Sunday, 25 June 2017

It's about time RBI converted all Payment Banks into Small Finance Banks

The Reserve Bank of India came out with an interesting proposition in 2014 to accelerate financial inclusion in the country by announcing guidelines to set up new banks under two distinct formats. Payment Banks and Small Finance Banks.

The stated objective of RBI to set up the Payment Banks#1 was to "further financial inclusion by providing (i) small savings accounts and (ii) payments/remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users."

While the stated objective to set up the Small Finance Banks#2 was to "further financial inclusion by (a) provision of savings vehicles, and (ii) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations."

You must have noticed that Small Finance Banks can do everything what Payment Banks were allowed or expected to do (including providing payment / remittance services) however the Payment Banks were not allowed to lend to these marginal strata of the society. If the objective was to further financial inclusion then why could it not be fulfilled by only creating Small Finance Banks.

A classic definition of a Bank is "A financial institution that accepts deposits and makes loans". In fact the primary objective of a commercial bank is to act as an intermediary to provide safe avenues for saving and borrowing to the general populace. 

Non-interest income of banks varies between 20% to 40% of their total income#3. In other words 60% to 80% of banks’ income is the Net Interest Income (NII). This is the income due to the differential interest rates between their loans and deposits. So what is the point of introducing a handicap while setting up new banks and depriving them of an opportunity to earn the NII? It will only worsen the odds for viability of such banks.  This is a supply side argument.

Now let’s look at the demand side. The total bank credit in India is INR 76 lakh crore (or roughly US$ 1.17 trillion) #4. This works out to per capita credit of INR 58,500/- (or about US$ 900). This compares very poorly as compared to say per capita bank credit in US of US$ 39,000.#5  This means India as a nation is starved for credit. One of the most important means to pull the marginal population out of their misery is give them access to affordable credit.

What is then baffling is why is RBI still continuing with its experiment of running Payment Banks. It's about time RBI converted all Payment Banks into Small Finance Banks.

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