The motivation for introducing payments banks in India came from the lack of access and prevalent financial literacy. Before initiating and setting payments banks, the Reserve Bank of India went through several policy considerations to promote financial inclusion. Aditee Dash explains the meaning and advent of payments banks in India. Aditee also understands its function and its contemporary role in democratising banking systems.
By Aditee Dash, fourth-year BBA LLB student, Kirit P. Mehta School of Law, NMIMS University, Mumbai
In a dynamic economy, the financial sector must be as flexible and competitive as possible. This is necessary to cope with the multiple demands placed on it due to various economic factors.
Adequate access to financial services is a prerequisite to poverty alleviation and social cohesion. Moreover, financial inclusivity is imperative to socially inclusive growth.
During a United Nations General Assembly Greenlights Programme, Kofi Annan first invoked the idea of ‘inclusive financial sectors’. In this regard, on December 29, 2003, Annan stated:
“The stark reality is that most poor people in the world still lack access to sustainable financial services, whether it is savings, credit or insurance. The great challenge before us is to address the constraints that exclude people from full participation in the financial sector. Together, we can and must build inclusive financial sectors that help people improve their lives.”
Even after two decades, financial exclusion is a policy concern for countries worldwide, especially in developing countries like India.
Over the past decade, the Indian banking industry has undergone tremendous changes with the advancement of technology. Especially after the liberalisation and nationalisation, there was a greater emphasis on customer satisfaction. Plus, the commencement of virtual or digital banking opened the doorway for users to access banking services like plastic money, ATM, e-fund transfers and daily account statements.
These services were less time consuming and more secure, thus made people’s life easier. However, despite this advancement in banking technology, the banking sector in rural areas remained unregulated.
Indian rural areas saw only a few commercial banking branches with very low financial literacy. To undo such exclusion, the Reserve Bank of India (RBI) introduced Payments banks in India in furtherance of the digital cashless economy campaign.
The motive was to promote financial inclusion and literacy among low-income groups, rural areas, migrant workers and small business owners. To do that, RBI previously implemented the following initiatives:
- Pradhan Mantri Jan Dhan Yojna
- Cashless payment through mobile applications
- Introduction of electronic fund transfer mechanisms like RTGS and NEFT
- The Digital India Campaign
Filling the Need-Gap
The Indian Express’ report on the poverty index in India estimated that around 150-199 million additional people are expected to fall into poverty in 2021. Therefore, given these figures and other socio-legal restraints, including no financial literacy, most don’t have access to regulated banking.
Around 40% to 50% of India’s population can open a bank account, but the number hasn’t really translated to actual access.
Although the Pradhan Mantri Jan Dhan Yojna focused on all these factors, there’s a jarring gap between opening an account and using it.
Due to high operational costs in rural regions, banks show reluctance to open new branches. Thus, the Government had to search for new innovative measures to solve this issue. Therefore, the introduction of payments banks in India is one such attempt by RBI to counter access and cost issues as both impede growth.
In September 2013, under the chairmanship of Nachiket Mor, a committee constituted by the RBI studied ‘Comprehensive financial services for small businesses and low-income households’.
The report recommended the introduction of specialised banks to cater to the needs of lower-income groups. The objective was to ensure that all Indian residents have a global bank account by January 1, 2016.
Acting upon this recommendation, RBI conceptualised new model banks known as payments banks. These banks had restricted operational activity without any involvement in credit risks.
Payments banks are the newest introduction in the banking sector, providing some particular banking services to a niche audience. These are licensed banks that can only receive deposits and provide remittances. However, they can’t perform lending activities.
These banks use technology strategically to leverage the current customer base and existing distribution channels to gain a critical mass rapidly. As a result, major banks in India can view payments banks as business correspondents to increase their customer reach without any infrastructural cost.
RBI received a total of 42 applications, out of which 11 payments banks have already received the license. But currently, there are only six payments banks in India, and others are yet to open.
The Emergence of Payments Banks in India: Step Towards Financial Inclusion
The Indian Government has defined specific regulations and restrictions for the banking sector and non-banking financial sectors, and it also provides differentiated licenses to small-scale banks.
All this was done to redefine the Indian economy and provide a secure gateway for online transactions. These transactions will be easily accessible and time-efficient. It will also cover a large chunk of the population, which previously remained left out through traditional banking methods. However, despite these options, the introduction of payments banks was imperative.
