1 October, 2015
Bank sector reform in India has been slow. The domination of state-owned or Public Sector Banks (“PSBs”), which began with the nationalization of banks in 1969, was loosened in the nineties to allow some private players (most of whom enjoyed the patronage of larger domestic institutional players) but under strict licensing restrictions, making a
‘bank license’ a scarce and a valuable resource.
More than a decade after the last two private entrants, YES Bank and Kotak Bank, the sector is witnessing a surge of 21 new entrants. These new entrants hold promise to bring in vast proportions of the Indian population who are currently outside the formal banking sector. The key question that remains is if it can be done in a commercially viable manner.
This paper take a brief look at some of these changes, all of which represent a significant shift in the manner in which banking players, incumbents and new entrants will operate.
New Ways of Thinking
Raghuram Rajan, the central bank governor at the Reserve Bank of India (“RBI”), recently completed two years in office. A year’s head start over the new Bharatiya Janata Party (“BJP”) government in Delhi has meant that he had a relatively free hand in preparing the banking sector for its next wave of change.
To Rajan’s credit, he has been single-minded in tackling the core issue at hand; the financial exclusion of India’s masses. Two new ‘full service’ bank licenses were issued last year and Rajan has alluded to more in the next few years (rather than the next decade). Even though there were more than 26 applicants for the bank licenses, only two licenses were awarded. Both license awardees, Infrastructure Development Finance Company (“IDFC”) and micro-finance lender Bandhan, are players with a proven record of building extensive reach in the grassroots parts of India (or Bharat as many would say) that banking incumbents have given up on for commercial reasons. Furthermore, Rajan has conveyed that new banks licenses will be issued more frequent, from the once-a-decade frequency that has been the norm until recently.
The other significant shift is the RBI’s (led by Rajan) faith in the rising use of telecommunications technology in banking which is shared by another technophile in Delhi, Prime Minister Modi. Both of them have consistently backed technology-driven solutions, whether it be broadband or mobile technologies, for efficient programme implementation and as tools of empowerment for those outside the formal reach of the banking system and the very poor. Last year, Prime Minister Modi over- ruled factions within his government to extend support for a national biometric identification system AADHAAR as a part of the basic “Know Your Customer” (“KYC”) requirement to open new bank accounts. While many within his government saw AADHAAR as a legacy of the previous congress-led government, Prime Minister Modi saw the value of a ready and scalable national identity system for India’s document-poor hinterland where most of its poor reside. The foundational base of a national identity system has since helped the RBI to develop its policy interventions further as well as the Modi Government to improve implementation of its welfare programmes.
Birth of ‘Differentiated Banks’ — Payment Banks and Small Banks
In January 2014, the RBI-constituted Financial Inclusion Committee (Committee on Comprehensive Financial Services for Small Businesses and Low Income Households), headed by Nachiket Mor, proposed a radical solution to the persistent problem of financial exclusion: creation of new categories of ‘differentiated banks’ that would perform very specific functions rather than provide ‘full-service banking.’ In August 2015, 11 new ‘payment banks’ licenses were awarded, to provide payment-only services (i.e. without any deposit taking function). Six of the 11 new payment banks are affiliated with telecom service players which provide an entry for players like Vodafone, Bharti Airtel, Reliance and Telenor to establish and expand their mobile money businesses, blurring the lines between telecom and banking services. This is linked to a realisation amongst policy makers that mobile money strategies, which co-opt telecom players into banking (as in parts of Africa) is an appropriate financial inclusion strategy for India to emulate. The earlier bank-led Banking Correspondent (“BC”) agent model, favoured till recently, has proven ineffective1 and telco-driven Payment Banks are being considered as a serious alternative.
One of the nine payment bank license holders, state-owned India Post Department which is one of the nine payment banks, poses a serious threat to banking incumbents and other payment banks alike. A Post Bank of India (“PBI”) with its wide network of 155,000 post offices (89% of which are in rural areas) could replace state-owned State Bank of India (“SBI”) as the biggest bank in India.
Another set of 10 ‘differentiated’ bank licenses for small banks were announced in September 2015, most of the license winners being micro-finance institutions (“MFI”) with strong local networks, which is in line with the RBI’s emphasis on financial inclusion. Small banks hope to improve credit facilities for small business. This is put into context when one realises that close to 90% of small businesses in India have no links to any formal financial institutions.
