Differentiated banks

Topics-

1.     Introduction to Differentiated banks

2.     Aim of Differentiated Banks

3.     Types of Differentiated banks

4.     Payment Banks

                                I.            Key Features of Payment Banks

                             II.            Services Provided by Payment Banks

                           III.            Criteria for setting up payment banks

                           IV.            Example of Payment Banks

                             V.            Key Challenges to Payment Banks

                           VI.            Opportunities

5.     Small Banks

                                I.            Introduction

                             II.            Key features of Small Finance Banks

                           III.            Key Challenges to Small Finance Banks

6.     Difference between Payment Bank & Small Banks

Introduction

·        Differentiated banks are banking institutions licensed by the RBI to provide specific banking services and products.

·        Differentiated banks licensing was launched in 2015.

·        It is a system refers to the system of different licenses for different sub components of the banking sector such as Limited Banking License, Commercial Banking License etc.

·        A differentiated license will allow a bank to offer products only in select areas.

Aim

·        Main aim for giving license to differentiated banks is to promote financial inclusion and payments. The term differentiated banks indicate that they are different from the usual universal banks.

·        The universal banks like SBI, Canara Bank etc. can give almost all products and services. On the other hand, the differentiated banks can give only selected products like credit, payments, deposit etc., with RBI regulations.

Types

The differentiated banks are of two types-

1.     Payment banks and

2.     Small finance banks.

1.Payment Banks

Key features of Payment banks

·        Non-finance company entities(NBFC) and existing non-bank prepaid instruments issuer may apply for the payments bank

·        Minimum capital required for the payment banks is Rs. 100 crore

·        Foreign shareholding is allowed to these banks but as per the regulations of FDI ( Foreign Direct Investment)

·        Payment Banks cannot provide lending services but allowed to distribute financial product such as mutual funds and insurance products.

·        25% of the bank branches of the payment banks must be in unbanked rural areas.

·        They Can not accept Fixed Deposit ( Can accept Current Account , Saving Account )

·        They Cannot give depositors money as loans. They can invest depositors money in government securities(G-Sec) only.

·        They Can not Isssue Credit Cards.

·        They cannot accept NRI deposits

Services provided under these banks

·        Acceptance of deposits  ( Can accept Current Account , Saving Account ) maximum balance of Rs 1,00,000/- per customer.

·        Payment Banks can provide services like ATM, net banking, debit cards, and net banking

·        Current and savings accounts can be operated through this bank.

·        Offer internet banking, sell mutual funds, insurance and pensions.

·        Have business correspondents and ATMs.

·        Offer bill payment service for customers

·        They can enable transfers and remittances from a mobile phone.

·        They can offer forex services at charges lower than bank

·        They can provide forex cards to travellers, usable as debit or ATM card all over India.

·        They can also offer card acceptance mechanism to third parties such as “Apple Pay”.

Criteria for setting up Payment banks

·        Existing non-bank Pre-paid payment instruments (PPI) issuers; and other entities such as individuals / professionals; Non-Banking Finance Companies (NBFCs), corporate Business Correspondents (BCs), mobile telephone companies, supermarket chains, companies, real sector cooperatives; that are owned and controlled by residents; and public sector entities may apply to set up payments banks.

·        Promoter/promoter groups should be ‘fit and proper’ with a sound track record of professional experience or run their businesses for at least a period of five years in order to be eligible to promote payments banks.

·        The minimum paid-up equity capital for small finance banks shall be Rs. 100 crore.

·        Maintains minimum 75% of deposits in Government bond and maximum 25% deposits with other scheduled commercial banks.

·        The bank should have a high powered Customer Grievances Cell to handle customer complaints.

Example of Payment Banks-

·        Airtel Payment Bank

·        Paytm Payment Bank

·        Vodafone m-pesa

·        India Post Payment Bank

Key challenges to Payment banks

·        Relies highly on low ticket account balances (capped at ₹1 lakh) for profitability.

·        Restriction on fund deployment: Payments banks are required to invest 75% of their CASA(current account and savings account)  balances in Statutory Liquidity Ratio (SLR) eligible government bonds or T-Bills. For the balance 25%, the option is deposits with other SCBs. While this is considered as a safety net for depositors, it restricts their ability to optimize treasury operations.