Payments banks are banks involving no credit risk. This means they cannot perform lending services but can accept deposits, facilitate remittances and provide a debit card facility. A payment is categorised as ‘Scheduled Bank’ but it is mandatory for businesses to integrate the term ‘payments bank’ in their names. This is done to make it easy to distinguish it from the traditional banks.
Since Independence, the development of the Indian financial sector and the role of banks has been the chief objective of policymakers in India. Further, in the 1990s, the general picture of financial inclusivity was abysmal.
The 1991 crisis made it clear that the banking sector was in a state of disarray with no signs of achieving financial inclusivity on a large scale. Therefore, the Government in 1991 started the process of liberalisation, which focused on restoring the financial wellbeing of banks.
This process was introduced based on the suggestions from two expert committees working under the chairmanship of M Narasimham in the years 1991 and 1998.
The committees focused on efficiency, greater autonomy to public banks, bad loan issue resolution, the introduction of global banks in Indian markets, adjustment of liquidity to encourage borrowing from RBI through buyback agreements and monetary policy instrument introduction. These changes led to institutions of cheap credit avenues and a boom in the formal financial sector.
In the early 2000s, the focal area shifted to financial inclusion. Former RBI Governor Y V Reddy mentioned the phrase ‘financial inclusion’ for the first time in 2005 while delivering the annual policy statement.
The Khan Committee constituted by the RBI in 2005 declared that banks can now open ‘no frills’ accounts. These accounts were zero balance or low balance accounts. The Rangarajan Committee report followed this.
This committee was constituted to examine the financial inclusion state in India under the chairmanship of a former RBI governor C. Rangarajan. This committee stated that the poor were excluded when it came to the formal financial sector.
Under the chairmanship of the future RBI governor Raghuram Rajan, the Rajan Committee suggested comprehensive reforms for deepening the financial sector to make it more inclusive. For instance, it suggested making an all-service sector that could provide insurance policies, savings accounts, payment services, credit, and pension schemes protected from inflation.
Additionally, to reach the financial inclusion goals, the committee also pushed for a change. It preferred to overburden public sector banks with these goals using small-scale private banks.
The Mor Committee report elaborated on this recommendation by introducing ‘payments banks’ as a part of Vertically Differentiated Banking Systems (VDBS).The committee believed that there should be regulatory flexibility where payments, credit, deposits are concerned. This would ensure good efficiency and low operating costs.
In this regard, it cited the South Korean Post Office Bank as an example of VDBS, which accepted only payments and deposits, GE Capital with only credit and payment facilities and the MasterCard Visa with only payment service.
Before the VDBS recommendation, there had been attempts to create small-scale banks within the sector to achieve ‘last-mile connectivity’. For instance, these banks include agricultural societies, local area banks, urban cooperative banks, and rural and regional banks.
Furthermore, digital wallets or Prepaid Instrument Providers (PPI) that work as quasi-banking organisations were a precedent to the Mor Committee report. This was because, since 2010, the PPIs have provided a crucial extension of low-operating cost services for individuals. However, PPIs mandate ‘Know Your Customer’ (KYC), for which the norms are lax, leading to security breaches. Other issues with PPIs include lack of interest payment on balances and possible contagion risk leading to massive security issues.
All these issues paved the way for the recommendation of payments banks by the Mor Committee.
Legal And Regulatory Framework For Payment Banks In India
On July 10, 2014, during the Union Budget, the Hon’ble Finance Minister declared that:
“After making suitable changes to current framework, a structure will be put in place for continuous authorisation of universal banks in the private sector in the current financial year. RBI will create a framework for licensing small banks and other differentiated banks. Differentiated banks serving niche interests, local area banks, payments banks etc. are contemplated to meet credit and remittance needs of small businesses, unorganised sector, low-income households, farmers and migrant work force.”
RBI formulated the draft guidelines for differentiated licensing of payments banks in the private sector considering the above statement. Further, the guidelines were released on July 17, 2014, based on comments and suggestions received on the draft guidelines.
The guidelines stated that the payments banks would be registered under the Companies Act, 2013 as a public limited company. Also, they will be licensed under Section 22 of the Banking Regulation Act, 1949.
