Niti Aayog discusses Full Battery Digital Banks in India to Close MSME Credit Gap; publish a discussion paper

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The document offers a roadmap for these full-stack digital banks as well as standards for their licensing and regulatory regime in the country. (image: Pixabay)

Credit and financing for MSMEs: Niti Aayog on Wednesday released a discussion paper to present new financial entities called “digital banks” that would fundamentally aim to bridge the current credit gap for Indian MSMEs and bring them into the formal financial fold. The document entitled Digital Banks: A Proposal for Licensing & Regulatory Regime for India posted on Niti Aayog’s website and seeking comments until December 31, 2021, offers a roadmap for these full-stack digital banks as well as standards. regarding their licensing and regulatory regime in the country.

“These entities (digital banks) will issue deposits, grant loans and provide the full range of services authorized by the Banking Regulation Act, 1949. As the name suggests, however, DBs will rely primarily on the Internet and other nearby channels to offer their services and not on physical branches, ”according to the discussion paper. However, these banks will be subject to prudential and liquidity standards comparable to those of historical commercial banks.

According to IFC estimates, the total addressable credit deficit in the MSME segment is Rs 25.8 trillion, with a CAGR of 37%. The total addressable market demand by the MSME sector is around Rs 37 trillion, of which banks, other institutions and NBFCs provide around Rs 10.9 trillion.

“Digital banks will expand banking and reduce overhead costs. It will appeal more to technology enthusiasts on the deposit side. For loans, they will also compete with financial technology companies. The two distinguishing factors will be the cost of the loan and the speed or timeframe for borrowers, ”Madan Sabnavis, chief economist, Care Ratings, told Financial Express Online.

The need for separate digital banks stems from the fact that “incumbent commercial banks have inefficient business models, as evidenced by the high cost to revenue and the high cost to serve numbers,” the newspaper added.

While the existing neobanks, which also rely primarily on digital channels, are a potentially effective channel through which policymakers can achieve social goals such as empowering small businesses that have so far been underbanked and Building confidence among retail consumers they’ve found a balance between growth and profitability is a challenge, according to the newspaper. By comparison, their digital banks “seem to have found the secret sauce for profitability.”

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“With traditional banks barely reaching 15% of MSMEs in India, a large portion of small businesses remain outside the banking network. Digital banks bring hope to unbanked MSMEs, especially in rural areas, ”Anil Bhardwaj, secretary general of the Federation of Indian Micro and Small and Medium Enterprises, told Financial Express Online.

In addition, estimates indicate that digital banks have high profitability. For example, Chinese digital bank Webank incurs an operating cost per account of $ 0.5. This can be up to 10 to 20 times higher than traditional banks. In the Indian context, a 2019 FIBAC annual report estimated the cost-to-income ratio of the banking sector at around 50%, the discussion paper added. On the other hand, while private banks run a more efficient operation compared to their peers, they still have a cost-to-income ratio of 43 percent.

“These ratios reduce their reach by excluding micro and small businesses and small note credit from their reach. Digital banks are promising because their business model can organically reduce the costs of servicing and acquiring customers, thus giving them the necessary margin to extend the coverage that the commercial bank in place, ”reads Niti Aayog’s journal. .

“The idea of ​​a full-battery digital bank is a timely innovation for MSMEs, given the recent digital penetration during Covid. In addition, the behavior of MSMEs has also changed in the acceptability of digital techniques and the need for more credit. However, this innovation will also require the creation of enterprise ecosystems to achieve success, as finance is only one ingredient for MSME success, ”Shashank Tripathi, Partner, PwC India told Financial Express Online.

To enable a DB licensing and regulatory regime for India, the document states that infrastructure enablers such as a national identifier, credit information architecture, real-time payment protocol such as UPI and an emerging open banking regulatory framework known as account aggregators are already present.

“As a threshold problem, a two-step approach is recommended. Considering the important role of credit in the growth of the economy and the urgent need for public policies to close the credit gap of Rs 25 trillion in the MSME sector, it is recommended that the banking license of digital business is gradually introduced at stage 1 ”.

The licensing sequence would first involve the issuance of a restricted digital merchant bank license to the applicant and the license will be restricted in terms of volume / value of customers served; second, the licensee’s enrollment in a sandbox regulatory framework enacted by the RBI; and third, the issuance of a full digital merchant banking license following the licensee’s satisfactory performance in the regulatory sandbox.

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