Small banks and payment banks: two niche banking formats introduced
RBI has issued draft guidelines on two new banking formats: (1) small banks and (2) payment banks. The primary objective of small banks is to play an important role in credit supply to MSME, agriculture and banking services in unbanked and under-banked regions in the country. The primary objective of payment banks would be to provide small savings/current accounts and provide a platform for high-volume, low-value payments/remittance services. There is a big focus on reaching out to the customer through a strong technological platform. The guidelines have been fairly silent on mergers and acquisitions.
Return ratios and scalability appear to be a challenge
Niche banking comes with niche problems; however, we construe that small banks can be more profitable but payment banks can give better growth. Small banks, given their charter, may have issues on scalability and events like a debt waiver, impact of high interest rate in MFI and the consequence of being involved in the vagaries of regional growth can result in volatile earnings performance. On the other hand, payment banks may be constrained in lending as they will be allowed to invest only in G-Sec portfolios. It does appear that profitability will be a function of their cost of deposits, operating expenses model and fee income on the high-volume transactions.
Collaborators and not competitors for now
We dont see these new banks emerging as a major threat to the frontline banks, at least in the short term, as they will be working in a tight environment with defined objectives that do not overlap with each other. Besides, we think that banks, especially private banks, would act as promoters rather than competitors of the payment banks, as these banks are allowed to act as banking correspondents (BCs) for offering credit products to their customers. These customers could help reduce PSL requirements of the banks.
Are we giving up on the existing structure
We like the minimum capital required of RsRs1 bn and the restrictions in the business model (scalability and profitability) as it would probably attract very serious players in this space. There are quite a few pre-paid instrument providers and financial inclusion-focused NBFCs like FINO and Eko, which are now eligible to convert into banks.
It does appear that RBI is disappointed with the banking sector as financial inclusion is yet to reach the entire country. Hence, it believes that the objective can be achieved by companies that are currently working in these specific areas.
However, we would have been a lot more comfortable if RBI were to give a definite roadmap on the cooperative banks landscape. Currently, we have >95,000 credit cooperatives in India, of which 1,606 pertain to urban cooperatives that have a large share of credit. As of FY2013, these banks (consolidated) delivered RoAs of 1.1%, RoEs of 9.7% and gross NPLs of 6%.
Payment banksprofitability is a serious question
The primary objective of payment banks would be to provide (1) small savings/current accounts and (2) high-volume, low-value payments/remittance services to migrant labor force, low-income households, small business, unorganized sector entities and others. Existing non-bank pre-paid instrument issuers, NBFCs, banking correspondents, mobile telephone companies, super-market chains, companies, cooperatives and PSUs are eligible to apply. Even banks can take a stake in these banks. They need to open 25% of their access points in rural areas.
The maximum balance per customer would be Rs0.1 mn. KYC (Know Your Customer) norms can be relaxed if (1) total credits in a financial year do not exceed Rs0.1 mn, (2) aggregate withdrawals and transfers do not exceed Rs10,000/month and (3) balance at any time does not exceed Rs50,000.
These banks would (1) have to maintain the regulatory charges of CRR and (2) not have the option to lend but would have to invest in G- Sec/T Bills with a maximum of 1-year maturity. The minimum capital required to start the bank would be Rs1 bn and the bank would have to have a minimum capital adequacy ratio of 15%. These banks would be governed by a simple leverage ratio of 20X (assets to net worth) as they dont have loans.
The promoters would have to progressively reduce their stake. The promoters would need to have at least 40% for the first five years while progressively reducing any excess beyond 40% within three years of commencement of business. The stake should be further reduced to 30% within a period of 10 years and to 26% within 12 years of commencement of business.
Profitability is a serious question
As compared to conventional banks, we are not too sure if we can understand the profitability of these banks. The severe restriction on lending makes the business model extremely challenging.
The exhibit below shows illustrations of a possible payment bank. We have created a few scenarios to highlight our concern. Our base-case scenario assumes (1) average RoEs of 14% in this business, (2) investment yield at 8%, (3) fee income of 1% and (4) cost of operations of 1%.
What does appear from this exercise is that there are two key parameters to make this business a viable proposition: (1) interest on deposits and (2) cost of operations. We think the offerings of these banks are unlikely to provide 4% on savings accounts and see it a lot lower as the spreads of the business are too thin. If possible, they need to link the cost of savings to the underlying interest rate on yields to reduce the volatility of returns, though it comes at the cost of the borrower. Cost of operations depends on the business model (tech-heavy initially or a cost/transaction platform) and the pace of expansion.
Small local banksscalability an issue
The primary objective is to play an important role in the supply of credit to micro and small enterprises, agriculture and banking services in unbanked and under-banked regions in the country. Their area of operations would be restricted to contiguous districts but would be allowed to neighboring states, making it challenging to build a scalable business model.
The minimum capital required to start the bank would be Rs1 bn and the bank would have to have a minimum capital adequacy ratio of 15%. The promoters would have to progressively reduce their stake. The promoters would need to have at least 40% for the first five years while progressively reducing any excess beyond 40% within three years of commencement of business. The stake should be further reduced to 30% within a period of 10 years and to 26% within 12 years of commencement of business.
These banks would have to maintain all the regulatory requirements like CRR (cash reserve ratio), SLR (statutory liquidity ratio) and PSL (priority-sector loans). The loan portfolio has to be well-diversified within its area of operations though we are not sure if the diversification risk has been reduced.
15% of capital funds would be the maximum that can be lent to individuals or groups. At least 50% of the loans have to be below Rs2.5 mn.
We are not sure if a single promoter would be allowed to open multiple small banks to address the (1) scalability of the business model and (2) concentration risk as lending could be due to the progress of a particular local industry and would be impacted by the vagaries of economic growth.