NextGen banking: smaller, niche banks can change India's financial landscape

The Reserve Bank of India (RBI) on Thursday spelled out draft rules for creation of payments banks and smaller, which marked the beginning of a historical chapter in India’s Rs 86 lakh crore banking industry.

The start of differentiated banking regime in India is also an idea mooted by the International Monetary Fund economist turned-Reserve bank governor, Raghuram Rajan, much before he moved to India.

Entry of payment banks and smaller banks, in simple words, would mean the birth of a new generation of banks in Asia’s third largest economy, which will undertake specific banking activities. So far, India is familiar with only full service banks-banks which offer a full range of services from retail customers to SMEs and large corporations, from low-income groups to high networth individuals, all under one roof.

Differentiated banks would undertake specific banking activities, say either serving small income groups or large corporations or offering restricted services such as transactional banking. The proposed payment banks are mainly transactional banks, while smaller banks, as the name suggest, will cater to tiny companies and small value customer segment.

The guidelines are only draft ones at this stage.The final set of rules, after taking into account feedback from various stakeholders, will come in the next few months.

The idea of payment banks was first proposed by an RBI panel headed by Nachiket Mor, a member central bank’s board and a former ICICI Bank deputy managing director, in the roadmap for financial inclusion in India, early this year.

Differentiated banks, on the other hand, was in discussion stages of the Reserve Bank way back in 2007, but gained critical public attention when the RBI released a discussion paper of banking structure reforms in 2013.

There are a few differences with the Mor panel recommendations on payment banks and the draft norms.

One, the RBI has kept the entry capital barrier for payment and small banks at Rs 100 crore, double of what Mor had recommended.

Second, is the limit of deposits per customer, which payment banks can accept. The RBI has increased it to Rs 1 lakh as compared with Rs 50,000 suggested by Mor.

There was an uproar from certain quarters when in April the RBI permitted only two-IDFC and Bandhan-out of 25 applicants to start as commercial banks. Now that the floor has been opened for payments and smaller banks, a number of entities can become banks given on the condition that the non-banking financial corporations (NBFCs), corporate business correspondents and even resident individuals have a good track record.

The Rs 100 crore entry cap isn’t an impossible task for many microfinance companies and other NBFCs to meet. The RBI has set a 15 percent capital adequacy ratio (CAR) for both banks, which too isn’t a burden given the low-risk profile of these banks. CAR is calculated on risk-weighted assets. For payment banks, there is virtually zero risk to operate because except the reserve requirement in the form of cash reserve ratio (CRR), their entire deposits will be invested in zero-risk government bonds.

Also, the RBI’s emphasis on usage of internet banking in payment and small banks as the main potential mode of banking transaction has a lot of promise given that companies with expertise in technology, say telecom firms, can utilise this as an opportunity to use their existing platforms to offer banking services.

Payment banks can invest in only one-year maturity government bonds.Given that such banks will mostly offer savings deposits, there won’t be any pressure on their margins. The yield on one year-treasury bill was 8.725% on Friday, giving enough leeway for such banks to make a good margin even if they offer 4-6% return on deposits.

But there could be one grey area that might need a relook. It doesn’t make much sense to cap the deposit limit at Rs 1 lakh given the rise in income levels in rural segments. Even a start-up firm with low-capital base might want to have higher cash savings, which they might want to deposit in such banks.