Small & Payment Banks: Future of Local Banking

Published on 25 May 2017 by Team

The Reserve Bank of India grants two kinds of licenses – Universal Bank License and Differentiated Bank License. Universal Banks as the name suggests cover inter alia all the Commercial Banks like HDFC, Axis Bank, ICICI etc. On the contrary Differentiated Banks deal in a niche or specific demographic segments of the society.

Small Finance Banks and Payment Banks are examples of Differentiated banks that have recently got established into the banking regime of India. RBI had granted in-principle approvals to 11 entities for setting up payment banks (PBs) in August 2015 and 10 for Small Finance Bank (SFB) in September 2015. These banking models are based on High Technology- Low-Cost Operations.

What are Small Finance Banks

SFBs are the banks that focus and serve the needs of a certain demographic segment of the population. (Provide for the requirements of a curated or a tailor-made section of society in terms of banking requirements.)

The objective of SFBs is to further financial inclusion of generally what is considered to be the mid and lower strata of banking consumers whether personal users or businesses. SFBs are more like traditional banks where they can sell forex to customers, sell mutual funds, make plans and sell insurance and pensions or alternatively, SFBs can also later convert into a full-fledged bank.

SFBs can be distinguished from traditional banks firstly as per their objective of serving a niche area. SFBs cannot extend large loans which only the commercial banks are allowed to do. They also cannot float subsidiaries and deal in sophisticated products among other distinctions.

To pull off their efforts successfully SFBs primarily rely on a model based on High Technology- Low-Cost Operations.The idea is to supply credit to consumers which include farmers, Micro and Small Industries as well as the unorganised sector.

Technology, is not the biggest challenge to SFBs, at least not as much as Human Resources. For Example - 'Suryoday' has increased its workforce from 1,700 to 2,200 in the run-up to its launch. It has hired people from India’s new private banks. At the top tier, there are 10 executives—eight of them joined in the last 21 months during the transition and rollout phase. The bank has given stock options to 200 employees and plans to extend it to around 800.

The biggest challenge hence becomes delegation of responsibilities to the executives below the line. For most small finance banks—not all—the promoters/founders are at the driver’s seat as managing directors and chief executives, and it is not easy to delegate effectively, ensuring adequate controls. A few of them have done it. They are focussing more on strategies and marketing the bank instead of getting bogged down by day-to-day operations.

What are Payment Banks

The objective of setting up of payment banks is to further financial inclusion; by acting as a savings bank to lower and mid-level banking consumers. In addition to acting as a savings account, Payment Banks provide the crucial aspect of remittance, which is something that can be a game changer as the easy transfer of hard earned money had always been a loophole to be captured by some business idea ready to serve the demands of the society.

The migrant labour workforce in India is huge and metro cities are crammed with people from rural areas which is almost the undercurrent of the real Indian success story to the global world. Along with low-income workers who have migrated to seek jobs, low-income households, small businesses, and the unorganised sector entities are to be catered under this ‘Differentiated Banks category.  

Services being provided by Payment Banks-

  • Internet banking, mutual funds, insurance and pensions.
  • Business correspondents and ATMs.
  • Bill payment services for customers
  • They can enable transfers and remittances from a mobile phone.
  • They can provide forex cards to travellers, usable as debit or ATM card all over India, card acceptance mechanism to third parties such as “Apple Pay”, forex services at charges lower than bank

Payment Banks are not allowed to perform some traditional banking services-

They cannot lend money or offer any credit cards which is indirect lending of money. Although Payment Banks are to make remittance of money easier they are not authorized to handle cross-border transactions and hence they cannot accept deposits from NRIs either.

Operating Guidelines of RBI - Risk Mitigating

Know your customer (KYC) is the process of a business identifying and verifying the identity of its clients. The term is also used to refer to the bank and anti-money laundering regulations which govern these activities.

RBI through their guidelines has in effect allowed payment banks and small finance banks to use digital banking to open bank accounts. Both small finance banks and payments banks can open accounts without a wet signature, relying completely on the digital signatures and electronic verification, which makes onboarding of customers easy for geographically distant places where opening a physical branch might not be viable.

