Payments Banks: The Way Forward

In the last few months we’ve had 21 licenses issued to banking institutions – payments banks and small finance banks which is more than the total number of licenses issued in the 4 decades prior to that. The breakthrough in this process is that we’ve moved from commercial universal banking to a more niche, focused, and differentiated model. A basis for this is the recognition that if we are to address the needs of the heterogeneous population, then we cannot use a one size fits all approach. The standardized business models cannot be expected to handle all the needs of the individuals.

Payments Banks represent an effort to reach out to a large number of previously unbanked households by offering a set of services which meet their requirements but also reducing the load on organisation by managing their portfolios, minimizing their risks by restricting the kinds of investments that can be made. And hopefully finding a way to use these as not only stand-alone business model, but also finding a way to integrate them into the larger banking system. Payments Banks can potentially fill what has been a significant last-mile gap in the financial system.

However, the systems under which Payments Banks have been set up and have received licenses require some clarification and assurance that this is a viable and attractive business model.

Financial Inclusion landscape in India

As we contemplate the emerging landscape of financial inclusion in India there are three important trends we need to consider:

• Driven by the Jan Dhan Yojana, Mudra Yojana and other products and services being rolled out, financial inclusion seems to be moving along very quickly
• Addition of 23 new banks, deposit taking institutions, in the financial landscape after almost a decade
• Driving direct benefits transfers through the JAM trinity

The combination of these three factors becomes a profoundly important time for the financial sector landscape in India.

Payments Banks are a revolutionary initiative as far as India is concerned. They make access of financial services for every individual more convenient.  This has been achieved through an open architecture. India has taken the m-pesa concept and made it into an open architecture by allowing people to choose who their payments bank should be. This has allowed for the creation of competition in the financial access industry by bringing down barriers to entry in order to provide last mile access.

The Direct Benefits Transfer are providing the transactions that will provide liquidity in the system. The DBT are adding liquidity into the system and making sure that NREGA payments, pensions, scholarships etc which were happening through government offices are now moving through bank accounts and the cash out is coming through payments banks.

This combination of Inclusion – Access – Liquidity will be transformational for people in India who have so far been excluded from participating in the financial inclusion system. Once this architecture is in place, the next step must be to think about the type of products and services that can be provided that will change people’s financial behaviour.

Pensions have become a huge liability, as most people do not have any long term financial savings. Indians typically have not done a good job in saving for their old age. Hence, the need arises to encourage people to save for the future. The Atal Pension Yojana is one such product targeted to those who are not in organised employment, and provides them with the ability to save for their retirement. However, there is a need to come up with innovative approaches to enable people to participate in and take advantage of such schemes.

There is a tremendous opportunity for collaboration between the larger banks and organisations which have the last-mile access. The open architecture can facilitate such collaborations in order to provide last-mile access. Regulations for Payments Banks were designed in such a way to facilitate collaborations – allowing a one lakh limit, and only for cash in – cash out purposes.

Innovations in the financial sector

Most innovations in the financial sector have been organic – they occurred in response to a need which arose. The need was to integrate all Indians within the formal banking system in the least possible time and at the lowest possible cost. These needs can be fulfilled through innovations in both hard and soft technologies – mobile banking, VSAT technologies etc. Using existing institutions, existing frameworks, relying on existing players such as Kirana shops, citizen service centres, post offices etc is the way to achieve low cost access in the least possible time. These institutions have the trust and support of the individuals in the area, hence, using them to act as BCs and providers of DBT can prove to be useful. Using existing institutions to sell products and to explain advantages of the products, to instil confidence, to carry inputs back to the banks are the kinds of things that can be leveraged.

Certain issues however still persist in the payments banks space, these include:

• Providing connectivity at a reasonable affordable cost in the areas which are not yet connected.
• Interoperability of point of sale machines is a real concern which needs to be resolved
• There is a need to think of the short and medium term solutions to connectivity which can in a cost effective way be migrated to a later availability of say a national optical fibre network
• Other concerns include – Sustainability of banking institutions, targeting, economic security, putting money into circulation.

In order for the Payments Banks experiment to work there are four elements which need to be addressed; business model, reliability of technology, regulators, reasonably reliable source of business.

Session 1: Regulatory Challenges

Key Insights –

• Regulatory Attitude towards payments banks
  • RBI has constituted a group for payments banks to develop a regulatory and supervisory framework. This involves developing a potential framework and activity regulation. The purpose of this is to maintain financial stability. These are new banks that have entered the arena and we cannot afford to have them fail. The primary requirements for these banks to succeed are a good net worth and good capital reserve ratio. Payments Banks are relatively small institutions which will not pose a systemic threat for a long time.
  • Activity based regulations must be the same for similar types of institutions in order to not have arbitrage and facilitate a level playing field. If a regulation exists for a particular activity then that would apply similarly to payments banks as well unless there are reasons to differentiate. In terms of activity of the banks, the RBI would try to minimize regulations. They will let the market innovate and compete and watch, and in case there are any customer service related issues then intervene.

