The Road Less Traveled
Reserve Bank of India (RBI) granted ‘in-principle’ approval to 11 payments banks in August 2015. By the end of 2016, three had already dropped and timelines for others were hazy, creating doubts on the success of this seemingly progressive experiment of RBI.
The year 2017 began with a good omen, though. Airtel payments bank and India Post payments bank (IPPB) have commenced operations, Paytm is slated for August launch and Fino PayTech is tentatively confirmed for 2017 end. Although the news from Reliance (along with SBI) is still ambiguous, NSDL is still sticking to its launch date of ‘very soon’ for long and the recent talk of Idea and Vodafone merger creating doubts on their plans (both have payments bank approvals). For 2018, my hope is four to five payments banks would be operational across the country. Considering the challenges for payments banks, it’s still good news.
The verdict on the viability of payment banks varies, depending on whom you speak to. While the critics would easily fault the regulatory framework, even the strongest advocates would concede that payments bank isn’t a cakewalk. It necessarily needs a new, innovative approach. Innovation, in turn, requires creativity. And creativity is in some ways an antithesis of banking!
The road to building a payments bank is not only less traveled (considering this is one of a kind experiment) but is likely to be bumpy.
On paper, the concept of payments bank kills two birds with one stone. Firstly, it gives an impetus to the financial inclusion initiative by widening the digital payment infrastructure. Secondly, it encourages the FinTech culture in the Indian banking landscape and indicates RBI is in tune with times, despite its legacy.
While both are desirable objectives, in reality, the case of payments banks is a tough nut to crack. The key challenges are:
1. The payments-only model
A payments-only offering is an incomplete proposition and relies highly on low ticket account balances (capped at ₹1 lakh) for profitability. It’s akin to any high volume-low margin commoditized business, driven by convenience and pricing, with little customer stickiness. Making a payments bank viable requires a fine balance between cost of acquisition of granular liabilities, offering competitive pricing on transaction charges and ability to quickly reach critical mass. Going by the example of Airtel offering 7.25% interest rate to acquire balances and high inter-bank transaction charges (which will discourage interoperability and high customer attrition), seems they are yet to figure out what to do with the license. Contrastingly in traditional banking, CASA (current account-savings account) is still the best source of low-cost funds while high transaction charges are the worst way to build customer loyalty.
2. Cross-sell fee
While the cross-sell fee is touted as a ‘green pasture’ for building profitability, unfortunately, it is a shade less than green for the following reasons:
- Selling of insurance and mutual fund products is closely regulated by sectoral regulators (IRDA and SEBI). Not only are the distribution and sales commissions capped, there are strict requirements to prevent miss-selling. Both require certified and trained manpower to sell the products, which implies hiring better quality manpower, expense on training them and longer gestation before the resource is productive. In simple words – higher costs and limited upside on income.
- Cross-selling credit products like loans from NBFCs or Banks is not easy either. Building competence for basic credit evaluation to target right customers has a learning curve for both individuals and organizations.
- Cross-selling is successful where the deep relationship with the customer exists. If payments banks rely on third-party point-of-sale intermediaries like retail shops, where this is a side activity, revenue from cross-selling is unlikely to make a significant contribution to the bottom line.
3. Restriction on fund deployment
Payments banks are required to invest 75% of their CASA balances in Statutory Liquidity Ratio (SLR) eligible government bonds or T-Bills. For the balance 25%, the option is deposits with other SCBs. While this is considered as a safety net for depositors, it restricts their ability to optimize treasury operations.
4. No lending. No NII (Net Interest Income) or IRR (Internal Rate of Return)
Scheduled Commercial Banks (SCB) and Small Finance Banks (SFB) earn anywhere between 4 to 10% NII from working capital loans and as high as 30% IRR on small-ticket business loans or credit cards. Even the Micro Finance Institutions (MFI) lend at a rate of 25%.
Payments banks are not permitted to lend. Their investment in stipulated government securities and bank FDs would yield 2-4% net of cost of funds (or negative if they try to aggressively mobilize balances at higher rates like Airtel). Adjusted for other operating costs, the net return may fall to sub 1% levels, again corroborating the high volume-low margin nature of this business.
With existing SCBs upping their focus, multiple payments banks and SFBs vying for the customer attention and even the FinTech startups disrupting the existing models, the segment is already too hot to handle. While some of the players like Airtel or Vodafone, with the existing distribution network and large customer base, have an advantage, the nature of the relationship they are now trying to build with the customer is different from a duopolistic market we normally see in telecom where top two players become market makers. India Post may be an outlier with distinct advantages of large physical distribution; however, for others, it’s a long haul to acquire critical mass.
