In the year since it was launched, India’s national financial inclusion drive has generated plenty of headlines – and even scored a Guinness World Record. But the August 2015 announcement from the Reserve Bank of India (RBI) could prove to be one if its most consequential moves.
On Wednesday, the RBI announced that it has issued in-principal approval to 11 of the 42 applicants that requested Payments Bank (PB) licenses. The government’s goal for these banks is that they further financial inclusion by providing a limited slate of financial services to low-income households, migrant laborers, small businesses and other underserved populations. To that end, PBs will be allowed to:
- Accept demand deposits, with an initial limitation of USD $1,800 per individual customer.
- Issue ATM/debit cards – but not credit cards.
- Provide payments and remittance services through various channels.
- Serve as Business Correspondents of other banks.
- Distribute simple, non-risk sharing financial products like mutual fund units and insurance – but not provide loans.
Assuming they’re able to comply with government requirements, these new PB entities – which range from telecoms to the national Postal Department – will officially receive their licenses in 18 months.
RBI Governor Raghuram Rajan has said that PBs will “revolutionise banking” in India, without posing a competitive threat to existing banks. And the decision to grant licenses to one in four applicants represents a pretty unusual degree of latitude from the central bank. Further, the RBI has stated that the entities that didn’t receive approval this time (along with many others) could be accepted in future licensing rounds, as it intends to grant more licenses "virtually on tap." So the government clearly views PBs as a powerful weapon in its financial inclusion arsenal.
But the impact of these banks is not guaranteed, and they will face the same hurdles as any financial services provider that aims to serve the country’s low-income, rural communities. If it were simple to serve these customers, India’s previous Business Correspondent efforts – not to mention its experience with private services like M-PESA, which captures almost every payment in countries like Kenya and Tanzania – would have met with more resounding success. Let’s take a look at 10 challenges PBs will face – and how they can live up to the government’s ambitious goals.
Finding the Right Leadership
The Payments Bank concept is perhaps the first of its kind anywhere in the world – a hybrid of banking and distribution with a running thread of technology. Thus far, business leaders from the fast-moving consumer goods and technology sectors have led teams in the payments space in India. But with payments now married to banking – a granular business of managing distribution points prudentially – it will be critical to have the right set of skills steering PBs’ efforts. Without the right mix of people, they may become a juggernaut hurtling towards failure.
Designing the Right Products
Remittances generate profits – indeed, India’s Business Correspondent initiative survived largely because banks outsourced remittance services to them. But because of these competing services, PBs will need to explore a “remittance plus” model, creating a differentiation between themselves and existing Business Correspondents. This essentially means investing heavily in customer-centric product design, thus capturing face-to-face and remote transactions by offering innovative products delivered via mobile phone.
Moving Beyond Cash-in/Cash-out
How well a PB is positioned with its network of cash-in/out points or low-cost and tech-heavy branches will undoubtedly determine its initial footprint in the hinterlands. But cash-in/out alone will not be enough, as these banks’ sustainability and scale will ultimately depend on customers’ adoption of digital cash for making transactions. Just cash-in/out services and no (or negligible) transactions would result in inactive digital accounts, whereas PBs’ whole value proposition is based on developing a revenue model around actual payment transactions. Critical drivers, therefore, lie in PBs’ ability to leverage the e-commerce ecosystem in India, which is slated to cross the USD $16 billion mark by the end of 2015. PBs will also need to be proactive, helping to build out the digital payment infrastructure through partnerships with online e-commerce and physical offline merchants – especially in rural areas which mostly lack the required connectivity to take part in the expansion of e-payments.
Pulling Customers Past the 'Cash is King' Mentality
The challenge of moving toward e-payments isn’t limited to infrastructure: For PBs to succeed, cash-obsessed Indians will need to migrate to digital alternatives, which will require behavioural changes above and beyond technological hurdles. Though a few e-wallet players and online marketplace providers like Paytm, Foodpanda, Shopclues, etc., have been experimenting in this space in recent years – albeit mainly in urban centres – for PBs, the task will be herculean. Ultimately, they will need a concerted ecosystem effort and additional policy support to spur the growth of interlinkages and missing markets.
Shifting Interactions to ATMs and Mobile
According to the World Bank, just 39 percent of all account holders in India own a debit or ATM card, and as mentioned, mobile banking has struggled to take off – especially in rural areas. Yet compared to branch banking, ATM and especially mobile banking are far less expensive per transaction, not to mention more convenient for customers. PBs have a great potential to change the patterns of interactions between customers and banks by making banking transactions via ATMs and mobile phones self-assisted, seamless, convenient and foolproof over the payments-based architecture in India.
Enabling Payments Ecosystem Partnerships
Effective partnerships will be crucial for running a digital payments system – particularly at cash-in/out points and merchant/retail points. Facilitating these relationships is often the role of special intermediary services providers like Pep Intermedius in Kenya and Uganda, which manages float and distribution points for major supermarkets and players like AirTel, M-PESA and KCB Mattani Bank, and Kopo-Kopo, which helps to manage the merchant ecosystem in Kenya. India will need to put similar service providers in place to make PBs’ partnerships successful.
Avoiding the Government Business Trap
Government business, in the form of government to person (G2P) payments, may seem like low-hanging fruit to many PBs. But they should resist the temptation to make G2P services a core part of their business case, or else they’ll run the risk of encountering the same sustainability challenges that Business Correspondents have faced in the past in india. With government commissions for G2P services subject to frequent and unpredictable decreases, depending on government business could bring the sustainability of PBs into question.
Working with Regulators
PBs will have to comply with RBI regulations and prudential banking norms, maintaining prescribed bank ratios like statutory liquidity, cash reserve and capital adequacy, and following rules involving financial fraud, Anti Money Laundering & Combating Financial Terrorism (AML-CFT), etc. And the need to comply with these regulations is one of the factors that many analysts blame for mobile money’s struggles in India, which has required mobile money players like Vodafone and Airtel to work through partner banks to offer payment services. With the important role PBs play in the government’s financial inclusion drive, and the degree to which the RBI is clearly invested in their success, hopefully it will ensure that these requirements won’t deccelerate PBs’ momentum.
Embracing Risk and Innovation
PBs’ success in India will largely depend upon how well they are able to break the traditional banking mentality and innovate. For instance, India’s banks – particularly those in the public sector – have often heavily invested in government securities and bonds, as these instruments are perceived to be safer than credit-market investments. But with Prime Minister Modi calling upon Indian bankers to take a more proactive approach to banking, it’s clear that PBs must avoid this lazy and risk-averse mindset and embrace new thinking and innovation. Even though they may not have the option, right now, of offering credit products, PBs should embrace a forward-looking mindset in exploring payments innovations – and even eventually offering credit services directly or in partnerships.
Locating Patient Capital
Even though they are allowed to raise deposits, this may not be sufficient for PBs to fund their expansion. And with cutthroat competition, acquiring customers will be a substantial challenge – as will maximizing revenue per customer. So the PB industry will need deep-pocketed, risk-taking investors – and they must be in it for the long term. The mere fact that the RBI issued so many initial licences clearly indicates that not all are expected to stay alive. So investors must be willing to remain patient, at least for three years (or until they attain a net worth of USD $80 million), at which point PBs will be allowed to have an IPO and get listed on the Indian Stock Exchange.
It will be interesting to see how PBs overcome the challenges discussed above as they roll out their operations in the next 18 months.
This article originally appeared in NextBillion Financial Innovation.