The difference between small finance banks and payments banks

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Question – Identifying the difference between small finance banks and payments banks, discuss whether payments banks in India have failed to achieve their stated objectives? 21 February 2022

AnswerA payments bank is like any other bank, but operates on a smaller scale, without any ‘credit risk’. In simple words, it is capable of performing most banking functions but cannot give loans or issue credit cards.

Small finance bank

  • These banks have been set up to facilitate financial inclusion to some of the vulnerable sectors of the economy like small business units, small and marginal farmers, micro and small scale industries and unorganized sector entities.
  • These were recommended by the Nachiket Mor Committee on Financial Inclusion.
  • It is a smaller and limited version of commercial banks that can take deposits and give loans.
  • The minimum capital for setting up SFB should be Rs 100 crore.
  • It can sell other products such as insurance, mutual funds etc. and take the size of a full-fledged commercial bank.
  • These banks can do almost everything that a normal commercial bank can do but on a much smaller scale. One such difference is that the payments bank has a limit of Rs 1 lakh on deposits per account; There is no limit to small finance banks. Payments banks cannot lend, whereas small finance banks can.

Objectives of setting up of a payment bank:

To promote financial inclusion

(i) Providing small savings accounts and

(ii) Providing payment/remittance services to the migrant working class, low-income households, small businesses, other unorganized sector entities, and other users will be the objectives of setting up payments banks.

If payment banks have failed to achieve its objectives?

  • When the RBI granted 11 payments bank licenses in 2015, it was aimed at expanding financial inclusion and riding on a low-cost digital payment system to reduce physical cash transactions. But basically only 6 out of 11 are currently operational. Some payment banks have closed within months of the license being granted.
  • Of these, only three (Airtel Payments Bank, Fino Payments Bank and Paytm Payments Bank) have seen active transactions as per RBI data on mobile and NEFT transactions. India Post Payments Bank is also evaluating options to convert to a small finance bank (SFB).

Why have payments banks in India failed to achieve their intended objectives?

  • Challenging business model: Payment Banks face a blanket ban on any type of lending and are required to maintain cash reserve ratio and statutory liquidity ratio (SLR) on the outside liability.
  • Limited revenue inflow: Payments banks cannot accept deposits exceeding 1 lakh. Their income mostly includes interest from investments in safe government securities and fee income, which they can earn by distributing simple financial products such as mutual funds and insurance.
  • Small profits: As per RBI guidelines, payments banks will also have to invest 75 per cent of their deposits in government securities with maturities of up to one year and the remaining 25 per cent can be kept with commercial banks. When yields on one-year government securities decline sharply, it will further reduce the already very low margins of payments banks.
  • Tough Competition from Traditional Banks: With traditional banks investing heavily on digital initiatives and offering integrated payment systems such as mobile banking services and technology to enable cheaper transactions, customer acquisition will continue to be a major challenge for payments banks.
  • Apart from the above there are some other challenges like lack of customer awareness, lack of incentives for agents, lack of infrastructure and other technical issues.

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