Digital Banks: Will The Idea Work In India?
Singapore has them. So does Hong Kong and Malaysia. Should India, too, start issuing licences for digital-only banks? The NITI Aayog thinks so but not everyone is convinced these entities will be able to achieve anything that existing lenders can't.
A discussion paper floated by the government's think-tank suggests that a new category of bank licences be introduced. These can be given out to entities with experience in areas such as e-commerce, payments and technology. These lenders can first start operating in a regulatory sandbox and, over time, transition into full service digital banks. No special dispensation, such as lower prudential or capital requirements are being suggested for such entities once they are fully operational.
Mandar Kagade, head of Black Dot Public Policy Advisors, which was knowledge partner for the paper, argues that India needs more banks.
Our median age is 28, the population is young and a technological shift is imperative. Indians are significantly underbanked when compared to our peers. We need more banks. Due to the digital form factor, the cost of capital can be reduced since these lenders can also take deposits.Mandar Kagade, Founder, Black Dot Public Policy Advisors
Can the idea work? The views are mixed.
Banks Going Digital Vs. Digital Banks
Over the past few years, banks have seen a significant shift towards services offered digitally.
For the country's largest lender State Bank of India, 37% of retail loan accounts and 58% of savings accounts were opened through their digital banking platform YONO in the quarter ended September. In the case of India's largest private lender HDFC Bank Ltd., that percentage was even higher. The lender saw over 95% of all retail transactions take place digitally.
As transactions go digital, particularly for younger and new-to-banking customers, some believe digital banks are a natural extension.
"Over the next three years, 33% of the customers will be first-time customers. And they are all digital natives. Their previous experience of doing business is with apps like Amazon and Myntra," Jaikrishnan G, head of financial services consulting at Grant Thornton Bharat, said. "Hence, they won't understand the need to sign a document and then courier it. They'll never get it."
Jaikrishnan thinks this changing customer profile requires a new profile of banks as well. The incumbents, he argues, are focusing on retaining customers and serving institutions, leaving a gap in the market to address new-to-bank customers.
This gap is currently being fulfilled by neo-banks, which aren't banks at all as they aren't allowed to accept deposits or lend directly. These entities typically tie up with traditional banks and offer services built atop traditional banking services.
With a (digital banking) framework, the balance sheet belongs to neo-banks/fintechs and RBI can directly do an inspection or call for any audits.Jaikrishnan G, Head - Financial Services Consulting, Grant Thornton
Not everyone is as convinced.
Former banker Arijit Basu, who was managing director at State Bank of India, asks what purpose these entities will serve that is different from what existing banks can do. For instance, if the idea is to target and expand lending to small businesses, why can't that be done by existing institutions within the current bank licencing framework.
"Right now, the market that digital banks are seeking to address is small businesses which are not getting the financing they need. But the small finance bank model exists to specifically address this market," Basu said. "It's not clear how a new segment of banks will do anything which cannot already be done."
He said small finance banks are not expressly required to have a physical branch presence, yet they are working through a hybrid model for a reason. Besides, non-bank platforms that want to offer services to this segment can tie up with commercial lenders.
Asim Parashar, partner at PwC India, thinks there is merit in thinking of digital banks but not from the viewpoint of financial inclusion.
If we want a good digital banking framework, we have to remove the financial inclusion tag from it... We have to let the companies decide the kind of business they want to do.Asim Parashar, Partner, PwC India
According to Parashar, there is plenty of business to be done in urban areas, through the poorer or financially excluded client base.
"Legacy banks tend to not adequately address this group and a digital bank can tap into this opportunity. If you force them to get into remote locations, the digital-only approach may not work," he said. "In such locations, customers prefer having phygital (physical + digital) presence so there's a place where their grievances can be addressed."
A former banker, who spoke on condition of anonymity, said that a special class of digital banks seems unnecessary given that India already differentiated banks in the form of small finance banks and payment banks. These platforms can be utilised as a base to develop digital banking, this person said.
Newer banking platforms have also struggled to raise retail deposits. Would digital banks face the same challenge?
When it comes to things like deposits, people would like to see a physical entity, said the banker cited earlier. We know from experience in under-banked locations that if you ask customers to do everything on a mobile phone or a computer, the activity reduces over time, this person said, adding that a hybrid model of assisted banks has emerged because it helps build trust.
No Regulatory Arbitrage, But...
The NITI Aayog paper said it seeks no regulatory arbitrage for digital banks. "It's proposed that digital banks will be subject to prudential and liquidity norms at par with the incumbent commercial banks," the paper said. "Creating a new licensing / regulatory framework is being proposed as regulatory innovation and not as regulatory arbitrage." It said while they may be treated at par with commercial banks in terms of prudential and liquidity requirements, there may be scope to treat them differently in other ways.
According to the paper, one such way is to widen the eligible entities to those who may have experience in e-commerce, payments and other adjacent areas. So far, the Reserve Bank of India, which will eventually decide on any framework for digital banks, has been cautious about the set of promoters it allows into banking.
These requirements were eased when payment bank licences were issued but with strict checks and balances on the amount of deposits permitted and investment of those deposits. Recently, as part of a review of the private bank ownership rules, the RBI didn't accept a recommendation to allow large business houses to promote banks.
"It took the RBI two years to think about allowing corporates into banking and they still didn't go ahead with it. What makes you think they're going to go one step further and give digital banking licences," said Suresh Ganapathy, analyst at Macquarie Securities.
He said that the current available technology in India, ranging from e-KYC to account aggregators and now the open credit enablement network, means that anyone can do digital banking. "When you can use these open architecture system and grow your business, why do you need a separate set of digital banks?"