Payment Banks - Will they make money ?

There has been a huge hype about payment banks. Some in the business media have said that these banks will be a boost to financial inclusion...look at telecom companies offering mobile wallets and white label ATMs they said.

I am very skeptical about this story of financial inclusion ...I don't think it will happen with Jan Dhan scheme ( I hear that 75% of the accounts opened have no balance and no operations ), or with payments banks or what ever... Financial inclusion can happen only with economic inclusion. But somehow, policy makers don't seem to be talking about it....

Lets us assume that these banks would help in financial inclusion, as policy makers would want us to be believe....the question that begs an answer is - will these entities make money and be sustainable as stand alone entities ? 

What these banks can do : 

i) Accept demand deposits ( current and savings bank deposits) upto Rs 1 lakh per customer 

ii) Payments and remittance services through various channels including branches, business correspondents and mobile banking

iii) Issuance of pre-paid instruments.

iv) Function as Business correspondents 

v) Apart from CRR,  all monies have to be held in SLR securities as investments. The capital adequacy ratio has to be 15% , which is not very difficult, considering that the risk weights in their exposure is negligible - but they the overall leverage ratio should not be below 5. The bank should also have a minimum capital of Rs 100 Crores at all times. 

But these banks cannot lend. And that means, they don't make any spread . The most important way that banks make money is hence gone. And that means, they will have to rely entirely on their ability to charge customers for using their payment systems to make money. While that is possible, will they be able to actually generate enough business volumes to remain profitable is a big question....particularly, since all banks currently offer all that the payments bank can offer. 

First , I don't think people are going to just queue up to open accounts in a payments bank ? Why would they ? As these banks cannot lend, their ability to pay interest on savings accounts is going to be limited...so why will somebody shift ? 

Second, the expectation that POS terminals in Kirana will start functioning as ATMs ( the payments bank can offer cash-out at POS terminals) is a wildly optimistic one - at least in the forseeable future. 

Third, I also don't know what additional benefits would be available for an existing telecom companies offering mobile wallets or the white label ATMs by becoming a payments bank. In-fact, RBI has prohibited telecom majors from using their existing channels for the payments business - and  so, even if there were players interested, they would now have a contend with the cost of setting up a new channel for this business....

Fourth, while the payment of subsidies and benefits may move to banks, it is unlikely that ALL cash transactions between individuals will move into banks. In-fact the recent move limit free transactions over the ATM and to charge for it, will only increase the use of cash....I am already hearing of people drawing out a big chunk of their salary as soon as it is credited !

I don't think stand alone payment banks will be sustainable. I will be surprised if commercial entities will evince interest in this - with the current guidelines. If at all there is any entity that may be interested, it can be India Post. But, although there will be a large HR policy rework that will be required, I think India Post should work on a becoming a full fledged bank - not just a payments bank. 

IMF's comments on the Indian Regulatory System

The IMF has recently released the India: Financial System Stability Update. While commending on the fact that the system has a tightly controlled regulatory and supervisory regime and is reasonably resilient with no likelihood of near time stress recommends certain actions, some of which merit some thought - while others are merely incremental in nature.

a) That the regime for large exposures and connected lending needs tightening in line with good international practice. The report points to the fact that the maximum level permissible at a group level including lending for infrastructure is high at 50% of bank's capital and that it needs to be reduced to 10-25% in line with international practises. While this can be a goal post over a long time period, reducing the limit steeply will reduce availability of finance to some sectors. The solution to this could be development of alternate markets for financing which will temper , if not reduce significantly , the requirement of bank finance.

b) Reducing SLR holding limits : While appreciating the fact that CRR and SLR requirements help ensure liquidity availability during crises, IMF recommends reduction in SLR holdings in Goverment Securities. The recommendation, to my mind, comes from IMF's observation of the unsavory experience with the European banks which have held large investments in Government Bonds. This recommendation fails to take into cognizance the fact in general the G Sec investment holdings in most banks is significantly higher than the mandated requirement, which in any case is being lowered in a slow manner. This also fails to take into consideration that what is held by Indian Banks is national debt ( not international debt as in the case of most European banks)and the Debt to GDP ratio of India is better than its European counterparts. Any risk of sovereign default is hence far fetched. There is also no reason to believe that reduction in SLR norms will lead to improvement in the Corporate bond market (which acceptably has to develop in the country), as what matters is the levels of government borrowings.

c) RBI nominees on PSB Boards may lead to conflict of interest: While the recommendation in theory is probably correct, the fact is that the presence of a RBI nominee helps the regulator to get information on a real time basis and thus help in supervision. It also helps act as a deterrent , preventing activities that may be inimical to the bank and the system at large. Considering the pros and cons, RBI would do well to retain this system or retain the right to use this option.

d)Insolvency framework businesses and more particularly for proprietorship firms - which are the majority businesses in the country. The amendments to the Company's Act, which provide for OPC (One Person Company) will largely address this issue.

e) International and domestic supervisory information sharing : This is being addressed by RBI considering supervisory colleges for particularly large banking organizations. RBI has already set up supervisory colleges for SBI and ICICI Bank which have significant international presence.

