100 new banks in 3-5 years? Don't rule it out with RBI's new payment, small bank norms

The Reserve Bank of India's (RBI's) final guidelines for issuing licences for payment banks and small finance banks have the potential to revolutionise Indian banking. If competition for the customer's wallet spikes as a result - as it certainly will - the new limited-objective banks could threaten the current oligopolistic banking structure where margins are high and competition weak.

In the current structure, inefficient public sector banks set low profitability benchmarks for private sector banks - making them seem like paragons of high performance. This keeps margins high and customer service is just about tolerable, if not poor. Right now customers are being dazzled by the use of technology at ATMs and net banking so that they stop complaining about poor service and high charges. Small businesses are forced to borrow at extortionate rates since the big banks do not treat them as well as the big corporate borrowers. When payment and small finance banks enter the field, this cosy set-up will be dismembered.

If the RBI does not become too conservative in its issue of licenses, I would expect at least 100 new payment and small finance banks to be set-up over the next few years since the field has been opened up for almost every one - from mobile companies to supermarkets to non-bank finance companies (NBFCs) and microfinance institutions (MFIs) and what-have-you. The big corporates have been denied a back-door entry into banking through the small finance route, but they can still enter payment banking.

The truth is 99 percent of Indian households need nothing more than payment and small finance banks to get by with their basic transaction needs. They will lack nothing that big banks like SBI, HDFC Bank and ICICI Bank can now offer, including ATMs, internet banking, small loans to buy cars and two-wheelers, or to borrow against gold ornaments or other such family collateral. Only the top one percent of better-off India and big companies need the Godzillas of public and private sector banking.

Consider what all you need to do with a bank. You need to deposit money, draw cash, pay bills, issue small cheques, and buy things at the mall with a debit card. The only big-ticket transaction you may not be able conduct with payment banks (but not small finance banks) is buy a house in a big city or invest significant sums in stocks or mutual funds. For these you still need the big banks or big NBFCs. Small finance banks can ultimately handle even this need, but they will first need to establish their credentials of trust.

A look at the RBI's guidelines for payment and small finance banks will explain why this is so.

Payment banks need Rs 100 crore of capital and can offer savings or fixed deposits up to a value of Rs 1 lakh. They are nearly 100 percent secure since they can't lend money to anyone except the government. They have to keep 75 percent of the deposits in government securities of up to one year (ie, treasury bills with upto 364-day maturities), four percent as an interest-free cash deposit with the RBI (ie, cash reserve ratio), and the balance with other banks to meet day-to-day cash pressures from customers. Any corporate with a decent record can start a payment bank. The guidelines specifically say that mobile companies, retail chains, finance professionals, NBFCs, public and private sector companies, and cooperatives can set up payment banks. In other words, practically anybody can set up a payment bank. If Subrata Roy of Sahara Group had just waited a while, he could have started a payment bank. For defying laws and the court, he is instead in jail.

As for small finance banks, they are like any other bank except that they have to lend 75 percent of their loan portfolio to sectors categorised as priority (agriculture, small businesses, etc), and 50 percent of the loans cannot exceed Rs 25 lakh in value. Otherwise, they are like any universal bank - and can seek to transition to one once they have established a track record.

Given these guidelines, here's why Raghuram Rajan's guidelines can revolutionise the banking industry:

One, every major company with a large captive customer base can seek to become a payment bank. The Indian Railways, big public sector entities, the Tatas, Birlas, Ambanis, and even medium-sized companies can set up such banks. The attraction could be this: once you set up a viable payments bank, you have one foot in banking. And you would have developed expertise in the deposit and treasury part of banking operations. Who knows, once established, the RBI could allow payment banks to lend against deposits, and the deposit limit of Rs 1 lakh could be raised with inflation and experience.

Two, mobile, supermarket and e-commerce companies are obvious candidates for setting up payment banks. Right now Airtel offers bill payment facilities through Airtel Money, but you have to keep loading money from banks at regular intervals and the limits are low. If Airtel, Reliance Communications, Idea Cellular and Vodafone set up payment banks, they can effectively become the key to daily transactional banking. You could pay for your mall purchases, settle bills, etc, with ease. The mobile companies and retailers - from Big Bazaar to Flipkart to Amazon - can create payment banks so that they can offer seamless payment facilities to their millions of customers. Airtel, for example, has more than 215 million customers. In future, they can offer mobile and bank accounts in one combo.

Three, payment banks can facilitate per-to-peer transactions. If you want to send money through your mobile to another friend or even a cabbie, you may be able to do it through mobile authorizations. With a payment bank as the transaction backbone, an Airtel customer will be able to pay any other Airtel user (and ultimately any user of any mobile network), even a prepaid user like a plumber or electrician, via the mobile and receive confirmation of credit instantly. Transaction closed.

Four, the big banks - the SBIs, HDFC Banks, et al - now make a huge spread on CASA, current and savings banks accounts on which they pay very little interest. They will find their customers migrating a part of idle savings account balances to payment banks for their day-to-day smaller value transactions. The float of cheap deposits with the big banks will reduce. Small finance banks, with their lower cost structures, and with their ability to lend to households and small businesses, can take away the bulk of the profitable personal loan, two-wheeler, car and truck financing portfolios of banks. So, one should not be surprised if the big banks themselves invest in small and payment bank ventures to retain a slice of the action. They will face a squeeze both on the deposit float and the high-interest paying small borrower.

Five, small and payment banks are the key to financial inclusion, since they will have lower costs. They are, in fact, the ideal vehicles for Narendra Modi's Jan Dhan Yojana for financial inclusion and for the routing of direct cash subsidies for the poor. One cannot thus rule out the possibility of the big banks offloading their Jan Dhan customers to payment banks for operational reasons. India Post, which wants to become a universal bank, is the ideal small finance bank with its 1,55,000 branches, most in rural and semi-urban areas.

Six, to keep costs very low, the new banks can effectively operate as pure internet banks, with very few physical branches. They can easily operate as virtual banks. Big Bazaar can have its bank branches at its super markets, but customers can transact anywhere.

Seven, small and payment banks, which will have considerable scope for selling mutual funds and other financial products, will also have the ability to earn fee incomes in the hinterland. This will rob the big banks of easy money from such sales.

The RBI's guidelines for payment and small finance banks will open up the banking sector to the economy's real potential. The big boys of public sector and private banking will have to work harder for their margins in future.

Updated Date: Dec 21, 2014 18:05:44 IST