Simplifying licensing key to digital-age banking

Consolidate the banking categories into two, namely, universal banks and specialised banks

As pragmatic policy-making, it would be useful to accept the futility of licences when they have not helped the intended cause.

By Srinath Sridharan

As of September 2021, the size of the Indian banking industry is about Rs 109 lakh crore ($1.46 trillion). With our services sector, a veritable blend of services, being the dominant GDP-driver, we would need to double credit growth (or the banking sector’s size) to help achieve the $5-trillion-economy goal.

This would need a larger number of banks, with stronger balance-sheets to provide credit offerings to  various consumer segments.Over the past decades, we have accumulated various categories of banking licences. With the original intent of serving specific consumer segments or consumer needs having either gotten diluted—even absent now—and, in cases, remaining unmet despite years of licensing, such licensing continues to accumulate rust in the system and burden the regulatory supervision task, with neither ease of banking nor improved credit-access to the consumers.

The banking categories today include public sector banks (12), private banks (21), small finance banks (12), payments banks (6), regional rural banks (43), foreign banks (44), local area banks (3), financial institutions (4), urban cooperative banks (1,531), multi-state cooperative societies and banks (1,130).The business viability of many of these categories are in doubt, while some of the categories have not proven their relevance and significance. For how much longer should we wait to acknowledge that these business models did not work ?

As pragmatic policy-making, it would be useful to accept the futility of licences when they have not helped the intended cause. Licences were perceived as valuable, and hence licence-hoarding has happened over the years across BFSI, including in the banking and non-banking spaces. The lending ecosystem today has not just banks, but also NBFCs, HFCs, MFIs and digital lenders. Proliferation of non-banks happened due to the large finance-distribution gaps found across the length and breadth of the country.

Consumers who found NBFCs open to them treated these reverentially as if they were banks! In many instances, banks found it easier to extend credit to NBFCs and tick-mark their PSL compliance. That our domestic debt market is shallow is an understatement. Credit access is low, sporadic and with moody disbursal, even after the decades of licensing trying to solve for it. For example, what is the point of having a universal bank that does not lend to SMEs or other critical-to-economy segments ?

After all, one cannot hide behind PR-exercises every quarter by changing the lending focus—let’s call it the “credit flavour of the quarter”!While there is no formally acknowledged hierarchy in banking categories, there surely is the perception of a “banking-Brahmin” of sorts. Ask any senior management personnel across industries, and you will hear tales of such perception. In addition, even the proven ability of many fintechs to raise large and patient capital from respected investors and to deploy credit prudently has been ignored in the mainstream narrative.

Recently, NITI Aayog floated the idea of setting up full-stack ‘digital banks’, which would primarily work on the internet and other proximate channels to offer their services, instead of physical branches. The discussion paper titled ‘Digital Banks: A Proposal for Licensing & Regulatory Regime for India’, dwells on this idea in detail, including on operationalising them. It proposes that these digital banks will issue deposits, lend and offer the full suite of services that the Banking Act empowers banks to provide.

NITI, in this paper, has remarked that India’s public digital infrastructure, especially UPI, has successfully demonstrated how to challenge established incumbents.The UK has successfully proven the concept of digital-only banks. What started as the ‘challenger bank’ idea a few years ago, to challenge the might of the Big4 legacy banking giants, opened up newer ideas for credit-access for segments that had been ignored for years.

While Indian regulations don’t allow for the term “bank” to be used unless there is a banking licence granted, we have turned a blind eye to the phrases like “neo bank” being used. Isn’t the phrase misleading? Why wait till the next problem to sort it?Make banking licensing simple and consolidate banking categories into two categories, namely, universal banks that can carry out all functions within the entire banking spectrum and specialised banks (SME bank, Mortgage bank, Infra bank, etc) that can focus their lending, based on specific competency, to SMEs, MSMEs, mortgage, commodity, wholesale, infra, etc.

Let each licensee in this banking category compulsorily lend at least 80% of its assets to the consumer segment it targets.This would also help RBI prescribe asset-liability management guidelines, as each of the sectors has different asset tenors. For example, housing loans typically have 15-20-year loan tenors whereas MSME loans can be of 2-3-year tenors.

Link this with debt paper tenors available, and risk management becomes easier when it is connected to regulatory supervision.By allowing for specialised banks, the challenges of financial inclusion and the credit-shunning issue that we have been facing for long can be solved. This would induce the banks to be profitable and to serve their affinity consumer segment rather than grow the balance-sheet mindlessly, or worry about PR optics for appeasing investors.It is not surprising to see the hierarchy between banks and non-banks, and, consequently, the application of differing regulatory provisions to them.

Bringing all of them under mainstream regulation and uniform-access would allow for preserving financial stability and ensuring adequate consumer protection. To collapse various banking legislations into a single one, convert all lending entities (banks or non-banks) into one category of banking or the other, and then subject them to proper scrutiny through real-time digital-led supervision.

One-size-fits-all supervision does not work in an interconnected world. For example, what a large bank, such as SBI, needs in terms of supervisionwill be very different from what a small, regional private sector bank needs.In this endeavour, it would be useful to have a roadmap over the next five years, on converting all lending entities beyond a certain AUM size (say, `25,000 crore) into banks. Phase out non-banks who don’t conduct much business or don’t have proven track record within a certain timeframe.

The regulatory ‘brahmastra’ of ‘fit & proper’ can be prodigiously used in this endeavour.It would help to put a target date for simplification of banking categories and set about grand-fathering the existing books. While being at that, having a common data format across BFSI to track real time movement of monies to ensure fiscal stability is also important. As a nation, we are moving from physical to Phygital and from physical distribution of banking to a hybrid mode; let’s get our licensing norms simple. Then we can move from Digital-also to Digital-First to Digital-Only. Let our consumers decide ‘when’!

Corporate advisor & independent markets commentator. Twitter: @ssmumbai

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