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ROLE OF SMALL AND PAYMENTS BANKS IN ACHIEVING FINANCIAL

INCLUSION

Copyright by Vision IAS

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transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise,

without prior permission of Vision IAS

2 www.visionias.in Vision IAS

Role of Small and Payments Banks in achieving financial inclusion

Contents

i. What is Financial Inclusion?

ii. What are Payments Banks?

a. Conditionalities for setting up Payments Banks

b. Role in financial inclusion

c. Challenges

d. Way forward

iii. What are Small Banks?

a. Conditionalities for setting up Small Banks

b. Role in financial inclusion

c. Challenges

d. Way forward

What is Financial Inclusion?

As per the 2011 census, only 65% of urban households and 55% of rural households have access to banking

services. The proportion of population having access to formal credit is even lesser. A miniscule percentage of

population has any kind of insurance and pension coverage. There are intra-regional and inter-regional

variations to go with these numbers. To rectify these anomalies, both the government and RBI have taken

various initiatives to usher in Financial Inclusion

Financial Inclusion means that everyone must have access to

Banking services like bank accounts, ATM services etc

Credit at affordable rates

Investment opportunities like Mutual funds, pension plans

Insurance services which includes life, non-life and health insurance

Keeping with its previous initiatives to usher in financial inclusion, RBI has recently announced guidelines for

licensing of Payments Banks and Small Banks. Both these banks fall into the category of niche or differentiated

banks, meaning that they serve a specific purpose or a specific category of customers.

What are Payments banks?

Payments banks will provide a limited range of products, such as, acceptance of demand deposits and

remittances of funds, but will have a widespread network of access points particularly to remote areas,

either through their own branch network or through Business Correspondents (BCs) or through

networks provided by others. They will add value by adapting technological solutions to lower costs.

Existing authorized non-bank pre-paid instrument issuers (PPIs like Airtel Money, Flipkart Wallet,

Mobikwik etc), non-banking finance companies (NBFCs), corporate BCs (business correspondents),

mobile telephone companies, super market chains, companies, real sector co-operatives and public

sector entities are eligible for setting up a payments bank.

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Conditionalities for setting up Payments Banks

Minimum paid-up capital of Rs. 100 crores

Promoters will have to have an initial minimum capital of at least 40 per cent. It has prescribed a

lock-in period of five years for promoters holding.

If promoters stake is in excess of 40%, it will have to be brought down to 40% within 3 years.

Within 10 yrs it has to be brought down to 30% and to further 26% within 12 yrs from date of

commencement of business

A payments bank cannot set up subsidiaries to undertake non-banking financial activities

Payments Bank will have to comply with SLR and CRR requirements

1/4th

of the access points must be in rural areas.

Role in financial inclusion

Our migrant labour force accounts for 1/3rd

of the population. Most of them use informal

channels for fund transfer. These channels charge hefty fees and are unreliable. A payments

bank, says the RBI, will further the cause of financial inclusion by providing small savings

accounts and payments and remittance services to migrant labour workforce.

Payments Banks will also serve low-income households, small businesses and other unorganized

entities thus bringing hitherto those sections of populations into the banking fold which were

earlier excluded. The idea is to facilitate high volume and low value transactions in a secure and

technology-driven environment.

A payments bank will have to ensure widespread network of access points particularly to remote

areas, either through their own branch network or BCs or through network provided by others.

Thus, the geographical coverage of banking services will increase

Challenges

Banks like SBI and ICICI are already providing these services through mobile banking. Hence,

payments banks will have to provide lucrative products to match the already existing players.

Though payments banks will earn fees on remittances and payments but will it be enough to

make the bank viable, remains to be seen.

Payments banks will have to invest all their deposits in government bonds maturing in one year.

Though this ensures safety to deposits by it seriously limits the profitability of the bank. In the

current scenario, when inflation is raging close to 8%, returns from government bonds may

prove inadequate.

