Differential Banks

Differential Banks

This article deals with ‘Differential Banks (Payment Banks, Small Area Banks, Local Area Banks etc.).’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Differential Banks vs. Universal Banks

Difference Universal Banks Differential Banks
Branches Can open Branch anywhere: example SBI, ICICI Geographical Restrictions on branch opening for Local Area Bank (LAB), Regional Rural Banks (RRB) etc.
Money acceptance Both Time & Demand Deposits of any amount can be accepted. Restrictions are there . Eg Payment Bank : Can accept maximum amount of Rs 1 lakh only in deposit.
Give Loans to Anyone Restrictions present. Eg : Small Finance Bank, Regional Rural Bank : must give 75% to Priority Sector  . Payment Bank can’t give loans .

1. Regional Rural Banks  (RRB)

Need of RRBs

  • In 1975 , Government appointed MM Narsimham Committee to look into rural banking .
  • Observations of the Narsimham Committee were as follows :-
    • Staff of Banks has expertise in banking & financial matters but are not aware of the problems of rural people .
    • Primary Agriculture Credit Societies (PACS) have members from villages & are aware of needs and problems of the villagers .
  • Recommendation :  CREATE HYBRID OF BOTH i.e. BANKS HAVING FINANCIAL STRENGTH OF COMMERCIAL BANKS & GRASSROOT PROBLEM AWARENESS OF COOPERATIVES. Hence, concept of RRB came to being.
  • As a result of this , Regional Rural Banks (RRBs) were first set up on 2 October, 1975 (only 5 in numbers) under RRB Act.

Client of RRBs

RRB provide loan & saving facilities to villagers & they include

Farmers Rural Entrepreneurs
Agricultural Labourers Cooperative societies
Rural Artisans Primary Agricultural Credit Societies

Structure

  • RRBs are sponsored by Commercial Banks
    • Sponsor Bank provides training to staff of RRB.
    • Sponsor Bank also provides initial capital to setup RRB.
  • RRB operates in selective districts & don’t have all India presence .
  • According to original RRB Act, paid up capital ( ownership) of RRBs was as follows .
Central govt State govt Sponsor Bank 
50 % 15 % 35 %
  • Priority Sector Lending (PSL) is applicable to RRB (75% loans should be PSL)   .
Regional Rural Banks

Failure of RRBs

  • Due to excessive lending towards social Banking & catering highly weaker sections , these banks started to incur huge losses by early 1980s .
  • Private & Public banks too started to operate in rural areas , which resulted in low deposits in RRBs . As a result, RRBs had to depend on NABARD for credit .
  • Debt waiver to farmers & NPA also created lot of problems .

Subsequently , following the suggestions of the Kelkar Committee, the government stopped opening new RRBs in 1987—by that time their total number stood at 196.

Steps to revive

  • RRB Amendment Act , 2015 
    • Earlier shareholding requirements  – Central : State : Sponsor Bank = 50:15:35 .
    • After Amendment – Centre, State & Sponsor Bank’s cumulative share holding can reduce upto 51% .
RRB Amendment Act , 2015
  • From 2005, amalgamation process of RRBs with their ‘Parent Banks’ was initiated so that these banks can become more viable (As of April 2020, there are only 53 RRBs ) .
  • Obligation of concessional loans has been abolished & RRBs have started to charge commercial interest rates on lending .
  • Target client restrictions have been ended & RRBs can now serve anybody.
  • Dr KC Chakrabarty Committee has recommended that CAR /CRAR for RRBs should also be 9% & to achieve this, government should recapitalise RRBs as well.

Note – Recently launched Priority Sector Lending Certificates (PSLC) are going to help them because they do a lot of PSL.

2 . Local Area Banks (LAB)

  • In 1996, Manmohan Singh (as FM) mooted to start Local Area Bank (LAB) .
  • They are licensed under Banking Regulation Act but not included in 2nd Schedule of RBI Act. 
  • Vision was  to increase financial inclusion .

Conditions

  • They can operate only in Rural & Semi-Urban Areas .
  • Can operate in Max 3 geographically contiguous districts .
  • Can open only 1 branch in Urban / District city  .
  • PSL norms apply=> 40% loans should go to Priority Sector.
  • They are not Scheduled Commercial Banks because their names are not mentioned in RBI Act.

Problems with Local Area Banks

  • MSME loans given by LABs aren’t covered under Credit Guarantee Scheme of the Governments .
  • Farm loans arent covered under Interest Subvention Scheme .
  • State/Central PSUs/Institutes don’t open account in them.
  • Branch expansion heavily restricted in rural & semi-urban areas.
  • Cant get loans from RBI at Bank Rate /MSF .
  • Don’t get refinance from NABARD /SIDBI .

