Unbundling banking services. Unbundling of banking services is a reality, says MK Jain, RBI Deputy Governor

Unbundling of banking services is a reality, changing how banks operate and testing their adaptive capacity, according to MK Jain, Deputy Governor, Reserve Bank of India.

Jain cautioned that they might be marginalised very soon unless traditional firms adapt to new ways of doing business.

“Even as banks’ reliance on technology has grown by leaps and bounds, technology is also revolutionising the competitive landscape in the financial system.

“Entry of BigTech firms and innovative Fintech players into the traditional domain of banks has already revolutionised the way financial transactions are carried out,” the Deputy Governor said in a speech at India International Centre, New Delhi.

Jain observed that even while individual entities adapt to the new competitive landscape, it is imperative to ensure that heterogeneity is preserved at the system level.

“A homogenous financial system will be less resilient and prone to systemic crisis if the underlying economic conditions change.

“Hence, it is important that the financial system consists of entities which follow different business models even while adapting to the newer ways of doing business,” he said.

Lemon problem

The Deputy Governor underscored that reducing the incidence of ‘lemon problem’, whereby the lender cannot distinguish between the borrowers of good quality and bad quality (the lemons), is an important feature of building resilience in the financial system and improving the credit flow.

The lemon problem results in making the loan at an interest rate that reflects the average quality of the good and bad borrowers.

“The result is that high-quality borrowers will be paying a higher interest rate than they should because low-quality borrowers pay a lower interest rate than they should.

“One result of this lemons problem is that some high-quality borrowers may drop out of the market, with what would have been profitable investment projects not being undertaken,” Jain said.

The ‘lemons problem’ also impedes banks’ ability to anticipate risk build-up in lenders portfolios.

The Deputy Governor noted that borrowers are probably the first to see early signs of difficulties in their respective segments. When they do not pass on the information to their lenders, fearing that the lender may refuse new loans or tighten the conditions of existing loans, lenders' ability to identify risks early is severely hampered.

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