A glimmer of hope for Payments Banks (#19)

On the years of struggle and a new opportunity

Dec 06, 2020

Economists have long pronounced the opportunity of demographic dividend in India. Speeches, debates, and research have made the average Indian realise as much. The tone, however, has shifted lately. That dividend we used to talk about seems a train we might be too slow to board. There is perhaps no essay as heartfelt and thoroughly brilliant on our growing failure to live up to that potential as the one Andy Mukherjee recently composed.

Understanding this is important to understand Payments Banks.

In Sept 2013, RBI formed a Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households. Their objective was to fight the demons of financial inclusion. And it was necessary, if not already late. For a country hopeful and reliant on the young generation to build a China-like growth for itself, a bank account lies at the bottom of the need-hierarchy.

In 2012, PM Manmohan Singh had announced the plan to provide a bank account to every household by 2014. This, of course, did not transpire. But a target was set, and these actions were in that direction.

By Jan 2014, the committee released a report, laying down their vision for financial inclusion. This is when the idea of Payments Banks in India took hold. The rationale was to provide differentiated businesses to act as vertical banking institutions and capture people in the remotest corners of the country. All to enable those above 18 to hold a bank account.

In Nov 2014, the guidelines for licensing of Payments Banks were released. According to the final rules, the existing non-bank Prepaid Payment Instrument (PPI) issuers, NBFCs, mobile telephone companies, super-market chains, real-sector cooperatives, and many others with ‘fit and proper’ track record were deemed worthy of setting up Payments Banks.

An opportunity to get a banking license – in one form or another – was hardly lost on anyone. RBI received 41 applications, of which it allowed an “in-principle” license for 18 months to only 11 entities. These included applications from Airtel, Paytm, to applications from India Post, Sun Pharma, and NSDL. As diverse a list as one could expect.

Three years from the speech on Independence day in 2012, India had also successfully opened ~175 Mn new bank accounts. This increased the bank account penetration from 35% to 53%. But this was an impact of multiple other policies such as PMJDY.

Elsewhere, things had gone sour for Payments Banks. Of the eleven shortlisted, Tech Mahindra, Cholamandalam Investment and Finance, and a consortium including IDFC and Telenor had dropped by late 2016, citing profitability concerns. Meanwhile, Airtel, IndiaPost, and Paytm had set up their payments banks but received limited success. And today, despite the initial fanfare, only six of the original eleven are active: Airtel, IndiaPost, Fino, Jio, Paytm, and NSDL.

What explains this failure of sorts? We go back to the guidelines issued in Nov 2014. The following were described under the scope of activities for the licensees’:

Payments bank will initially be restricted to holding a maximum balance of Rs. 100,000 per individual customer.
Payments banks cannot issue credit cards.
The payments bank cannot undertake lending activities. However, it can distribute on-risk sharing simple financial products like mutual fund units and insurance products, etc.
Apart from the mandated CRR with the RBI, Payments Banks will be required to invest minimum 75 per cent of its "demand deposit balances" in Statutory Liquidity Ratio(SLR) eligible G-Secs/T-bills (maturity upto one year) and hold maximum 25 per cent in current and time/fixed deposits with other scheduled commercial banks for operational purposes and liquidity management.

A cap on deposit balance, inability to lend, and strict guidelines on the use of deposits made the difference between Payment Banks (PBs) and traditional commercial banks painfully great. Especially considering that, for profitability, banks rely on cross-subsidisation onto lending or insurance products. To add, the yields on T-bills have halved from the ~6.5% only two years ago.

What this has also done is reduced the savings rate on PBs deposits to ~2.5-3%, hardly comparable to the interest rates on commercial bank deposits. The popularity of UPI hasn’t helped either, with no-KYC payments suppressing the obvious need for bank accounts.

But these were, unfortunately, not the only issues.

Sidhartha and Arundhati in an article for The Ken summed it bluntly:

In the short two-year history of payments banks, everything that could possibly go wrong for them did. Crippling rules from the Reserve Bank of India (RBI). Check. Companies backing out. Check. Regulatory flip-flops on know-your-customer (KYC) norms. Check. Frauds. Check. Suspension and fine. Check.
May 2019

The criticism has been consistent as the suggested business model left little room for flexibility. PBs only had the option to scale so significantly that the transaction revenues from debit and prepaid based payments would cover the costs. Otherwise, with no changes in RBI’s stance, it made little sense to continue. That is what we have seen as well. Aditya Birla Payments Bank, with little traction, winded up in July 2020. Vodafone Idea Ltd’s m-pesa vertical soon followed.

Case for Optimism

But, wait. Not all is bad. Paytm Payments Bank reported profits of ~Rs. 30 Cr for FY20, serving a consumer base of 58 million. More surprisingly, without the big arms of Paytm, Fino Payments Bank has also achieved profits consistently over three quarters now, enabling transactions worth Rs. 12,500 Cr in October itself. This gives more support to the minority view that sees the existing business model of Payments Banks as sustainable. Although, the low adoption of PBs by payments businesses more strongly reflects the difficulties posed by its restraints.

