Not everybody who asks for credit should get credit: Nachiket Mor

Nachiket Mor, 49, member of the central board of the Reserve Bank of India, headed the committee on comprehensive financial services for small businesses and low income households. The committee's report has suggested setting up a new kind of bank called 'Payment Banks' to foster financial inclusion, which would make payments but would be barred from lending. Mor, whose name is also doing the rounds as a possible deputy governor of the RBI, spoke to Anand Adhikari. Edited excerpts:

Q. When you were deputy managing director  of ICICI Bank, private sector banks came out with an innovative idea of  a franchisee model to  reach out  to rural and semi-urban areas. Is the Payment Bank suggestion in your report on the same lines?

A. We have actually referred to the ICICI Bank model in our report. It was a good lending model. That model ran into trouble with the RBI because of the outsourcing guidelines. The outsourcing guidelines say every lending proposal has to be examined by the bank itself. So when you use a third party agent, then this becomes a problem. In our report, we have recommended that this needs to be re-examined.  The bank should internally take a view on whether the person sitting at headquarters decides or or the people who are closer to the customer. It is always better to rely on people at the grassroots level. What is upsetting today is that many people don't even have basic bank accounts.

Q. Currently, some NBFCs  such as Mahindra Finance or a Shriram Transport  are doing good job in the rural semi-urban areas. Why not turn them into banks instead of creating a new structure?

A. Our view in the report is that while the  banks  will certainly do  financial inclusion, there are other entities like those you mentioned - which are not necessarily banks - doing interesting work. How can they be encouraged in a way that ensures that even if they grow to a big size , we don't get concerned about their stability or systematic risk?  There should be a clean model.

Q. Among the applicants for new banking licences are micro-finance institutions, a remittances player in the semi-urban and rural areas,  and also India Post. Aren't such entities in a better position to achieve financial inclusion if given licences?

A. I cannot  talk about banking licences as I'm also a member of the committee (that is deciding on them).  But why not,  if there are players who are interested ? India is a vast country. There are already NBFCs (Mahindra Finance  or Shriram Transport) fully engaged in this work.  They don't do anything else. Of course , it is a separate discussion - whether they should get a full banking licence or not.  What we  have recommended in the financial inclusion report is that such a route has to be a deliberate and slow process. We cannot hand over full service licences to everybody just like that. Whereas to call somebody a Wholesale Bank or a Payments Bank is much easier . The big risk in banking comes from 'When you take retail deposits and lend them'. The 'and' is a very important issue. There is not much risk if you just take retail deposits but don't lend.  This is what we have recommended. The Payment Banks will only accept deposits. Similarly, a Wholesale Bank will take only wholesale deposits (not retail money ) and lend money.

Q. One of the recommendations of the committee is bank accounts for all by 2016. Many say opening bank account is the easier part. Creating the infrastructure for all these accounts, like payment banks, is difficult.

A. May be it is easier, but it has not happened. Today, only 35 per cent of people in the country have bank accounts. Most people including in urban areas  don't have basic banking. Take for example , the maids in urban areas. They are not welcome in the banks. There are a variety of issues. Today, we have a good opportunity because of technology and the mobile revolution (to increase financial inclusion). There are one billion mobile connections.  Even if you keep aside aadhaar, there are 700 million unique mobile connections. If you gave these mobile phone subsidiaries banking licences as Payment Banks , in a two week time frame, you could end up with all these people having bank accounts. One of the reasons we set so aggressive a deadline as 2016 is to send the signal that either you do it in two days or in  60 years by the branch model (opening full fledged bank branches). There is no third alternative.  You cannot take four years.

But credit ( lending ) is clearly important.  As a banker, I must tell you that you have to go slowly.  You cannot move too fast on the credit side. Not everybody needs credit and not everybody who asks for credit should get credit.  I'm an old style bankers who thinks that credit has to be handled much more carefully. You have to carefully evaluate the credit requirements. We have to live with a slow experience ( on the credit side).  It should be faster than it is today. But it should not be as fast as (deposits).

Q. Historically, we have seen PSU banks losing money in semi-urban and rural  areas. Do you call it a 'slow process' because of the difficulties in lending in such geographies?

