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ROLE OF SMALL AND PAYMENTS BANKS IN ACHIEVING FINANCIAL

INCLUSION

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transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise,
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Role of Small and Payments Banks in achieving financial inclusion

Contents
i.
ii.

iii.

What is Financial Inclusion?

What are Payments Banks?
a. Conditionalities for setting up Payments Banks
b. Role in financial inclusion
c. Challenges
d. Way forward
What are Small Banks?
a. Conditionalities for setting up Small Banks
b. Role in financial inclusion
c. Challenges
d. Way forward

What is Financial Inclusion?

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Banking services like bank accounts, ATM services etc

Credit at affordable rates
Investment opportunities like Mutual funds, pension plans
Insurance services which includes life, non-life and health insurance

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Financial Inclusion means that everyone must have access to

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As per the 2011 census, only 65% of urban households and 55% of rural households have access to banking
services. The proportion of population having access to formal credit is even lesser. A miniscule percentage of
population has any kind of insurance and pension coverage. There are intra-regional and inter-regional
variations to go with these numbers. To rectify these anomalies, both the government and RBI have taken
various initiatives to usher in Financial Inclusion

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Payments banks will provide a limited range of products, such as, acceptance of demand deposits and
remittances of funds, but will have a widespread network of access points particularly to remote areas,
either through their own branch network or through Business Correspondents (BCs) or through
networks provided by others. They will add value by adapting technological solutions to lower costs.
Existing authorized non-bank pre-paid instrument issuers (PPIs like Airtel Money, Flipkart Wallet,
Mobikwik etc), non-banking finance companies (NBFCs), corporate BCs (business correspondents),
mobile telephone companies, super market chains, companies, real sector co-operatives and public
sector entities are eligible for setting up a payments bank.

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What are Payments banks?

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Keeping with its previous initiatives to usher in financial inclusion, RBI has recently announced guidelines for
licensing of Payments Banks and Small Banks. Both these banks fall into the category of niche or differentiated
banks, meaning that they serve a specific purpose or a specific category of customers.

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Conditionalities for setting up Payments Banks

Minimum paid-up capital of Rs. 100 crores

Promoters will have to have an initial minimum capital of at least 40 per cent. It has prescribed a
lock-in period of five years for promoters holding.
If promoters stake is in excess of 40%, it will have to be brought down to 40% within 3 years.
Within 10 yrs it has to be brought down to 30% and to further 26% within 12 yrs from date of
commencement of business
A payments bank cannot set up subsidiaries to undertake non-banking financial activities
Payments Bank will have to comply with SLR and CRR requirements
1/4th of the access points must be in rural areas.

Role in financial inclusion

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Our migrant labour force accounts for 1/3rd of the population. Most of them use informal
channels for fund transfer. These channels charge hefty fees and are unreliable. A payments
bank, says the RBI, will further the cause of financial inclusion by providing small savings
accounts and payments and remittance services to migrant labour workforce.
Payments Banks will also serve low-income households, small businesses and other unorganized
entities thus bringing hitherto those sections of populations into the banking fold which were
earlier excluded. The idea is to facilitate high volume and low value transactions in a secure and
technology-driven environment.
A payments bank will have to ensure widespread network of access points particularly to remote
areas, either through their own branch network or BCs or through network provided by others.
Thus, the geographical coverage of banking services will increase

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Banks like SBI and ICICI are already providing these services through mobile banking. Hence,
payments banks will have to provide lucrative products to match the already existing players.
Though payments banks will earn fees on remittances and payments but will it be enough to
make the bank viable, remains to be seen.
Payments banks will have to invest all their deposits in government bonds maturing in one year.
Though this ensures safety to deposits by it seriously limits the profitability of the bank. In the
current scenario, when inflation is raging close to 8%, returns from government bonds may
prove inadequate.
Some experts have raised a question that as Small banks are allowed to do all the activities that
are entrusted to payments bank, then why would anybody open a Payment bank? Here, it needs
to be remembered that Small Banks will serve a very limited area which is unsuitable for services
like remittances. Payments banks will provide the vast geographical coverage for remittance that
SBs will not be able to provide.
Opening up widespread access points is a challenge in itself. Access points in rural points are
deemed unviable. ATM business is also now not seen as a profitable business. With Banking
Correspondent model also running into rough weather, it remains to be seen how the
requirement of widespread access points will be fulfilled.

