Home / Opinion / Online-views /  Allow a few small, payments banks to fail

Nobody is surprised at the number of applications that Reserve Bank of India (RBI) has received for setting up small finance banks and payments banks. If nothing else, the numbers—72 applications for small banks and 41 for payments banks—show how starved of banking services Asia’s third largest economy is.

The highest number of applications seeking licences for small banks are from the national capital region (14), followed by Mumbai (12), Kolkata (nine) and Bengaluru (seven).

There are seven more applications from other parts of Karnataka as well as Tamil Nadu, six from Kerala, four from Uttar Pradesh, three from Andhra Pradesh and two each from Assam and Gujarat. More than half of the applicants are non-banking finance companies, many of whom operate as microfinance institutions giving tiny loans to poor people. For them, turning into a small bank is a logical progression to the next stage of growth. It’s difficult to scale up operations of a microfinance company beyond a point. Besides, by being a bank and embracing regulations, they can also insulate themselves from political pressures.

The challenge before most microfinance companies will be pushing up the promoters’ stake and, in some cases, finding new promoters. For instance, three promoters of SKS Microfinance Ltd, India’s sole listed microlender and one of the applicants, collectively hold a 9.27% stake. The promoters need to hold at least a 40% stake in a small bank which will be brought down to 26% within 12 years of operation.

The small banks will be subject to all prudential norms like any other commercial bank and, on top of that, they would need to give 75% of their loans to the so-called priority sector and 50% of the loan portfolio should constitute smaller loans of not more than 25 lakh. Despite such restrictions, the response has been overwhelming—simply because if they do well, the small banks can graduate to universal banks in coming years.

The payments bank is a different story. Teaming up with the State Bank of India (SBI), the country’s largest private sector conglomerate Reliance Industries Ltd (RIL) has applied for it. Others in the fray include a Bharti group company (with Kotak Mahindra Bank Ltd), Aditya Birla Nuvo Ltd, Vodafone Group Plc’s Indian arm, Tech Mahindra Ltd, Department of Posts, and individuals such as Kishore Biyani of the Future Group, Dilip Shanghvi of Sun Pharmaceuticals Industries Ltd and M.G. George Muthoot of the Muthoot group.

A payments bank is not allowed to give any loans; it will take deposits (maximum 1 lakh) and 75% of such deposits will have to be invested in government securities while the rest can be placed as deposits with other commercial banks.

In the past, residuary non-banking companies of Sahara and Peerless groups were subjected to such stipulations. This gives the impression that it will be extremely difficult for a payments bank to make money and the industrial houses are simply following a foot in the door policy—they are taking a calculated gamble on securing licence for a commercial bank in future. However, there are ways to make money and it will be a volume game.

The $7.69 billion Indian e-commerce industry is expected to grow to $17.52 billion by 2017 and around 70% of the business is based on the cash-on-delivery model. The payments banks can change this. In a market of 833 million active mobile phone users, such banks can revolutionize banking services. Currently, around 8% of mobile connections are linked to bank accounts and not all of them are active users.

Globally, money transfers through the mobile networks are being done at most geographies where mobile penetration is higher than banking penetration. Kenya is a success story; even in Bangladesh, 22% of the adult population use mobile banking services. This explains the rush by mobile operators to set up payments banks.

Besides, through banking, the cellular operators will also be able to create stickiness for their customers. Not every prepaid mobile customer is committed to their service provider but once they gets the banking services from the same operator, they may stick around.

There are ways to make money. For instance, payments banks can mobilize low-cost deposits and keep part of that with other banks, making a good spread even as they earn from investments in government papers. As a business correspondent, they will earn transaction fees from banks; they will also sell insurance, mutual funds and other financial products. Finally, they can play the role of a business facilitator and earn fees by referring their customers to banks for loan products.

How many licences should the RBI give to small finance banks and payments banks? In 1993, when it opened the banking sector for private entities, there were an identical number of applications —113—and the RBI gave licences to 10 of them, including one cooperative bank. This time around, it should welcome more banks.

We need creative disruptions in Indian banking to shake the incumbents of their complacency and infuse competition. It’s more than a month since the RBI cut its policy rate but no bank is willing to bring down their loan rates even though the yields of both government paper and corporate bonds have come down and many of the banks have pared their deposit rates.

Unless we create disruptions and intensify competition, banks will not care for their customers. Besides, through new alliances, the new banks will also pull down the boundaries between banking and telecom and retail businesses.

The RBI should allow as many small finance and payments banks as it finds fit and proper. Let some of them fail; it’s worth taking the risk. Many urban cooperative banks have failed in the past. Failure of a few small and payments banks will not create any systemic risk.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Financial Services Pvt. Ltd, India’s newest bank in the making. He is also the author of Sahara: The Untold Story and A Bank for the Buck.

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