·        No lending. No NII (Net Interest Income) or IRR (Internal Rate of Return): Unlike Scheduled Commercial Banks (SCB) and Small Finance Banks (SFB) Payments banks are not permitted to lend. Their investment in stipulated government securities and bank FDs would yield 2-4% net of the cost of funds (or negative if they try to aggressively mobilize balances at higher rates like Airtel). Adjusted for other operating costs, the net return may fall to sub 1% levels, again corroborating the high volume-low margin nature of this business.

·        Over-competition: With existing SCBs upping their focus, multiple payments banks and SFBs vying for the customer attention and even the FinTech startups disrupting the existing models, the segment is already too hot to handle. While some of the players like Airtel or Vodafone, with the existing distribution network and large customer base, have an advantage, the nature of the relationship they are now trying to build with the customer is different from a duopolistic market we normally see in telecom where top two players become market makers. India Post may be an outlier with distinct advantages of large physical distribution; however, for others, it’s a long haul to acquire critical mass.

Opportunities:

·        The sheer size of the market: India’s unbanked population stands at 233 million. Even those who can be considered ‘included’ through Pradhan Mantri Jan Dhan Yojana (PMJDY), are still new to banking products.  Importantly, the sheer size of the market can accommodate multiple players, offering their services to various segments of society.

·        Simplification: With the government initiative on JAM (Jan Dhan-Aadhar-mobile)  (click here to read Jan Dhan Aadhar mobile) )Aadhar and more recently demonetization, there is a push for digitization.
The initial traction of wallets was primarily driven by the proposition of a ‘free’ and ‘more convenient’ payment method. There is still an opportunity to bring cost-effective and simplified technology interfaces for real-time payments.

Payments banks can utilize the payments infrastructure of National Payments Corporation of India (NPCI), where the SCBs may have some lag due to their legacy systems.

·        Offer Financial Advisory: Unless you count the insurance pitch from your bank’s relationship manager, 99% of the people in India have little access to any form of financial advisory. This inefficiency opens a huge white space for payments banks to offer real advisory services to rural and BOP.

·        Bank as a Platform: Payment banks can be the financial services gateways or platforms to re-bundle a host of innovative services. One such wholesome combination could be a tie-up with MFIs.

2.Small Finance Banks

Introduction

·        Small Finance Banks are registered as a public limited company under the Companies Act 2013.

·        These are registered under the Banking Regulations act 1949.

·        Financial inclusion is the main aim for setting up of these banks.

·        Small Finance Banks (SFBs) shall primarily undertake basic banking activities including acceptance of deposits and lending credit to unserved and underserved sections.

·        SFBs shall be subject to all prudential norms and regulations applicable to commercial banks, including maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).

key features of Small Finance Banks

·        Who can apply? - Existing NBFCs (Non-Banking Finance Companies), Micro-finance Companies and Local Area Banks may apply for the small finance banks in India.

·        Small Finance Banks are established as a public limited company in the private sector.

·        Minimum paid-up capital for the small finance banks is Rs 100 crore

·        Small Finance Banks are required to establish its 25% branches in unbanked areas.

·        These entities must add the term small finance bank with its name to differentiate it from other banks.

Example-Ujjivan Small Finance Bank

·        Foreign Shareholding is allowed as per the FDI (Foreign Direct Investment) policy.

Key Challenges to Small Finance Banks

·        Restructuring of capital to comply with the strict RBI guidelines.

·        Mobilizing deposits in a highly competitive environment.

·        Re-engineering front- and back-end systems.

·        Another challenge is the SFBs will require comprehensive and efficient change management processes.

·        SFBs will also need to approach their technology requirements with a different lens compared to the traditional banks as the former will be serving a customer base that is markedly different from that of a typical commercial bank.  Hence, there is a need for cost-effective mobile-based technology deployments that are better suited to reach underserved areas.

·        With additional scrutiny by the RBI, the SFBs will also require strengthening their governance structures.

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