Why Converting a Payment Bank to a Small Bank is a counter-intuitive idea?

May 6, 2020

Payment banks are claiming that they have an unfeasible business model and must be allowed to lend as well. We are already in that phase of the market cycle where all NBFCs are under stress (thanks to IL&FS crisis) and many are failing. The asset quality and the ability to assess credit of FIs (Financial Institutions) – especially the new and emerging ones – has always been a question in the Indian financial system. Not much water has flown under the bridge since when we celebrated banks having higher CASA ratio. It made banks like HDFC our role models for being conservative, especially while the ones like ICICI and Axis suffered.

Now, has credit become the mantra for bailing out failing payment banks? I am not sure.

The problem is neither external nor the model and not the licensing either. The problem is strictly ‘internal’. Payment Bank license was given after evaluating a submission. The submission was choice-based and not based on the invitation. The same board/management/investors have approved and submitted the applications earlier. How come there is a problem post getting the license and not before? 

The framework of the license was digital and innovation-based in order to catalyse financial inclusion. Out of the 11 licenses granted, a few did not start, a few started and are struggling, and only one – PayTM to be precise – seems to be succeeding. One look at the reasons behind its success will show because PayTM sticked digital and innovation-driven approach. It’s a reflection of Vijay’s vision, product design, and support of the Board in Paytm’s strategy. The same year, 2013, when PayTM was launching its wallet (one of the last companies to get a PPI license), some boards were approving a 1-page memo to shut down their existing business which was poised for an imminent. For every dime which has died a silent death in this domain, there is a PayU, a Freecharge, and a PhonePe to blame.

Models succeed not because of the license terms but because of management vision and execution capacity.

Everyone nowadays seems to be looking at the RBI for a bailout. This is the typical, old-fashioned banking strategy. Inefficient PSU banks have always been capitalized and recapitalized (including the current year as well) and failing private banks have been forced to be taken over by deep-pocketed private banks. RBI literally feels obliged to save bad banks from creating a ripple in the market. RBI has time and again shouldered the responsibility to safeguard its small depositors and has succeeded in creating a stable banking system in India.

Payment Bank’s construct has the perfect regulatory design of capping deposits at Rs. 1 lakh. This saves the depositor from associated risks and brings the onus back on the management/board for success based on the decisions they make, especially vis-à-vis the application they submitted to obtain the license. The money they have accumulated to date is safe in the government securities. If they fail, small depositors’ money will remain safe, unlike other models. In fact, if such failing and non-profitable payment banks are allowed to lend, this capital would no longer be available and will directly increase the risk of an uninitiated small depositor. It will also transfer the responsibility of their success/failure to RBI due to macroscopic economics.

Small finance banks have had a proven and viable model of profitability in lending as in the case of NBFCs. They were allowed to provide banking services in order to lower their cost of borrowing. All 10 of them have built a liability franchise with varying degree of success and are on the right path. Payment banks have no previous history of an effective credit assessment in the long haul. By allowing them to lend, we will be putting to risk the customer deposits that they have mobilized and further add burden to the RBI (deposits are guaranteed by RBI/government).

Instead of looking at conversion as a bailout approach, we should look at conversion as a growth strategy. We must only focus on the needs of strong, successful payment banks and grant them the Small Finance Banks status. Definition of ‘success’ being ‘digital and innovation-driven with the view of financial inclusion’, the very criteria on which their submissions were evaluated. Definition of ‘strong’ being ‘support from existing investors’ like post bank and telco parents or the promoter himself. In a number of cases, this much-needed support is available. 

If this does not happen, not only will it be unfair to those players whose applications were rejected previously, it will also disincentivize the models and market players who have worked hard to build a competitive and scalable model. Ultimately, it will put a needless financial burden on the RBI considering the moral obligation that it has to face every now and then. The non-successful payment banks need to be allowed to fail rather than being bailed out.

Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of DLAI and DLAI does not assume any responsibility or liability for the same