i nc lu s i ve f i nanc e i nd i a re port 2014
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5.3 MAKING WAY FOR THE SMALL
TO BLOOM
As described earlier the report of the Raghuram Rajan
Committee made proposals for the setting up of private
sector small finance banks and bestowing appropriate
legal status to channels like telecom companies to become
regulated financial intermediaries as part of its suggestion
to restructure Indian banking system. As for small finance
banks, the committee recommended the establishment
of more of them ‘with the ability to provide both asset
and liability products to their clients’ (p. 60). According
to the assessment of the committee such banks have not
proven their viability in India historically because of poor
governance structures, excessive government and political
interference, and an unwillingness/inability of the regu-
lator to undertake prompt corrective action’ (p. 59). A
strong emphasis on good quality lending, low cost struc-
tures mediated by technology, effective governance and
management, and tight prudential norms, could help the
emergence of a competitive small bank sector to provide
financial services to the poor. Importantly, the commit-
tee did not look small banks as ends in themselves. They
could be ‘an important entry point into the banking
system from which some banks could grow into large
bank’ (p. 60).
The 2013 discussion paper of the RBI cited in the pre-
vious section reinforced the arguments in the Raghuram
Rajan Committee about small banks and re-emphasized
their undeniable role ‘in the supply of credit to small
business units, small farmers and other unorganized sec-
tor entities’ (p. 19). Small capital requirement, small scale
of operations, spatially limited and niche markets, simple
structure, low operational expenses, and the potential
for relationship banking were identified as the major
strengths of small banks, while
their vulnerability to con-
centration risk and local economic shocks were highlight-
ed as the major weaknesses. The paper concluded that
‘on balance … small banks do embody the potential for
furthering the cause of financial inclusion’ (p. 20). Again
the paper took the position that the specific risks on
account of the business model of small finance banks can
be overcome ‘by calibrating the prudential regulations’. It
was expected that these banks would be able to manage
their costs by exploiting communication technology and
by making use of the deregulated interest regime.
Most recently, the More Committee (2014) has
elaborately discussed the concept of differentiated
banking structure. The report presents two types of
differentiation in the banking system—horizontal and
vertical. In a horizontally differentiated banking system
design, the basic design element is of a full-service bank
that combines the three building blocks of payments,
deposits, and credit. It is differentiated primarily on the
dimension of size or geography or sectoral focus. In a
vertically differentiated design, the full-service bank is
replaced by banks that specialize in one or more of the
building blocks of payments, deposits, and credit. Most
banking systems will have a mix of both designs. Drawing
on the theoretical understanding of banking system,
the committee makes the recommendation for setting
up wholesale banks and payment banks in India under
the Banking Regulation Act (Table 5.1). Specifically,
the recommendations urged the regulator to facilitate
conversion of pre-paid instrument issuers to payments
banks and setting up of such banks as subsidiaries by
SCBs.
T
ABLE
5.1
Wholesale and Payment Banks: Comparison
Wholesale consumer
Payment bank
7
bank
6
Primary role
Lending;
Provide payment
can accept deposits services and deposit
larger than
products to small
Rs. 5 crore
businesses and low-
income households;
maximum allowed
balance per
customer Rs. 50,000
Minimum entry
Rs. 50 crore
Rs. 50 crore
capital requirement
Plausible relationship BC
Subsidiary
with full
service banks
Those who wholeheartedly appreciated the proposals
(PPIs, BC companies, NBFCs for instance) pointed
out that they have the potential to accelerate financial
inclusion by making it viable for the banks to devise
customized business models that suit the target
population. The introduction of payment banks, it is
argued, would eventually ‘move more savings into the
