Payments, small banks to ring in innovation

The Reserve Bank of India (RBI) on Thursday released the
final guidelines for licensing of payments and small banks.
These banks are intended to cover the unbanked and
underbanked areas and increase banking penetration in the
country, stated the circular. Let’s take a look at the
changes that these banks are likely to bring in financial
services.

What’s on offer?

According to the guidelines, payments banks can open
small savings accounts and accept deposits of up to Rs.1
lakh per individual customer, and provide remittance
services. These banks are allowed to issue automated
teller machines (ATM) or debit cards but are not allowed
to issue credit cards or lend in any form. Payments banks
can also distribute “non-risk sharing simple financial
products like mutual fund units and insurance products”,
stated the circular.

Small finance banks, on the other hand, will be allowed to
take deposits as well as lend money, the way other
commercial banks do, but the focus will be on small
lending. They can finance small business units, small and
marginal farmers, micro and small industries and
unorganized sector entities. These no longer face
geographical restrictions on operations.

Companies that are already present in the payments or
finance space—such as prepaid payment issuers and non-
banking finance companies (NBFC)—are considering
applying for the new licences. For instance, ItzCash Card
Ltd, FINO PayTech Ltd, Oxigen Services India Pvt. Ltd and
Citrus Payment Solutions Pvt. Ltd are planning to apply for
payments bank licence.

NBFCs such as Shriram Group, Muthoot Finance Ltd and
Manappuram Finance Ltd want to enter the banking space
and are studying the new guidelines to take a decision.
“We’re interested and our board members are studying the
new directives of RBI. We will undertake a decision soon,”
said George Alexander Muthoot, managing director, Muthoot
Finance.

The RBI has also allowed mobile telephone companies,
supermarket chains, and other companies and cooperatives
to set up payments banks. Also, a company can form a
joint venture with an existing scheduled commercial bank.

New formats expected Small finance banks and payments banks are expected to further the government’s aim of financial inclusion. With
small savings and remittance services targeted at low-
income households and the unorganized sector, this will
help increase financial penetration and financial savings,
and help bring the currently largely unorganised remittances
and payment systems in India into the organised sector,
Nomura stated in a report.

According to World Bank estimates, only 35% of India’s
adult population has accounts with financial institutions.

“The differential banking will be able to provide more
people access to formal financial products. For instance,
the payments bank will have to give the standard interest
rate, if not more, on deposits,” said Vishal Narnolia, banking
analyst at SMC Global Securities Ltd.

Will payments banks be able to launch low-cost and
innovative products? “They will be able to generate revenue
broadly in 3 ways—interest from deposit on SLR (statutory
liquidity ratio), fee from distributing third-party products
such as mutual funds or insurance, and from transaction
fees on any payments. This ability to earn income should
push the companies to provide low-cost products to the
end consumers,” said Narnolia.

Innovation, however, will be the key to their success. “With
the launch of these niche banks, the one-size-fits-all
approach will come to an end in banking. Once the small
finance banks are launched, you will see simple and basic
products that work for the lowest strata of the income
pyramid. The community lending approach of NBFCs will be
extended in a banking setup,” said G.S. Sundararajan, group
director, Shriram Group.

Competition in this space will work in favor of consumers.
“Competition to get and retain customers in financial
services business will go up. Hence, there will be focus on
technology to provide innovative products,” said Pramod
Saxena, founder, chairman and managing director, Oxigen
Services. The company is planning to apply for a payments
bank licence.

Jitendra Gupta, founder and managing director, Citrus
Payment Solutions, agrees that there will be innovation.
“The existing commercial banks are not doing justice in
terms of technology in the payment space. With dedicated
payments banks, there will be significant change in the
payment space. If we have a banking licence, we don’t
have to depend on another bank’s settlement cycle for our
customers. Also, we will have access to the full ATM
network,” said Gupta.

Joint ventures likely

While more banks with innovative services and products is
good news, these may not be in direct competition with the
existing commercial banks. A Kotak Institutional Equities
report stated: “...these banks may not emerge as a serious
threat to the banking sector in the medium term as they
continue to work in a very tight regulatory environment.
Private banks may look to act as promoters of payments
banks rather than competitors given restrictions on credit.
However, we would need to watch developments in small
finance banks. Most private banks use the services of
NBFCs to meet priority sector lending (PSL) requirements.
Any conversion of a large NBFC can impact the meeting of
their (private banks’) PSL requirements.”

Interested parties have to submit their applications for
licences by 16 January 2015. Once the licences are given,
companies have a gestation period of 18 months. While the
guidelines are out, it will take some time for the dust to
settle, and for prospective participants to decide if being a
payments bank or a small finance bank makes sense.

Also it is too early to say how accessible their services will be.
Hopefully, these new formats will be able to work in letter
and spirit.

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