On payment banks: Rajan is right, Bhattacharya is wrong

On August 19, 2015, the Reserve Bank of India (RBI) gave an approval to 11 entities to start “payment banks”. These include Vodafone, PayTM, Department of Post, Aditya Birla Nuvo, Reliance Industries, Airtel M Commerce, Vodafone m-pesa etc. As the name suggests, payment banks will be allowed to collect money from depositors and make payments to others, on their behalf.

These banks can accept deposits of up to Rs 1 lakh only. Further, they are not allowed to give out loans like normal banks are. A bulk of the deposits they collect need to be invested in government securities which mature in a period of up to one year.

So what is the idea behind setting up these banks? The simple answer is financial inclusion—to improve the penetration of the banking system in India. A recent World Bank report points out that between 2011 and 2014 the number of bank accounts in India increased by 17.5 crore, thanks to a massive push by the government. With this increase in numbers, the penetration went up from 35% to 53%. The worrying thing is that even after this massive increase, half of India does not have a bank account.

Further, the high dormancy rate is another worrying factor. As the World Bank report points out: “India, with a dormancy rate of 43 percent, accounts for about 195 million of the 460 million adults with a dormant account around the world.”

The hope is that payment banks will help address this problem to some extent.  As the Draft Guidelines for Licensing of “Payments Banks” document points out: “There is a need for transactions and savings accounts for the underserved in the population…Higher transaction costs of making remittances diminish these benefits. Therefore, the primary objective of setting up of Payments Banks will be to further financial inclusion by providing (i) small savings accounts and (ii) payments / remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users, by enabling high volume-low value transactions in deposits and payments.”

The RBI governor Raghuram Rajan has been a driving force behind these banks and sees them as a game-changer. Nevertheless, the existing banks are not looking forward to the competition that these new banks will bring in.

As Arundhati Bhattacharya, chairperson of the State Bank of India said recently: “Why this payments bank is a little worrisome is because they will be allowed to have savings deposits. What if they go for poaching rates, then many of the commercial banks could lose a portion of the deposits which are relatively lower priced so that will take away the ability to transmit rates and give further loans at lower rates.”

What Bhattacharya is worried about is that the new payment banks will try and attract savings deposits at a higher rate of interest. Most big banks currently pay around 4% on deposits on their savings accounts. It is a cheap source of funding for them.

The payment banks will offer higher rates of interest on deposits, Bhattacharya feels. This is a possibility. The question is how high? The payment banks are not allowed to give out loans. Further, they are allowed to invest only in government securities of up to one year. Also, they are supposed to maintain a cash reserve ratio of 4% with the RBI. On these deposits no interest is paid. If all these factors are taken into account, the payment banks cannot go overboard with offering very high rates of interest on deposits, if the idea is to make profits.

As Rajan said in response to Bhattacharya: “I don’t think these 11 new banks are a threat to the existing banks. These new banks will complement the existing system by traversing the last mile. The reason for this is that there is nothing the universal banks cannot do that the payments banks can do. But there are some of the things that the payments banks can’t do which the universal banks can.”

What Rajan meant here was that payment banks unlike scheduled commercial banks cannot give out loans. And that limits their ability to make profits. And given that they cannot go overboard while offering a higher rate of interest to attract deposits.

Another fear that has been raised is that people will move their money from scheduled commercial banks to payment banks in order to be able to pay electricity/telephone bills etc. The point is that people are already using services offered by scheduled commercial banks to pay such bills. Hence, there is no real reason for them to move on to a payment bank, lock, stock and barrel.

If we might just rephrase what Rajan said: “A scheduled commercial bank can do everything that a payment bank can do.” In fact, a lot of them already have the necessary infrastructure in place to do things that payment banks are likely to do.

Also, banking in cities and urban areas is pretty much stagnated. The low hanging fruit has more or less been taken. If payment banks want to attract deposits, they need to look beyond the middle class, and look at the urban poor as well as the rural areas to attract deposits.

Anybody who has read Rajan’s first book Saving Capitalism from the Capitalists (co-authored with Luigi Zingales) would know where his thinking is coming from. In this book Rajan explains in great detail as to how the only way to develop finance is to increase competition. As he writes along with Zingales: “Finally, and perhaps most important, increased competition resulting from forces beyond control of incumbents—in particular, competition as a result of technological changes…—can reduce incumbents’ incentives to use financial underdevelopment as a barrier to domestic entry.”

What does this mean in the context of payment banks? Payment banks will bring in increased competition through forces that are beyond the control of incumbents i.e. the scheduled commercial banks. Further, payment banks are likely to use a lot of technology in their bid to expand the market. This will keep the scheduled commercial banks on their toes.

Rajan is hoping that payment banks will bring in a new way of doing things. As he said last week: “The bank branch can become a centre of activity, helping with cash handling or do some completely new work…There is a lot of scope for everyone… not everybody will succeed but this is a revolution which can happen.”

Further, if these banks end up expanding the banking penetration of the country, Bhattacharya’s fear of interest rates going up, will not hold true. If payment banks are able to expand the total deposit base of the country at a faster rate than the current rate, the interest rates are likely to come down.

