How the Reserve Bank is redrawing India’s banking landscape

Budhilal Verma has been driving an autorickshaw in Mumbai since 1996 after leaving his village in the northern state of Uttar Pradesh in search of a more lucrative job than farming.

He left behind his mother and wife in the village, and sends them money as often as he can.
Verma has an account in State Bank of India, or SBI, in Mumbai, but his family in the village doesn’t. So, he often transfers money to someone else in the village with a bank account, who then withdraws it and hands it over to the family. Alternatively, he uses a money transfer agent, who charges him Rs.120-130 for every Rs.10,000 transferred.

“I don’t get time away from driving a rickshaw to go and line up at the bank,” says Verma, who has heard that you can now transfer money through mobile phones but hasn’t tried it himself. “Bade logon ke liye hain (it’s for big people),” he says about Internet fund transfers.

Usha, a Mumbai household help who identifies herself by only one name, has a somewhat similar story. Being in a city, she finds money transfers have become easier; for her family back in their village, receiving money remains as cumbersome as ever.

She uses the Internet to transfer money to her sister, who lives in a village in the state of Chhattisgarh. The closest bank branch to the village is 25km away, she says, which means every time she sends money, someone in the family has to spend an entire day to withdraw it. Usha hasn’t heard of mobile money transfers, but is open to trying it if it makes the process more convenient.

Such stories will be heard all over India—a reflection of the poor penetration of banking services in a country of 1.25 billion people, where the vast majority of rural poor have had no, or at best limited, access to banking services for decades.

Outstanding consumer loans in India as a percentage of gross domestic product (GDP) is low at about 9.5%, compared with 22% in China, SBI chief economic adviser Soumya Kanti Ghosh wrote in a report on 25 August. And only 4% of the 57.7 million small businesses have access to formal finance from the banking sector, according to the 2013 report of the National Sample Survey Office.

The Reserve Bank of India (RBI) under governor Raghuram Rajan and the government of Prime Minister Narendra Modi are trying to bring about change, using the power of technology to deliver basic banking services, including credit and deposit facilities, in remote, unbanked locations.

On 16 September, RBI gave in-principle licences to 10 entities to set up so-called small finance banks in a move towards expanding access to financial services in rural and semi-urban areas. Small finance banks will offer basic banking services, accepting deposits and lending to unserved and underserved sections, including small business units, small and marginal farmers, micro and small industries, and entities in the unorganized sector.

That was a follow-up to the in-principle approval given on 20 August to 11 entities to open payment banks that will provide basic savings, deposit, payment and remittance services to people without access to the formal banking system.

Under the Prime Minister’s Jan Dhan Yojana, aimed at ensuring that every household has a bank account and access to financial services, India’s banks had opened 185.4 million bank accounts (40% of them with zero balance) as of 30 September, according to a government website.

The intention is to plug the gap in so-called last-mile connectivity that brings these services to the end-user and push the government’s goal of “financial inclusion”. The effort could well end up disrupting the practice of banking as we know it.

Payment banks: getting the last mile right

“In 2009, there was a WhatsApp moment in telecom. My argument is that, in 2015, there is a WhatsApp moment for finance in India,” Nandan Nilekani, the man behind the creation of the Aadhaar unique identity platform in India, said at The Indus Entrepreneurs (TiE) Leapfrog summit in Bengaluru on 21 August. A video of his presentation is available on YouTube.

Nilekani argues that just as WhatsApp, started by a Ukranian immigrant in 2009 and taken over by Facebook for $19 billion last year, disrupted the telecom messaging (and now, calling) industry, the move towards the digitization of payments can disrupt the financial sector.

“...banking is going to get disrupted, payments will move to the mobile, lending will move to algorithms. This is only the beginning,” said Nilekani.

“WhatsApp entered the fray by messaging, which was 15% of the telco business. Now you have voice on WhatsApp, so you attack the other 85% of the business. We think someone can enter in the payment business and use that to get CASA (current account and savings account) deposits and do lending based on regulation. So, there is fundamental disruption happening.”

That disruption, many say, could come from the 11 payment banks that have been given in-principle approval by RBI.

In selecting the 11 licencees, RBI chose a mix of telecom firms, technology companies and mobile wallet firms among others, as it “selected entities with experience in different sectors and with different capabilities so that different models could be tried”.

Among those selected were entities such as Aditya Birla Nuvo Ltd, Airtel M Commerce Services Ltd, Reliance Industries Ltd and Vodafone m-pesa Ltd that have a significant network in place through existing mobile phone connections. (See graphic for full list).

