First steps for small finance and payment banks

By Rajashekara V Maiya

The broad-basing of banking services in India received a shot in the arm from the Committee on Comprehensive Financial Services for Small Business and Low Income Households, which recommended the creation of Small Finance and Payment Banks as a formal banking delivery arm targeted at the underserved. A quick definition: Small Finance Banks come with obligations of rural branch presence, priority lending targets and minimum paid up capital, but may take deposits and give loans, whereas Payment Banks, which aren’t subject to these conditions, are allowed mainly to participate in payment transactions.

Despite these restrictions, a huge opportunity awaits both. In India, 60 percent of the population is unbanked, 85 percent has no life insurance, mortgage to GDP is 10 percent when it’s 20 percent in China and 80 percent in the U.K., and per capita credit is a mere US$742. That’s not all. With the government setting a target of INR 40 trillion for mortgages and the creation of 300 million new manufacturing jobs by 2020, the pent up demand for financial products and services will receive further economic stimulus.

As Small Finance/Payment Banks prepare to enter this market, they must take certain key decisions:

Target customers: The underbanked are not a monolithic, undifferentiated group; though they are classified into segments based on region, profession, income, age, etc. just like their banked counterparts. Regional factors are quite significant, as they have a strong bearing on the customer profile and banking product portfolio.

The business to be in: Small Finance Banks, which may issue loans subject to a ceiling of INR 2.5 million, might want to focus on niche areas, such as personal or small business lending, initially. They must augment the basic offerings with a value-adding advisory component, to make productive use of their investment in branch infrastructure. Successful models of peer banks in other countries, such as Japan’s Jibun Bank or Slovakia & Czech Republic’s Zuno Bank, could be followed.

The products to offer: Banks can focus within their chosen niche through simple products to begin with, and expand their portfolio once they have systematically penetrated the market. One way to relieve the pressure of building a lending portfolio, and especially its obligatory priority sector component, is to acquire loans from local micro or non-banking finance companies and refinancing them.

Geographies: Locations have strong impact on several aspects of the business. Regulations pertaining to labor, real estate, taxation etc., vary across states, it may be judicious to proceed slowly, rather than launch in several regions at the outset.

Technology decisions areequally vital to the creation of a cost efficient, nimble and competitive Small Finance/ Payment Bank model.

How intensive: Small Finance/Payment Banks faced with prohibitive infrastructure, people and financing costs, have several cost-efficient technological options to choose from. Banks can pursue a mix of manual and automated banking to going branchless. While the latter model is most efficient from a resource point of view, it runs the risk of excluding several people who lack the required level of tech-proficiency to use an ATM or mobile banking.

Hence, a more practicable approach is a blend of touch and tech. Here, banks can decide whether to take a tech-minimalistic route or not. That decision could be a function of ambition and regional focus; for instance, a bank with small goals and a purely rural agenda would prefer to deploy bare-bones technology etc., while investing in manned branches and banking correspondents. However, a bank targeting the semi-urban unbanked would leverage all the technology possible, whether it is Internet & mobile, biometrics or customer analytics, to stay cost competitive.

How entrenched: Banks can limit themselves to core banking activities or choose a larger role in facilitating the local economy. For instance, they could establish an online/mobile marketplace platform where their customers could buy or sell produce, seek profession related advice, and learn from experiences of customers in nearby villages. Banks could also createan ecosystem of service providers to the rural economy, and thereby eliminate nefarious business practices of corrupt middlemen. In fact, they already have a ready-made platform to create such an ecosystem and connected community in the form of 900 million mobile subscriptions and over 800 million plus Aadhaar enrolments.

How proprietary: For Small Finance/Payment Banks with limited resources, on-premise infrastructure might be out of reach. These banks (like Nabard) could opt for hosted or cloud-based services, availing benefits like flexible provisioning and pay-per-use pricing. A mutually beneficial model could be one where large scheduled commercial banks offer their assets, such as IT infrastructure, products, processes and knowledge of domain and risk/regulatory compliance practices, as “Banking as a Service” on the cloud to Small Finance/Payment Banks.

Previous efforts at enforcing financial inclusion did not succeed since the big banks couldn’t evolve a viable business model. Now, as the newly licensed Small Finance/Payment Banks eye this opportunity, they will find technology playing a massive role in creating a business that is sustainable, profitable, and also compliant with all the regulatory obligations set out by the Reserve Bank of India.

(The author is head of product strategy and pre sales, Finacle, Infosys)