What happens when regulators decide to play God

Then there are payment banks, a curious new lifeform artificially engineered by the RBI in 2014—banks that could collect deposits, but not lend. An initial stampede for licenses by India’s largest business groups in 2015 led to 11 licenses being granted that year. Fast forward to 2018: just three have been operational for more than six months. And they too, are still searching for their raison d’être.

To try and trace back the policy paternity/maternity behind floundering mobile wallets and payments banks, we have to go all the way back to 2013. That was when the RBI constituted a committee under Nachiket Mor, a wunderkind banker who now heads The Bill and Melinda Gates Foundation. Called the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households, its job was to study and recommend policies to aid financial inclusion in India.

When it came to mobile wallets (part of what are called Prepaid Payment Instruments, or PPIs in RBI-ese), the committee wasn’t a fan. Money stored in wallets didn’t appear to fall within the ambit of RBI’s deposit insurance cover.

To address this, the regulatory framework required wallets to escrow the value outstanding from customers with a sponsor bank on a 1:1 basis. But the committee believed that this nested set-up exposed both parties to reciprocal risks.

The solution? Create a new kind of financial services player under the direct regulatory oversight of the banking regulator—payments banks.

While this reasoning was debatable, the RBI accepted the recommendation to create a new regulatory category termed ‘payment banks’ in 2014. This was a subset of the broader push towards differentiated banking that articulated a disintermediated (unbundled) view of banking.

Payment banks could offer what might be termed as deposit-side banking and up-sell other financial sector products for fee-based income. But most importantly, they could not engage in lending and were subject to CRR and SLR covenants (stringent rules that define a percentage of a financial institution’s deposits that must be kept or invested with the central bank or government-backed securities).

Wallets, bad. Payments banks, good. All would be well.

However, the initial euphoria surrounding the idea soon turned to buyer’s remorse as the 11 licensees realised the constrained operating environment left little money on the table. Three of the original 11 – Sun Pharmaceuticals, Cholamandalam Distribution Services and Tech Mahindra – surrendered their licenses without even starting operations. Today, only three of the remaining eight have completed more than six months of operations in the space—Paytm*, Fino and Airtel.

Playing God

To make payments banks attractive, the RBI needed wallets to be the opposite. So in parallel to the new regulatory moves which introduced payments banks, the RBI also came down heavily on wallet operations.

The most prominent step was a law stipulating that wallet operators execute a full KYC of their customers. This imposed an onerous requirement on wallets. The quid pro quo here was that the regulations permitted enhanced interoperability between wallets through the UPI platform.

But there is such a thing as “necessary but not sufficient”.

The RBI either didn’t realise or ignored the fact that merely enabling interoperability through regulatory mandates does not, in and of itself, guarantee inter-loop transfers. The economics of interoperability (in terms of fees between the issuing and acquiring wallet) is a necessary condition for wallet-interoperability. We are still to get there.

Moreover, while wallets were increasingly subjected to bank-like regulation, they continue to be excluded from offering open-loop products (like debit cards) and Authorised Dealer licenses that enable participation in the remittance market.

The Process

A December 2016 ASSOCHAM report had predicted that the mobile wallet market would be worth Rs 54,000 crore ($7.9 billion) by 2021. However, by playing God in the products and services market by engineering newer business models through an inorganic process, the RBI has brought us to a point where wallets find themselves incapable of delivering on their initial promise of furthering financial inclusion.

Ironically, at the same time, payments banks, purportedly designed by the RBI to be their efficient alternatives, face a constrained operating environment and appear unable to effectively rebundle financial services on one balance sheet.

Why? Because with the RBI drastically reducing the ability of payments banks to lend or make money in the manner most regular banks do, the only option left was to leverage technology to achieve scale and lower operating costs.


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