Differentiated Banks – Leading the March Towards Financial Inclusion

[The following guest post is contributed by Neelasha Nemani, who is a 4th
year B.A. LL.B. (Hons.) student from National Law University Odisha, Cuttack.]
India’s impetus on financial inclusion is now stronger than ever. Recently,
the Reserve Bank of India (RBI) granted an in
principle
approval to 11 entities to set up Payments Banks[1]
and 10 entities to set up Small Finance Banks[2]
as an expression of its concern over the immediate requirement of rapid
financial inclusion to boost the economic situation in the country. In an
attempt to resolve the long-pending debate over the most ideal vehicle for
financial inclusion between having a few large banks with several branches and
having several small banks, the RBI has, after much consideration and upon the
recommendation of the Nachiket Mor Committeee,[3]
come to the conclusion that the setting up of several small, localized,
well-capitalized, technology-driven banks in unbanked and under-banked regions
of the country is indispensible for achieving the goal of financial inclusion. And
better yet, the setting up of Differentiated Banks[4]
or Niche Banks that either offer specialized services or are geographically
limited in their operations would best cater to the needs of a specified class
of customers.
Differentiated Banks indeed have much to offer. Since Small Finance Banks[5]
are regionally limited in scope, they will be in a better position to cater to
customers’ local needs and will easily be able to assess their needs and
accordingly tailor-make the services provided by them. A bank with a localized
base of operation tends to be hassle-free in the services provided by it and
would thereby encourage the lower-income groups and small businessmen to participate
in the formal financial system. Payments Banks,[6]
on the other hand, being limited in scope of activity, provide specialized
services that put resources to optimum use and prevent their potential wastage.
Considering the current rate of market expansion, such specialization is more
than just desirable and is, in fact, a very natural response to an increase in
competition amongst banks.
The granting of differentiated licenses after the failure of Local Area
Banks (LABs)[7] is
indeed a bold step on part of the government, nonetheless a calculated one. Firstly, the government has learnt that
a high capitalization base is required for the banks to be able to endure the
potential risks associated with geographically distant areas and more
importantly the kind of sectors these banks are being set up to cater to, which
have a high incidence of credit default and has therefore, as a corrective
measure, increased the minimum paid-up capital requirement to Rs. 100 crores
from the erstwhile Rs. 5 crores of LABs. Secondly,
the entities that it has granted license to are those that have access to state
of the art technology and resources to build the necessary infrastructure to
penetrate into the remotest of areas through the click of a button on a mobile
phone, where it would not be possible to set up physical banks or branches. However,
some potential challenges still persist which threaten the success of the RBI’s
financial inclusion drive.
First is the banks’ ability to
remain economically viable in a restrictive environment. For instance, Payments
Banks are not allowed to create credit by granting loans and are also required
to invest 75% of their money in government securities/treasury bills maturable
in one year. Their source of income would be the fees charged by them for
providing remittance services, insurance and mutual fund schemes and their
profitability will depend on the most cost-effective technology employed by
them. Given that these banks are privately owned, the targets on profitability
are likely to be strict and short-term focused. 
Therefore, while it may not be difficult for these entities to enter
unbanked areas, it might become difficult for them to sustain.
Second is the issue of
consumers’ willingness to avail of financial services.  Even as far as the savings customer is
concerned, their coming forward and actually utilizing these services will
largely depend on their financial awareness and level of trust.  It has been shown that lack of trust in the
formal financial system still binds large segments of consumers to exploitative
moneylenders.  Therefore, the financial
inclusion drive must contain an element of financial literacy as well – which
the licensed entities may not be in a position to invest in.
Third, there is the issue of
making services sufficiently inexpensive to induce consumers to utilize them. In
recent news, the State Bank of India is gearing up to set up a low-cost model
to provide payments services in similar sectors,[8]
thereby increasing the competition in the market.
While only the passage of time will determine the success of the
financial inclusion drive, it is certainly worth noting that the RBI has made a
push in the right direction.  With the
progress of time, the approach will not need to be re-worked but only dynamically
refined.
– Neelasha Nemani



[1] RBI Press Release no.
2015-2016/437 dated August 19, 2015 which discusses the in-principle approval
of license to 11 Payments Banks. Link: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=34754.
Also see: RBI
Press Release no. 2014-2015/1089 dated November 27, 2014 which discusses the
guidelines prescribed by the RBI for grant of license to Payments Banks. Link: https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32615
[2] RBI Press Release no.
2015-2016/693 dated September 16, 2015 which discusses the in principle
approval of license to 10 Small Finance Banks. Link: https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=35010
Also see:
RBI Press Release no. 2014-2015/1090 dated November 27, 2014 which discusses
the guidelines issued by the RBI for grant of license to Small Finance Banks.
Link: https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32614
[3] Report by Committee on
Comprehensive Financial Services for Small Businesses and Low Income Households
headed by Shri Nachiket Mor dated January, 2014. Link: https://indiacorplaw.in/wp-content/uploads/2015/12/CFS070114RFL.pdf
[4] Differentiated Banks are
banks that provide niche banking facilities and include Local Area Banks,
Payments Banks, Small Finance Banks etc. See:
Budget Speech 2014-15 dated July 10, 2014, Ministry of Finance, Government of
India. Link: http://finmin.nic.in/fmspeech/FM_BudgetSpeech_july2014.pdf.
[5] For further reading on
Small Finance Banks, see: Vivina
Vishwanathan, What to Expect from Small
Finance Banks
, Live Mint, December 29, 2015. Link: http://www.livemint.com/Money/PuQ6tbCp3IiYHWxd1MH5CP/What-to-expect-from-small-finance-banks.html.
[6] For further reading on
Payments Banks, see: Puja Mehra, All You Need to Know about Payment Banks,
The Hindu, August 20, 2015. Link: http://www.thehindu.com/business/all-you-need-to-know-about-payment-banks/article7561353.ece
[7] For a holistic
understanding of the functioning of LABs, see:
Report of the Review Group on The Working of The Local Area Bank Scheme dated
September 2002, RBI. Link: https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=294
For further reading, see: M. S. Sriram, Small
Banks:
Lessons Learnt from Local Area
Banks
, Live Mint,  July 25, 2014.
Link: http://www.livemint.com/Opinion/v4higxQgKD3c5kDIQ03sMK/Small-banks-lessons-from-local-area-banks.html
[8] PTI, SBI developing Low Cost Model to Counter Payments Banks, The
Economic Times, August 21, 2015. Link: http://articles.economictimes.indiatimes.com/2015-08-21/news/65706389_1_payments-banks-arundhati-bhattacharya-sbi

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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