So, why did Bhattacharya react the way she did? Rajan and Zingales have an explanation for that in their book. As they write: “Throughout its history, the free market system has been held back, not so much by its own economic deficiencies as Marxists would have it, but because of its reliance on political goodwill for its infrastructure. The threat primarily comes from…incumbents, those who already have an established position in the marketplace…The identity of the most dangerous incumbents depends on the country and the time period, but the part has been played at various times by the landed aristocracy, the owners and managers of large corporations, their financiers, and organised labour.”

Bhattacharya runs the biggest bank in the country, the State Bank of India. And given that she is an incumbent, and incumbents don’t like increased competition. It tends to disrupt their existing business model. Hence, her reaction was not surprising.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on SwarajyaMag.com on August 25, 2015

Lessons in competition from a taxi driver in Goa


If I were to ask you, what is common between Bangalore and Goa, what would you say? Actually, I could even ask you what is common between Delhi and Goa? Or for that matter Chennai and Goa? And to some extent Mumbai and Goa?

If you are the kind who goes to Goa regularly, you would know that the taxi drivers in Goa are a pain to deal with. They remind you of the auto-rickshaw drivers of Bangalore, and Delhi, and Chennai, and to some extent Mumbai, who are an equal pain to deal with and always want to be paid more. These guys would rather sit and idle away their time than take people from one place to another, which is what they are supposed to do.

Sometimes I wonder why are these guys in the business of transportation in the first place, given that they don’t want to go anywhere?

But jokes apart, why is this the case? Why do the autorickshaw drivers more or less all over the country, and the taxi drivers of Goa, behave in the way they do? The reason they behave in a similar way is because they know that they have no competition. If some competition were to come along, their obnoxious behaviour is likely to improve. While nothing works better than some completion, things are not as straightforward as that.

On a recent visit to Goa, I found the taxi driver (who also owned the cab) driving me around to be slightly worried about his future as an owner of two taxis. As the conversation went along I found that he was worried about taxi operators like Ola, Uber etc., entering the state.

They would offer a significantly lower price than what the taxi operators currently charge and in the process end up driving them out of business. “We are thinking of doing a chakka jaam against this,” the driver told me. “Otherwise thousands of taxi owners will be out of work.”

There is a lot that this statement tells us about how incumbents in a particular line of business behave when they are about to face new competition which is likely to make things more difficult for them. Along the lines of the taxi-driver who drove me around Goa, the drivers of kaali-peeli taxis and the autorickhaws of Mumbai are also a worried lot. Recently there was a strike to protest against the new kids on the block (read Uber/Ola etc.).

Further, conversations I have had with many kaali-peeli taxi drivers in Mumbai tell me that their daily earnings are down. A couple of them told me that their earnings are down by around 25%.

As Raghuram Rajan, the current governor of the Reserve Bank of India wrote in Saving Capitalism from the Capitalists (co-authored with Luigi Zingales): “Throughout its history, the free market system has been held back, not so much by its own economic deficiencies as Marxists would have it, but because of its reliance on political goodwill for its infrastructure. The threat primarily comes from…incumbents, those who already have an established position in the marketplace. The identity of the most dangerous incumbents depends on the country and the time period, but the part has been played at various times by the landed aristocracy, the owners and managers of large corporations, their financiers, and organised labour.”

In the case of Goa these incumbents are the existing taxi owners and drivers, who are organised. They have had an easy ride up until now. So is the case with autorickshaw drivers in cities all across in India. With almost no competition, they have been fleecing consumers for years now.

The trouble is that in all this no one thinks about the end consumer. In case of Goa, the end consumers are the huge number of tourists who visit the state every year. Data from the Goa Tourism department shows that in 2014 a total number of 4.05 million tourists came to Goa. Of this around 5.13 lakh tourists came from abroad. The remaining 3.54 million tourists were Indians.

Hence, if some competition were to be introduced in the taxi-cab space in Goa, it would benefit tourists who come to the state tremendously. They would be able to get cabs to go around at reasonable rates and wouldn’t feel fleeced every time they decide to use a cab. Their holiday would be a much more pleasurable experience than it currently is. This is true about other Indian cities where people are dependent on auto-rickshaws for transport.

The trouble here is that unlike the few thousand odd taxi owners, the 4.05 million tourists do not have an organised voice. And given that there is no way they can put across their point of view. Further, most of them visit the state just as tourists and do not live there. Hence, even if they had a voice, there would be no commitment to the cause.

This brings me to Bangalore, Delhi and Chennai (actually Delhi has improved a bit in the last few years). The cities needs to stop being held to ransom by autorickshaw drivers. The citizens deserve better.

Given this, it is time to move to the likes of Ola and Uber, lock, stock and barrel. At least, till their prices are competitive enough. These companies if they have to survive will eventually end up raising rates, and we will end up having another headache on our hands. Nevertheless, until then the autorickshaw drivers and owners need to be put in their place.

Also, the government needs to think about the consumers, who do not have voice, as well. As Rajan and Zingales put it: “The most effective way to reduce the power of incumbents to affect legislation is to keep domestic markets open to international competition…Openness creates competitions from outsiders-outsiders that incumbents cannot control through political means.”

The column appeared on The Daily Reckoning on July 21, 2015