A. I do not want to single out any category of banks. The reality is that the lending is a hard business whether it is urban, semi urban, rural or corporate. Giving money is easy, collection is the hard part.  Everywhere and for everyone, whether it is a public or a private bank, lending is a difficult business. The committee has taken a view that the first order of business is to reach payments ( deposits) and banking out to everybody. The entire population should have bank accounts. People may not be able to borrow or may not need to borrow , but they should be able to move money. The recommendations we  have made are (to achieve this) by using the infrastructure of mobile phone companies  and  local kirana stores. We also believe that in the medium term, people should be able to stop using cash.

On the credit side, I would say we have multiple vehicles. In some pockets, PSU banks are doing quite well. They understand agriculture much better than other sectors. In rural areas, they have a presence. They command respect, locally.  Certainly, all the NBFCs including the MFIs have a role to play. One of the reasons we recommended that some entities should be given wholesale banking licences is to allow them to do credit. Maybe we are not  confident enough today to allow them ( wholesale banks ) to mobilize retail deposits, but they are free to  raise wholesale deposits and  lend in the market. This  will allow them to grow faster, make them stronger institutions and as a system we will also be well secured.

Q. Do you want banks to create an entirely new infrastructure by creating a new subsidiary for payments bank?

A. If they want to. If the banks are confident of doing it within the current structure , they can do that.  But if a bank feels that for this business , it needs a separate operation, it is free to set up a subsidiary. Generally, our  belief is that the issue - whether a bank chooses to do with the current structure or as a separate subsidiary - should be left to the bank.  We today have the capabilities to consolidate supervision. We don't need to be bound by legal boundaries.  But legal boundaries allow you to have different compensation structures, different operating and  different  management styles, which you cannot have within the same legal structure.

Q. So  the committee is not suggesting creating a new infrastructure to achieve financial inclusion?

A. For payments,  the infrastructure is all there.  The kirana stores , mobile phone re-charge  outlets, etc.  The mobile SMS  facility already exists. You can actually do banking if you can accept and send an SMS.

Q. Will there be a need to change regulations if you allow 'cash out facility' for pre-paid mobile companies?

A. Airtel is a prepaid provider. Our understanding is that if you allow cash out, the money you give Airtel Money becomes a deposit under the Deposit Regulations  Act.  Legally, there is no way to say it is not a deposit. So one alternative is to say don't allow cash out. The other way , which we are backing, is to call them Payment Banks. Today,  Airtel Money  is already a new company.  So instead of calling it Airtel Money Pvt Ltd , they will call it Airtel Money Bank Ltd. The entity will transform into a  Payment Bank.  The interest on deposits will be at the discretion with the mobile based Payment Bank. But these payment banks cannot lend money. Whatever they have to accept as deposits will be parked in government securities. In fact , there is no change needed either in the banking regulations or telecom regulations. All these entities need is to be given banking licences with a letter on top saying that you cannot lend money.

Q. The committee report also talked about Post offices as Payment Banks. India Post has also applied for a full scale bankingc. Your comments?

A. I would not like to comment on India Post as I'm also part of the screening committee on new licences. Globally, post offices have functioned very well as payment banks.  If you look at the South Korean postal system, it operates as a full service payment bank.  It does not lend money. It offers basic services.

Q. Don't people in rural and semi-urban areas need full scale banking services?  Two of the committee members have talked about the need for full scale banking services.

A. Ideally, a customer needs all the services. There is no dispute about it. It is also true that all people do not need to borrow money. But all the people today need a bank account.  Even for a child, there is value in opening a bank account.

On the credit what we are saying is that customers should ideally be able to do both payments and credits.  But it is not obvious to us that every banking institution must be required to offer both. And only if they offer both, should they be allowed to expand? Today, we don't bank with a single bank but have multiple relationships. That seems like the most efficient model because not every bank will have the product you want. We have found and documented in the report that there is already enough infrastructure for credit in the country. In fact, we wanted to recommend that the RBI should not insist on the rural branching requirement for banks. Frankly, it seems there are enough branches. Our view is that there are enough full service branches.  Today, what you need is payments next to your door. In urban India, there is enough of it, but in rural areas, it is simply missing. You need more effective lending infrastructure.  It is not about having branches. The existing structure is not able to actually lend effectively. That needs a very different approach. There are some NBFCs, which are doing it differently or approaching it differently.  It needs a new credit technology. Today, just having a branch is not enough. You need motivated people, and a deeper understanding of how credit works.

