Demonetisation’s Winners: Payments Banks Are Now More Viable Than Ever

Follow the money, they say. Who is spending the most in these post-demonetisation weeks? The answer, as any newspaper reader would know, are e-wallets and banks themselves are promoting digital payments. The ones seeking to scale up operations are the likes of PayTM, Mobikwik, Freecharge, Payzapp (HDFC Bank’s wallet), and Buddy (State Bank of India’s offering), among others.

Demonetisation of high-value notes has changed the game, and suddenly, it is the payments players – e-wallets, mobile money vendors, and future payments banks that look like the next big thing. In two weeks, PayTM has seen transactions surge three-fold, and this may be only the beginning.

Remember the scenario earlier this year, when three of the 11 payments banks licensed by the Reserve Bank of India (RBI) returned their licences? The ones opting out were Dilip Shangvi, Tech Mahindra and Cholamandalam, a pharma king, a software company and a financial services company respectively.

Actually, at least two of them had no business applying for licences. It is mobile companies like Airtel, Vodafone, Jio and Idea, those who already had the telecom infrastructure and millions of customers who were ripe for this business, who ought to have been the drivers of this change. Ditto for e-wallet companies like PayTM, PayUMoney, Mobikwik, Oxigen, Citrus, et al.

This is where demonetisation and the gradual reduction of the cash economy are changing the rules forever.

Payments banks are looking viable once more, and not just because cash is currently in short supply. The dash towards digital cash is likely to remain permanent and will impact the whole banking business model. Payments banks are going to revolutionise banking.

Right now, payments banks are constrained by rules that limit their growth and expansion. Under current regulations, they have to invest 75 per cent of their deposits in government paper of less than one-year’s maturity, which means regular banks can offer depositors higher returns. Customers can keep upto Rs 1 lakh with them, which is why the entry capital requirements are low at Rs 100 crore.

But let’s look at what customers are already doing: they are holding small amounts with wallet companies on which they earn no returns. The wallet companies can use this “float” to earn money. They can also charge for transactions at some point. With demonetisation, and with the possibility of earning at least some returns on idle deposits, payments banking looks as attractive as holding money in a bank.

On the other hand, look at what regular banks do: the bulk of their business is about deposits and loans, with the spread between the two rates being their gross margins before costs. They offer wholesale banking and advisory services to big customers, and earn fees from retail customers (by issuing drafts and cheque books, charging fees on credit card and ATM services).

But in future large parts of the retail business can move to payments banks, for payments is what you use banks for. In fact, if regular banks do not become nimble payments banks themselves, they will lose a large chunk of their customers and low-cost deposits to payments banks.

Just consider: if the RBI relaxes the deposit limit for payments banks, and also allows them to offer overdraft services to long-term customers, payments banks too will be able to replicate what banks do with minimum fuss. Fees from plain-vanilla services like charging for cheque books and draft issuances will also vanish, for payments banks can handle such payments digitally, without any paper floating around, especially for small value payments. Poof goes a large part of future fee incomes.

The development of the unified payments interface (UPI) app for mobile phones by the National Payments Corporation of India (NPCI) ensures that digital will become the norm for peer-to-peer small cash transfers. Even the big banks know it. Yesterday (22 November), both State Bank of India, India’s biggest bank, and HDFC Bank, India’s most valuable bank, joined the UPI bandwagon. They know they cannot be left out of the coming tectonic shift, even though they are trying hard to shift customers on to proprietary platforms like Buddy, PayZapp and Pockets (ICICI Bank’s wallet). UPI is another game changer, for it now makes it possible for India to leapfrog the world on payments.

On the other hand, payments banks are set to go places, for capital is the least of their concerns. They can do almost any kind of banking with retail customers, who constitute the bulk of the banking system. Airtel with nearly 250 million mobile users is bigger than State Bank of India in terms of its customer base, and is thus wonderfully placed to become a payments bank. Ditto for Jio or Idea or Vodafone.

It is also easy to see how India Post can do the same in rural areas (it already has a payments bank licence, and has nearly 1.5 lakh physical branches); what is not clear is why IRCTC, the railways’ online ticketing service with millions of customers, and India’s most profitable digital platform, should not become a PayTM. It would bring guaranteed profits from day one since it has a ticketing monopoly.

Let’s be clear: payments (both receiving and giving) is what constitute the bulk of retail banking. And payments banks are looking a lot more viable than before.

If the Reserve Bank allows payments banking licences for anybody, and if it relaxes some of the existing rules by prescribing a higher capital base, payments banking is the way to go. Both for the new entrants and for incumbents.

Payments banking is lean, narrow banking. It is the future brought into the present by demonetisation. India needs lean, cost-effective banks, and this is where payments banks will lead us if the regulators do not trip them. The rest of the banking system should stay warned.