DIFFERENTIATED BANKING

What is differentiated banking?

Differentiated banks are banking institutions licensed by the RBI to provide specific banking services and products.

It is a system refers to the system of different licenses for different subcomponents of the banking sector such as Limited Banking License, Commercial Banking License, etc. A differentiated license will allow a bank to offer products only in select areas.

The main aim of giving license to differentiated banks is to promote financial inclusion and payments. The term differentiated banks indicate that they are different from the usual universal banks. The universal banks like SBI, Canara Bank, etc. can give almost all products and services. On the other hand, the differentiated banks can give only selected products like credit, payments, deposit, etc., with RBI regulations.

Differentiated banks licensing was launched in 2015. The differentiated banks are of two types-payment banks and small finance banks.

Payments Banks in India

Based on the recommendations of Dr. Nachiket mor committee RBI granted license for the commencement of banking business under the Banking Regulation Act 1949 and registered as a private company under Companies Act.

The main Objective of setting up Payment banks for the purpose of financial inclusion by providing:

• Small saving account
• Payment services

Key features of Payment banks

Non-finance company entities and existing non-bank prepaid instruments issuer may apply for the payments bank

Minimum capital required for the payment banks is Rs. 100 crore

Foreign shareholding is allowed to these banks but as per the regulations of FDI ( Foreign Direct Investment)

Payment Banks cannot provide lending services but allowed to distribute financial product such as mutual funds and insurance products.

The bank must use the term payment bank in its name to differentiate it from other banks.

25% of the bank branches of the payment banks must be in unbanked rural areas.

Services provided under these banks

Acceptance of deposits  (initially restricted to Rs 100,000)

Payment Banks can provide services like ATM, net banking, debit cards, and net banking

Current and savings accounts can be operated through this bank.

Key challenges to Payment banks

The payments-only model: A payments-only offering is an incomplete proposition and relies highly on low ticket account balances (capped at ₹1 lakh) for profitability. It’s akin to any high volume-low margin commoditized business, driven by convenience and pricing, with little customer stickiness.

Cross-sell fee:  Selling of insurance and mutual fund products is closely regulated by sectoral regulators (IRDA and SEBI). Not only are the distribution and sales commissions capped, but there are also strict requirements to prevent miss-selling. Both require certified and trained manpower to sell the products, which implies hiring better quality manpower, expense on training them and longer gestation before the resource is productive. In simple words – higher costs and limited upside on income. Cross-selling credit products like loans from NBFCs or Banks is not easy either. Building competence for a basic credit evaluation to target the right customers has a learning curve for both individuals and organizations.

Restriction on fund deployment: Payments banks are required to invest 75% of their CASA(current account and savings account)  balances in Statutory Liquidity Ratio (SLR) eligible government bonds or T-Bills. For the balance 25%, the option is deposits with other SCBs. While this is considered as a safety net for depositors, it restricts their ability to optimize treasury operations.

No lending. No NII (Net Interest Income) or IRR (Internal Rate of Return): Unlike Scheduled Commercial Banks (SCB) and Small Finance Banks (SFB) Payments banks are not permitted to lend. Their investment in stipulated government securities and bank FDs would yield 2-4% net of the cost of funds (or negative if they try to aggressively mobilize balances at higher rates like Airtel). Adjusted for other operating costs, the net return may fall to sub 1% levels, again corroborating the high volume-low margin nature of this business.

Over-competition: With existing SCBs upping their focus, multiple payments banks and SFBs vying for the customer attention and even the FinTech startups disrupting the existing models, the segment is already too hot to handle. While some of the players like Airtel or Vodafone, with the existing distribution network and large customer base, have an advantage, the nature of the relationship they are now trying to build with the customer is different from a duopolistic market we normally see in telecom where top two players become market makers. India Post may be an outlier with distinct advantages of large physical distribution; however, for others, it’s a long haul to acquire critical mass.