Rating Rationale

Strengths
* Strong market position in the micro loan segment; expected benefits from portfolio diversification driven by the amalgamation with Gruh
Bandhan, after transitioning to a universal bank in 2015, registered a compound annual growth rate of 47.4% over the five years through March 2019, having attained a loan portfolio size of Rs 44,780 crore. Post amalgamation of Gruh, Bandhan's loan portfolio increased to Rs 64,186 crore, an annualised increase of 86% over the half year ended September 30, 2019. Excluding Gruh's portfolio, the standalone annualised growth during this period was around 12%.

Bandhan has a competitive advantage of reach and local knowledge in the microfinance sector, especially in East and North-East India, which constituted around 86% of its loan portfolio as of March 31, 2019. As per the bank's management, penetration measured as active borrower-to-state's population ratio - stood at 9.5% for Tamil Nadu and 5.9% for West Bengal, reflecting scope for growth in West Bengal.

More recently, after amalgamation with Gruh, diversity in Bandhan's loan portfolio has improved with increased share of Gruh's secured asset classes such as housing loans and loan against portfolio (LAP). This portfolio accounted for about 30% of Bandhan's total loan portfolio as of September 30, 2019. As Gruh primarily extends housing loans to individuals in rural and semi-urban areas and catering to the low-income group, Bandhan is expected to benefit from strong growth potential arising in the affordable housing segment driven by incentives offered by the Government of India - to promote faster development of the affordable housing segment. Nevertheless, cultural and operational challenges in the assimilation of Gruh into Bandhan, if any, need to be monitored as these could take time to settle. Complementarity of product portfolio may also be a challenge due to the difference in customer segments. Nevertheless, there is potential to expand the customer base and offer affordable housing products backed by the strong underwriting capabilities of Gruh.

CRISIL believes Bandhan will continue to benefit from the expected growth potential in both, microfinance and affordable housing finance segments and maintain healthy growth over the medium term.

* Strong financial risk profile supported by robust capital position and strong profitability
Bandhan has built up its networth along with scale of operations, thereby maintaining adequate capitalisation over time. Bandhan's networth of Rs 14,016 crore and tier I capital adequacy ratio (CAR) of 23% as on September 30, 2019, are a result of frequent capital raising and healthy internal accrual. Over the years, Bandhan has raised over Rs 5,000 crore of capital through various routes such as preferential allotment and rights issue from mutual funds, foreign investors, and domestic corporates. The reported CAR of 25.1% as of September 30, 2019 excludes the half yearly profit, including that ' the overall CAR stands at 28.5% on that date. The accumulated networth was 41.4 times the bank's net NPAs as on September 30, 2019, and has historically been high.

Bandhan's pre-provision profitability also remains comfortable at 6.8% (annualised) and 6.4% for the first half of fiscal 2020 and fiscal 2019, respectively. The bank had stable non-interest income of above 1.5% over the past three years. As majority of the bank's portfolio is priority sector lending (PSL), it has the opportunity and ability to generate income through PSL and inter-bank participation certificates (IBPCs). Even Gruh's portfolio has a component of PSL eligible loans (83% of Gruh's existing loan portfolio is PSL compliant) which would further allow Bandhan to monetise those PSL certificates, and demonstrate its high ability to generate fee income.

* Healthy reported asset quality
Bandhan has maintained healthy and stable asset quality over the years. Gross NPAs remained below 2% over the past few years, including the demonetisation period. As on June 30, 2019, the gross NPAs stood at 2.02% including the bank's exposure of Rs 388 crore to IL&FS. Excluding this exposure, the gross NPAs were at 1.02%. The exposure to IL&FS has been fully provided for by the bank as of September 30, 2019. Adequate ground level control and detailed operational checks are key contributors to stability in asset quality in the micro loan segment, despite the high ticket size. Being in the microfinance sector for nearly two decades and based in West Bengal, Bandhan enjoys strong brand equity in East and North-East India and has developed good understanding of borrowers' requirements. Owing to this knowledge, the bank has been able to implement practices like weekly collections from micro loan customers which helps in building regular connect with borrowers. Even during the demonetisation period, Bandhan was able to maintain collections due to its bank status because of which it could accept old currency notes from the borrowers.

The recently amalgamated Gruh business has also demonstrated its ability to maintain healthy asset quality over business cycles as gross NPAs have been lower than the industry average over the past few years. As on June 30, 2019, gross NPAs and two-year lagged gross NPAs stood at 0.95% and 1.23%, respectively, for Gruh. Asset quality is supported by Gruh's robust underwriting and recovery processes developed on the basis of its strong business understanding which has emanated over its track record of three decades in this segment.

On an overall basis, Bandhan's reported gross NPAs were comfortable at 1.76% as on September 30, 2019. However, given that Assam accounts for over 20% of the microfinance portfolio, the second largest after West Bengal, the ongoing socio-political unrest in certain districts of Assam and related implications at the ground level will be key monitorables. Nevertheless, Bandhan's strong process management systems and collection mechanisms should enable it to maintain healthy NPA level over the medium term.

* Healthy resource profile supported by demonstrated ability to build up a retail deposit franchise
Bandhan has a granular deposit profile, with low reliance on bulk deposits. The proportion of retail deposits (retail term deposits + CASA) stood at 78% of the total deposit base at the end of half year ended September 30, 2019. The bank's retail term deposit book is granular with deposits of ticket size less than Rs 1 crore at 63% of the total term deposits on the same date. While microfinance borrowers are the largest constituent of the bank's customer base, they accounted for only 5.8% of the deposit base as of September 2019.