The licensed Payment Banks have to necessarily make sure that KYC done by them, (being promoted by telecom companies) is of the same quality as prescribed for a banking company, the bank account can be opened without any document. This verification process regulation can really give a boost to the Payment bank savings account users across the nation as KYC norm procedures can be done relatively easily by Telecom Companies.

While the licensed Small Finance Banks have to necessarily make sure that 25% of the branches should be in the rural areas within the first year of operation. 

Area of Operation: Payment Banks are very different from SFBs

Acceptance of  Deposits/ Savings Account and Lending of Money/ Credit Facility-

Payment banks will initially be restricted to holding a maximum balance of Rs. 100,000 per individual customer.  The payment bank cannot undertake lending activities.

Whereas, the primary function which SFBs are to undertake is basic banking activities of acceptance of deposits and lending to unserved and underserved sections. Small business units, small and marginal farmers, micro and small industries and unorganised sector entities are some of the targeted consumers. There will not be any restriction in the area of operations of small finance banks. Hence SFBs can freely accept deposits and lend money.

Issuance of ATM/debit cards

  • Payment banks cannot issue credit cards.
  • There are no such restrictions on SFBs

Remittance services through various channels-

Both SFBs and Payment Banks are allowed to carry forward with this function. Payment Banks, in particular, provide for a niche service of easy remittance of money.

Pre-requisites for Establishment

The minimum paid-up equity capital for both SFB and Payment banks shall is Rs. 100 crore.

Exclusively for Small Financial Banks

Individuals/professions with 10 years of experience in finance, Non-Banking Financial Companies (NBFCs), microfinance companies, local area banks are eligible to set up SFBs.

Promoter’s minimum initial contribution to the paid-up equity capital of such small finance bank shall at least be 40 percent and gradually brought down to 26 percent within 12 years from the date of commencement of business of the bank.

Exclusively for Payment Banks

Existing non-bank Pre-paid Payment Instrument (PPI) issuers; and other entities such as individuals / professionals; Non-Banking Finance Companies (NBFCs), corporate Business Correspondents (BCs), mobile telephone companies, supermarket chains, companies, real sector cooperatives; that are owned and controlled by residents; and public sector entities may apply to set up payment banks.

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

Most importantly, the point that distinguishes Payment Banks is that the operations of the bank should be fully networked and technology-driven from the beginning, conforming to generally accepted standards and norms.

Additional Requirement for Payment Banks owing to the technical nature of this Banking System

  • Promoter/promoter groups should be ‘fit and proper’ with a sound track record of professional experience or run their businesses for at least a period of five years in order to be eligible to promote payment banks.
  • Maintains minimum 75% of deposits in Government bond and maximum 25% deposits with other scheduled commercial banks.
  • The bank should have a high powered Customer Grievances Cell to handle customer complaints.

Challenges in the near future 

Challenges for Small Finance Banks

  • Have to compete with existing public sector banks and RRBs.
  • The cost of deposit mobilisation will be higher for these banks as they cover rural and underserved segment.
  • Micro Finance Institution (MFI)/NBFC are specialised in microlending operations with limited exposure to banking operations; that means they have to hire, train talent from the banking industry.
  • Recruitment or Human Resources in the lower tiers can pose to be a huge problem.

Challenges for payment banks

  • Low revenue can be a major limitation. Payment Banks cannot undertake any lending businesses and the income stream is initially restricted to charges on remittances and efficiency of operations.
  • Experience from Jan Dhan Yojna has shown that many such no-frill accounts have remained dormant, thus affecting the viability of the banks.
  • Required to invest minimum 75 percent of its “demand deposit balances” into government securities. This limits their ability to earn from the deposit base as well.
  • Other saving instruments like Kisan Vikas Patra, gold bonds etc have better returns than payment banks.
  • Banks are already offering most services that payments banks can and hence, for payments banks to offer a new and differentiated proposition will not be easy.

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