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Banking on payment and small banks for financial inclusion

and , October 26, 2015, 0 Comments

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The notion of financial inclusion promoted by the erstwhile government   is now taking   shape by erecting structures   which are very new   not just to Indian banking industry but the world as well. A new concept called payment banks is seeing the light of the day. This along with the category of small banks will change the shape of the banking sector in the emerging future.

Far reaching innovative steps have been taken by RBI in the field of inclusive finance. In-principle approval had been given to 11 entities to set up payment banks. Now another 10 players have been granted licenses to run small banks. Both these measures are path breaking and can prove to be major innovations in the spearheading of the goal of financial inclusion.

Small banks will have equity capital of at least Rs 100 crore with a quarter of their branches in villages that have population of less than 10,000 according to RBI norms. In the first five years, they will need RBI’s approval for new branches and should have a capital adequacy of 15% of risk-weighted assets. Hitherto banks were considered purveyors of credit and played an instrumental role in secondary credit creation. The deposits accepted, after taking in the reserves, were all translated into   lending.

Payment banks are not intermediaries of credit but are unique in banking industry. Their primary function is to   be “licensed   payment entities“ providing a one stop solution of making all payments – college fees, utility bills, grocery bills…. This will empower customers to undertake end to end transactions.

Payment banks are permitted to take deposits but are prevented from granting loans. Small banks can take deposits and lend just like full-fledged banks. They can also trade in foreign exchange and sell financial products such as mutual funds and insurance. But atleast half the loans of small banks should be less than Rs 25 lakhs and they can’t lend more than 10% to a single borrower and 15% to a group. These banks will be a boon to a large   mass of   unbanked rural economy where transactions are cash and they will be driven into the ambit of formal banking channels.

Payment banks are an innovative concept by itself, tailor-made to the needs of a country with a large semi-literate population that is living on the borders of the poverty line. These people are incapable of working on a computer. But their capabilities permit them to operate a mobile phone. Most of the people holding accounts in a payment bank are expected to undertake their transactions through the medium of their mobile phones. The payment banks are the case of a partnership between banks and telecom operators. It is a model where banks work in cooperation with the medium of mobile technology to extend the reach of the semi-literate and the poor and permit them to be partners in the world of inclusive banking and finance.

For their very existence the payment banks will have to target a large number of small deposit accounts since they cannot take deposits beyond Rs 1 lakh per account. Growth   of such payment banks will lead to reduction of the currency deposit ratio – one of the major components of money multiplier. These banks will be absolved of credit creation and will not be struggling with problems of NPA.   The deposits would be created just to service payment obligation converting a cash driven rural economy into   a banked one.

Another advantage of payment banks would be remittances. A large part of unskilled and semi-skilled workers who have migrated to other countries and regions within India will   find it easier to transfer remittances   to remote locations through payment banks. This will expedite other transactions in the financial system. The   new avatar of banks – money transfer agency – one stop billing to payments is really unique. The new generation of youth may be attracted by the fact that they can do all the banking through their mobile sitting in the comfort of their homes.

The payment banks and small banks may provide stiff competition to their larger counterparts. Many of the mid-sized banks that are ill-equipped in terms of technology and poor quality of staff may face a nightmare. There might arise a fresh demand for bank mergers as many of the small and inefficient ones will be able to survive only with the support of crutches. The banking sector is going to witness volatility and acute competition in the next few years with destabilizing turmoil and a struggle to survive.

The idea of payment banks and small banks are unique contributions of an innovative central banker which will promote economic development and rural banking in our backward economy through hitherto unavailable methods of operations. It is for these two innovations that the name of Dr Reghuram Rajan will be remembered and cherished in the pages of history of India’s economic development.