The bank's funding profile is strong backed by healthy CASA deposits. The share of CASA deposits stood at 33% (35% excluding Gruh term deposits) of total deposits as on September 30, 2019. Being based in West Bengal for nearly two decades, a large chunk of these deposits is from East India. CRISIL notes that Bandhan offers higher interest than many other large private banks for both savings account balance of more than Rs 1 lakh as well as retail term deposits of more than 6 months tenure. Consequently, the bank's overall cost of funds is higher than the industry average. CRISIL also noted a drop in absolute CASA deposits as on June 2019 in comparison to March 2019. Hence, increasing the share of CASA deposits from current levels will be integral to its profitability and will be a key monitorable in the medium term.

Weaknesses
* Geographic concentration in operations and exposure to local socio-political risks inherent in the micro loan business
Bandhan has a strong brand presence, and competitive advantage of reach and local knowledge in East and North-East India in the micro loan business, which constituted 62% of its loan portfolio as of September 30, 2019. The bank's significant presence in these regions exposes it to geographical concentration risk, inherent to the segment. As of September 30, 2019, about 40% of Bandhan's microfinance borrower base, which is the largest loan portfolio, was in West Bengal alone. The top three states (including Assam and Bihar) constitute nearly 66% of its micro loan book.

The microfinance sector has witnessed two major disruptive events in the past 15 years. The first was the Andhra crisis in 2010, and the second was demonetisation in 2016. In addition, the sector has faced issues of varying intensity in several geographies. Promulgation of the ordinance on microfinance institutions (MFIs) by the government of Andhra Pradesh in 2010 demonstrated their vulnerability to regulatory and legislative risks. The ordinance triggered a chain of events that adversely affected the business models of MFIs by impairing their growth, asset quality, profitability, and solvency. Similarly, the sector witnessed high level of delinquencies post-demonetisation and subsequent socio-political events. Recently, the sector is facing challenges in certain districts of Assam, largely due to political influences. This indicates the vulnerability of the business model to external risks. As the business involves lending to the poor and downtrodden sections of the society, MFIs will remain exposed to socially sensitive factors, including charging high interest rates and, consequently, to tighter regulations and legislation.

It is important to note that Bandhan has not faced any such significant issues thus far. Even during the demonetisation period, Bandhan maintained its collections as it was operating as a bank then and could accept old currency notes from borrowers. Since demonetization, the number of new MFIs entering West Bengal has increased in the recent past, thereby creating competitive pressure. While Bandhan's strong footing in the region has remained largely unaltered thus far, it is consciously focused on expanding the portfolio in new geographies. Its ability to diversify and de-risk operations can protect market share in its home state against the aggressive operations of other MFIs, and will be a key monitorable.

* Modest credit risk profile of borrowers
A significant portion of the portfolio comprises microfinance loans to clients with modest credit risk profiles and limited access to formal credit. For instance, in the individual loan and micro and small enterprise loans, typical borrowers are vegetable vendors, small machine and lathe owners, tea shops, provision stores, small fabrication units, waste paper recycling units, tailors, and power looms.

Owing to relatively lower competition and Bandhan's long standing presence in the East and North-East India, the bank captured a fairly large chunk of the market early on and most of the borrowers have been associated with it for over a decade. Many borrowers have graduated across cycles and credit profiles, and are now eligible for bigger ticket loans by the bank. This is reflected from the fact that about 54% of the existing customers are in higher loan cycles (4-19 years) having an average disbursement of Rs 65,000. Besides, certain customers (erstwhile microfinance borrowers) are availing micro business loans with ticket size of Rs 3-5 lakh and are covered under the micro banking vertical. Consequently, the average ticket size is high as per MFI lending standards. However, CRISIL understands that majority of the borrowers have loans only from Bandhan unlike for many other NBFC-MFIs, wherein the borrowers may have more than one loan.

Nevertheless, as these borrowers belong to the semi-skilled self-employed category and their income streams could be volatile and dependent on the local economy, pressure on the borrowers' cash flow due to unforeseen circumstances may affect their repayment capability.

* Potential risk of regulatory strictures linked to non-dilution of promoter holding
As per RBI guidelines, Bandhan Financial Holdings Ltd (BFHL) was required to reduce its shareholding in the bank to 40% within three years from the date of commencement of operations as a bank, that is by August 2018. BFHL is also required to reduce its shareholding to 20% and 15% within 10 years and 12 years, respectively, from the date of commencement of operations as a bank. To achieve this objective and as the first step to reduce promoter shareholding, the bank acquired Gruh. Subsequently, the promoter stake reduced to about 61% as on September 30, 2019, from 82% earlier. However, as the bank failed to reduce the shareholding to 40%, in October 2018, the Reserve Bank of India imposed restrictions on automatic branch expansion and capped the salary of the Chief Executive Officer, Mr Chandra Shekhar Ghosh, until the promoter shareholding is reduced.

The bank is still obligated to reduce its promoter holding by around 20%. While the bank is exploring ways and means to achieve this, the potential risk of regulatory strictures continues. Any other form of regulatory directive which impacts business operations will remain a key rating sensitivity factor.