Despite privatisation of PSU banks, low-cost banking needs digital approach

The scope of banking is much more than can be read from the current rate of credit growth to industry, which has only picked up to 4.1% in October 2021 from a contraction of 0.7% a year ago

Lots of policy and market developments are happening in the Indian credit space--surprisingly when banks have turned cautious about lending. This week rating agency S&P has turned “cautiously optimistic” on Indian banks after a long time. The optimism has a lot to do with the confidence that banks are not lending much. Non-food credit has risen less than one per cent seven months into this financial year from that of March 2021, as per RBI data. 

Just a week before, in a clear indication of how RBI views the banking landscape, it has rejected its own internal group report to allow corporates to   own banks. At the same time, the government has announced plans to privatise at least two banks, soon and possibly more later. And all of these have happened as the debate on cryptocurrency has got stirred with the finance ministry planning to bring a bill to ostensibly bar its usage. 

All these developments have the overriding priority to expand credit opportunities fast as the economy rebounds. In the second quarter of FY22, the GDP has grown 8.4 percent, much above the consensus estimate of 8 percent of most forecasters. To keep the momentum going, more lending is a must. But the higher lending does not seem to come from the banks. 

Among the lending opportunities, a handsome segment should be for the MSME sector which accounts for 30 percent of the gross value added in the GDP. These are FY20 figures but those numbers have not changed much. 

Lending options to MSME: 

Yet of the total industrial bank credit, only 14 per cent is channelled to micro and small enterprises as per RBI data at the end of October 2021. While this is however an improvement--it was a full hundred basis points lower till the same period last year, S&P has already found reasons to be concerned. It has pointed out accurately that most banks do not have the governance and the risk management to handle such a jump. “If risk management does not improve, then the coming growth cycle could produce a new crop of sour loans”.

It is the reason why different agencies are offering different prescriptions for reaching loans to these productive enterprises. The government’s own Niti Aayog has floated a discussion paper to set up full fledged digital banks to reach credit to the MSME sector. This is however easier said than done though former deputy governor, RBI, N S Vishwanathan is hopeful. "Digital banking will ensure there shall be lots of banking but no banks. The concept of a physical bank will have to wither away but the role of banks as the key intermediary in the financial sector will remain. Essentially the digital banks will become the cheaper place to do business for the customers," he said speaking with Business Standard. 

The other alternative is bank privatisation so they become less rigid about giving out loans. In any case a bank, digital or otherwise has to be set up by the RBI. But Governor Shaktikanta Das is saddled with pressure to maintain the balance among the existing ones, the private sector and state-owned. 

The corporate sector is keen he opens up banking ownership for them to invest in, which he has refused. The RBI had set up an Internal Working Group last year “to review the extant guidelines on ownership and corporate structure for Indian private sector banks”. Among other things it had suggested opening up the banks for investment by corporates. The RBI has so far accepted 21 suggestions from the group, but not the one to revise ownership in the private banks.  

In the absence of banks, the space for incremental lending in the economy is being usurped by the fintech firms. These are as the Niti Aayog paper says are neo-banks. They ride on an existing bank offering expensive credit lines bunched up with conveniences like a digital debit card, personal finance management tools like spend analytics for better budgeting and investment avenues through their mobile applications. As the potential market is big at about Rs 25 trillion, the attraction for new entrants to join almost every week is massive. They are unregulated. In January this year, responding to reports of coercive tactics of loan recovery by some of these entities, RBI set up a committee under one of its executive directors Jayant Kumar Dash to examine the world of online lending. Expectedly the committee has recommended another legislation to set up yet another regulatory body to decide which lending works and which does not. So if a food aggregator shares data on restaurants with payment practices with a lending app or offers to share costs of building one, it is not kosher according to the committee.

Digital banks:

This is what Niti Aayog has suggested, RBI could look into. It has suggested a two-stage digital bank license regime. The first stage could be a regulatory sandbox. if the performance of the licensee in the sandbox meets pre-set goals, “the initial set of restrictions can be progressively relaxed” to offer a full stack digital business bank license. On the other hand if the progress is halted, the licensee will be allowed to offload the business including deposits created and assign the assets created to an identified buyer and exit the sandbox.

The enabling conditions for the interface of such a bank with the rest of the financial sector has already been established by RBI. "RBI has recognised the concept of a digital NBFC already. So we already have regulations for their functioning. Also the concept of digital banking is to an extent embodied in the concept of payments bank", said Vishwanathan. On the same lines the conventional banks have been allowed more space through the banking outlet model run by business correspondents, he added.   

In September this year, the regulator set up an Account Aggregator framework. The framework is a data sharing system that will provide easy access to financial data to different parties in the financial ecosystem. These aggregators can store all the financial data of a person or a firm and with her consent share it with any financial entity. This means credit history, bank details and soon GST details will all be available in this framework. Digital banks sit very well in such a universe. Mandar Kagade, founder principal at Black Dot policy advisory and one of the authors of the Niti Aayog report said digital bank licensing will offer a clear line of sight for the RBI to regulate the sector, instead of setting up more oversight bodies.

This is because just like small finance banks, digital banks will also have to be registered under the Banking Regulation Act, 1949. It means they can offer the full suite of services that the Act empowers them. The crucial difference is the latter will principally rely on the internet and other proximate channels to offer their services instead of physical branches.

It will help the government expand banking even as it gets out of the business of banking, to cut down on budget pressures to continually refinance the weaker state owned ones. For lending to flourish more options like small finance banks and digital banks thus need to be explored vigorously. There are only 11 small finance banks in the country with a total asset size of less than Rs 70,000 crore as on March 2020. In fact as an RBI paper shows they have less rural footprint than the state owned banks. 

Finance minister Nirmala Sitharaman has already announced she will move a bill in this session to privatise at least two banks. This will of course create its own headache for the RBI. Since an industrial group cannot bid for any of them, the choice is restricted to the existing clutch of non banking financial companies (NBFC). There are not too many among them who have the balance sheet to take on the additional liability of these banks. 

To prime these NBFCs to the task of holding a bank, the RBI has recently announced more convergence in their recognition of bad loans at par with the strict standards of banks. This will paradoxically make the NBFCs less able to offer loans at attractive prices for the MSME sector. “Even one of the largest well-capitalized (deposit-taking) NBFCs in India has a cost of funds of approximately 7.5 per cent” a Bajaj Finance investor report from early this year notes. Compare that with the rates of banks at about 3.8 per cent. In this context, new forms of banks but regulated as a concept need to be explored continually or unregulated pockets will emerge. 

This has become particularly significant to take on the competition that cryptos, regulated or otherwise shall inevitably pose. The scope for digital money has grown metronomically in India. The UPI, the bag of settlement options for digital money, has clocked Rs 4 trillion in the value of transactions cleared since it came into being in 2016. The scope of banking is vast with this infrastructure, much more than can be read from the current rate of credit growth to industry which has only picked up to 4.1 per cent in October 2021 from a contraction of 0.7 per cent in October 2020.