It required that banks go for a restricted license for only deposits, remittances and payment provisions. Payments banks also fall under the Reserve Bank of India Act 1934, Foreign Exchange Management Act, 1999, Payment and Settlement Systems Act, 2007, and the Deposit Insurance and Credit Guarantee Corporation Act, 1961.
Further, they are also governed by other relevant Statutes and Directives, Prudential Regulations and other Guidelines/Instructions issued by RBI and other regulators from time to time.
According to RBI, the objective of introducing payments banks was the need for saving accounts and transactions for the poor in the population. Payments banks can facilitate remittances with both macro-economic profits for the area and micro-economic profits for the receivers. Allowing these banks to facilitate remittances reduces the operation cost, making it more beneficial and profitable.
The guidelines lay down the list of eligible promoters. The list includes PPIs authorised under the Payment and Settlement System Act, 2007, NBFCs, other professionals/individuals, Telecom companies, supermarket chains, real estate companies controlled or owned by Indian residents, corporate BCs and public sector enterprises.
Although payments banks have no credit or market risks, they must invest in technological infrastructure for all their operations. Thus they are open to operational risks too. Therefore, payments banks in India must have robust risk management systems as they are most exposed to this risk. In addition, they are subject to the RBI’s liquidity risk management guidelines in case of liquidity risk.
The payments banks have to submit applications in Form III under Rule 11 of the Banking Regulation (Companies) Rules, 1949 and furnish their entire business plan to RBI in detail. In addition, the bank’s board should have independent directors in the majority, and it should conform with corporate governance procedures.
Guidelines And Working Mechanism Of Payments Banks
There is not much difference in the working mechanism of payments banks and commercial banks, but the services provided by payments banks are subject to certain restrictions.
Unlike commercial banks, payments banks cannot issue credit cards as they cannot get involved in credit risks and lending activities. However, the payments banks can accept deposits up until a specific limit of Rs. 2 lakhs. In an attempt to promote digital payments banks, the RBI increased the limit from Rs. 1 lakh to 2 lakhs on April 7, 2021.
Functions of the payments banks are as follows:
- Like other commercial banks, payments banks are authorised to open savings and current accounts. However, they would deposit the amount as a cash reserve ratio with the RBI.
- Although payments banks are not allowed to give out credit cards, they can issue ATM Cards or debit cards.
- The banks can only accept deposits from Indian resident citizens, which means they cannot accept NRI deposits. However, they can also get remittances and make personal payments on cross border accounts from the accounts in India.
- The bank can admit remittances that have to be sent or receive remittances from other commercial banks through payment mechanisms like RTGS, NEFT, IMPS authorised by the RBI.
- These banks need to invest a minimum of 75 per cent of their demand deposits in the form of government securities bills with up to one year of maturity. They can hold a 25% maximum of the current and fixed deposits for operational functions with commercial banks.
- They can also provide their customers and the public in general with utility bill payment facilities.
- Payments banks are not allowed to open subsidiaries to commence NBFC services.
- A payments bank can work as business correspondents with commercial banks to sell mutual funds, insurance services and pension provisions with approval from the RBI. In addition, they are allowed by the RBI to provide internet and mobile banking services to its customers.
- As payments banks do not provide loans or accept time deposits, they cannot benefit from the interest gained from these services. Instead, transaction fees are the main source of their revenue as these banks charge customers for fund transfer transactions and withdrawal of money transactions. Payments banks like commercial banks generate their revenue through the fee charged in these transactions by point of scale (PoS) terminals and Merchant Discount Rates (MDR).
- Another way payments banks gain interest is when they deposit the amount their customers deposit in their savings accounts to a commercial bank or government deposit. This deposit happens with a higher interest rate than what they are providing the customer.
On November 27, 2014, the RBI approved 11 applicants out of the 42 to set up payments banks in India. These eleven payments banks are:
- Airtel M Commerce Services Limited
- Aditya Birla Nuvo Limited (Idea Cellular) (Discontinued on July 26 2019)
- Fino PayTech Limited
- Reliance Industries (Jio Payments Bank)
- National Securities Depository Limited (NSDL)
- Department of Posts (India Post- IPPB)
- Cholamandalam Distribution Services Limited (Surrendered license to RBI)
- Sun Pharma (Surrendered license to RBI)
- Tech Mahindra Limited (Surrendered license to RBI)
- Vodafone M-Pesa Limited (Didn’t start due to certain complications)
Conclusion and Suggestions
The advent of payments banks in the Indian banking sector has been a striking step. The issue of financial inclusion in a country with a low overall literacy rate could only be solved with something so radical.
