Differentiating to include

Reserve Bank of India works on connecting with the unbanked

Following up on its announcements that it would rely on a differentiated licensing approach to push its financial inclusion agenda, the Reserve Bank of India, or the RBI, published its draft guidelines on two new categories of financial intermediaries - payments banks and small banks. Payments banks will be allowed to take deposits up to a maximum of Rs 1 lakh for now, which will be fully insured. They will not be allowed to engage in any lending activity. Rather, their business model will depend on an array of payments services - remittances, prepaid payment instruments, or PPIs, and so on - for which they can charge fees. They can also invest their deposits in government securities, earning interest. Since this model buffers them from credit risk, their prudential requirements can be lighter than those for regular banks, reducing their costs. They will be allowed to partner with a variety of organisations to carry out both their deposit-raising and payments businesses. Small banks are expected to deliver credit more effectively to small businesses. By confining their geographic presence to relatively small, contiguous areas, they are seen as being more sensitive to local opportunities and risks - "local feel" as the guidelines put it. They will raise deposits and make loans in their designated areas. Existing non-banking finance companies, microfinance institutions and individuals with a track record in banking will be eligible to set these up.

As things go, both these models provide a promising last-mile capability to connect with the large unbanked or underbanked constituencies. It is now quite clear that the large commercial banks find this market segment unattractive, and their inclusion objectives are mostly compliance to a mandate. Innovations in appraisal, delivery and, particularly, the use of technology are unlikely to come from these organisations. The thrust of the RBI's strategy now is to move from mandate to viability, which requires a completely different model to address those three critical factors. De-risking is the key element of the payments banks proposal, while local knowledge is what is supposed to differentiate the small banks. By drawing boundaries on what both types of institutions can do, a separate space is being carved out, which is under no real threat from the bigger players. This also encourages a range of players to try their hand at it.

However, it must also be recognised that the guidelines, particularly for the small banks segment, have a "been there, done that" feel to them. Regional rural banks, co-operative banks, local area banks, state finance corporations - several models have been in place for years on end, of which a fair assessment would be that there have been more failures than successes. There are several plausible explanations for this rather disappointing record. In the build-up to the final guidelines, the RBI must articulate its own assessment of the problems that these categories faced or still face, and how the new models provide solutions to them. The last thing that the economy needs is another set of initiatives that look like reforms, but end up not having any impact because one or more necessary steps were missed. The draft guidelines are a good first step, but there are many more to go.