Making payments banks work

India has in theory created what is envisaged to be a major financial inclusion driver in the form of ‘payments banks’, a whole new vehicle aiming to establish a new paradigm of financial inclusion.

The basic elements are well covered in the RBI guidelines issued including deposit-taking of up to ₹10,000 per account, remittances, selling of products such as insurance, issue of debit cards and no lending. There is a rider that payments banks cannot lend or issue credit cards.

Overall the initiative has all the key components. Yet, while 11 licences were issued there has been a surprising turn where three entities granted these licences – Cholamandalam, IDFC Bank-Telenor-Sun Pharma combine and Tech Mahindra have already pulled out. That is a near 20 per cent drop-off rate from institutions which have already created business plans around this initiative even before it began. Naturally the key consideration driving this decision would be financial viability and cost to serve such a low-revenue generating segment.

Consider these for mainstreaming the whole financial inclusion initiative:

Rewiring the source: Payments banks aim to include unbanked small businesses, low-income households and the migrant labour force. The current model envisages creating a distribution infrastructure, both physical and virtual, where, say, a migrant worker or a labourer can walk into and open a deposit account.

Now consider the source of funds for the labourers. They get paid almost entirely in cash with no record of when the payment was made and no clear audit trail in most cases, given that most businesses employing them want to save on taxes.

Many years ago, markets such as the UAE also had a similar challenge where a labour force was paid entirely in cash and there was no record, resulting in issues of insufficient payments against contracts and lack of timely payments.

The solution: It is mandated that in the UAE all migrant workers get their payments not through cash but through a prepaid card where the amount is credited, just the way payroll is processed for most salaried workers. These prepaid cards provide cash withdrawal through connected ATM networks either free or at a very nominal cost that is also added to the payout to ensure the worker does not suffer any loss of pay.

What if small industries are mandated to make a payment through a prepaid Rupay card, India’s own payment network where the cost per transaction both to the issuer (the payments bank issuing the card) and to the acquiring bank (the ATM owner) is minimal? There is also the requirement of a tax concession where the entity making payments through such means will not only be not taxed but will get significant concessions. Imagine a small factory owner now paying his workers, not through cash, but through a prepaid card owing to not just regulation but also a huge tax advantage.

The second challenge of financial inclusion is financial knowledge, and experience is the best teacher. Once unbanked customers start using their own prepaid cards, the knowledge they acquire on managing their cash and linked saving options also increases.

While the RBI has mandated 25 per cent physical presence in unbanked/ rural areas and physical distribution points tend to be expensive, this option of prepaid cards also allows for using concepts such as mobile ATMs with low capex. Saving plans and insurance sales can also be provided through these mobile ATMs.

Broadbasing distribution: Many of the unbanked prospects work for small industries such as grocery stores. One can safely estimate that 99 per cent of the transactions, if not more, at these stores happen in cash. Today there is an extremely versatile cashless solution available in the form of Card Acceptance Point of Sale (POS) machines which can be procured for less than $100. These machines can accept all cards including prepaid cards and it does not end at that. They can also be programmed to provide cash advances on these cards.

So a worker employed in a grocery store can get his salary on a prepaid card, buy groceries for his own consumption using it and can also withdraw cash at this store itself from the POS machine.

For this it is critical to make all payments banks, default payment card acquirers at least for India's homegrown payment network Rupay. This will allow payments banks to create distribution points at low cost using devices like the Credit Card Accepting Point of Sale machines.

Once there is sufficient traction on both prepaid cards and acceptance points that double up as cash withdrawal points, there is a whole new play that comes into effect. Many of these customers can now get a credit score depending on their salary credits and usage, getting access to lending. And payments banks can refer these cases to lenders with full information opening up a whole new source of fee revenue for them, where lenders pay for these references without the Banks taking any risks.

Finally, these consumers also have spending needs for which they get little or no loyalty. Payments banks can now create loyalty and discount programmes tailored to everything this consumer base uses, from prepaid mobile cards to cooking oil. The loyalty points can also go into special savings programmes, such as special education funds for children, with higher-than-market returns.

Microfinance emerged from Bangladesh and the unique MPESA money transfer service emerged from Kenya. India’s payments banks can set global benchmarks for pioneering mainstreaming low-cost financial inclusion and more.

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