Operating Banks

  • 10 Licenses were given at that time & only 4 are operating presently .
  • Was in news in 2016 when applications for Small Financial Banks were called. Usha Thorat Committee  allowed them to apply for Small Finance Banks    & one out of them ie Capital Local Area Bank based in Punjab got license to open Small Finance Bank
Differential Banks

3. Payment Banks

Side Topic : Prepaid  Payment Instrument (PPI)

  • Airtel Money is an example of PPI .
  • You give them money from your account &  they transfer that money in Digital Wallet . Later, you can use it to pay bills, shopping, movie tickets etc .

Problems  with PPI

  • Doesn’t offer any interest. Hence, not good for financial inclusion .
  • PPI is nested payment model ie they deposit your money in account of some bank .  This increases contagion risk  .
  • There are issues related to security and KYC norms.

What are Payment Banks ?

  • PPI aren’t good due to above mentioned reasons. But their idea as a whole is good  .
  • Payment Banks are new stripped-down type of banks (Differential Banks), which are expected to reach customers mainly through mobiles rather than traditional bank branches .
  • These are under the recommendations of Nachiket Mor Committee  that RBI should give license to new type of banks i.e. Payment Banks under Banking Regulation Act .
  • Sept 2015 : RBI  granted ‘in principle’ approval for payment banks to 11 entities.  Later, 3  backed out of the business . Hence , 8 in market now
    1. Aditya Birla Nuvo Ltd.
    2. Airtel M Commerce Services Ltd.
    3. Department of Posts
    4. Fino PayTech Ltd.
    5. National Securities Depository Ltd
    6. Reliance Industries Ltd. (Jio)
    7. Vijay Shekhar Sharma  (Pay TM)
    8. Vodafone m-pesa Ltd.
    9. Cholamandalam Distribution Services Ltd (withdrew later)
    10. Dilip Shantilal Shanghvi (withdrew later)
    11. Tech Mahindra Ltd. (withdrew later)

Characteristics of Payment Banks

Target Audience Small businessman , poor (domestic) immigrant workers and rural population .
Potential candidate to run Mobile  companies, consumer goods companies, post office system, agri/dairy type cooperatives and Corporate Business correspondents.   
CRR Have to keep CRR just as Scheduled Commercial Banks .
Entry Capital Require ₹ 100 crore as entry capital .
Features Payment Banks can hold upto ₹ 1 Lakh  in an account and pay interest on these balances just like a savings bank account.
But they cant involve in any credit risk i.e. can’t give loan to others . However, they can invest in SLR approved securities & earn about 8% interest .
– They can issue debit cards (but not Credit Cards) and ATM cards usable on ATM networks of all banks.
They can enable transactions , transfers and remittances through a mobile .
– Since , Payment Banks can become Banking Correspondents of Universal Banks, hence customer can use same account as that of Universal Bank and take services of Payment Bank from that account.
Payment bank will enjoy all the rights and responsibilities of a Scheduled commercial banks .
Payments Banks are required to use the word ‘Payments’ in its name to differentiate it from other banks.  

Working of Payment Banks

Payment Banks

Case Study of m-Pesa : Why India should get Payment Banks (case study)

  • M-Pesa is Kenya’s Payment bank .
  • M = mobile & Pesa = Money in Swahili .
  • It provides banking services through mobile and works in same way as Payment Banks. Nachiket Mor Committee recommended to start Payment Banks based on the success story of m-Pesa innKenya.
m-Pesa

Benefits of Payment Banks

  • Help in financial inclusion : It is uneconomical for traditional banks to open branches in every village but mobile  coverage is a promising low-cost platform  .
  • Remittances at Zero Cost : Their main target is migrant labourers . It will tap India’s domestic remittance market  .
  • Increase in disposable income of poor migrant families : Since Remittances will happen at zero cost , it will  increase disposable income in the hands of low income migrant families  .
  • They  will help in easy implementation of Direct Benefit Transfer.
  • They will help in moving India towards less cash society . 
  • They will create job opportunities in form of Payment Bank’s Agents.

Problems with Payment Banks

  • Low revenue: can’t undertake any lending businesses + can invest in SLR approved securities only  .
  • Banks are already offering most services that payments banks can offer  . Hence, for payments banks to offer a new and differentiated proposition will not be easy.
  • RBI has launched Unified Payment Interface (UPI) giving blow to business plans of Payment banks .

As a result, after initial enthusiasm in applying for payment banks, companies like Tech Mahindra, Sanghvi’s, Cholamandalam Investment have opted out.

Started till now

Jan 2017  (1) Airtel (first to start)
May 2017 (2) PayTM
2018 (3) Reliance Jio , (4) Fino, NSDL and (5) Birla launched their Payment Banks
September 2018 (6) India Post Payment Bank

Side Topic : Indian Post

September 2018 : India Post Payment Bank was launched

  • All 1.55 Lakh Post Offices  linked to Payment Bank System .
  • 3 lakh Post men and Grameen Dak Sewaks will provide on the door banking facilities  .
  • Upto 1 lakh deposit | 4% interest Rate | Debit Card facility | Free withdrawls from own ATMs and Punjab National Bank’s ATMs | No minimum balance .
  • India Post Payment Bank has all the features & benefits of Payment Banks (with additional benefit that they already have post office infrastructure) .
  • They have also partnered with Bajaj Alliance Life Insurance (BALIC) to sell insurance policies.

