🏦 Digital Banks: NITI Aayog v/s RBI
Indians are facing a major lack of credit. NITI Aayog thinks it is a big problem that can be solved through digital banks. Here's how.
If we asked you what a major problem with our economy was, your answers would probably be inflation, recession, or the rupee falling.
But there is yet another problem that is often ignored: a lack of credit or loans.
Now, the words ‘credit’ and ‘loan’ may bring up negative emotions. Whenever we hear about them, we think of the high interest rates, mortgages, burdens and whatnot.
However, more credit could be a gamechanger for our economy. Wondering how? ReadOn!
💸 Giving Credit to Credit
Credit is a wonderful thing.
Want to buy a pair of shoes on sale but don't have the money right now? Get credit (through credit cards, buy-now-pay-later schemes, EMIs, or personal loans) and get it right now.
Now if you are careless, this could land you in trouble financially, but otherwise this option is great for everyone: the customer, the shopkeeper and the economy.
Here's how:
If you couldn't buy the shoes immediately because of lack of money, chances are you wouldn't have been able to get them later.
But because you bought it using a short term loan, the shopkeeper has money to buy more stock, thanks to which the manufacturers and suppliers also get money.
This money will help them grow their business and hire more people, who now have money to buy more things.
So, you see, giving credit could help the whole supply value chain.
But right now, there is a severe lack of credit for both retail customers and MSMEs (Micro, Small, Medium Enterprises).
Of the 60.34 million MSMEs in India, over 50.7 million have no access to formal credit.
And of the 220 million credit eligible retail customers, banks only serve 33%.
But why is this so?
Because a lot of these MSMEs and retail customers do not have an appropriate credit history.
And even when they do have an okay enough credit history, they don't always get loans.
Because MSMEs and retail investors take loans of lower ticket size. And a lot of traditional banks don't have the capacity to go through the due diligence for loans of around Rs. 1 lakh-Rs. 10 lakhs, as it takes up a lot of their time and money.
What about NBFCs then? Aren't they created exactly for lending purposes?
Yes, but because they take money from banks, their cost of capital acquisition (getting money) is high.
So, they can only give out loans at high interest rates.
Which means those who really need it can't access it.
So, we really need a player to lend to this segment.
Because otherwise they are at a huge risk of falling prey to loan sharks.
And NITI Aayog's suggestion is digital banks!
🕵️ The Case for Digital Banks
Wait, ReadOn! Don't we already have digital banks?
No, what we do have are front-end-only neobanks. Huh?
So, neobanks are companies that exist only in the online world. Since they're not technically banks, they can't take deposits (just like NBFCs), which is why they partner with traditional banks which give them access to money, while they give the banks access to their tech.
Okay, so what are digital banks then?
Digital banks would be neobanks but with a banking license that allows them to take deposits as well.
And NITI Aayog has suggested creating two kinds of digital banks: Digital Business Banks and Digital Consumer Banks.
How will these digital banks help?
Well, firstly, since these banks have no physical branches its cost has already been reduced, making it more cost-efficient than a real bank and allowing it to lend money at low interest rates, which is needed for MSMEs and retail lenders.
For instance, the per account profit cost of Webank, a Chinese digital bank, is $0.5 which is 10-20 times less than that of a traditional bank.
Plus, because digital banks can conduct due diligence and other formalities online, they can afford to give loans at lower ticket sizes and still earn a handsome yield.
And experiments have shown that the launch of such digital banks in China boosted the business of 40,000 MSMEs.
Second, a lot of new tech-focused businesses are emerging right now and they need credit lines and codes that are tailored to their business. Now, traditional banks cannot do this thanks to the outdated banking code they follow, but digital banks would be able to do this.
Third, these digital banks could also help revolutionise regular banks and NBFCs by giving them their tech stack. This would improve their cost to income ratio as well, allowing them to give credit to more customers.
So, what's stopping us from launching these digital banks?
The RBI.
Yes, the RBI thinks they pose a major risk, which is why it is not giving them a license (you can read all about it here).
But without this license, it is very difficult for these Neobanks to become profitable because right now they mainly earn money from fees earned from bank partnership. This also makes it difficult for them to disburse loans.
Plus, since there is no license, any company can now come up and become a neobank, opening customers to a major risk.
So, NITI Aayog has proposed that the RBI should give neobanks a limited digital bank license first, with restrictions.
Using this license, they can conduct business within a regulatory sandbox*.
Their functioning will be monitored for a specific period by the RBI and then only when it is satisfied it can give the company a full-fledged license.
And if it is not satisfied, it can ask the neobank to sell its assets, find a buyer and leave the regulatory sandbox.
Sounds simple enough, right?
It also gives some suggestions that the RBI should keep in mind before launching a digital license:
Set a minimum capital requirement so that not anyone and everyone can become a digital bank.
Employees of the digital bank should have experience in a field similar to digital banking like e-commerce.
They should have the same rules applicable on them as banks like cash reserve ratio, etc.
They should take extra precautions to mitigate technological risks.
Now, we'll have to wait and watch if the RBI accepts this line of thinking by the NITI Aayog and gives the go-ahead to digital banks.
If RBI does accept it, it could be a lifesaving move for BNPL players like Slice who have been impacted by the RBI's latest circular (You can read more about this link here). The circular claims that non-banking companies cannot issue a credit line in prepaid payments instruments. This move has killed their entire business model.
But if Slice were to become a digital bank, it could once again issue its credit cards.
Will that deter the RBI from issuing digital banking licenses?
P.S. You can read NITI Aayog's full paper here.
Noob’s Corner: Just like how kids learn how to play in a sandbox first (so that they don’t get hurt), companies can learn to function ina safe regulstory framework with a few restrictions.
⚡ In a line: Credit could be a gamechanger for our economy and the NITI Aayog believes this change can only come through digital banks.
💡 Quick question: Do you think digital banks could help our economy?
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