Will payments banks help foster financial inclusion?

Unlike jurisdictions such as Singapore, India did not (until very recently) have differentiated licensing for banks, i.e. granting licences for conducting a specific line of banking business. The prevalence of universal banking licences coupled with the burden of fulfilling increasingly stringent prudential norms meant that banks that received licences rarely ventured outside Indian cities which were their main profit centres. Consequently, the avowed goal of successive central governments to make basic banking services available to all citizens was not fulfilled.

While the Reserve Bank of India (RBI) tried to work around this roadblock through means like allowing banks to use business correspondents, linking branch expansion to the opening of branches in lesser banked areas, and offering incentives for priority-sector lending, the lack of commercial viability meant that millions of Indian citizens in rural and lesser banked areas did not have access to basic banking services. Government initiatives such as requiring public sector banks to take an active role in lesser banked areas too had limited success.

The lack of access to basic banking services became glaring when the government tried to move away from the subsidy model towards the direct cash benefit model, in which the subsidy recipient’s account would be credited with the amount of the subsidy enabling them to purchase goods like kerosene at non-subsidized rates. While the direct cash benefit model would have helped India’s woeful balance of payments situation, its implementation required subsidy recipients to have access to low or zero balance accounts. The lack of basic banking services for most subsidy recipients meant that the direct cash benefit model could not be fully implemented.

Sawant Singh is a partner and Aditya Bhargava is a principal associate at the Mumbai office of Phoenix Legal.