By: Sharanya Ranaga and Laxmi Joshi
The government led demonetization drive in November 2016 led to a surge in the usage of digital payments in India with even mom and pop stores and hawkers embracing cash-free payment options. Mobile wallets suddenly became the buzzword and gained mainstream acceptance from being seen as a niche player. The other aspect that came into the spotlight was India’s low financial inclusion rate (only around 35% of adults in India had access to a formal bank account) and how the benefits of going digital can be leveraged to increase financial inclusion for the teeming millions. Conceptually this is one of the key drivers of payment banks in India.
What is a Payments Bank?
A payments bank is a differentiated micro-bank with limited banking functions set up under the payments banks guidelines issued by the Reserve Bank of India (“RBI”) in November 2014 (“Guidelines”). These banks are allowed to provide basic financial services through a smart phone as it may not be economical for conventional banks to have branches in remote areas. Given the reach and proliferation of mobile phone penetration in India, payments banks can use this network to bring such remote areas into the banking system, without incurring significant expenses. Typically, a payments bank has a low deposit limit which is a comfortable amount even for persons belonging to lower income groups. Since the transactions are cashless, it will also help in transitioning the users to a less-cash dependent lifestyle.
Setting up a Payments Bank
As per the Guidelines, the RBI undertakes a preliminary assessment of the applicants and grants an in-principle approval to the applicant to set up a payments bank. This approval is valid for a period of 18 months, during which time the applicants have to comply with the other requirements under the Guidelines and specific conditions that may be stipulated by RBI in the in-principle approval. These include the following:
The minimum capital requirement is INR 1 billion.
Restriction on dilution of promoter shareholding in the payments bank company below 40% for the first five years from the commencement of its business.
The voting rights of stakeholders in a payments bank company will be regulated as per the Banking Regulation Act, 1949, which in the first instance caps voting rights of a shareholder in a private sector bank at 10%. This limit can be increased by RBI upto a maximum of 26% in a phased manner.
Acquisition of more than 5% of stake in the payments bank company by any party will require prior approval of RBI.
Availability of fully networked and technology driven infrastructure right from the outset.
Foreign shareholding in a payments bank will be as per the prevalent Foreign Direct Investment (“FDI”) policy for private sector banks. So currently FDI upto 49% is permitted in private banks under the automatic route and further FDI upto 74% investment falls under the prior government approval route.
Have at least 25% physical access points, including business correspondents in rural areas.
Operations of a Payments Bank
A Payments Bank is permitted to undertake only the following activities:
Operate both savings and current accounts.
Accept deposits upto INR 100,000 per customer and pay interest on these balances like that of a savings bank account of conventional banks.
Enable transfers and remittances through a mobile phone.
Offer services such as automatic payments of utility bills and cashless/chequeless purchases through mobile phone.
Set up branches and ATMs (automated teller machines) and issue debit cards and ATM cards usable on ATM networks of all banks.
Transfer money directly to bank accounts at nearly no cost being part of the gateway that connects banks.
Provide forex cards to travellers, usable again as a debit or ATM card all over India.
Offer forex services at charges lower than banks.
Offer card acceptance mechanisms to third parties such as Billdesk and Paypal.
Sell third-party non-risk sharing simple financial products like mutual fund units and insurance products through its mobile apps and outlets.
A Payments Bank is prohibited from undertaking any kind of lending activities and issuing credit cards. In addition to the cash reserve ratio, it is also required to invest a minimum of 75% of their “demand deposit balances” in Statutory Liquidity Ratio (SLR) eligible government securities/treasury bills with maturity of up to one year and to hold maximum 25% in current and time/fixed deposits with other scheduled commercial banks for operational purposes and liquidity management. Setting up subsidiaries to undertake non-banking financial services activities is also prohibited for payments banks.
Viable business model?
The stringent norms prescribed for payments banks under the Guidelines may appear to be on the right track as far as financial inclusion and safeguarding depositor interest is concerned. However, it leaves a lot to be desired from an investor perspective on two core aspects:
Interest/charges on lending services is one of the major revenue generator for conventional banks and in the absence of the same, payments banks are essentially dependent on transactional charges for their banking services as the main source of income. A blanket prohibition on lending activities is a big drawback for payments banks.
Investment prohibition is yet another sore point for payments banks. As mentioned above, Guidelines require payments banks to invest minimum 75% of its “demand deposit balances” in SLR eligible government securities/treasury bills and maximum 25% in current and time/fixed deposits with other scheduled commercial banks. This restriction will obstruct a payments bank from optimally augmenting its resources through diversified funds management.
This strikes at the very root of a viable long-term revenue model for payments banks to grow and flourish in India. The direct revenue stream of payments banks are transactional charges for banking services such as transfer, depositing or withdrawing funds. Additionally payments banks can also look at generating revenues through the means of advertisements, cross-selling permitted third party financial services/products to its customer base and providing other data-led assisted services.
Can Payments Banks Replace Conventional Banks?
The main goal of payments banks is financial inclusion of the population that is outside the scope of the traditional banking network. They are not intended to replace the conventional banking system. Further, given the strict licensing norms and restricted scope of activities, these banks can function at best as auxiliaries to the conventional banking system of the country.
The biggest challenge to achieving complete financial inclusion in India is lack of banking facilities in remote areas of the country. Payments banks have the potential to bridge this gap with their telecom assisted banking services, even in areas where there are hardly any ATMs or banks. This is a major advantage for payments banks over their traditional counterparts, which can also be a game changer for the banking sector in India. The first step however would be to overcome the initial operational/ business hurdles as well as the onslaught of the ever- growing competition in the fin-tech arena where mobile wallets and unified payments interface initiative are increasingly gaining popularity. While the news of 3 applicants for payments bank license surrendering their in-principle approvals brought the business viability factor to the forefront, India Post Payments Bank, Airtel Payments Bank and Paytm Payments Bank have already commenced operations in the last two quarters. With notable players such as Reliance, Aditya Birla Nuvo and Vodafone MPesa looking to enter the fray over the next few months, it is wait and watch to evaluate how successful payments banks are in bringing about the avowed objective of financial inclusion in India.