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Cracking the payments bank puzzle

Source: Hindustan Times
Source: Hindustan Times

It is widely believed that India is on the cusp of a financial services revolution. Perhaps no move has generated as much excitement as the licensing of payments banks, a new class of differentiated financial providers announced by the Reserve Bank of India (RBI) last year.

Of the 11 players who were issued in-principle approvals for payments bank licenses, one (Airtel M Commerce Services Ltd) has received the final license, and others have announced high-profile launches and recruitments. Recently though, three payments banks (Cholamandalam Investment, Dilip Shanghvi-Telenor Financial-IDFC Bank and Tech Mahindra) have withdrawn their applications, reviving questions about the viability of the business model.

We believe that the success of these new entities will depend to a great extent on their ability to go beyond serving the well-banked smartphone-carrying consumers, such as the readers of Mint, who have been the focus of digital payments in India so far. Payments banks will need to creatively reach the low-income and financially underserved—the so-called base of pyramid (BOP) consumers. Indeed, universal financial inclusion was a driving motivation behind RBI’s issuance of these payments bank (and small finance bank) licenses.

However, as traditional banks can testify, developing a model that is both effective in reaching the BOP consumer and commercially profitable, is far from easy. It will require a paradigm shift. Leveraging technology to reduce cost-to-serve will of course be important, but much more will be needed. In this series, we will explore three key factors that we think are critical to successfully serving BOP consumers.

First, players will need to deepen their understanding of the unique needs of BOP consumers and develop products and customer experiences tailored to these needs. This doesn’t sound like rocket science and it isn’t, except that the financial products currently available to BOP consumers often look suspiciously like hand-me-downs and do not match their distinct income, expenditure and savings patterns. For example, income at the BOP tends to be more irregular and unpredictable, often cobbled together from various sources. Savings are limited, often taking the form of small amounts saved daily that need to be banked quickly to prevent them from being spent. Formal credit histories are virtually non-existent. There is heavy reliance on informal networks like friends and family for financing big-ticket needs.

Providers will need to develop new products that are better suited to the financial lives of BOP consumers, for example, daily micro-saving products and micro-loans that rely on non-traditional data. They will need to develop partnerships with other financial institutions to meet the full scope of customer needs. More fundamentally, while they can leverage their existing customer relationships (like the ones led by telcos), they will need to orient themselves to become truly customer-centric. They will need to embed within their organization the ethos of providing a respectful and positive customer experience to BOP customers to earn their trust and loyalty (as Janalakshmi recently aimed to do, working with CGAP and Dalberg). CGAP refers to the Consultative Group to Assist the Poor, a global partnership of 34 organizations that work to advance financial inclusion.

Second, reaching out to this new target user group will require combining ‘high-tech’ with ‘high-touch’. Technology is, of course, going to be key to keeping costs low. The use of Aadhaar-linked authentication, know-your-customer and e-sign (elements of the so-called IndiaStack) and the proliferation of mobile/online payment systems hold special promise for reducing the cost of delivery. However, smartphone penetration is still low and digital literacy is a major challenge among the BOP. So, payments banks will need to rely on physical agent networks, at least in the foreseeable future, to serve this segment. Given the sobering experience with business correspondents (BCs) in India, it is far from clear that financial institutions have cracked the agent model.

Currently, banks largely rely on BCs who are dedicated to the financial services business. To achieve scale and keep costs manageable, players will need to harness the potential of varied agent models—ranging from dedicated ‘wealth advisors’ at one end of the spectrum to ‘lite’ BC agents who just focus on a few simple transactions while doing core businesses at the other.

Finally, players will need to harness the potential of the ubiquitous kirana (neighbourhood) store, by making it worth their while to accept digital payments. This is particularly true for payments banks, which will need to rely heavily on small-ticket transactions for revenues, given limitations to their net interest income. Today, ~95% of retail in India is unorganized, and only 6% of these retail establishments accept digital payments. Clearly, cash is still king and digitizing small merchant payments is a herculean task. But research we recently conducted among small merchants as a part of a USAID-ministry of finance-led partnership to support financial inclusion through digital payments suggests that there is hope. We found that small merchants who do accept digital payments are satisfied with their experience, recognizing its benefits in terms of safety and overcoming pain points of cash such as managing loose change. But many others lack awareness and have limited interest in trying digital payments, citing the pervasiveness of cash around them as the key reason (interestingly, ahead of issues such as tax and transaction costs). Those who are willing to try face far too many up-front barriers—documentation requirements (for example, business registration papers), high setup costs (for example, point-of-sale device charges, opening a new bank account with the acquiring bank) and complicated pricing plans. Payments banks, as late entrants, are well-positioned to take up the challenge of disrupting merchant acceptance as it stands today.

Varad Pande is a partner at Dalberg, a global strategy and policy advisory firm focused on social impact, where he leads the financial inclusion practice. Manisha Pandita is a senior project manager at Dalberg. This article was first published on Livemint. These is the first article of a four-part series on what it would take to succeed for India’s payments banks. Click here for the second, third and fourth part of the series.

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