BackDoes it pay to open payments banks?
To differentiate payments banks from existing banking structures, some serious restrictions have been placed
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Payments banks (PBs) are a regulatory innovation in India predicated upon two primary objectives: financial inclusion and universal banking for small depositors. There have been earlier attempts to create smaller sized banks to infuse competition in the banking system and deal with the last-mile problem. For example, in an attempt to mobilize rural deposits and to meet the financial needs of the rural poor, Reserve Bank of India (RBI) had flagged a new set of banks, Local Area Banks, in 1996. It licensed five such banks between 1999 and 2001. These banks are, however, facing a number of issues, such as profitability, competition for funds with scheduled commercial banks and capital and regulatory constraints for expansion. Seen against this backdrop, does it really pay to open a payments bank?
Payments banks formally induct a whole host of technology players into the banking fold—including telecom companies, payment instruments innovators and e-commerce aggregators on the threshold of emerging as de facto banks riding on payment innovations. Their outreach to consumers and potential for a free float has created space for the emergence of new types of financial intermediaries.
However, in order to align with these objectives and differentiate payments banks from existing banking structures, some fairly serious restrictions are placed on their activities. To begin with, PBs face a blanket ban on any type of lending. Besides, apart from the requirement of maintaining cash reserve ratio (CRR)/statutory liquidity ratio (SLR) on the outside liability, they would be required to de facto maintain 75% SLR on their demand liabilities and face a cap on keeping deposits with commercial banks at 25% of their current and time deposits. This reduces the business of PBs to that of a fixed spread business akin to asset management companies (AMCs) where higher revenue is directly a function of total deposits mobilized by them.
The spread thus earned would need to cover the costs incurred on the enabling technology infrastructure and its expansion, employee and other operational expenses, market risk on the investment portfolio, provision for operational risks and a minimum return on capital. Illustratively, if the PBs are perforce required to pay a minimum of 4% on their savings deposits and an average earnings on government securities is 7.5% (benchmarked to 10-year G-secs), their spread would be capped at 3.5%. This is comparable to that of AMCs with minimal capital requirement.
On the liability side too, they cannot accept deposits higher than ₹ 1 lakh. Besides, capital requirement is quite steep at 15% capital to risk weighted assets ratio (minimum 7.5% Tier-I). However, a stricter clause of capital requirement is to put a floor on leverage at not less than 3% (that is, outside liabilities being restrained to a maximum of 33.33 times of net worth). In fact, if we incorporate all these assumptions, the return on equity for PBs comes out to less than 5%!
The severity of this restriction can also be understood from a hypothetical scenario where India Post becomes the designated PB for disbursement of all types of government welfare benefits through direct benefits transfer (assumed at 3% of GDP, including rural employment guarantee, food security, LPG, and so on). At the current GDP level, this would mean a net worth requirement of ₹ 122 billion. This contrasts sharply with just ₹ 8 billion of capital infusion envisaged at present in the Post Bank. Alternatively, it would require the presence of nearly 25 PBs, each the size of systemically important financial institutions, to do the job of distributing government benefits alone.
The business of PBs is free from credit risk and face relatively lower market risk, but is subject to operational and liquidity risk. Perhaps an unintended consequence of a large SLR requirement is the implication of PBs acting as a captive source of finance for the government. PBs may thus turn out to be working merely as an aggregator—a disintermediation vehicle for depositors to invest directly in G-secs. PBs emerging as a real competitor to banks is not a near-term possibility with deposits up to ₹ 1 lakh comprising only 9% of total deposits of the banking system in terms of value (70% in terms of number of accounts).
PBs would be subject to a whole host of other regulations that are unique. In particular, the higher disclosure norms that oblige them to share their business plan with the regulator could prove to be somewhat tricky when the business model of the technology intensive companies itself could be the biggest source of their competitive strength. There are other regulatory burden including (i) a majority of independent directors (could be a human resources challenge in itself), (ii) a minimum of 25% of physical access points in rural areas, (iii) subsidiary structure like non-banking financial companies are not permitted, and (IV) non-resident Indian deposits not permitted, although foreign remittance is.
If one takes note of the quick exit of some players after obtaining PB licences, some of the factors highlighted above may need revaluation and suitable amendments. Alternatively, the PB model could still be a success—but only with the universal banks and telecom companies working together having strong infrastructure, deep pockets and network in place. Isn’t it an irony after all?
Soumya Kanti Ghosh and Dipankar Mitra are, respectively, chief economic adviser, State Bank of India, and independent economist.
Comments are welcome at theirviews@livemint.com
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