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Smita Aggarwal: No more bank clones

The setting up of payments banks would move more savings into the formal sector, provide better safety to customers and de-risk the inclusion strategy of banks

Smita Aggarwal 

Smita Aggarwal

The Reserve Bank of India has for the last several years persistently pursued financial inclusion as a core agenda. However, it continues to remain a challenge. The traditional banking models in India have failed to penetrate the low-income and self-employed segment for various reasons: non-accessibility; the lack of well-defined revenue streams; the informal nature of the market; a lack of documentation and of a history of credit behaviour or formal savings; the high cost structure of full-service banks; and the high risks associated with this segment.

The recent report of the Nachiket Mor Committee has made several recommendations that could make it more viable for banks to pursue the financial inclusion agenda. First, banks may be permitted to create a subsidiary dedicated to this segment. This would allow banks to have the desired focus with a customised business model and differentiated cost structure suitable to cater to this segment. Second, it is proposed that the banking correspondent (BC) model may be made more flexible by permitting NBFCs to act as BCs, removing restrictions on the distance between the bank and BCs, and changing outsourcing guidelines to allow banks to determine risk-sharing arrangements with their agents. Third, the criteria for a qualifying branch under the rural branching mandate may be more flexible. Fourth, the recommendation to mandate universal reporting to credit bureaus for all loans would help create a proper credit history for borrowers and improve the lending appetite of banks. Sixth, on priority sector lending, the proposal to have weights based on sub-sectors and geographies should be beneficial to the banks in two ways - one, this ensures that each bank is not forced to lend to all sub-sectors and allows fungibility for the banks based on their core competencies and two, it incentivises banks doing business in less banked geographies.

In addition, the recommendation to allow banks to freely price farm loans based on their risk models would allow banks to price them suitably based on risk and cost-to-serve, making it viable for them to offer products and providing the borrower with an alternate to high-cost informal sources. Finally, the recommendation to permit banks to purchase portfolio-level hedges against rainfall and commodity price risk would improve the risk management ability of the banks.

One of the recommendations of the report is the introduction of 'payments banks' focused on offering savings and payments products. The additional note submitted by two members of the committee states that while creation of such banks is a step forward and shall improve accessibility, some concerns remain. First, what purpose would be served by these banks when the goal is to provide all products to customers, including credit? While it is true that access to credit is a critical part of financial inclusion, because of the low risk in savings and payments it may be prudent to isolate the latter in order to accelerate the process. Credit cannot be pushed beyond a point, whereas savings and payments can be made ubiquitous. The resultant rich data on customer transaction and savings behaviour can be mined and used by lenders for credit due diligence and improve credit uptake as well.

The second issue is that creation of this new category would de-focus the existing Bank-BC model. The present level of usage of formal institutions for small savings and payments is much smaller than that of the informal channels, mainly due to lack of accessibility and convenience. Given the scale of the task ahead, multiple models should be encouraged.

The report also proposes that the existing banks may also be permitted to set up payments bank subsidiaries. A question that arises is the viability of these banks, given that they would be permitted to deploy their funds only in short-term SLR securities. Additionally, as with all banks, 'payment banks' would need to meet the CRR and capital adequacy requirements and comply with full KYC norms. While payments banks would be free to pay interest on deposits to their customers, this segment is not very sensitive to interest earned. It is more important to eliminate hidden costs in the form of travel and time cost, and opportunity cost, if money is not accessible all the time or if there are restrictions like minimum balance and limit on number/value of transactions. The key to the success of this model would be: ubiquitous presence and easy access. Banks would need to extensively leverage technology to provide balance between convenience and cost-to- serve. The low cost on deposit balances, combined with earnings on SLR investments and fees from customers, would provide an adequate revenue model to the payments banks, apart from saving hidden costs for the customers. Setting up of 'payments banks' would move more savings into the formal sector, provide better safety to customers and also de-risk the financial inclusion strategy of banks.

The report envisages many different types of banks co-existing - full-service banks (scheduled commercial banks), small-loans focused banks (wholesale banks), small-savings focused banks (payments banks). This would allow banks to choose their own niche based on their area of expertise and risk appetite, rather than being clones of each other. The banks need to realise that this is where the future of banking lies and unleash their creativity to make it happen.

The writer works for the Centre for Advanced Financial Research and Learning

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First Published: Sat, February 01 2014. 21:48 IST