Q. Today ,many banks sell tractor loan products as five to seven year loans for use in agriculture. But there are also NBFCs , which have been selling two to three year tractor loan products for use on roads  and other infrastructure projects. What about customized or flexible products in the rural market?

A. The way we respond to it is to say allow more players into the banking system, especially Wholesale Banks.  This will encourage new innovators to come in. We are also not waiting for one type of institution to innovate. No regulator will tell you to be innovative. It is up to the banks.  Our recommendations are to allow a greater variety of players into the system. Product innovations will follow.

Q. Do you think Payments Banks will have enough of a profit margin by parking their money in government securities?

A. You should talk to the players. Take for example, Airtel Money. Today it doesn't even have that facility.  It does not earn money on escrow accounts.  But it is still a viable model.  If you try to set up a Payment Bank on its own and build a structure, we know for sure that just doing payments you will not make enough money. We have seen that in the business correspondent model. You have to combine that with some other business.  The whole idea of the payments bank is that 'players who are already into some other business' should become payment banks as well.  The mobile re-charge operator infrastructure is a good example.  The infrastructure is fully deployed in the mobile space. The Payment Bank will give them additional business.

Q. The current electronic payment system is also not responding to market needs. PSU banks today issue 80 per cent of debit cards, but when it comes to creating point of sales (POS ) infrastructure, private banks dominate?

A. Banks tend to innovate a lot on the credit side.  They are not quite as innovative on the payments side.  In the case of non -banks, they tend to be very innovative on the payment side or the transaction side. Mobile money operators or players like Oxycash, for example, are transactions space players. They don't actually make money when you keep deposits with them. They make money because they have high volumes, low costs and they charge a small transaction fee. Our belief is: that is what makes payment business a success. Payment banks branches will not work.

Q. Shouldn't we be strengthening the existing infrastructure, especially the regional rural banks (RRBs) and co-operative banks, to achieve financial inclusion?

A. In the report, we have spent a lot of time discussing these models. We argue that they actually have a lot of strengths.  We studied the US  and German models. In creating a bank, there are two problems - governance and structural risks. Banking is a very high leveraged play (as it functions on borrowed capital).  You have to be very careful about governance. But the sense we have is that we have made good progress in our RRBs and the cooperative sector.  There is another challenge in the regional banks, which we call structural risk. The bank can avoid structural risks if these can be covered by way of catastrophic risk. We are of the view that we should not give new licences until between NABARD and RBI , we figure out how to help these institutions manage these risks. We want more tools for them. Securitization is needed. More catastrophic insurance is needed.

Q. What is the next step if the RBI accept your report in full?

A. The actions to be taken are very few. What will take time is the debate and the discussions. Once recommendations are clearly understood, the implementation is a trivial matter. There is no nod from any other higher authority yet. We wrote the recommendations keeping that in mind.

Q. Do you think it is  time to rewrite the RBI Act or change many of the banking practices we have been following for the past many decades?

A. I would say one should see  the work of the financial legislative reforms committee (FLRC). It is not a good idea, in my view at least,  to do piecemeal work.  I think the Banking Regulations Act 1932  has enough flexibility to do all that we recommended. No act needs to be changed. But is it also true that there is  value to rewriting  all the legislation using the design principle laid out by FLRC. It is better to stay with the current act and then do what is needed immediately. Once there is a clarity on the work of  the FLRC, go for it.

Q. Even the Srikrishan Report on FLRC talked about achieving financial inclusion by incentivizing the existing system?

A. The general argument is that the role of the regulator is not to force institutions to do anything. A lot of this should be done through incentives. The best incentive is competitive pressure. It's not necessarily financial incentive.  Why did mobile phone companies go to rural areas? It is not because they were given financial incentives. There was no choice because urban got saturated. Today, you can buy a Wipro bulb in the remotest areas of the country.  The view of Srikrishan commission is to create competitive situation in market.

Q. Some of the experts have branded your report as 'ambitious' , 'academic' , 'impractical' etc.
A. Ultimately, what matters is the RBI view. Of course, RBI will look at it very carefully. It is not going to recommend the report just because a RBI appointed committee suggested the change. If RBI is convinced, it will implement it.