Payments Banking – A way Forward for Financial Inclusion

A quiet financial revolution has begun in India. Reserve Bank of India, India’s central bank, has granted permission to set up payment banks to 11 Indian companies. This is with the objective of bringing new areas under financial inclusion which otherwise are neglected by traditional commercial banks. Payment banks can accept deposit up to INR .1 million, and will offer other banking services such as an issuance of ATM/debit cards, and money transfer.

Among the big names which are granted license (likely to be operational by September 2015) are India Post, Reliance Industries, Airtel, Vodafone, Tech Mahindra, Paytm, IDFC, National Securities Depositary Limited (NSDL), Fino PayTec, Cholamandalam group, and Aditya Birla Nuvo. Although India Post, with 0.15 million post offices, has already got a network in place, others are tying up with commercial banks (for instance, Reliance with State Bank of India, Airtel with Kotak Bank, etc.) to leverage their presence.
The usher of payment banking system is an important step for financial inclusion in India.

In 2014, only 35% of the adults have a bank account and a meagre 8% availed loan from banks. Access to formal banking is a necessary condition for any economy to grow. It will increase saving rates, which will enable capital investment in sectors such as roads, ports, and railways. India needs to invest over USD 320 billion in infrastructure. As capital is scarce, a perfect capital market will ensure a higher return for each additional dollar of saving invested for building India’s infrastructure.

Importantly, access to banking will increase the productivity of the Indian Micro, Small and Medium Enterprises (MSMEs) sector, and aid the much touted Make in India campaign for India. Only 5% of the MSMEs avail loan from institutional sources, underscoring the need for financial inclusion for the MSME sector, and to drive India’s inclusive growth agenda.

Although, economists and policymakers, in general, are worried about individual well-being, and the factors affecting this well-being, they somehow seem to assume the market is perfect. All the growth models in economics, explaining why some economies grow faster than the others, have tried to explain the higher standard of living (read, per-capita income) without explicitly accounting for market imperfection. In fact, the fundamental assumption for any country to grow is to assume that the capital market is perfect – so that whatever is saved can be invested for productive purposes.

Imperfection in capital market affects distribution of income. A person who is economically poor and does not have a bank account has no other choice but to store his money in the form cash, livestock, or jewellery. The value of cash withers with inflation, jewellery run the risk of being stolen, and livestock can fall ill. All these adversely affect flow of income, and hence affect consumption smoothening.

Payment bank will be a big boon for thousands of migrant workers. In India, only 2% of the people used an account to receive money from their family member living in other regions. A survey among Indian migrant workers showed they pay a commission of 4.6% when they transfer money through informal route such as Hawala. The cost of the loan through an informal channel is also high in India. Firms/people with access to finance/capital are guaranteed with more income than the ones without access to banks and capital.

As these payment banks are backed by big corporates (some of them have already pioneered use of technology in the financial sector such as Tech Mahindra and NSDL), it will usher in a technological revolution in India. Technology helps to augment financial inclusion by making accessibility to bank and financial transactions easier. Long are the days of waiting in a long queue in banks. In a digital world financial transaction happens through a click of the mouse, and over the mobile phone.

In India, changes have already happened in three specific areas. First is the introduction of Real Time Gross Settlement (RTGS) system, enabling banks to transfer funds across all deposit accounts in real time. The newer version of RTGS has many advanced capabilities such as national electronic fund transfer (NEFT), and electronic fund transfer (EFT) across national boundaries. Second is the introduction of online automatic clearing mechanism such as BillDesk, underlying any retail transfers between the point of sale for credit/debit cards and bank automatic teller machines. And, third is the introduction of electronic clearing service (ECS) for cheques, an electronic mode of fund transfer from one bank account to another.

Payment banks will make mobile network operators (MNOs) and internet banking more popular. According to ‘Internet in India 2014’ report jointly published by the Internet and Mobile Association of India, and IMRB International, Internet users in India will cross 300 million by December 2014. The year on year growth rate registered stands at an impressive 32 percent. In rural India, the number of Internet users increased by 39 per cent to reach 101 million in October 2014. India has the third largest Internet user base in the world, after China with more than 600 million Internet users and the US with an estimated 279 million users.

For a populous country like India future strategy for financial inclusion will call for technology to reach the bottom of the pyramid, something that these payment banks can facilitate. Bringing poor people under the garb of digital banking platform will help financial transfer meant for social security payment easier. A study by McKinsey points out online payment of social security benefits will save the government USD 22 billion per year.

A study involving 2016 households in Kenya found people availing M-PESA service (banking through mobile, and the service is provided by Vodafone) are better equipped to absorb negative income shocks arising from poor health, crop failures, and job loss. Statistically comparable the household not availing M-PESA service are likely to experience a 6 – 10% reduction in consumption in response to similar income related shocks.

The future will see the emergence of contactless payment enabled through usage of near field communication (NFC) technology. NFC will enable smartphones and other devices to establish radio communication with each other by touching devices together or bringing them in close proximity. Going paperless by saving time will not only reduce transaction costs but will also play an important role for financial inclusion. Some big commercial banks such as HDFC has already started work on it.