In November 2021, NITI Aayog published a discussion paper titled “Digital Banks: A Proposal for Licensing & Regulatory Regime for India”, which explained the value proposition of full-stack digital banks and laid down an implementation plan.

This was followed by final report in July 2022.

According to the ‘Expert Committee on Micro, Small and Medium Enterprises’ report submitted to RBI in 2019, there were 63.38 million MSMEs in India. They contribute about 45 per cent to the manufacturing output, constitute 28 per cent of the GDP and create 111 million jobs. The report mentions that “due to their informal nature, MSMEs lack access to formal credit as banks face challenges in credit risk assessment owing to lack of financial information, historical cash flow data, etc. Further, very few MSMEs are able to attract equity support and venture capital financing.”

The main plank of Aayog’s advocacy of full-stack digital banks was the lack of credit penetration among MSMEs. Full-stack digital banks is a potential solution for the persistent policy challenge of credit deepening and is seen as “the next stage of financial inclusion”.

The report also drew distinction between digital banks and Digital Banking Units. Digital banks are financial institutions that have no physical branches and offer banking services entirely online through their website and mobile banking app. Digital banks will be completely independent banks to be licensed under the Banking Regulation Act, 1949 and they will follow the Reserve Bank norms on par with commercial banks. DBUs do not have legal personality and are not separately licensed under the Act .

With online banking gaining momentum during the pandemic, there are a number of compelling factors to make digital banks a reality.

According to a Deloitte study published in February, India will have one billion smartphone users by 2026 with rural areas driving the demand. Internet enabled devices in the rural market will also get a push with the government’s BharatNet programme. An estimated 205 million Indian adults already have a digital-only bank account, and this number is predicted to increase to 397 million within the next five years (source : analyticsindiamag.com).

Evolving infrastructure

The India Stack, consisting of identity rails (Aadhaar, e-KYC, e-Sign and Digilocker), payment rails (IMPS, UPI, RuPay, JanDhan, AEPS and APBS) and data sharing rails (Account Aggregators) is widening access to financial services at lesser cost.

The Ministry of Electronics and IT (MeitY) recently amended the Information Technology Act, 2000 removing several documents from the negative e-Sign list including key real estate and property agreements. Resultantly, negotiable instruments governed by financial regulators and Power of Attorney documents for businesses regulated by them can now be enforced electronically. Dematerialisation of home loans is now only a few steps away bringing transparency to these loans.

The government-backed National E-Governance Services Ltd. (NeSL), through its digital document execution (DDE) platform, has started digitalizing loan documents from submission to payment of stamp duty, to digital e-stamping to e-sign by the signatories to a completely secure digital storage system. NeSL has processed one million transactions through its DDE platform.

RBI is setting up a Public Credit Registry (PCR) which could “reshape our credit eco-system for the future so that micro-credit can thrive to unlock economic value”. PCR will help “reduce information asymmetry by enabling the lender to know the credit history with past lenders and the current indebtedness of the borrower.”

In other words, the infrastructure for digitising services allied to financial services already exists. What remains now is to connect these dots with digital banks to make full-stack digital banking services available to customers.

Road ahead

Each SME is unique. Traditional banks find it difficult to assess creditworthiness while manually curating information from physical documents such as financial statements, tax returns and payroll statements. The latest issue of RBI’s ‘Trend and Progress of Banking in India’ states as much: “The current delivery systems are largely paper-based, with high turnaround time and requiring multiple visits to bank branches. It entails high operational costs for lenders and opportunity cost for borrowers.”

MSME borrowers want fast approval process and certainty regarding funds availability. They value speed and convenience. They want a seamless, consistent lending experience that delivers instant decisions and immediate delivery of funds.

Digital banks are best suited to use new age techniques like predictive analyses and artificial intelligence (AI) to arrive at real time decisions for time-busy MSMEs. These technologies allow banks to move from traditional funding methods based on collaterals to advanced cash flow lending.

“Digital banks can rethink and retool lending mechanism, credit underwriting process and gradually shun security-oriented lending,” Jack Ma, the Chinese entrepreneur said. “Continuous innovation and new capabilities that digital banks are slated to bring will no doubt add more engines of growth to ….. financial sector”, complements Sopnendu Mohanty, Chief Fintech Officer of Monetary Authority of Singapore. The history of banking in India shows that the banking regulator has licensed new banking institutions to cater to changing times. And this is where digital banks’ entry becomes a natural progression in banking and finance. What we have done to payments eco-system in India, we need to replicate in the field of credit assessment and delivery.

The writer is a former central banker. Views expressed are personal

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