The report indicates that the Indian regulatory system is clearly in good shape and while being structured to suit Indian needs meets international requirements in most cases - and what will work is independent and tight regulation. 'Gaps' (if one may say so) which are there are either by design or are already being worked on. The recent crisis has exposed the weaknesses of the neo-liberal light regulatory framework that was championed by developed nations and the Bretton Wood Twins. And as they say, it is only when the tide goes down, that we know who has been swimming naked. IMF's commendation is this context is hence an interesting development.

Regulating MFIs

MFIs are back in the news and once again for the wrong reasons - or probably the right ones. I am not talking about the sacking of Suresh Gurumani as SKS's CEO - days after the successful IPO.

The AP CM has again raised issues about the interest rates being charged by MFIs and has sought regulation of MFIs. Reports talk of some MFIs charging effective interest rates as high as 45% and about the farmer suicides ( The average lending rate is around 27-30%). A few years back - roughly 5 years back ( during Dr YSR's time) too, the AP Gov raised this as an issue. If my memory serves me right, I remember Dr Nachiket Mor, who was then heading the agri biz (among other things) at ICICI bank flew down to meet the AP CM to sort out the issues. ICICI bank then had a large exposure to MFIs - mostly in AP . Issues have time and again been raised about the way MFIs do their business ...the only thing that remains to be done is regulation.

Most of the MFIs have ROA well above 2 % (SKS reported 3.07% ROA and Spandana - for instance reported an ROA of around 4.68%) in contrast to the ROA of around 1 to 1.5 of scheduled commercial banks ). There is a resistance among MFIs to bring down the rates. For instance SKS justified the ROA as being 'justified and appropriate' as the business was unsecured. While on the face of it , it appears a correct reasoning, the fact is that - the social / peer security structure that works when lending is done is as effective - if not more than secured lending. Most MFIs report neglible portfolios in stress ( basically overdue portfolio). The on-time repayment rates are upwards of 98% and ultimate repayment is much higher. Infact most MFIs trumpet this achivement of on time repayment when they seek funding assistance from banks , who would naturally be wary of lending money for on-lending small and unsecured amounts. It requires ingenuity to use the same point to argue both ways !

40% interest and 3% ROA are only a shade better than what money lenders make. And that ' shade better' is because these MFIs are sophisticated, organized , - some owned by management grads from premier institutions and have letter pads ....

SKS has the following mission statement
'Our purpose is to eradicate poverty. We do that by providing financial services to the poor and by using our channel to provide goods and services that the poor need'

The only point that I used to keep pondering over was ' whose poverty are these MFI's seeking to eradicate' ?. With the phenomenal success of SKS's IPO, I think I have the answer.

Bank regulation

Bloomberg reports that the rules for tighter capital requirements and liquidity requirements by banks could get delayed. They are to be discussed by the G 20 in November and implemented from 2012 on. But as Mario Draghi the Governor of Bank of Italy and the Chairman of the Financial Stability Board - a global coordination body, which works closely with Basle Committee put it - it is better to delay the standards put in rather than weaken them. My only concern is that as public memory is short, time might prove a weakening factor in itself. So the fond hope is that delay is not too long.

The norms - detailed by a consultative paper released by BIS in 2009 December - apart from other areas - are on two major fronts
a) Capital - particularly, what can constitute Tier 1 capital and if there can be a minimum floor level of Tier 1 that can be stipulated.

b) Liquidity - reserves which are liquid and can handle short and medium term volatility.

The powerful banker's lobby ( The Institute of International Finance ) and other bodies had predictably painted a bleak picture for the economies if the Basle proposals are implemented - and have also indicated that the recovery would get jeopardized if they are put in place now. The lobby in the US has succeeded in diluting some of the recommendations in the reform package - largely on the liquidity front and in part on the capital front - that will be soon cleared by the Obama administration.

Thankfully in India RBI has had a significant amount of forethought - and the IBA - dominated by PSBs is not also unreasonably strong. I am not surprised to see several positions made by BIS - including counter cyclic capital stipulations - have already been implemented in India. The norms for classifying instruments is relatively tighter in India and we do have a floor at 6 %. There is no concept of Tier 3 in India. The SLR and CRR requirements have also helped maintain the required amount of liquidity comfort in the banking system. No wonder we have a resilient banking system !

On the Base Rate

There is a lot of hype and noise about banks being advised to switch from the BPLR system to the base rate system. After the PLR system, the benchmark rate system and the benchmark PLR system which failed to bring in the 'much needed transparency' in pricing of loans, this is RBI's latest well meaning attempt. The key points of this move and its likely impact are

1. RBI has given banks the freedom to determine the base rate. It just wants it to be consistent and available for supervisory review.