The expectation is that these firms will be able to use their mobile networks to push payment and remittance products and also take small deposits. As per RBI’s guidelines, payment banks can take deposits of up to Rs.1 lakh and offer payment and remittance services, but not lending products.

These banks, however, can offer lending products of traditional banks once they have a client base in place.

Offering such services is a logical next step for companies such as Vodafone m-pesa, which already offers mobile wallet services. Mobile wallets, which were launched just about two years ago, have seen transactions surge. According to rating agency Crisil Ltd, the value of transactions more than tripled to Rs.2,700 crore in fiscal 2015, which indicates the huge potential for payment services.

Behavioural change
Over the past few years, banks have significantly expanded their network through expanding their business correspondent market, says Sethi, adding that this has brought down hawala transactions to roughly half of the remittance market.

Still, the addressable market for any firm in the mobile payments space is large.

“When you go on the ground, you really start appreciating the current infrastructure or the lack of it. Our focus right from the beginning was on the financial inclusion aspect and look at money transfers as the bedrock of building the entire business,” says Sethi, who oversees a network of 90,000 Vodafone m-pesa outlets across the country.

The ramp up, however, hasn’t been easy, accepts Sethi, pointing to the difficulties payment banks may have in building business. One big challenge is convincing people to move from “assisted behaviour” to “self-service”.

“One learning for us was that people are still very reliant on assisted behaviour. So, people are very willing to give money to someone and say ‘transfer it on my behalf’. One of the earliest challenges we found was that converting the person from assisted behaviour to self-service—where you are telling them to go to an outlet and put money on a mobile and send it as and when you want it. That shift is a big change,” says Sethi, adding that fear of technology and fear of transacting play a role in the reluctance to move towards self-service.

The limited number of banking service points may push that behavioural change.

Rating agency Icra Ltd said in a 20 August note that India had around 120,000 bank branches and 180,000 automated teller machines (ATMs) as of March for a population in excess of 1.25 billion, potentially providing “adequate growth opportunities to payments banks”.

Crisil said it expects telecom operators to capture around 15% of the domestic remittances market in the next five years.

To be sure, most analysts also point out that profitability will be challenge for firms operating in this segment. Apart from the low margins that these businesses are likely to generate, restricted options to invest the deposits raised will also keep earnings in check.

As per RBI rules, 75% of the deposits generated by payment banks must be invested in government securities and the remaining 25% as deposits (including fixed deposits) with scheduled commercial banks.

Sethi agrees that generating profits will be tough.

“This has to be a scale business. The only earnings are transactional fees, which are marginal. Competition will also keep such earnings in check,” says Sethi, adding that once they build scale in the business, they can expand into other areas such as direct benefit transfers and international remittances, among others, which could eventually help grow the earning potential of the business.

Small finance banks: a community banking approach

Financial exclusion in India is not restricted to individuals. A majority of small businesses and entrepreneurs find it equally onerous to get finance from the formal banking system.

With the objective of filling that gap, RBI granted in-principle approval to 10 small finance banks with the intention of supplying “credit to small business units; small and marginal farmers; micro and small industries, and other unorganized sector entities”.

Eight of the entities which got in-principle approval were microfinance firms that have an established presence in different parts of the country. These firms will now transition into banks, with the ability to take deposits and expand the products they can offer to the communities that they have been servicing.

“We will carry on doing the group lending business, which we have built, but now we have the ability to take deposits, which is a big game-changer in terms of our ability to offer them a safe avenue for savings. So far, a lot of deposit services have gone to the unorganized sector, which has been the reason schemes like chit funds have been popular,” says Samit Ghosh, founder and managing director, Ujjivan Financial Services.

Ujjivan, with a loan book of about Rs.3,300 crore, is one of the 10 entities given in-principle approval.

Ghosh adds that the conversion into a small finance bank will also help them target the micro entrepreneur segment and offer working capital loans.

“A credit facility that depletes over time is not as useful as a working capital facility,” says Ghosh, adding that the micro entrepreneur segment remained underserved despite a recent push from the government asking state-owned banks to expand their services to such firms.

Others such as Janalakshmi Financial Services Pvt. Ltd, Equitas Holdings Ltd, Disha Microfin Pvt. Ltd, Suryoday Micro Finance Pvt. Ltd and Utkarsh Micro Finance Pvt. Ltd have also received in principle approval (see graphic for full list).

Together, these 10 entities have loan assets of Rs.20,100 crore and a balance sheet size of Rs.22,200 crore, according to a 23 September report from rating agency India Ratings and Research Pvt. Ltd.

While most of these entities have an established track record in the micro-lending business, the transition into a bank will bring its own challenges. One such challenge will be moving away from wholesale funding and towards building a deposit base.