All put together, India has seen 21 new banking entities being created in India (if one were to add up all the payment banks, small banks and the two players who were granted ‘full-service’ licenses last year) in the last 18-months.
A New National Financial Inclusion Programme
The dynamism of the financial regulator RBI has been matched by political action in Delhi. Within six months, the new Bharatiya Janata Party Government launched the Government’s Comprehensive Financial Inclusion Plan (”Pradhan Mantri Jan Dhan Yojana“) which is a national financial inclusion programme that made an entry into the Guinness Book of World Records for the fastest enrollment of new bank accounts to cover 99.74% of Indian households. Over 11.5 crore (115 mn) new bank accounts were opened across the country in a span of five months.2 While account opening drives are not new, this programme was accompanied by a number of benefits for the poor — a small over-draft facility to tide over financial exigencies, bundled life insurance and promises of future accident and health insurance as well. As the programme enters its next phase, the Finance Ministry is busy drawing up plans to ensure account holders actively use these accounts, a nuisance of previous account opening schemes. The objective has been to bring about 60% of India’s rural and urban population, which currently does not have a functional bank account, within the ambit of the formal banking sector.
The BJP Government has also been working on linking Government-To-Person (“G2P”) welfare payments, termed Direct Benefit Transfers (“DBTs"), to these newly opened bank accounts and making the national biometric system, AADHAAR, as the KYC filter to ensure such payments are transferred electronically to real beneficiary accounts.3 All put together, these central and state government transfers account for INR 4.2 trillion annually (approximately 70 billion, 4% of India’s GDP),4 transferred annually from the National Exchequer to individual beneficiaries. Such low-ticket, high-volume transactions have been attracting the interest of the new Payment Banks, some of whom are planning to build their business models around such G2P transfers and remittances.
A New Indian Bankruptcy Law
Incumbent banks are struggling to change, scaling up their ‘mobile banking’ operations and cleaning up their own books, weighed down as they are under their non-performing/stressed loan assets. Years of liberal credit to Indian companies, many of them reeling under slow growth of the last two years, has bloated the bad debts on the books of many Indian banks with little or no recourse to recovery.5 Here too, there seems cause for regulatory cheer.
Last year, there were some landmark developments in terms of banks restructuring bad loans and seeking legal recourse against defaulters, with some of the borrowers being tagged as ‘willful defaulters’ and attracting more severe penalties. The Finance Minister Arun Jaitley in his budget speech earlier this year spoke about bringing in a new Bankruptcy Code, replacing two inefficient pieces of regulations, to introduce a sound bankruptcy framework, akin to the U.S. Chapter 11 bankruptcy code. The Bankruptcy Law Reform Committee (“BLRC”) has been instituted to frame this piece of legislation, which if enacted would put an end to the abuse of the banking system that has continued for years abetted by weak bankruptcy laws and few effective options for recovery.
Both RBI and the Finance Ministry have played fairly dynamic roles in the last 24-months in addressing some of the policy asks of the sector. It is now for the newly created ‘banks’ and incumbents to build out businesses that are relevant to the needs of Indian customers and do so in a commercially sustainable manner.
At one end of the spectrum, many incumbent ‘full-service’ bank players need to re-capitalise and possibly consolidate. At the other end, a new set of players are adopting local strategies to overcome the challenge of financial exclusion and lack of access to credit.
Overcoming both respective challenges requires significant external investments, and in some cases divestment from the government, a sharper focus on operations and implementation, as well as an open mind towards innovation. By embracing new technology, the regulator and the government have shown maturity in pursuing the correct policy options. The ball is clearly in the banking sector’s court — as it steps up and creates the two million jobs it is expected to create over the next decade, extending the reach of formal banking channels to reach the deepest parts of the rural hinterland, which is also where most of its poor reside.
1 RBI College for Agriculture Banking and the Consultative Group to Assist the Poor (CGAP) survey in September 2013 declared 47% of the listed 2,358 agents across 15 large states as untraceable.
2 Media report in Economic Times
3 Biometric authentication number created by UIDAI (Unique Identification Authority of India).
4 Media report
5 Media report excerpt http://www.reuters.com/article/2015/03/12/india-banks- debt-idUSL4N0WE3JR20150312.