On the road to 75 new digital banks, there will be twists and turns

The finance minister's Washington announcement signals an acceleration of the government's plans but there are many basic questions to address still

Finance Minister Nirmala Sitharaman’s statement that “75 digital-only banks and non-banking financial companies” (NBFCs) are to be set up this year has caused a ripple of excitement. It is a reiteration of her stance in the Union Budget but in a much more public forum, the Atlantic Council think tank in Washington, on Tuesday.
 

The announcement clearly signals an acceleration of the government’s plans for digital-only banks. But these plans have to be seen in the context of the Reserve Bank of India’s guidelines for the “Establishment of Digital Banking Units (DBUs)” on April 7 this year, and a working group’s (WG) report on digital lending released on November 18, 2021. The two documents have to be read together to better appreciate Sitharaman’s Washington announcement, and get a sense of the urgency on hand.
 

The WG on digital lending for the first time revealed the remarkable ramp-up in digital lending (compared to the payments’ volumes captured in the RBI’s monthly bulletins). It pointed out that disbursements through the digital mode (for the sampled banks and NBFCs) grew more than 12-fold to Rs 141,821 crore in 2020 from Rs 11,671 crore in 2017. This accounted for 75 per cent and 10 per cent of total assets of banks and NBFCs for FY20).
 

Again, while lending through digital modes is still at a nascent stage for banks compared to the physical (Rs 1.12 trillion versus Rs 53.08 trillion), these figures were diametrically opposite for NBFCs — Rs 1.93 trillion versus Rs 0.23 trillion. Now, given that the banks are the main vendors of credit in the country, it’s clear that they have a lot of catching up to do when it comes to lending via the digital mode.
 

But first things first: what is a digital banking unit (DBU)? According to the RBI’s April 7 circular, it is “present and future electronic banking services provided by a licensed bank for the execution of financial, banking and other transactions; or orders and instruments through electronic devices and equipment over websites, mobile phones or other digital channels as determined by the bank…”
 

And as for disclosure under Accounting Standard 17, it stipulates a sub-division into: (i) digital banking and (ii) “other retail banking”. The central bank also made it clear that this route is open only for “scheduled commercial banks” — not for other regulated entities such as regional rural banks (RRBs), payments banks (PBs) and local area banks (LABs).
 

This brings us to some key issues. Do banks really need to go through the DBU route? For this is not going to be cheap by any stretch of the imagination. And we have no idea how much investments banks have made in the digital area as the sums are not disclosed in their annual reports. This is way different to companies, which disclose their capacity expansion, or investments in new plant and machinery — the short point being that banks’ investment in digital should be seen as no different.
 

Perhaps, the RBI could explore a model akin to co-lending between banks and NBFCs. Let banks and NBFCs tie up with best-in-class fintechs. After all, not only is the digital lending report to be operationalised soon, but the RBI has also set up a department of fintech to mainstream the newbies. Is it necessary for banks to invest on their own in the entire digital food chain — from origination, on-boarding to collections? Would they not be better off teaming up with the RBI tightening its outsourcing guidelines?
 

There’s also another matter of detail. While Sitharaman made an explicit reference to “digital-only banks and NBFCs”, the RBI in its April 7 circular on DBUs doesn’t specifically exclude NBFCs even as it does RRBs, PBs and LABs. This can lead to another set of worries for the excluded entities — how are they to survive the competition from banks with DBUs? As it is, RBI-regulated entities other than banks, including small finance banks, are facing tough times. Even a top-of-the-line entity such as HDFC Ltd has opted for a merger with its offspring HDFC Bank — a move hastened by the “Scale-based Regulation (SBR): A Revised Regulatory Framework for NBFCs” of October 2021.
 

And in all this is the bigger question: will 75 entities qualify to set up DBUs?
 

Remember, it doesn’t naturally follow that all “scheduled commercial banks” that want to set up a DBU will make the cut. The RBI has also added that “each DBU must offer certain minimum digital banking products and services. Such products should be on both liabilities and assets side of the balance sheet of the digital banking segment”. If liabilities are a must, it automatically rules out non-deposit-taking NBFCs. Again, if deposit-taking NBFCs were to get in, then it’s no different from allowing them to apply for a banking licence, albeit a limited one — with only a change in the form factor: digital. And if any one were to qualify for a DBU, what’s the status of that legacy NBFC?
 

Despite Sitharaman’s US announcement, it is clear that the road to DBUs has many twists and turns.