Payments Banks - The Viability Concerns
When the idea of payments banks was first mooted in the year 2014, it generated much enthusiasm, and 41 eager participants entered the sweepstakes for grant of licences. Reserve Bank of India (RBI) granted licences to 11 applicants in August 2015, but post grant of permission, there has been a marked lethargy in the roll out of services by licence holders. The 18 months period allowed for the launch of operation is steadily ebbing away, with little sign of conversion of ideas into reality.
On the contrary, three licence holders have surrendered their licences – Cholamandalam Distribution Services Limited, a joint venture of Telenor Financial Services Limited, IDFC Bank Limited and Dilip Shanghvi, the promoter of Sun Pharmaceuticals Limited, and Tech Mahindra Limited. Is there more than what meets the eye in the slow take-off? Are licence holders developing cold feet? What are the viability concerns?
Lending Prohibition
Traditional banks generate much of their spread – the net interest margin – from their credit business. For payments banks, lending is a forbidden fruit. While the prohibition of credit deployment from the business mix is intended to protect payments banks from the hazards of borrower delinquencies, it also denies them head-room for booking profits. Payments banks must, therefore, must learn to manage with the slim spreads available from investment of customer deposits and fees they charge for remittances.
Remittance Fees
The pain point for payments banks is likely to be the inescapable fact that fees for remittance services in India are already reasonably low – India Post is at 6%, hawala at 4.6% and banks at 3%, and the average cost of a remittance stands at 3.5%. Payments banks may have to offer lower rates to make inroads in the remittance market and slash costs to protect spreads by harnessing low cost technology. A silver lining for payments banks is the result of an IFMR (Institute for Financial Management and Research) study that conclusively establishes that users of hawala channels would much prefer to switch over to a formal channel provided that near-doorstep convenience and competitive rates are on offer.
Non-Fund Based Income
An additional avenue to earn non-fund based income is retailing of products of traditional banks, mutual funds, insurance cover, etc. But these revenue streams are low margin activities which it makes it incumbent upon the bank to generate high volumes to make the model a profitable proposition.
Mobilising Deposits
Payments banks are allowed a play only in CASA (Current Account and Savings Account); term deposits are taboo. With the exception of RBL Bank, YES Bank, Kotak Bank, Lakshmi Vilas Bank and Bandhan Bank, no bank offers a rate in excess of 4% per annum for deposits with daily balance upto Rs.1.00 lakh (the day end ceiling on deposits for payments banks). If the payments bank is making a foray in virgin territory, it could mobilize deposits by offering a rate of 4% per annum for savings accounts, but if it plans to wean away customers of traditional banks, it will have to dangle the carrot of an interest rate of more than 4% per annum.
Investing Deposits
Payments banks are directed to maintain 4% of their demand liabilities to meet the Cash Reserve Ratio (CRR) stipulation of RBI and no interest is paid by RBI on the amount held as CRR. 75% of demand liabilities have to be invested in Government Securities (G-Secs) or Treasury Bills (T-Bills) with maturity of not more than one year. The residual amount may be held as current or time deposits with other scheduled commercial banks. The cut-off rate at the last 364 days T-Bills auction was 6.948% and 1 year term deposits with banks will fetch between 7% to 7.50% per annum. This will give the payments banks a wafer thin spread of around 3% to 3.50%
Competition
Although doomsayers have been predicting the demise of traditional banking for long, the fact is that these banks have been expanding their pan-India footprint, embracing technology to prune administrative and operating costs, and becoming far more customer friendly. Traditional banks also have a whole suite of product with which to entice customers who may prefer to avoid having to deal with more than one organisation unless there are compelling advantages.
Capital Investment and Gestation Period
Willingness to invest in technology, without reserve, is a condition precedent in the payments bank sphere. Players must have not only financial strength but also a healthy risk appetite. Unless the licence holder is entering with distribution network muscle, the road to profitability will be long and with many a winding turn. With a network in place, cash positive flows may be reached after around 3 years. Creating a structure of business correspondents and agents is a slow process and could push back the dateline for profitability to closer to 5 years. First profit margins are likely to hover in the range from 2% to 5% and it could take 7 to 10 years for these margins to reach 9%.
Bibliography
Live Mint. Payment Banks Aren’t Looking That Lucrative Anymore. http://www.livemint.com/Industry/Hr2enPpVN8hWzoESJREQdP/Payments-banks-arent-looking-that-lucrative-anymore.html . 24 May 2016. Web. June 14, 2016.
Bank Bazaar. Banks Providing Best Saving Account Interest Rates in India. https://www.bankbazaar.com/savings-account.html. Web. 14 June 2016.
CGAP (Consultative Group to Assist the Poor). What will it Take for Payments Banks to Succeed in India. http://www.cgap.org/blog/what-will-it-take-payments-banks-succeed-india. 27 January 2015