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Challenges

Way Forward

There is a large segment of population that needs to be tapped with the products that payments
banks are required to provide. The large volume of business can easily make payments banks
viable. The need is to have the right kind of schemes and products.
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Government should also expedite the completion of National Fibre Optical network. The
combination of NFON, mobile banking and Payments Banks will help in achieving financial
inclusion.
Setting up of payments banks is a step in the right direction and they will help fill the existing
gaps in banking services by providing basic banking to hitherto left out population.

What are Small Banks?

Small banks will provide a whole suite of basic banking products, such as, deposits and supply of credit,
but in a limited area of operation. The entities eligible to set up a small bank include resident individuals
with ten years of experience in banking and finance, companies and societies, NBFCs, Micro Finance
Institutions and Local Area Banks
The area of operations of the small bank will be restricted to contiguous districts in a homogenous
cluster of States/Union Territories so that the bank has the local feel and culture. However, if
considered necessary, the bank will be allowed to expand its area of operations beyond contiguous
districts in one or more States with reasonable geographical proximity.

Conditionalities for setting up Small Banks

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Minimum paid-up capital of Rs. 100 crores

Promoters will have to have an initial minimum capital of at least 40 per cent. It has prescribed a
lock-in period of five years for promoters holding.
A Small bank cannot set up subsidiaries to undertake non-banking financial activities
It must comply with SLR and CRR norms
It has to comply with Priority Sector Lending norms
The upper limit for loan/investment is capped at 15% of its capital funds

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Small Banks will engage in basic banking service of acceptance of deposits and lending activities to
small farmers, small businesses, micro and small industries and unorganized sector entities.
Upto 50% of SBs loans portfolio would constitute loans and advances upto Rs. 25 lakhs. It means
that most of its loans will be small loans which commercial banks deem cumbersome. Thus, small
businesses, educational loans etc will find easier credit access

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Role in financial inclusion

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The Small Banks concept is not very different from the concept of Local Area Bank made in the 1997
budget. The difference is that while LABs were restricted to contiguous areas in one state, Small
Banks are allowed to grow into contiguous areas of more than one state. Only 6 LABs got license and
only 4 of them are operational till date, which shows the lack of enthusiasm for such niche banks.
Many NBFCs and LABs have shown interest in opening SBs but they are searching how viable this
business model will be. The risk of default on small loans is least but the returns may not be that
high.
As Small Banks will operate in a limited geographical area hence they suffer from concentration risks
like droughts, floods etc which affect contiguous areas. If such a thing happens, then the risk of mass
defaults of loan repayments will rise. This is precisely the reason why LABs didnt succeed. RBI has
taken care of concentration risks by allowing SBs to open in more than one district in a state and
further expand into more than one state. Thus, SBs are less likely to suffer from concentration risks
though the possibility of such risk still exists.

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Challenges

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Way Forward

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Small farmers and small businesses have had difficulty accessing cheap credit. Small Banks will be a
major boost to this segment. Small banks must develop innovative technological solutions to keep
the transaction costs low and thus generate enough revenue to make the business model viable.
In a vast country like India, it is highly imperative to tailor the credit needs of the population
according to their specific needs. Small Banks are a step in this direction to tap the fortune that lies
at the bottom of the pyramid.

Copyright by Vision IAS

All rights are reserved. No part of this document may be reproduced, stored in a retrieval system or
transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise,
without prior permission of Vision IAS
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