In Chennai, during Dussehra a 10-day festival, there is a tradition of inviting people for Golu, where people display dolls and serve a lentil snack called sundal. This Dussehra, a bank used Golu to reach out to customers. Bank employees placed a stack of dolls in a mini-truck and took it door to door to neighbourhoods giving the residents sundal along with a pamphlet. The pamphlet spoke of a bank called Equitas Small Finance Bank that offered fixed deposit rates of 8.5% and savings account rate of 6.5%. Higher than most banks. It seemed too good to be true. The large banks offered no more than 3.5-4% on savings account. So how could this rookie bank promise so much? Besides, most used the pamphlet to wrap the snack and tossed it.

Who or what is Equitas anyway?

Equitas, its peers Ujjivan, AU Small Finance, Suryoday and Jana Small Finance all belong to a class of banks called Small Finance Banks created by the financial regulator Reserve Bank of India in 2014. Along with their infamous cousin, payments banks. Unlike payments banks, that have a shaky business model to start with as they can’t lend, small finance banks don’t suffer structurally. They can lend and accept deposits, with the caveat that 50% of the loans should be upto Rs 25 lakh ($34,680).

Both payments banks and small finance banks were created with one intention in mind. Financial inclusion. While payments banks are mired in regulatory tangles, small finance banks are looking to ride the micro, small and medium enterprises (MSME) wave that the government is keen on driving. The banks have started well. In fact, they’ve even taken analysts by surprise. In the last two years alone, the top three banks—AU Finance, Equitas and Ujjivan—have deposits worth over Rs 15,000 crore ($2 billion). And they’ve lent over Rs 25,000 crore ($3.4 billion) in two years. In comparison, payments banks only had deposits worth Rs 540 crore ($74.9 million) in these two years. And AU Finance has already become the world’s most expensive banking stock, as of October.

One of the biggest reasons for this early success has been the interest rates on the deposits they offer. Small banks’ savings account interest rates are a good three percentage points above other banks. The reason they are able to do this is because of their golden goose—the microfinance portfolio (MFI). What’s not to love about giving small ticket-sized loans to low-income households that earns the banks upto 24% interest rates?

But just a few months after demonetisation came unannounced, the small banks gave their MFI portfolio the short shrift. As 86% of the notes became invalid overnight in November 2016, the MFI segment felt severe pain as most of the repayments and loan disbursals are made through cash. Equitas, in 2017, struck down its MFI exposure from 50% to 27%. Ujjivan is now focused on reducing its exposure from 80% to 50% over the next few years. Suryoday has a 90% exposure to MFIs and wants to bring it down to 60% in three years.

What this eventually boils down to is the banks’ continued ability to give high interest rates on deposits. As it is, even with high deposit interest rates, only few open an account. “If we reach out to a 200, only one or two may finally open an account,” said PN Vasudevan, founder of Equitas, without batting an eyelid.

So how will the small banks fill that MFI-sized hole?

The MFI yo-yo

Of the nine Non-Banking Financial Companies (NBFCs) that were given licenses to be small finance banks, eight were microfinance institutions. The idea was since they already have experience lending to those who find it tough to access banks for credit, they would be in a position to drive financial inclusivity. So Equitas, Ujjivan, Suryoday, Jana were all NBFCs that lent to MFIs and gave loans worth Rs 25,000-Rs 50,000 ($347-$695) at a 24% interest rate and collecting it back in 1-2 years. They perfected the art of giving risky loans at efficient operating costs, a skill fintech lenders such as Capital Float, Lendingkart will kill for. The only thing holding them back, as NBFCs lending to MFI, was the cost of funding. Since they borrowed from banks to lend to MFIs, their cost of funds was at 11-12%. But now as a bank themselves, this was down to 8%, and that made MFIs a highly profitable product.