Financial inclusion and literacy are crucial steps towards the formation and development of a digital ecosystem. In addition, these banks have helped the government immensely in implementing government welfare schemes, transfer schemes and subsidies in various sectors.
These schemes and subsidies are now directly paid to the beneficiaries’ account rather than a physical payment. Thus, creating competitiveness between the payments and commercial banks, beneficial for the banking sector. Moreover, such competition will expand the quality of banking services and reduced service costs.
Currently, the payments banks can be called game-changers of the banking sector due to their user-friendly app-based platform and attractive services. Plus, they are a gateway for low income and middle-income groups to access banking services in a more accessible form.
Although it’s too early to judge the competency of payments banks, the effects till now are positive. They are becoming popular amongst the youth as a model of digital transaction, bill payment and recharging.
It is arguably one of the best strategies implemented for financial inclusion, which is showing benefits. This has been a milestone achievement in bridging the gap between commercial banks and rural regions.
Here are some suggestions that could make payments banks a more accessible, sustainable and efficient aspect of the banking sector.
- The government should collaborate with these banks to organise awareness campaigns in areas/regions with less financial literacy. This will make people more aware of the benefits of the financial services offered by the regulated banking sector.
- Something like payments banks needs steady and cheap internet access. So the government should make provisions for internet access to the people in rural areas.
- The government could draft separate legislation to streamline the governance of payments banks in India. However, the legislation should be technologically unbiased and centred on payment activities.
- The legislation should be clear and adaptive to the recent emerging services and products.
- The legislation should also offer a risk-based framework for incorporation in the payments banks so that activities can be differentiated based on their risk.
- The existing PSS Act should be amended to accommodate and regulate all the services currently offered by the payments.
Press Release, General Assembly Greenlights Programme for the International Year of Microcredit 2005
 the Digital India Campaign is the latest attempt to introduce payment banks in the Indian banking sector.
 Global Findex Report 2018, World Bank
 Radhika Merwin, ‘Why five out of the 11 payments banks have shut shop’ (2019) https://www.thehindubusinessline.com/money-and-banking/five-out-of-the-11-payments-banks-have-shut-operations-why/article29381134.ece
 RBI releases Draft Guidelines for Licensing of Payments Banks and Small Banks, The Reserve Bank of India, (April 2nd 2014) https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=31646
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 Indradeep Ghosh, Ajit Ranade, Can Payment Banks Succeed? A Trilemma and a Possible Solution, Economic & Political Weekly, Vol.55 Issue no. 15 (11th April 2020) https://www.epw.in/journal/2020/15/special-articles/can-payments-banks-succeed.html
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Reserve Bank of India, ‘Guidelines for Licensing of Payment Banks’ (2014)
https://www.rbi.org.in/scripts/bs_viewcontent.aspx%3FId%3D2900. See also Reserve Bank of India, ‘Operating Guidelines for Payments Banks’ (2016) https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10635&Mode=0
 Guidelines for Licensing of Payments Banks, The Reserve Bank of India (November 27th, 2014) https://rbidocs.rbi.org.in/rdocs/Content/PDFs/PAYMENT271114.pdf
 Preeti Motiani, Payments bank deposit limit hiked to Rs 2 lakh by RBI, (Apr 07, 2021) https://economictimes.indiatimes.com/wealth/save/payments-bank-deposit-limit-hiked-to-rs-2-lakh-by-rbi/articleshow/81945184.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
 Guidelines for Licensing of Payments Banks, The Reserve Bank of India (November 27th, 2014) https://rbidocs.rbi.org.in/rdocs/Content/PDFs/PAYMENT271114.pdf
 Gupta, Saloni, Payment Banks: Bare Essential Banking for Most Essential Goal of Banking Inclusion, Indian Journal of Applied Research 5.11,(2016).
 Websites of Banks in India, the Reserve Bank of India, https://rbi.org.in/scripts/banklinks.aspx