The likely impact : I share the expectation of most analysts that the Base rate of PSBs and most large Pvt sector banks will hover around the rates that SBI sets - which many expect to be around 8%. Foreign banks may keep it lower. I dont rule out the possiblity of cartelization .
Now this BR will be the floor. What is likely to happen - which is in any case welcome - is that this will be market determined and banks will need to work backwards and tweek their cost structures. For the borrower though - particularly the SME, Retail customers - I am not sure if there will be any effective positive impact as banks are free to load fee structures over and above the base rates and there is no cap on the mark up over the Base rate.

2. All loan prices will need to be linked to this base rate ( with some exceptions).

The likely impact: The practice of quoting on treasury advised rates for short term buckets - say 30 days , 90 days, 180 days etc will be affected. Essentially well rated corporates will find this market closed - and they would move to the commercial paper market ( in which banks will again be their largest source of funds). That's a nice way to invigorate the short term corporate debt market !!!

3. External benchmarks are allowed , provided they are equal to or above Base rate at the time of sanction or renewal.


The likely impact : The MIBOR linked short term facility market for large corporates will vanish. However, banks and corporates may circumvent and innovate in the CP market

4. Current cap of BPLR as lending rate for loans upto Rs 2 lakhs is withdrawn

The likely impact : I ( hope to )see banks getting very active in the Micro Finance segment. I have been skeptical of the way MFIs do purely commercial business (more recently rather ruthlessly) in the guise of social inclusion and women empowerment. The major reason why banks - which are surely several shades better in their commercial activities - was this cap on lending rates. The operating costs in this space are rather high and now with this cap gone, if banks get their act right, the largest beneficiaries will be the small SHGs and entrepreuners.

5. The interest rate on rupee export credit has been deregulated

The likely impact : Increased transparency . Nothing more. Banks were anyway charging customers over and above the caps by way of charges under various names.

Net net ...

This move may bring in additional transparency - if the guidelines are followed in letter and spirit ( though it is common knowledge that it is followed in letter only). My guesstimate on the impact on the bank's profitability - NIL

Deregulation of interest rates on SB account

Those who clamour for deregulation of interest rates on savings accounts found a new supporter in the Deputy Governor of RBI , who said that RBI was keen on deregulating all rates - including SB rates. ( The Business Line , without naming him reports that he was vehemently against deregulating SB rates, when he was CMD of a bank which had a large SB base !!! ..well they say the only thing that is constant is change !!)

Banks have always competed for current accounts which are non interest bearing and savings accounts which are low interest( 3.5% pa) bearing - as these are the cheapest source of funds for banks. Some nationalized banks because of their large presence and some private sector banks , because of their deliberate strategy have a larger share of these accounts than others. The have nots - if I can call them thus, had to compete with the haves on all parameters - except interest rates. With this ( likely ) move, they would also be able to compete on interest rates.

Most banks already segment their customers based on the balances they maintain in their savings account. In my view, the higher end segments might get another 50 to 100 bps more for their account balances. The lower end segments may lose out - that is if one considers 3.5% interest rate to be a number of any value - particularly considering the current inflation rates !. I also expect banks to step up charges for deposit related services and penal charges for non maintenance of stipulated balances. At the end of the day, I dont see the net adverse impact on the bank's financials to be more than say 25 bps.

The usefulness of this move in asset liability management is, in my view, stretching things a bit too long. Currently 10 % of the SB balances are considered volatile and withdraw-able and are bucketed in the 'next day', 2-7 days and 8 to 14 day bucket. The rest of it is bucketed as core deposits in the long term bucket. I dont see how a 50 to 100 bps change will impact this bucketing significantly.

Making banks manageable

The Future of Banking Commission report co-authored by Vince Cable, a Liberal Democrat Politician in the UK and currently its Business Secretary in the UK , has placed a set of 39 recommendations to the Government . One thing that caught my eye was that fact that it has endorsed the idea that large banks may have to be broken up.

Following the crisis, several economists have suggested that banks should not be allowed to become too big to fail - requiring compulsory bail out with tax payers money , in case of failure caused by reckless business decisions. I for one agree with this view for two reasons

a. I believe that notwithstanding the best in class systems and processes put in place, it is humanly impossible to manage beyond a particular size.

b. I don't think tax payers need to bail out shareholders. That is not logical.

However, this is one suggestion that has been conveniently ignored.

Now, the same thing coming from somebody , who is now high in the Government and that too from UK makes it interesting. Knowing the power of the finance lobby though I know it is going to be a very difficult task - and banks have experts in circumventing rules - so I wont be surprised if they find a way around this one too - should it become a rule. I wish Vince Cable the best of convincing ability !!