• Differentiated supervisory approach is required in the payments banks space. Payments Banks are regulated by multiple regulators, hence there is a need for inter regulatory cooperation – moving towards a more common framework instead of each regulator looking after their own domain. Supervisory approaches however, tend to be difficult to manage. Innovations in products must be recognised in order for these to work and facilitate effective payments banks. Each regulator has their own separate guidelines, moving away from that to a common consumer protection forum might be helpful. Regulation must not only be lightweight but be innovative in thinking
  • Failed transactions are key concerns for capacity for payments banks, this settlement process for this space will pose a challenge particularly when dealing with very low volume transactions.
  • In terms of what constitutes a branch in under the RBI guidelines is any brick and mortar structure with available staff and an independent accounting unit. Cash out points and BCs would be connected to these branches. They do not envisage a virtual banking concept yet. In this scenario, the 25% limit will not apply for payments banks. This limit only exists for physical access points and not branches.
  • Guidelines for handling breach of 1 lakh limit – unintended breaches do occur, exceptions are granted for those.

• Connectivity for Payments Banks
  • Mobile operators are now one of the players as Payments Banks, hence, they should not see the others as competitors but in fact they have to facilitate this competition and not exclude the non-smartphone owners.
  • Since both telcos and banks are merging to provide banking services a different kind of regulatory approach must be adopted. TRAI has set up committees to ensure that unbanked people who do not have smart phones can still operate mobile banking services.
  • This is a period of transition with mobile operators migrating towards 3g and 4g services. There are many constraints to this however, primarily related to the availability of spectrum. TRAI is working with the government that more spectrum is provided. Operators within the last few months have set up more towers to facilitate improved connectivity. Hence, steps are being taken to address this challenge

• KYC and facilitation of data sharing
  • Digitising KYC is the way forward for the banking system, however, it poses some challenges due to poor last mile connectivity to rural areas. Using technology to allow for data sharing would help in lowering operating costs though challenges such as awareness and accessibility in rural areas must be considered. In this scenario having paper print outs and pass books would prove useful until the technology reaches the area.
  • Sharing of KYC between payments banks can be further extended to sharing between the mobile operators and the banks. For example, Airtel has 240 million KYCed customers. This ecosystem is robust and tightly controlled in execution. Thus, is may make sense to think about the ways in which this can be shared with banks which would then boost the last-mile access. Banking KYC norms are quite flexible, hence adapting to that system is possible

• Other key issues
  • New age payments banks will come up with new and innovative ways to address the requirements of paper based customer engagement or fulfilment. In this scenario a certain amount of flexibility must be allowed and banks should to forced to adopt or issue such systems which will increase the costs of operations if they are to remain viable.
  • In this scenario, cash outs will pose the biggest challenge as the digitization of the entire system may take some. Hence, cash management processes in the meanwhile must be improved, the onus of which rests with the payments banks.
  • The payments banks model must be high velocity with low cost transactions in order to facilitate access and ease of usage. Mobile operators can play a significant role in being able to facilitate this.
  • Creating a backend standardization process if very important as shared services will come under threat if the same standards are not followed.

Session 2: DBT Perspective

Key Insights –

• The DBT mission looks at accurate targeting of the beneficiaries, de-duplications, plugging the loopholes and the leakages in the system, ensuring efficiency, and greater transparency are some of the larger objectives of using the platform in making some of these services available to the poor.
• Prerequisites for a DBT transfer to happen – beneficiary database must be available on an IT platform, opening of bank accounts, Aadhaar is an important factor with the need to map the biometric data with both the beneficiary and banking side of the transaction
• Since the inception of the mission, approximately 50000 crore of benefits have transferred to approximately 30 crore people. The government had seen huge windfall gains in terms of plugging loop holes, better delivery systems, and increase in savings, better reach and accessibility.
• Last-mile delivery mechanisms – unless banking services are taken to the doorsteps of the beneficiaries, the distribution of DBTs becomes a challenge. The DBT has two dimensions; getting the funds from the government to the bank is the easy part. However, in making those funds available from the bank to the beneficiary is where the challenge lies.
• The postal department plays an important in role in facilitating the DBT. It has been in the banking space since its inception with over 1 lakh 30 post offices in rural areas. Currently approximately 9 crore beneficiaries are receiving DBT through post offices. The Postal department is uniquely placed, the staff are local and trusted by the populace. Hence, people are not intimidated by going to a post office and are more comfortable than going to a bank branch.
• The ease of doing business in the DBT space has improved. These accounts cannot be looked at as another savings accounts as most of the times after withdrawals not much balance is left within them – most of them become near zero balance accounts. It is difficult for a bank to maintain such accounts and provide services to them. In order for the DBT to be made sustainable, must have a re-think on the service delivery platform. Complimentary technologies such as micro ATMs at rural post offices can be considered.
• The transfer of benefits must be made as efficient as possible and in the quickest manner possible. Currently the beneficiary is spending 12-20% of the amount transferred to him to just access those funds.
• The JAM trinity has proved to be successful in achieving financial inclusion in India. However, the 200 million accounts that have been opened lack the basic access to services. Hence, payments banks have the opportunity to provide those services to these bank accounts
• Aadhaar would make eKYC a possibility and make it easier and more efficient to share across platforms
• Connectivity is a major concern which needs to be tackled. This is crucial if the DBT is to succeed needs to be improved

