1. Column: Making payments banks work through large customer volumes, controlling costs

Column: Making payments banks work through large customer volumes, controlling costs

Achieving large customer volumes and controlling costs are two factors critical to their success

By: | Updated: September 5, 2015 9:32 AM
Payments bank

Achieving large customer volumes and controlling costs are two factors critical to their success.(Illustrations: Shyam)

India will witness the introduction of payments banks (PBs)—an experiment with little precedence from elsewhere—in the coming year. We have had regional rural banks and cooperative banks in the country, but their focus has been more on lending than deposits. The idea behind PBs, from the point of view of the RBI, is to extend financial inclusion by using novel delivery channels. Hence, the 11 parties that have gotten an in-principle nod include telecom companies, NBFCs, the department of posts, a banking-correspondent player, depository, and some large corporates. Each of these must have thought through the plot while filing the application. The existence of entrepreneurs with diverse backgrounds could ultimately be a test for which model works best, beyond conventional banking.

Two factors have to be kept in mind. First, there is a large banking system already in place, with 65% of a total of 127,000 branches located in rural and semi-urban areas (as of March 2015). Second, the Jan Dhan Yojana has led to the opening of 180 million new accounts through banking channels. Hence, any growth, on top of these structures, will have to be accelerated and must be as rooted in the lowest level as the top.

Let us visualise the likely scenario. PBs have to target large numbers to build their business. As they cannot take deposits beyond R1 lakh per account, they have to look for a large number of mid-size deposits to reap economies of scale. But households, which may wish to make such deposits, would probably already be holding bank accounts.

Therefore, PBs have to look for new small account holders. The telecom companies may scale up their existing e-wallets, popular with the urban population in particular, but there will now be a cost involved as these accounts have to get converted to savings accounts with interest payout.

As much as 80% of all bank accounts—977 million of 1,226 million, as of March 2014—are savings accounts. The average balance held in savings accounts across different population groups is as follows: rural R11,082, semi-urban R17,263, urban R30,946 and metropolitan R41,274.

Rural and semi-urban households account for 36% and 29%, i.e., 65% of all savings accounts held with banks. Urban and metropolitan depositors comprise around 17% each. For PBs, while tapping into the latter looks attractive, the cost would be high because while there is fairly widespread use of e-wallets—companies actually charge a fee on these at the moment, but they will, from hereon, have to pay an interest on the amounts held in these. The remaining depositors would probably already be in a banking relationship. Therefore, even though targeting this segment is good economics, PBs have to offer other value-added service to bring them into their fold.

Targeting the rural segment of the customer base seems the logical option, given it is a highly under-penetrated market. But, here the ticket-size will be much smaller than urban/metropolirtan areas. Also, while banks are able to average a balance of R11,082 per account (as of March 2014) in rural areas, the new accounts may not be able to scale up to similar levels. The total amount of deposits collected in the 180 million Jan Dhan accounts was around R23,000 crore. Of these accounts, 45% held zero balance. Therefore, the average balance (discounting the nil balance accounts) was around R2,300 per account, rounded off to, say, R2,500. To reach even these levels, PBs have to garner a large number of accounts.

Now, let us look at the PB model. PBs can only take in demand deposits: that  means they can hold either current or savings accounts. Households largely prefer the latter because of interest rates, which means getting the depositors involves a cost for PBs. They have to offer a minimum of 4% interest, given existing bank rates for savings accounts. PBs can deploy these funds only in Treasury bills or G-Secs of less than 1 year and put another 25% in other banks for managing cash. There is no risk of default nor are there any capital adequacy issues. Their earnings would be at least 7% on their investments. The spread of 3% looks very attractive, comparable if not better than that earned by banks today in their ordinary business.

The crux for PBs would be to keep costs down. The fixed cost would vary depending on the models chosen by the banks. The operating costs would be on IT, staff, administrative and selling costs, etc. Eyeing an average balance of R2,500 per account, 1 million accounts would yield a corpus of R250 crore, giving a spread return of R7.5 crore. Multiplying the account numbers by 10 would escalate the same to R75 crore and so on. Costs have to be reined in here.

The intermediation cost, as a percentage of total assets, for banks is 1.8-2.5% today, depending on size, age and ownership of banks. Therefore, for PBs, the focus has to be on lowering these costs, which will presumably happen as they will be using existing infrastructure which can be scaled up to maintain low-cost models. The aim should be to get a net return of 0.5-1% on assets (which will broadly be equal to the deposits garnered).

If PBs can rake in a higher average balance, say R5,000, then the model would work better with a corpus of R500 crore for 1 million accounts. This looks more likely if they are able to cause metropolitan and urban bank account holders to migrate to their channels, where other value-added links such as the e-wallet are on offer. But such migration would not add to overall deposits and would mean a loss of business for banks.

The strategy has to be two-fold: to create the necessary volumes and to control costs. Given that the average return on assets for the banking system is 1% (0.8-1.8%, depending on whether the bank is a PSB or a new private bank) and return on net-worth being around 15%, PBs achieving these levels calls for major scaling up.

The challenge is that most PBs will have to compete with each other in the same geographies, with everyone focused on a diversified base across the four customer segments. The next set of entrants would probably be closely watching these developments.

The author is chief economist, CARE Ratings.
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