“Post conversion, the institutions are likely to face challenges in deposit mobilization—particularly in the initial years of operations as they might be competing directly with some of the existing established banks, postal outlets, and other financial institutions as well as other small finance bank/payments bank entrants,” says Swapnil K. Neeraj, principal investment officer, financial institutions group, and microfinance lead, Asia, at International Finance Corporation (IFC).

IFC is the private sector lending arm of the World Bank.

Neeraj adds that these entities will incur significant costs in the early years, along with significant investments needed in information technology, risk management and other operational aspects of running a bank, which will raise their cost of operations and dent profitability.

Six out of the 10 entities that have received in-principle approval to start small finance banks are IFC investee firms. IFC, which is among the largest investors in microfinance globally, has invested more than $4 billion in projects across 70 countries.

In India, IFC sees the licensing of payment banks, small finance banks and the Prime Minister’s Jan Dhan Yojana as part of “concerted policy efforts by the Reserve Bank of India, and government of India to promote financial inclusion.” IFC also agrees with Ujjivan’s Ghosh that allowing small finance banks and payment banks to offer deposit services will reduce the reliance of low-income segments on informal channels such as chit funds, which, at times, have led to unaffordable losses due to fraud.

“A vast majority of the unbanked do not have any access to formal financial institutions for small savings and an unmet need that large banks have not been able to meet,” Neeraj says.

“While non-banking finance institutions and microfinance institutions have contributed significantly to providing access to small loans to low-income borrowers engaged in the informal sector, these institutions were unable to mobilize savings. As a result, low-income segments relied on informal channels such as chit funds, and at times ended up experiencing unaffordable losses due to fraud. RBI is attempting to address this inability to mobilize savings by microfinance institutions.”

Will big banks face the heat?

Paresh Sukthankar is a career banker, who has been with HDFC Bank Ltd, India’s second largest private sector lender by assets, since its inception in 1994. Sukthankar is now the deputy managing director with the bank.

When asked whether the banking sector is set for a phase of disruption, his response is nuanced.

“When you talk about banking, there is the act of deposit taking, the act of lending and transactions, of which a large part is payments. That transactions and payments piece is the glue that keeps the economy moving. Now, the way you do those transactions and payments is certainly changing. So, if you call that disruption, then sure there is some sort of disruption in the way banking is done,” he says.

At HDFC Bank, the proportion of transactions going through the mobile and Internet has jumped to 63% now from 44% just two years ago.

Sukthankar, however, adds that this trend will not necessarily be disruptive for existing banking entities.

“It can be disruptive to players in the system that are not willing to embrace change or drive change, but I am more than convinced that for banks that are part of making that change happen, if anything, they are only disrupting the way they do business so they can make it more compelling to the customers,” he says.

To be sure, a number of existing banks have launched services such as mobile wallets to keep pace with evolving customer needs. For instance, ICICI Bank Ltd offers a mobile wallet called Pockets along with its tie-up with Vodafone m-pesa for mobile wallets. HDFC Bank offers a mobile wallet called PayZapp, while State Bank of India has a mobile wallet called Buddy.

“Anything that a payment bank will bring to the table, at least some of the banks are already doing,” says Sukthankar, adding that existing banks are offering a “super-set” of services being offered by payment banks.

There are other apprehensions.

Some bankers and analysts fear that the competition for non-urban deposits will rise as payment banks and small finance banks roll out. This could potentially have implications for the ability of traditional banks to maintain and expand their low-cost deposit base.

In a 19 August note, foreign brokerage Nomura Holdings Inc. pointed out that India Post, which has a network of 154,882 post offices, could, in particular, offer competition to banks, as it has been long trusted by consumers for parking their deposits.

Domestic brokerage Ambit Capital noted in a 20 August research report that payment banks could start offering competitive deposit rates as high as 6-7% to lure customers.

But not everyone is convinced it will play out this way.

“…luring deposits is another ball game altogether because they will have to invest in brand building and gain the trust of depositors. As a result, we forecast payment banks will have a minuscule share of less than 0.5% of the current and savings account deposits of the Indian banking system five years after launch,” said Crisil in the research report quoted above.

While the debate continues over whether differentiated banking entities have the potential to disrupt banking as we know it, Sethi of Vodafone m-pesa puts up the white flag.

“I think these are all complementary businesses. We are tapping a market which is largely unbanked and we are creating a distribution network that can tap into this network. Scheduled commercial banks are today largely working with people who are already in the system. So, we are bringing a new stream into the banking system. To that extent, I see a huge amount of complementarity by getting more people into the banking system,” he says.


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