Session 3: Viability through sharing

Key Insights –

• Organisational plan for payments banks – three distinct entities
  • Chief business officer who would be responsible for maximising gross transaction value – marketing, sales, development activities for the bank
  • Chief Reach Officer – the objective would be to see that marginal costs are zero – reach the nth guy in the nth place at zero marginal costs – payments banks coupled closely with technology can achieve this.
  • Chief Operating Officer to look at the risk, compliance, legal issues, finance, and other operational activities of the bank
    • Head of retail banking, retail payments, products
    • Head of BCs – BC driven approach or non-BC tech driven approach
  • Technology is the driving force behind all of this. We cannot replicate what traditional banks have been doing as this will develop a high cost structure which will not be sustainable for payments banks. Payments banks face the challenge of not owning assets to get interest income from, whereas the liabilities are all the deposits that they own. With a near zero asset base expenses must also be cut down. Traditionally commissions, and brokerage and other fees constitute 15% of income for banks, the rest is from assets. Payments banks have to find a way to increase the 15% to be a majority of their income flow. Technology is key in maximising their impact; it will help in balancing assets and liabilities in order to be successful in running a bank.
  • Fintech companies have a plethora of products and services, payments banks can reach out to them in developing low cost models for their operations, such as pay as you go models.
  • There is a need for interoperability in the payments banks space is they are to succeed. In the past most organisations have gone about conducting business in an individualistic manner, this model cannot be sustained if we are to have successful payments banks. Data sharing between the telcos and banks is also an opportunity for interoperability. This is an opportunity to democratize banking, with the need for multiple players to come together to create a robust ecosystem to provide accessible financial services.
  • Consumer Trust – common service centres employ local people which creates an environment of comfort for the community. These can be used to educate the consumers about the various products and services offered by the payments bank. In the case of defaulted transactions, Payments Banks can build trust by first compensating the consumer and then investigating the discrepancy.
  • High Cash Reserve Ratios, Statutory Liquidity Ratios, and Reverse Repo Rates can lead to challenges in the viability and operability of payments banks.

Session 4: Technology

Key Insights –

• The core technologies for the payments banks are not the differentiators. The way that payments banks can build a low cost model is focusing on technology which is above the core. Core technologies for most banks are fairly standardised, the feature, applications and what can be done from it fairly stable. What distinguished one from another is how to use the power of the core and build a layer above that to identify the service and retain customers. There is a lot of buzz around digital with the advent of payments banks.
• The emphasis on low cost technologies is important for the business model of payments banks. The digital architecture of PBs can be developed by borrowing from a basket of five technologies; Light technology (WAP), Dumb technology (SMS), Thin technology (NFC tags), Thick technology (Contactless payments), and Fat technology (block chains). A mix and match between these five can help in developing the right mix for a sustainable model.
• Moving away from paper based transactions such as printing pass books and receipts of payments towards digitizing all data can help in reducing operating costs significantly for payments banks.
• Partnerships with other NBFCs, commercial banks, and telcos must be driven for the business model and sustenance of payments banks. This will allow for the adoption of low cost technologies which are readily available. Payments banks will be exposed to higher risks if they move towards the more complex and high cost technology models.

Event Announcement

Brookings India and the Centre for Digital Financial Inclusion held a day-long conference on Payments Banks.

Inaugural Address by Shri Jayant Sinha, MoS Finance
Valedictory Address by Mr. R S Sharma, Chairman, TRAI

A payments bank has all the key functionalities of a traditional bank, except offering of loans. It is allowed to accept deposits up to ₹ 100,000 per account, payments and remittance services, and internet banking. It may also function as a business correspondent of other banks. The intention of these banks is to foster financial inclusion by providing small savings accounts for payments and remittances to low-income households, migrant workers, small businesses and unorganised sector entities.