This will be a learning process for the financial sector
There was scepticism when the concept of payments and small banks was floated in 2014 as the objective assigned to these banks was already a part of the roadmap for all commercial banks, especially the public sector banks. The argument was that if the commercial banks had not been successful despite the various models that they had pursued, it meant either they were not serious or that this area was not viable. One can say with confidence that the financial viability factor was the main reason for not expanding in an aggressive manner. The response to the opening of this door for various players was more than encouraging as evidently they had their models in place. But the withdrawal of some of them has brought the issue back on the table.
RBI had set the guidelines for setting up of these differentiated banks and had asked the public for feedback. On paper, it looked like a good idea. The cost of funds would not exceed 4% if they were savings deposits; in case they went as demand deposits, the cost would be nil; 75% of the money had to be invested in government securities with a maturity of less than one year with no MTM issues; the balance above the CRR could be put in bank deposits, etc. Assuming a return of around 7%, a net spread of 3% looked compelling. The trick was to cut down on operating costs; and move to the technology mode where there was wide use of mobile phones; a profitable model could be maintained. The Postal Bank fits the bill very well as it is also working on similar lines at present, where deposits collected are lodged in government paper.
The biggest threat came from the Jan-Dhan Yojana, which went about frantically opening bank accounts for the unbanked population. Around 220 million accounts have been opened, with 75% having non-zero balance and deposits totalling to almost Rs 40,000 crore. Banks have been instructed to open no-frill deposit accounts with card facility. This has been followed up by using these accounts to transfer funds for either MGNREGA wages or direct benefits payments. Intuitively, these dormant accounts have become active as there is money coming in at regular intervals.
But the challenge is to make banking a habit as the deposit-holders have to keep using this facility—to qualify for an overdraft at a later stage. But success here has been limited and, more important, the average balance per account is just about Rs 2,500. The upper limit was fixed by the RBI at Rs 1 lakh per account.
A new payments bank would have to keep in mind that while some would migrate to this mode as it could resemble an e-wallet, the so-called lesser banked population do not have the money that they can keep in a bank. This would impact the very premise of inclusive banking. When the household has limited income that is largely spent, there is little left for savings. Often, these savings are held as cash-at-home. For this to be converted into a bank account, there is a requirement for spreading awareness among the low-income households.
The small bank concept is also novel, but it would be interesting to see how the players plan their models. Here, deposits can be garnered for all durations, but the CRR and SLR norms would apply from the beginning. This will account for around 25% of the funds received. Further, 75% of the adjusted net bank credit has to flow to the priority sector which includes small and micro enterprises and farmers. Hence, the lending would be directed exclusively at the ‘priority sector.’ It is not clear whether small banks will have access to the repo window of RBI.
Such a model would be a challenge considering loans in the priority sector are more vulnerable to becoming non-performing assets. The farm sector is always under pressure from the vagaries of monsoon. The slowdown in industry over the last three years has affected the SME segment more—not only are they are borrowing at a high cost, but are also impacted by build-up of high level of inventories which are financed by high-cost capital and a larger entry under receivables due to the arrears of their clients.
Commercial banks have never quite said that they find this lending onerous, but given the volatile delinquencies and the fact that they seldom exceed the 40% target (they normally fall short and prefer investing the residue in the RIDF) it appears that such lending is more statutory in nature. Under these circumstances, running a business plan would be an edgy affair.
Differentiated banking does make a lot of sense, provided the paths of various categories of banks do not cross. In the pre-reform days, there were specialised financial institutions which helped capital formation and commercial banks provided working capital. As one ventured into the interiors, there were regional rural banks, land development banks and the cooperative banks which catered to the rural requirements. The move towards universal banking removed this distinction between development banking and commercial banking. Even today, there is serious talk on bank mergers, especially among PSBs.
Under these circumstances, having new ‘payments’ or ‘small’ banks would involve competing with well-established commercial banks for addressing the potential requirements of a community which doesn’t have enough money left after expenses to maintain deposits of significant amounts but is keen to have access to credit, given that it is out of the formal system. It may be pointed out here that the parallel banking system comprising RRBs and cooperative banks are fragile with several entities being merged due to non-viability.
However, as these factors are known, these new differentiated banks should be better able to plan their business models to jump over these hurdles. This would be a learning process for the financial sector as it will also reflect the delta that can be added to the system.
The author is chief economist, CARE Ratings
Views are personal