Payments Banks Still In Search Of Right Business Model

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More than four years after the first payments bank started operations in India, the banking regulator has doubled the maximum limit of funds that a depositor can keep with such a bank to Rs2 lakh. This has been done to help “financial inclusion” and “expand the ability of payments banks to cater to the growing needs of their customers”.

How will doubling the deposit-taking ability help such banks?

First, let’s take a look at the performance of this set of banks.

In August 2015, the Reserve Bank of India (RBI) gave conditional licences to 11, including a few corporate houses, among 41 applicants. Three of them opted out, leaving eight in the fray. Later, two of the eight got merged into one and decided to shut shop, leaving six behind.

Airtel Payments Bank Ltd, the first to take off, made a net loss of Rs464.5 crore in financial year 2020 after posting Rs228.98 crore loss in the previous year. India Post Payments Bank Ltd, which had started with a pilot project in January 2017 in Ranchi (Jharkhand) and Raipur (Chhattisgarh), recorded Rs334 crore loss in 2020. In the previous year, its net loss was Rs165 crore. Jio Payments Bank Ltd, which took off in April 2018 as a 70:30 joint venture between Reliance Industries Ltd and State Bank of India, reported a net loss of Rs1.1 crore in financial year 2019 (I don’t have its 2020 financials). NSDL Payments Bank Ltd, the last to commence operations (in October 2018), posted Rs14.28 crore loss in 2020 on a gross income of Rs6.29 crore.

Two of their peers are making profits. Paytm Payments Bank Ltd’s net profit rose to Rs29.8 crore in 2020 from Rs19.2 crore in 2019. Fino Payments Bank Ltd, which started operations in July 2017, turned profitable in the fourth quarter of 2020.

Indeed, both interest and non-interest income of these banks have been rising but their consolidated balance sheet ended the financial year 2020 in the red due to high operating cost. An RBI publication points out that due to twin factors of limited operational space and high initial costs in setting up the infrastructure, these banks are taking time to break even; the initial years are being invested in expanding their customer base.

The key to their survival and success is continuous investment in technology. Payments and remittance services is a volume-driven, thin-margin business. Besides taking deposits, they can distribute third-party financial products but cannot give loans. They also cannot issue credit cards but can offer debit cards and internet banking services to their customers. Unlike small finance banks, which can dabble in almost everything that a universal bank can, albeit on a smaller scale, payments banks don’t have all slices of the banking business on their plate.

Their ability to collect deposits is capped but they can forge partnerships with other banks for raising deposits on their behalf; they cannot give credit but offer investment products such as mutual funds and insurance to their customers. Transactions – consisting of bill payments, remittances, cash managements, recharge of mobile connections, etc. – account for three-fourth of their business.

This is a volume game. For remittances and cash withdrawal, typically fees earned by a payments bank is 50 paise per Rs100. Out of this, as much as Rs35 paise could be shared with the physical network of merchants for cash handling, leaving 15 paise with the bank to meet operational expenses and making profits.

There are other issues. They have no exposure to loans but they need to maintain 15 per cent capital adequacy ratio (CAR). This is meant to protect depositors in case a bank goes bust. CAR gives banks a cushion to absorb a reasonable amount of losses if too many loans go bad and discourages them from making excessively risky loans and investments. The rationale behind a high CAR for payments banks is probably the regulator’s concerns about the operational risks they are facing; they have no credit risks.

Sandwiched between commercial banks and pure-play payments service providers, payments banks do not enjoy a level playing field. They offer total solutions to their clients — payments, all kinds of transactions and cash management. For that, their clients – typically traders and small businesses – need to keep current accounts with such banks. But, going by the RBI regulation, money kept in such accounts too littlecannot exceed Rs2 lakh (till recently, it was Rs1 lakh) by the end of a day. One entity can keep either a current account or a savings account within this limit.

One way of tackling this is partnering with another bank – a universal bank or even a small finance bank – to transfer excess money and get it back the next day through the so-called sweep-in sweep-out arrangement. They have been doing this but it’s an operational challenge.

A commercial bank can do everything that a payments bank does; it has more flexibility besides the ability to offer loans to its customers and earn interest income. The payments service providers, on the other hand, have freedom from regulations. They don’t mind foregoing the transaction fees as they can use the customer data for multiple purposes, including cross-selling products.

The zero-MDR regime is yet another contributing factor to payments banks’ woes. MDR, or merchant discount rate, is the fee levied by banks from merchants for providing them with payment settlement infrastructure or point-of-sale machines. From December 2019, there has been no MDR on transactions done through RuPay card and Unified Payments Interface (UPI) of National Payments Corporation of India, two main platforms for all financial transactions.

A hybrid model can help and a few of them, in fact, are doing this — geo-mapping every inch of the country and making every kirana store, petrol pump, photocopier, saloon and mandi points for transaction, bill payment and withdrawal of cash.

The RBI also needs to raise the cap on deposit-taking to Rs5 lakh, the amount that is insured for every depositor in Indian banking system. As they need to invest three-fourth of the deposits in government securities, there will be more buyers for bonds once this is done. Incidentally, they are paying insurance fees for a Rs2 lakh cover but the fee structure is the same as what a commercial bank pays for Rs5 lakh.

Since the payments banks are not giving loans, they run a near risk-free model. Still, if the regulator has reservations on raising the cap on deposits, let the Rs2 lakh cap be applicable to savings accounts with a separate Rs5 lakh limit for current accounts. That will help them package total solutions for traders and small and medium enterprises – a win-win for both financial inclusion and payments banks.

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