The Butterfly Effect holds that a butterfly flapping its wings in some place can, in theory, cause a hurricane somewhere else weeks down the line. The term, coined by Edward Lorenz, came into vogue as weather forecasters saw that a small variation in initial atmospheric conditions can lead to completely unanticipated weather outcomes elsewhere.
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Yesterday (19 August), Reserve Bank Governor Raghuram Rajan flapped his wings and set off what could turn out to be a revolutionary storm in the Indian banking system - a storm bigger than the one created when private banks were first given licences in the 1990s.Eleven private parties were given licences to set up "payment banks" - banks which can do everything a regular bank can do - take deposits, pay bills, issue cheques and drafts, et al. The only thing they can't do is lend to you and me. Payment banks can only lend to the government and almost anybody with Rs 100 crore in his pocket can, in future, set up a payment bank, assuming they pass the RBI's "fit and proper" norm (which basically means if you are not a crook, or someone who has cocked a snook at the regulator, you can get a licence). This means payment banks will theoretically be the safest of banks since they have only the government as borrower - and governments don't default. In future, payment bank licences may be available on tap, and we could see even 50-100 such banks being set up. India will be fully banked over the next decade.
That payment banking is a big deal is evident from who's got the initial set of licences - the big boys and billionaires are there. Among them: the Aditya Birla Group, Reliance Industries (majority owner of Network 18, which publishesFirstpost), the big telcos (Airtel, Vodafone), the National Securities Depository (which holds almost all of India's stocks in demat form, and provides the backbone for a tax information network), PayTM (India's biggest mobile wallet company), Tech Mahindra (one of the Top Five IT companies in India), and Sun Pharma's Dilip Shanghvi. Billionaires wouldn't be filling in forms at the RBI's window if they didn't think payment banking was the in thing, though they might prefer to become regular banks, if that were possible. Since the RBI does not want corporates in banking, they are going for the next big thing that's available - payment bank licences.
The reasons why payment banking will revolutionise money movement are many. Consider the areas they will touch, and how their mere presence will impact everyone.
First, and foremost, payment banks will bridge the last mile (or last 10-20 miles) between bank branches and the remote customer living in a rural hamlet. Payment banks will essentially rely on technology to reach payment services to all customers, using mobiles as the vehicle of banking. Mobiles go even where humans don't. Physical bank branches (or bankers or ATMs) will still be needed for some functions - opening an account, depositing cash, etc - but all day-to-day payments, including peer-to-peer payments) can be done remotely. The mobile phone will become the virtual ATM and small-payments cheque-book. In less than 10 years, every Indian will have a bank account. Payment banks are the key enablers.
Second, banking costs will come down due to intense competition driven by the expected proliferation of payment banks. Currently, we pay through our noses for banking services, whether it is above-limit ATM transactions, additional cheque-books, big money transfers, maintenance of minimum balances, or draft issuance fees. These costs will come down as payment banks start offering zero-balance accounts and low-cost services. Currently, efficient private banks like HDFC Bank, ICICI Bank and Axis Bank make huge profits from their low-cost current and savings bank accounts, but a big chunk of this will move to payment banks, who may offer higher savings bank rates of 5-7 percent. The HDFCs mint money since they only have to compete with slothful public sector banks. Now, they will have nimbler rivals to worry about. The customer will finally be Queen.
Third, the public sector banks are sitting ducks for bankruptcy and taxpayer bailouts if they do not change. Between then, efficient payment and private sector banks will take away their lucrative businesses and prized customers, as they will be both well capitalised and efficient. The government should privatise the weaker banks quickly if it is not to be stuck with feeding white elephants permanently. It can't cope with one Air India; if it does not privatise, it will have several Air Indias on its hands. The weaker public sector banks are dead ducks.
Fourth, the arrival of payment banks - including India Post - will transform social welfare and subsidy schemes. Even if the Modi government does no other reform but this one, government subsidy payments to the poor - whether for LPG, kerosene or even food and fertiliser - can now be routed through regular and payment banks. India Post is already there in places where banks aren't there (with over 1.5 lakh post offices), and tomorrow Airtel and Vodafone and Idea (and Reliance Jio, when it enters mobile telephony later this year) will reach customers through mobile-enabled payment systems. The holy triad of Jan Dhan no-frills bank accounts, Aadhaar IDs and mobile banking will enable direct payments to the poor, eliminating fake recipients, ensuring cash in zero-balance accounts, etc. Inclusive banking and subsidy reforms are simply the biggest things to happen during the Modi government, even though the seeds for this were planted by earlier governments. The difference between State Bank and Airtel is simply this: both have over 200 million customers, but Airtel can go where State Bank cannot with a branch.
Fifth, mobile banking will create the conditions for cash-less banking. This means, over time, the mobile will perform the same role as credit and debit cards, obviating the need for too many cash payments. Even ATM expansion can now be slowed down in cities, and focused on distant villages or towns.
Sixth, we now have one additional tool to eliminate black money in large parts of the financial system. A government that wants to eliminate black money - which the Modi government says it wants to - can effectively ban cash transactions once a 95 percent mobile and Jan Dhan penetration rate is achieved. India is close to reaching a mobile user base of one billion, and Jan Dhan is said to have reached all households. The next target for Jan Dhan should be universal adult coverage through mobile, payment banking. It is achievable in five to 10 years, with some public and private investment in financial literacy education and empowerment of rural citizens, especially women.
Seventh, the government will be one of the biggest beneficiaries of payment banking, as payment banks will expand its access to cheap funds. Currently, banks are the major investors in government bonds. While this will remain so even with the entry of payment banks, the sheer impact of additional money coming into payment bank accounts which can only invest in short-term government bills of up to one year's maturity means short-term rates will come down, and the government can borrow more cheaply.
Eighth, bank depositors can expect to earn higher short-terms deposit rates from payment banks, and the old 4 percent savings bank norm will probably fade away.
After payment banks, the RBI will license "small banks", which have to focus loans on small borrowers and not big corporates. Once this happens, non-bank finance companies will become "small banks" and make financial inclusion more complete from the small borrower's point of view.
Between them, payments banks and small banks will make Indian banking more competitive and more inclusive on both the assets and liabilities sides - that is, for both depositors and borrowers. The era of the consumer is finally at hand.
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