Post office as Financial Intermediary

  • Indian Post is the oldest & largest organisation involved in resource mobilisation in India .
  • It has huge network of 1.55 lakh post offices , 3 Lakh postmen & 5 Lakh employees .
  • 90% of Post-Offices present in Rural areas . 
  • Earlier too, it was providing  wide array of ‘financial services’  such as saving and other time deposit accounts, Public provident fund, Monthly Investment schemes, National saving certificates. 
  • It comes to rescue government when banking system is not able to deliver cash benefits such as under MGNREGA, Old age/disability Pension Schemes etc.
  • Post offices around the world have gone through this transformation in many countries & experience was quite successful there. Most notable is Royal Post in UK  which apart from Banking services , is also providing mobile and broadband services . US is also considering such plans.
  • It can free bigger commercial banks to concentrate on competitive commercial operations leaving social security works to be handled by Postal Bank.
India Post

4. Small Finance Banks

  • The purpose of the small banks will be to provide a whole suite of basic banking products such as deposits and supply of credit, but in a limited area of operation (contiguous districts in a homogenous cluster of states or union territories) .
  • These are modelled on Community Banks of USA .
  • In Community Bank, Employees of banks know almost every family and therefore is well aware of their assets, credit history, financial position and business. As a result,  MSME Industry, Retail Business men and Farmers can take loans from them without any problem.

Indian Parallels of Community Banks

  • Old Private Banks like Catholic Syrian Bank of Kerala, Nainital Bank etc.
  • Local Area Banks
  • Regional Rural Banks
  • Microfinance Institutions

Their employees know their customers very well unlike big PSBs (like SBI) and New Private Banks (like Axis, ICICI Bank).

Hence, Nachiket Mor recommended creation of Small Financial Banks based on Community Banks of USA  . They should focus on unserved, underserved , small and marginal farmers along with MSMEs . Even Indian parallels can get SFB license . Atlast, 10 contenders got license . eg : Capital Area Bank (Punjab) , Au Financiers (Jaipur) etc

Small Finance Banks

Prelims related information regarding Small Finance Banks 

  • They are licensed  under Banking Regulation Act .
  • PSL requirement = 75% (40% category wise (as Universal Banks) + 35% into PSL with competitive edge)   .
  • They are Scheduled Banks under RBI Act.
  • CRR and SLR requirements are similar to existing Commercial Banks.
  • CRAR/CAR requirements – 15% (ordinary Banks – 9%) .
  • FDI – upto 74% allowed.
  • They can open bank branches with condition that 25% branches should be in rural unbanked areas.
  • The maximum loan size and investment limit exposure to single/group borrowers/issuers would be restricted to 15% of capital funds.
  • Loans and advances of up to ₹25 lakhs, primarily to micro enterprises, should constitute at least 50 per cent of the loan portfolio.
  • They can evolve into Universal Banks after 5 years subject to RBI’s discretion .

5. Wholesale Bank

It has not formed yet . RBI proposed it in 2017.

  1. Wholesale Bank will be regulated under Banking regulation Act
  2. They can only accept deposits larger than Rs.10 crore from big investors. Apart from that, they will raise money by issuing bonds.
  3. It will not give loan to retail /common person . It will only lend in wholesale markets such as infrastructure sector or to corporates.
  4. PSL norms are applicable but at wholesale level. They will finance big projects in Priority Sector and can sell extra PSL certificates to Scheduled Banks to fulfil their targets.
Wholesale Bank

Why we need Wholesale Banks?

  • India need huge investments in Infrastructure Sector ( ₹40 trillion in next decade) . But there are issues
    • Till now , government is the biggest spender in infrastructure sector (45% of total infrastructure spending). But  government cant invest more  because of Fiscal Deficit problems .
    • Next biggest investor are banks . But they too cant invest more due to NPA Problem.

To get more investment in infrastructure , government is planning to come up with Wholesale Banks.

  • Tenor of the infrastructural loans is very long and therefore it does not incentivize institutions like Banks. Therefore there is a need of separate infrastructure banks. Wholesale Banks will perform that work.
  • Right now NBFC are not under supervision of RBI (and act somewhat like Shadow Banks) and are not covered under SARFAESI to recover their Bad Loans .  It is not in our interest to let them continue as this because they don’t have protection cover of CRR& SLR . By making Wholesale Banks, bigger NBFCs can be made to come under RBI’s regulatory supervision.
  • Apart from that , they will help Banks to achieve their PSL Targets . They will invest huge amounts in PSL Projects and then issue their PSL Certificates which can be bought by Banks 
Wholesale Bank