The financial results aside, there are other positive developments too. In a press release released only two weeks ago, RBI said the following:

For Payments Banks intending to convert to a Small Finance Bank, track record of 3 years of experience as Payments Bank may be considered as sufficient

This implies that once the “track record” is proven for three years (earlier - five), a payment bank is guided by the scope of activities under this notification that says,

The Small Finance Bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries, and unorganised sector entities.
It can also undertake other non-risk sharing simple financial services activities, not requiring any commitment of own fund, such as distribution of mutual fund units, insurance products, pension products, etc. with the prior approval of the RBI and after complying with the requirements of the sectoral regulator for such products.
After three years from the date of commencement of operations of the bank, requirement for prior approval from the Reserve Bank will no longer apply and the bank will be governed by the extant norms as applicable to scheduled commercial banks.

This takes away the handcuffs that have been the downfall of five payments banks, allowing them to benefit from interest income. Moreover, with most of the PBs nearing the three-year mark, the wait will be minimal for those active. This is likely to solve the profitability dilemma. At the same time, if RBI invites applications for Payments Banks, there will be more companies willing to set-up shops.

And we will need more because the objective of financial inclusion is far from achieved. The banking account penetration has risen to >80%. But the number of zero-balance accounts is high at ~15%, and roughly half of all bank accounts were rarely used by 2018.

Payments Banks may still be key to solving this puzzle.

What can they do?

The basic tenets of financial inclusion are affordability and accessibility. RBI outsourced both these tasks to the Payments Banks, i.e. making deposits and payments accessible to the remotest corners, and providing these services at low costs.

Fund transfers, ATM/Debit withdrawals, merchant POS, and bill payments all offer PBs a low commission of ~1% on average. With these thin margins, lending to low-income households will not automatically solve the business model issues. There need to be more adjustments from both RBI and PBs.

With the increase in deposit insurance limit up to Rs. 5 lakhs, payment banks have demanded an increase in the cap of deposit balance. This would allow PBs to earn higher yields on an average customer, assuming similar acquisition costs. Moreover, they can then approach merchants with a monthly turnover of 1-5 lakh, which should form a significant portion of small businesses.
Removal of MDR has impacted the transaction revenues of payments banks equally, and re-introduction of MDR would do a world of good for others within the payments ecosystem as well
With the revenue dreams rested on remittances, insurance, and other transactions, PBs need to be efficient in providing these services. RBI should proactively adopt an advisory role in suggesting best practices, learning from firms reaching profitability, and transferring that knowledge to those struggling such as Airtel and IndiaPost. At the same time, if the directive of payments banks is of national importance, perhaps subsidisation of some costs would allow PBs to scale more fearlessly.

Today, each payments bank focuses on a different product and business model. IndiaPost is doubling down on government-to-citizen (G2C) payments, especially DBTs. Fino PB is leveraging its large business correspondent network to distribute. Paytm is concentrating on big-ticket auto and merchant partnerships. The divergence in focus areas bodes well for the PBs. This article in Inc42 explains the different strategies exceedingly well.

What the article also highlights is the use of deposit accounts as checking accounts. With a transaction value to deposit ratio of ~221, payments banks act as wallets more than consumer banks. This is an issue of either lack of incentives or awareness to the customers. If the PBs are able can the ratio down, there are exponential gains to be had.

Lastly, if the goal of Payments Banks has remained financial inclusion for RBI, then perhaps there are alternatives to combine payments players and banks. One example that we can particularly learn from is that of Google Plex. Here, Plex is a mobile-first bank account that will be offered by traditional commercial banks such as Citi on the Google Pay platform. The integration would allow Google Pay to handle the distribution of banking services, without the costs and hassle of building the infrastructure for core CASA services.

We will know how the Plex experiment turns out by next year, but my view is that it works in favour of both Google Pay, by buying-in more consumer loyalty, and banks, who outsource distribution. In India, such a service can be particularly useful due to the higher reach of payments players across tier-2 and 3 cities.

Final thoughts

Borne out of a novel and necessary goal of financial inclusion, payments banks have unfortunately struggled with paralysing regulations. There are, however, two rays of hope today. The broken model has copped tremendous criticism, forcing RBI to shorten the period for a payments bank to apply for an SFB license to three years. The SFB license would allow the much-needed lending-based revenue sources for the PBs.

Additionally, Paytm and Fino have shown the way towards profitability with a focus on distribution and differentiated transaction products. But as things look slightly up, there is still room for regulatory and operational changes, incl.

an increase in deposit balance cap,
a return of MDR, and
a model for sharing best-practices or subsidising costs of payments banks

Lastly, as models such as Plex come up to combine both payments platforms and banking, Indian regulators must stay proactive to identify them and act quickly to further the goal of financial inclusion.

Unit Economics

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