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Insights into Editorial: How many payments banks will come up finally?

 

 


Insights into Editorial: How many payments banks will come up finally?


Summary:

The Reserve Bank of India (RBI), in 2015, gave its approval in principle for 11 entities to set up payments banks. For this, RBI selected entities with experience in different sectors and with different capabilities so that different models could be tried. This move had generated much excitement across the country.

  • However, of the 11 licence holders, only eight remain in the fray now. Profitability concerns, coupled with the limited scope of business activity, are proving to be the biggest deterrent.
  • Those who have backed out have cited competitive pressure on the margins as the main reason.
payment banks
SOURCE: Times of India

What are payment banks?

Payment banks are non-full service banks, whose main objective is to accelerate financial inclusion. These banks have to use the word ‘Payment Bank’ in its name which will differentiate it from other banks.

 

Key facts:

Capital requirement: The minimum paid-up equity capital for payments banks is Rs. 100 crore.

Leverage ratio: The payments bank should have a leverage ratio of not less than 3%, i.e., its outside liabilities should not exceed 33.33 times its net worth (paid-up capital and reserves).

Promoter’s contribution: The promoter’s minimum initial contribution to the paid-up equity capital of such payments bank shall at least be 40% for the first five years from the commencement of its business.

Foreign shareholding: The foreign shareholding in the payments bank would be as per the Foreign Direct Investment (FDI) policy for private sector banks as amended from time to time.

SLR: Apart from amounts maintained as Cash Reserve Ratio (CRR) with the Reserve Bank on its outside demand and time liabilities, it will be required to invest minimum 75% of its “demand deposit balances” in Statutory Liquidity Ratio(SLR) eligible Government securities/treasury bills with maturity up to one year and hold maximum 25% in current and time/fixed deposits with other scheduled commercial banks for operational purposes and liquidity management.

 

What are the scopes of activities of Payment Banks?

  • Payments banks will mainly deal in remittance services and accept deposits of up to Rs 1 lakh.
  • They will not lend to customers and will have to deploy their funds in government papers and bank deposits.
  • The promoter’s minimum initial contribution to equity capital will have to be at least 40% for the first five years.
  • They can accept demand deposits.
  • They can issue ATM/debit cards but not credit cards.
  • They can carry out payments and remittance services through various channels.
  • Distribution of non-risk sharing simple financial products like mutual fund units and insurance products, etc. is allowed.

 

Why licence holders are bailing out?

  • Payments banks are not allowed to lend. This will limit their earning potential.
  • Profits will be a challenge as margins are very thin.
  • As income channels are limited, payments banks will be under pressure to generate volume.
  • Competition has intensified in the digital money transfer space with banks joining the race.
  • Government initiatives aimed at the unbanked population have considerably reduced the scope of doing business for payments banks.
  • Payments bank have to primarily survive on fee-income since 75% of their deposits have to be mandatorily invested in government bonds with maturity up to a year.
  • Also, payments banks can only accept deposits up to Rs 1 lakh.
  • To get deposits, competing with regular banks which offer up to 7% return on their savings deposits, payments banks will have to offer aggressive rates. However, a majority of the amount in government bonds for a maximum 7.45% -8%, would mean no real business.
  • The cost to set up and run operations far outweighs the benefits.

 

Other challenges before these banks:

  • The success of these new entities will depend to a great extent on their ability to go beyond serving the well-banked smartphone-carrying consumers, who have been the focus of digital payments in India so far.
  • Payments banks will need to creatively reach the low-income and financially underserved—the so-called base of pyramid (BOP) consumers. However, developing a model that is both effective in reaching the BOP consumer and commercially profitable, is far from easy. It will require a paradigm shift.
  • Income at the BOP tends to be more irregular and unpredictable, often cobbled together from various sources. Besides, savings are limited, often taking the form of small amounts saved daily that need to be banked quickly to prevent them from being spent.
  • Formal credit histories are also virtually non-existent. There is heavy reliance on informal networks like friends and family for financing big-ticket needs. Leveraging technology to reduce cost-to-serve will of course be important, but much more will be needed.

 

Why does RBI want the new banks to maintain a CAR?

The measure is meant to protect depositors in case a bank goes bust and maintain stability in the financial system. CAR gives banks a cushion to absorb a reasonable amount of losses if too many loans go bad. It also discourages banks from making excessively risky loans and investments.

 

So why do payments banks have to maintain such a high CAR?

The regulator is more concerned about the operational risks that such banks will face than the credit risks.

  • Payments banks are expected to provide small savings accounts and payments/remittance services to migrant labourers, low-income households, small businesses and other unorganized sector entities, and expand financial inclusion in Asia’s third largest economy.
  • Since nothing prevents regular commercial banks from offering such services, the payments banks will have to spend tons of money to create the right infrastructure to be in the business. The RBI is apprehensive that the payments banks will end up burning too much capital in building their franchises.
  • Also, more than the protection of the depositors, the regulator is concerned about the future of the payments banks themselves.

 

What can be done?

  • Payment banks will have to deepen their understanding of the unique needs of base of pyramid (BOP) consumers and develop products and customer experiences tailored to these needs.
  • Payment Banks will need to develop new products that are better suited to the financial lives of BOP consumers, for example, daily micro-saving products and micro-loans that rely on non-traditional data.
  • They will need to develop partnerships with other financial institutions to meet the full scope of customer needs. They will need to embed within their organization the ethos of providing a respectful and positive customer experience to BOP customers to earn their trust and loyalty.
  • Technology is, of course, going to be key to keeping costs low. The use of Aadhaar-linked authentication, know-your-customer and e-sign and the proliferation of mobile/online payment systems hold special promise for reducing the cost of delivery.
  • Since Smartphone penetration is low and digital literacy is a major challenge among the BOP, payments banks will need to rely on physical agent networks, at least in the foreseeable future, to serve this segment.
  • Currently, banks largely rely on Business Correspondents (BCs) who are dedicated to the financial services business. To achieve scale and keep costs manageable, players will need to harness the potential of varied agent models—ranging from dedicated ‘wealth advisors’ at one end of the spectrum to ‘lite’ BC agents who just focus on a few simple transactions while doing core businesses at the other.
  • Players will also need to harness the potential of the neighbourhood store, by making it worth their while to accept digital payments. They will need to rely heavily on small-ticket transactions for revenues, given limitations to their net interest income.

 

Conclusion:

Over the last few years, large banks, including private lenders, have significantly expanded their networks in rural areas. This means that these markets are no longer wide open for new business with limited competition. Banks are offering most services that payments banks can and hence, for payments banks to offer a new and differentiated proposition will not be easy. Hence, payment banks will have to learn as they go along and adapt themselves to the eco-system inhabited by the small-income groups and small enterprises.