139.2 crore. In July, IDFC Bank Ltd acquired a Tamil Nadu- based microfinance institution (MFI) called Grama Vidiyal for an undisclosed amount.

Announcing its acquisition of BSS Microfinance, Kotak Mahindra Bank said the blistering pace at which the microfinance space has been growing had caught the eye of the bank.

“The microfinance sector has been growing at a fast pace. In fact, last year, the industry saw an over 80% growth. The growth of the industry had attracted us to look at the space. Till now, we did not have direct lending exposure to this space,” said Narayan S.A., president (commercial banking & capital markets) at Kotak Mahindra Bank.

According to data from the Microfinance Institutions Network (MFIN), a self-regulatory organization for the industry, the loan portfolio of MFIs stood at Rs53,233 crore as of 31 March 2016, up from Rs28,940 crore a year ago, an increase of 84%.

For retail-focused private banks, access to the large customer base at the bottom of pyramid that these MFIs have built, and the potential for extending retail lending products to it, is a key attraction, industry experts said.

“The retail base of these MFIs, coupled with their strong on-ground presence and continuous customer connect, make them very attractive targets for inorganic growth for retail-oriented private sector banks. The ability to extend individual credit, mortgage finance and insurance to these customers makes it a compelling business case,” said Ritesh Chandra, executive director and head (consumer, financial institutions group and business services group) at Avendus Capital Pvt. Ltd.

For example, the BSS acquisition gives Kotak Mahindra Bank access to the MFI’s growing customer base, which currently stands at over 217,000, as of June. “This acquisition offers Kotak a deeper reach in the low income segment, and also increases the access of BSS’s customer base to Kotak’s wide array of products and services,” the bank had said.

Grama Vidiyal gives IDFC Bank access to a customer base of 1.2 million customers. Saturation of urban markets, was another reason why IDFC Bank found it attractive to buy an MFI.

The overall customer base of microfinance companies grew by 44% to 32.5 million in the financial year 2015-16, from 22.6 million in the previous year, data from MFIN shows.

Banks have had indirect exposure to the sector, lending to MFIs to meet priority sector lending (PSL) norms set by the Reserve Bank of India (RBI). As MFIs grow at a rapid pace, some banks and non-banking financial companies are looking at investing in the sector, said experts.

“Banks have always struggled to find the right priority sectors to lend to, in order to meet their PSL requirements. With the growth that microfinance sector has witnessed, coupled with the favourable metrics of the business, such as low rate of NPAs and high return on equity, the sector has become an attractive space for PSL lending for banks and thus the strong interest to take a direct exposure by acquiring these businesses,” said Khushroo B. Panthaky, additional director at Grant Thornton India Pvt. Ltd.

For the banking industry, struggling with Rs6.3 trillion of bad loans, mainly advances to corporate borrowers that turned sour, the microfinance sector has become even more attractive as a long-term bet.

“Large corporate lending is under stress. The mid-market corporates are still looking problematic. HNIs and the upper end of the retail clients are over-served. In such a market scenario, there is a strong business case for actively seeking out new, relatively unserved client categories,” said Alok Prasad, an independent industry expert and former chief executive of MFIN.