Finally, small is beautiful in Indian banking-LIVEMINT-22nd July 2014
It won’t be surprising to see hundreds of applicants queuing up for a small bank licence
Reserve Bank of India (RBI) governor Raghuram Rajan has kept his promise.
Less than four months after giving in-principle licence to two entitles for setting up commercial banks, RBI has drafted guidelines for so-called payments banks and small banks to open up the sector. A third category, wholesale banks, will probably be looked into later.
The payments banks, according to the plan, will accept deposits and offer remittance services to migrant workers, low-income households and small businesses in a secure, technology-driven environment.
The remittance business will earn fees, but will that be enough to run a bank? It will also get the so-called float money (the money kept in the custody of a bank between a deposit made in the recipient’s account and the money deducted from the sender’s account).
Such banks will not be able to give loans to anybody. Instead, they will invest all their deposits in government bonds. Minus the remittance business, in some sense, it resembles the model of erstwhile residuary non-banking companies, or RNBCs (remember Sahara India Financial Corp. Ltd and Peerless General Finance and Investment Co. Ltd?). Narrow banking—or the model of investing the last penny of deposits in government bonds—ensures safety but it’s difficult to make such a bank profitable unless the employees see this as charity and don’t take a salary.
I wonder why would anybody apply for a payments bank licence while such activities can be done through the small banks? Yes, the small banks are being allowed to do everything a commercial bank is expected to do but on a smaller scale. It is modelled on the local area banks, or LAB (former finance minister P. Chidambaram’s brainchild), with a difference. While operations of a LAB are restricted to contiguous districts in one state, the small banks will be allowed to expand their area of operations beyond contiguous districts in more than one state. The limit will not be on geographical spread, but size of the business as it is expected to undertake basic banking activities of accepting deposits and lending to small farmers, small businesses, micro and small industries and unorganized sector entities.
Chidambaram made public the idea of LAB in his 1997 budget speech. Six LABs got licences but at the moment only four of them are operational—in Punjab, Maharashtra, Andhra Pradesh and Telangana. The biggest handicap of a LAB is its playing field—a few contiguous districts (initially capped at four and later expanded to six). Such banks suffer from concentration risks as often natural calamities such as drought and flood affect contiguous districts and if that happens, the risks of mass defaults in loan repayment rise. Precisely for this reason, the LABs in India have not done well. Two of them died premature deaths and the largest one, based in Punjab, is very small compared with a commercial bank. By allowing small banks to operate in many districts and across states, RBI has taken care of this.
There will be many takers for the small bank, including a few of those who had sought licence to set up a universal bank but did not succeed in getting it. They could not meet the criterion of ‘fit and proper’ last time, but that does not mean they will fail this time, too. The draft guidelines have tweaked the fit and proper criterion for small and payments banks by removing the reference to a probe by an investigating agency as a deterrent to giving licence. If such banks can prove their competence, over time their scope of operations will widen. But to start with, small could be beautiful and I will not be surprised if hundreds of applicants queue up for a small bank licence.
Questions remain on viability of proposed payments banks-Livemint
RBI’s draft guidelines on payments banks have received a cautious welcome from probable entrants
The Reserve Bank of India’s (RBI) draft guidelines on payments banks have received a cautious welcome from probable entrants.
While most agree there is space for such banks in India, the restrictions and conditions proposed have raised questions on whether the model would be a viable business proposition
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Payments banks are a new category of banks envisaged to provide limited services such as accepting savings deposits and remittances, particularly in rural areas.
One key concern will be profitability. This is because payments banks will not be allowed to lend, effectively cutting off interest income—the main income source for a bank—although remittance services are permitted and could become the main income stream.
Again, they must invest all their deposits in government securities and treasuries maturing in one year, restricting the scope of investment income as well.
According to Rishi Gupta, chief operating officer (COO) at Fino Paytech Ltd, a banking correspondent which is also in the fray to open a payments bank, these banks will have to keep their cost of operations “really thin” to make profits.
“Banks will have to figure out how to make the model viable within the framework provided. But there are two-three areas where revenues can come from; firstly from the difference in the deposit rate a bank offers and the yield it earns from investments and also charging micro and small enterprises for services and individuals for remittances,” Gupta said.
Charges will depend on the kind of products these banks offer and linked very closely to the demographics of the geography they operate in, he said.
What interest these banks offer on deposits and how they manage their cost of operations will be crucial in determining how viable they will be, a Kotak Institutional Equities Research report said on 17 July. “As compared to conventional banks, we are not too sure if we can understand the profitability of these banks. The severe restriction on lending makes the business model extremely challenging,” M.B. Mahesh, Nischint Chawathe and Geetika Gupta said in the report.
The Kotak analysts added that these banks were unlikely to be in a position to provide 4% interest rate on savings accounts, as the spreads of the business are too thin. This could be a competitive disadvantage, as most banks in India offer 4% on savings bank deposits, while some smaller banks offer even higher. The analysts said payments banks, to make their model viable, will have to link the interest rates they offer on savings bank accounts to the yields they get on their government security investments in order “to reduce the volatility of returns.”
A cap of Rs.1 lakh on the balance a customer can keep in his account could also prove to be a challenge for such banks, said analysts.
Remittances, however, could prove to be a lucrative fee-generating activity, said some firms. Pradeep Kumar Sampath, chief operating officer, MMP Mobi Wallet Payment Systems Ltd (MMPL), a mobile payments company and a subsidiary of Tata Teleservices Ltd, said the company was looking at this new opportunity as a pure remittance model.
“There may be opportunities to leverage customer reach through financial inclusion, value-added or independent service for telcos, much more access through a mobile phone,” Sampath said, adding that though the company will be able to route its transactions through its own bank now, transaction costs for the end customer may not come down.
Robin Roy, associate director, financial services at audit and consultancy firm PricewaterhouseCoopers (PwC) said that for this model to become successful, customers will have to be charged.
“This is a fee income-based system. It has always been a business model in the OECD markets because it’s a part of the alternative channels. India now has more mobile phones than bank accounts and it is possible to make a market to ensure that we move more cash transactions to cashless mode,” Roy said.
Meanwhile, the firms likely to have a headstart in the payments bank business are those which already have a network in rural areas. Building a network from scratch may make it difficult for firms to make money, said Abizer Diwanji, partner and head of financial services at audit and consultancy firm E&Y.
“Companies which already have an access to the last-mile customer like telecom companies, microfinance companies and retailers will have an advantage; otherwise, to build a network like this doesn’t look profitable,” Diwanji said.
Retailers, along with telecom companies could be best placed to launch payment banks without much incremental investments.
“We have always been keen and feel the draft guidelines are tailor-made for us. Once the policy is out, we will be the first ones to launch operations,” said Kishore Biyani, chief executive officer of Future Group, the parent firm of Future Retail Ltd which operates the Big Bazaar and Food Bazaar retail chains.
Also, for firms currently out of the banking arena, it is important to understand concepts like capital requirements to which they are new, said Naveen Surya, managing director, at ItzCash Card Ltd, a prepaid card and money transfer company and one of the firms interested in setting up a payments bank.
“We will give RBI our suggestions and also try to understand the requirements with regards to capital because it is a new subject for us. These are still draft guidelines and the decision of when and how we enter this space can only be made when the final guidelines are out. We are already present in 3,000 locations with 50,000 touch points accepting our cards which holds us in good stead,” he said.
Payment banks have to adhere to the easier Basel I standards compared with the more stringent Basel III standards for commercial banks. RBI has asked for feedback on the draft norms by 28 August
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