But the devil, as always, is in the details. Once people start detailing the process of eliminating the reams of paperwork that hang around bankers’ necks like a regulatory albatross, the initial enthusiasm for a digital-only banking model might fade a bit.
The intention here, however, is not to discuss the pitfalls of a digital-only banking model, but to address a more fundamental question of how to slice and dice banking licenses to create a safer and more secure banking system. more resilient. Digital banks will be, at best, only a subset of these bespoke banks.
Let’s first take a step back and look at the history of banking licensing in independent India. For a long time, India has followed uni-flavor banking. All of the banks listed were licensed as commercial banks, but labeled as different flavors of vanilla based on their ownership and pedigree.
So we had nationalized banks, private sector banks and foreign banks. When new banks were added in the 1990s as part of economic liberalization, they were affectionately referred to as “new generation” private sector banks to distinguish them from their older cousins. The first effort to issue specialized licenses may have started with the Regional Rural Banks (RRBs) in the 1970s, prompted by Indira Gandhi’s slogan “Garibi hatao”.
Then, in 1991, the Narasimham Committee recommended reorganizing the banking sector into global banks, national banks, and local and regional banks. However, these proposals remained largely on paper until last year when the government attempted to merge the Public Sector Banks (PSBs) into something vaguely similar to what Narasimham might have had in mind.
Unfortunately, at that time, most PSBs were in such bad shape that instead of merging banks with complementary strengths and synergies as originally planned, they ended up merging banks with bearable weaknesses. Meanwhile, the government has also introduced the Local Banks (LAB) proposal, a hazy and overly optimistic idea at best. A few LABs settled in, but quickly faded away due to innate infirmities in the base percept.
Finally, a few years ago, two other types of banks were introduced: payment banks and small financial banks (SFBs). While most payment banks have already slipped off the radar, most SFBs are also struggling to make their mark despite their alleged domain expertise and lack of historical baggage.
All of this leads us to an irrefutable inference: that specialist banking licenses have repeatedly failed to work in India despite the best of intentions. The fact is that, until now, the distribution of banking licenses has been based on the asset side of the balance sheet, or the geographical area of operations. This approach has benefited neither the banks nor their customers.
It’s time we started thinking about licensing banks based on the twin questions: first, where is the money going to come from? Second, what are we going to do with this money? Ideally, we should have four types of banks: first, those that operate solely in the retail space – that is, accept deposits from individuals and provide loans to individuals. Second, those who are pure wholesale players where no retail deposits are taken or retail loans granted.
Three full-fledged commercial banks (universal banks) and four banking conglomerates – those which, in addition to commercial banking, are active in investment banking, capital markets, project finance, etc., directly or through through subsidiaries. Banks should be licensed and regulated differently depending on which of the above four categories they belong to.
Capital requirements as well as liquidity and reserve requirements should also change accordingly. Those who operate retail deposits may be asked to keep less cash reserves but more capital reserves. However, those using wholesale funding should retain more cash, while capital requirements can be moderate. In short, where the money comes from should be the first determinant of differential regulation, and how it is deployed should be next.
As for digital banks, they can be a subset of retail banks to begin with, and move into universal banking as the ecosystem evolves. But in the eyes of the regulator, they should only be one of the four categories listed above, regardless of the channel(s) they choose to use or avoid to connect with their customers.