payments

By Kabir Kumar and Anand Raman

India’s central bank, the Reserve Bank of India (RBI), has lagged behind other countries, moving gradually through a series of small steps to open up regulation for innovative models. However, on August 19, 2015, RBI finally took a massive catch-up step in digital finance, and, arguably, re-branded itself as innovation-friendly. It approved 11 applicants, including five of India’s MNOs, to organize and launch payments banks by early 2017. (The full list with ownership structures can be found on the RBI website and Quartz India).

Payments bank is a new category of specialized bank that can offer a variety of payment services. It can also provide an interest-bearing deposit account, a feature that extends the abilities of payments banks beyond a typical e-money issuer. In effect, from a regulatory perspective, payments banks have as much teeth as one can wish for on the liabilities side of the bank business.

While RBI was expected to give approvals this year, making it an important year for digital financial services in India, there were no guarantees on who would get a license. Some speculated that RBI would approve just the Department of Post as a first incremental step. But RBI has surprised most RBI-watchers.

RBI got a lot right by awarding approvals to a strong cast of institutions and partnerships with enough financial muscle between them to take risks and innovate and with enough diversity among them for experimentation in approaches. This is possibly the first time RBI has awarded any licenses or approvals to a sizeable number of applicants in one go. By doing so, they have clearly taken a portfolio approach and stacked the bench, as they say in American sports. Approvals were given to one or more in each category: MNO (Airtel, Idea, Reliance, Vodafone, Uninor), prepaid issuer (Paytm, Tech Mahindra and others), agent or business correspondent company (FINO), non-bank finance company (Cholamandalam) and government (Department of Post). Commercial banks are participants directly or indirectly. For instance, Kotak Mahindra has a 20% stake in the entity that will be set-up with Airtel; State Bank of India will have up to 30% percent stake in the entity set-up with Reliance; multiple banks, including ICICI Bank, have a stake in FINO; and multiple banks have a stake in National Securities Depository Limited (NSDL). Many expect that with banks involved, payments banks will quickly move to facilitating a link to credit products.

RBI may have also got it right in its attempt to balance innovation with stability, integrity and protection, both in what it has required from payments banks and who it has approved in this first batch. The payments bank requirements have capital requirements, promoter stake dilution roadmaps and deposit protection measures with the intent to protect public deposits. Moreover, included in the approvals were India’s largest corporate houses and high net worth individuals – Sanghvi, Ambani, Birla, Mittal, Murugappa, Mahindra – with collective net worth of close to $55 billion between them, not to mention Jack Ma, whose Alibaba has 25% stake in Paytm, one of the awardees. By awarding the licenses to some of the wealthiest corporates, not only in India but globally, RBI is saying that it will back innovative models, but only if they have financial muscle behind them. It is also a recognition from the RBI that financial strength will be needed to weather the challenges of the growth phase and the arduous path to profitability. Specifically, payments banks will need to develop massive agent networks, a large share of the cost of the business, which will require upfront investments with delayed returns.

The downside of an extreme application of this approach is that players, like Oxigen, Suvidha and Novopay, who may not have the same financial strength of India’s big corporate honchos but are not financially insignificant either, have not been given approvals. Those players have already made investment in agent infrastructure for financial services, larger, at least in the case of Oxigen, than any of the MNO’s financial infrastructure to date. It is unclear if RBI has different plans for businesses like those previously licensed as both prepaid payment-instrument issuers and business correspondents. The approach also does not explain why the Future Group did not get a license given that retail conglomerate’s financial muscle and efforts to go downmarket as one of India’s fastest growing retail groups.

RBI also got it right in terms of what these approvals mean for the financial system. Even if RBI had approved just a couple of entities, it would have taken an important step towards realizing a vision of a competitive financial system and differentiated banking articulated at different points by Governor Raghuram Rajan, Nachiket Mor – who is on the RBI’s board, chaired the RBI committee whose report recommended the payments banks and chaired the payments bank committee – and other members of RBI’s leadership (see here andhere). With the payments bank approvals, along with the two new commercial bank licenses awarded in 2013, one of which, Bandhan Bank, launched recently, and the upcoming small finance bank licences, RBI has taken steps to realize that vision.

RBI deserves kudos and its moment of self-congratulation. The real test of this moment though, will be whether RBI can make innovation-friendliness a habit. Soon RBI will face a massive expansion in agent footprint set-up by payments banks. With agent scale, consumer protection and other issues will surface. How it reacts to that will be an initial test. Payments banks and their bank and non-bank owners will experiment with product categories unlike others RBI has seen in traditional banking, especially on credit. How it reacts when faced with those products will be another test. Existing incumbent banks for whom deposits are an invaluable part of their business model will be quick to protest any perceived imbalance in the playing field on regulations. How the RBI reacts to that will be yet another test. Lastly, we expect other new, unexpected interventions in financial services. This is, after all, as Nandan Nilekani put it recently, a “Whatsapp moment” for financial services in India. RBI has undoubtedly played catch-up but will it fall behind again?

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Crossposted with permission from authors, read the original post on CGAP here.

Image Credit: Flickr user Roxanne Tamayo