Considering these challenges, it’s understandable that some players would get cold feet. Although, for those who decide to persist with the opportunity, there is light at the end of the tunnel.
1. Sheer size of the market
India’s unbanked population stands at 233 million. Even those who can be considered ‘included’ through Pradhan Mantri Jan Dhan Yojana (PMJDY), are still new to banking products. As per the 2011 census, 833 million people stay in rural areas and a significant part of that population has little awareness of new-age banking services, even if they have the accounts.
Another problem with a patriarchal society like India is the low participation of women (48% of the population or 586 million) in financial management and decisions. These challenges stem from complexity associated with banking and financial transactions.
This is precisely the opportunity a payments bank should encash. It requires smart segmentation, both geographical and demographic, to offer tailor-made products for bottom-of-pyramid (BOP), rural, the unbanked and women.
Importantly, the sheer size of the market can accommodate multiple players, offering their services to various segments of the society.
With the government initiative on JAM (Jan Dhan-Aadhar-mobile) and more recently demonetization, there is a push for digitization. Despite this, cash would still be a preferred mode for small value transaction, in absence of better alternatives that are as anonymous, convenient and free. MDR (Merchant Discount Rate) of 0.75-1.0% on debit cards and 1.5-2.5% on credit cards are obscenely high and unviable for small traders. Even the RTGS and NEFT are not free and OTP-based digital solutions offered by banks are too cumbersome and require a higher level of technology comfort.
Mobiles are ubiquitous but mobile banking isn’t. Even not so tech-savvy customers can store, dial phone numbers, send SMS but still find mobile banking tough! For them, banking still means a visit to the branch. Something wrong? The solutions are not simple.
The initial traction of wallets was primarily driven by the proposition of a ‘free’ and ‘more convenient’ payment method. There is still an opportunity to bring cost-effective and simplified technology interfaces for real-time payments.
Payments banks can utilize the payments infrastructure of National Payments Corporation of India (NPCI), where the SCBs may have some lag due to their legacy systems. Biometrics is another opportunity where the trend is yet to catch on. It is imperative for payments banks to move quickly, offer simplified solutions and occupy a specific niche or segment before everybody else. Can payment banks bring us simplicity of one-thumb-press banking?
3. Offer Financial Advisory (not cross sell!)
Financial advisory is a clichéd term, often used but rarely applied. It's unfortunate see ulterior motives of achieving cross-sell targets getting mixed up with the more well-meaning financial advisory. Unless you count the insurance pitch from your bank’s relationship manager, 99% of the people in India have little access to any form of financial advisory. As you go down the economic pyramid, money management advice is completely absent.
This inefficiency opens a huge white space for payments banks to offer real advisory services to rural and BOP. The key, however, is to reign in the tendency to mis-sell or do biased selling. This is an opportunity to bring lost ‘trust’ back to banking. While India Post Payment Bank, with its existing deposit base, may be uniquely placed, others can use this as an opportunity as well.
4. Bank as a Platform
The unbundling of bank products has resulted in many FinTech players emerging as leaders in their respective areas. Whether it is algorithm-based lending models or bots or NFC-enabled payments or real-time transaction monitoring or personal finance management, there is an opportunity to offer new age services. Payment banks can be the financial services gateways or platforms to re-bundle a host of innovative services. One such wholesome combination could be a tie-up with MFIs.
They may also explore going beyond financial services. For e.g. cross-selling water purifiers or LED bulbs, which not only address the challenge of clean water in rural areas or energy saving, respectively but also help take the relationship beyond transactions. There is more: crop insurance, weather forecasting services or integration with eNAM (Electronic National Agriculture Market) or issuing Soil Cards – the list is endless.
Conclusion: Become More Than a Bank
There is enough evidence that conventional banking is dying. Technology is reaching an inflection point to change banking paradigms. A payments bank license gives a vantage point to view these changes much better than any FinTech. Furthermore, RBI’s articulations indicate that the guidelines are not close-ended regulations. While it seems rightly cautious about creating systemic risks, there is an openness to revisit the account balance limits, product offerings and ‘upgrade’ the payments banks, based on the learnings and performance.
Payments banks can strategically use technology and smart segmentation as disruption tools and tactically leverage their existing customer base and distribution channels to quickly acquire critical mass.
This calls for quick collaborations with new age disruptors, optimization of resources, continual pivoting and regular engagement with RBI to evolve the rules of the game. In short, be like a humble, nimble startup instead of giving to the temptation of a becoming an upper-crust banker.