Some experts have raised a question that as Small banks are allowed to do all the activities that

are entrusted to payments bank, then why would anybody open a Payment bank? Here, it needs

to be remembered that Small Banks will serve a very limited area which is unsuitable for services

like remittances. Payments banks will provide the vast geographical coverage for remittance that

SBs will not be able to provide.

Opening up widespread access points is a challenge in itself. Access points in rural points are

deemed unviable. ATM business is also now not seen as a profitable business. With Banking

Correspondent model also running into rough weather, it remains to be seen how the

requirement of widespread access points will be fulfilled.

Way Forward

There is a large segment of population that needs to be tapped with the products that payments

banks are required to provide. The large volume of business can easily make payments banks

viable. The need is to have the right kind of schemes and products.

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Government should also expedite the completion of National Fibre Optical network. The

combination of NFON, mobile banking and Payments Banks will help in achieving financial

inclusion.

Setting up of payments banks is a step in the right direction and they will help fill the existing

gaps in banking services by providing basic banking to hitherto left out population.

What are Small Banks?

Small banks will provide a whole suite of basic banking products, such as, deposits and supply of credit,

but in a limited area of operation. The entities eligible to set up a small bank include resident individuals

with ten years of experience in banking and finance, companies and societies, NBFCs, Micro Finance

Institutions and Local Area Banks

The area of operations of the small bank will be restricted to contiguous districts in a homogenous

cluster of States/Union Territories so that the bank has the local feel and culture. However, if

considered necessary, the bank will be allowed to expand its area of operations beyond contiguous

districts in one or more States with reasonable geographical proximity.

Conditionalities for setting up Small Banks

Minimum paid-up capital of Rs. 100 crores

Promoters will have to have an initial minimum capital of at least 40 per cent. It has prescribed a

lock-in period of five years for promoters holding.

A Small bank cannot set up subsidiaries to undertake non-banking financial activities

It must comply with SLR and CRR norms

It has to comply with Priority Sector Lending norms

The upper limit for loan/investment is capped at 15% of its capital funds

Role in financial inclusion

Small Banks will engage in basic banking service of acceptance of deposits and lending activities to

small farmers, small businesses, micro and small industries and unorganized sector entities.

Upto 50% of SBs loans portfolio would constitute loans and advances upto Rs. 25 lakhs. It means

that most of its loans will be small loans which commercial banks deem cumbersome. Thus, small

businesses, educational loans etc will find easier credit access

Challenges

The Small Banks concept is not very different from the concept of Local Area Bank made in the 1997

budget. The difference is that while LABs were restricted to contiguous areas in one state, Small

Banks are allowed to grow into contiguous areas of more than one state. Only 6 LABs got license and

only 4 of them are operational till date, which shows the lack of enthusiasm for such niche banks.

Many NBFCs and LABs have shown interest in opening SBs but they are searching how viable this

business model will be. The risk of default on small loans is least but the returns may not be that

high.

As Small Banks will operate in a limited geographical area hence they suffer from concentration risks

like droughts, floods etc which affect contiguous areas. If such a thing happens, then the risk of mass

defaults of loan repayments will rise. This is precisely the reason why LABs didnt succeed. RBI has

taken care of concentration risks by allowing SBs to open in more than one district in a state and

further expand into more than one state. Thus, SBs are less likely to suffer from concentration risks

though the possibility of such risk still exists.

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Way Forward

Small farmers and small businesses have had difficulty accessing cheap credit. Small Banks will be a

major boost to this segment. Small banks must develop innovative technological solutions to keep

the transaction costs low and thus generate enough revenue to make the business model viable.

In a vast country like India, it is highly imperative to tailor the credit needs of the population

according to their specific needs. Small Banks are a step in this direction to tap the fortune that lies

at the bottom of the pyramid.

Copyright by Vision IAS

All rights are reserved. No part of this document may be reproduced, stored in a retrieval system or

transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise,

without prior permission of Vision IAS

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