Thursday, December 31, 2015

Differentiated Banks – Leading the March Towards Financial Inclusion

[The following guest post is contributed by Neelasha Nemani, who is a 4th year B.A. LL.B. (Hons.) student from National Law University Odisha, Cuttack.]

India’s impetus on financial inclusion is now stronger than ever. Recently, the Reserve Bank of India (RBI) granted an in principle approval to 11 entities to set up Payments Banks[1] and 10 entities to set up Small Finance Banks[2] as an expression of its concern over the immediate requirement of rapid financial inclusion to boost the economic situation in the country. In an attempt to resolve the long-pending debate over the most ideal vehicle for financial inclusion between having a few large banks with several branches and having several small banks, the RBI has, after much consideration and upon the recommendation of the Nachiket Mor Committeee,[3] come to the conclusion that the setting up of several small, localized, well-capitalized, technology-driven banks in unbanked and under-banked regions of the country is indispensible for achieving the goal of financial inclusion. And better yet, the setting up of Differentiated Banks[4] or Niche Banks that either offer specialized services or are geographically limited in their operations would best cater to the needs of a specified class of customers.

Differentiated Banks indeed have much to offer. Since Small Finance Banks[5] are regionally limited in scope, they will be in a better position to cater to customers’ local needs and will easily be able to assess their needs and accordingly tailor-make the services provided by them. A bank with a localized base of operation tends to be hassle-free in the services provided by it and would thereby encourage the lower-income groups and small businessmen to participate in the formal financial system. Payments Banks,[6] on the other hand, being limited in scope of activity, provide specialized services that put resources to optimum use and prevent their potential wastage. Considering the current rate of market expansion, such specialization is more than just desirable and is, in fact, a very natural response to an increase in competition amongst banks.

The granting of differentiated licenses after the failure of Local Area Banks (LABs)[7] is indeed a bold step on part of the government, nonetheless a calculated one. Firstly, the government has learnt that a high capitalization base is required for the banks to be able to endure the potential risks associated with geographically distant areas and more importantly the kind of sectors these banks are being set up to cater to, which have a high incidence of credit default and has therefore, as a corrective measure, increased the minimum paid-up capital requirement to Rs. 100 crores from the erstwhile Rs. 5 crores of LABs. Secondly, the entities that it has granted license to are those that have access to state of the art technology and resources to build the necessary infrastructure to penetrate into the remotest of areas through the click of a button on a mobile phone, where it would not be possible to set up physical banks or branches. However, some potential challenges still persist which threaten the success of the RBI’s financial inclusion drive.

First is the banks’ ability to remain economically viable in a restrictive environment. For instance, Payments Banks are not allowed to create credit by granting loans and are also required to invest 75% of their money in government securities/treasury bills maturable in one year. Their source of income would be the fees charged by them for providing remittance services, insurance and mutual fund schemes and their profitability will depend on the most cost-effective technology employed by them. Given that these banks are privately owned, the targets on profitability are likely to be strict and short-term focused.  Therefore, while it may not be difficult for these entities to enter unbanked areas, it might become difficult for them to sustain.

Second is the issue of consumers’ willingness to avail of financial services.  Even as far as the savings customer is concerned, their coming forward and actually utilizing these services will largely depend on their financial awareness and level of trust.  It has been shown that lack of trust in the formal financial system still binds large segments of consumers to exploitative moneylenders.  Therefore, the financial inclusion drive must contain an element of financial literacy as well – which the licensed entities may not be in a position to invest in.

Third, there is the issue of making services sufficiently inexpensive to induce consumers to utilize them. In recent news, the State Bank of India is gearing up to set up a low-cost model to provide payments services in similar sectors,[8] thereby increasing the competition in the market.

While only the passage of time will determine the success of the financial inclusion drive, it is certainly worth noting that the RBI has made a push in the right direction.  With the progress of time, the approach will not need to be re-worked but only dynamically refined.

- Neelasha Nemani

[1] RBI Press Release no. 2015-2016/437 dated August 19, 2015 which discusses the in-principle approval of license to 11 Payments Banks. Link:
Also see: RBI Press Release no. 2014-2015/1089 dated November 27, 2014 which discusses the guidelines prescribed by the RBI for grant of license to Payments Banks. Link:
[2] RBI Press Release no. 2015-2016/693 dated September 16, 2015 which discusses the in principle approval of license to 10 Small Finance Banks. Link:
Also see: RBI Press Release no. 2014-2015/1090 dated November 27, 2014 which discusses the guidelines issued by the RBI for grant of license to Small Finance Banks. Link:
[3] Report by Committee on Comprehensive Financial Services for Small Businesses and Low Income Households headed by Shri Nachiket Mor dated January, 2014. Link:
[4] Differentiated Banks are banks that provide niche banking facilities and include Local Area Banks, Payments Banks, Small Finance Banks etc. See: Budget Speech 2014-15 dated July 10, 2014, Ministry of Finance, Government of India. Link:
[5] For further reading on Small Finance Banks, see: Vivina Vishwanathan, What to Expect from Small Finance Banks, Live Mint, December 29, 2015. Link:
[6] For further reading on Payments Banks, see: Puja Mehra, All You Need to Know about Payment Banks, The Hindu, August 20, 2015. Link:
[7] For a holistic understanding of the functioning of LABs, see: Report of the Review Group on The Working of The Local Area Bank Scheme dated September 2002, RBI. Link:
For further reading, see: M. S. Sriram, Small Banks: Lessons Learnt from Local Area Banks, Live Mint,  July 25, 2014. Link:
[8] PTI, SBI developing Low Cost Model to Counter Payments Banks, The Economic Times, August 21, 2015. Link:

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