India's banking revolution started without the banks

By Andy Mukherjee

No deposit-taking institution in the world is trusted more by savers and enjoys bigger cachet with investors than HDFC Bank Ltd. What this plenitude has done to India’s most valuable lender is make it so lethargic — literally, with its digital services suffering repeated tech outages — that it had to be banned from issuing new credit cards for eight months. But a regulatory slap on the wrist is no durable solution. Bank licenses are permits to make money out of thin air. The prospect of sharing the privilege with a new breed of digital rivals will be more effective at keeping HDFC Bank and other traditional financiers on their toes.

On valuation metrics, HDFC Bank’s price-to-book multiple of four is way ahead of much bigger lenders in China, the US, Japan, Australia, Europe, Singapore and Hong Kong. Some Indonesian, Middle Eastern and South Korean peers, and even a couple of Indian rivals including the Mumbai-based Kotak Mahindra Bank Ltd., are more expensive on a per-share basis, but none can boast HDFC Bank’s $189 billion deposit base.

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And yet, such is the inertia inherited by new Chief Executive Officer Sashidhar Jagdishan that he had to thank the regulator for the ban on credit-card issuance and new digital initiatives. “This rap has opened our eyes to the world of possibilities,” he told employees in August, as the restrictions were being eased. But instead of patting itself on the back for waking the sluggish lender, the Reserve Bank of India should ask why it has to do the market’s job of pushing firms to embrace best-in-class technology.

The country’s licensing policy for financial institutions is past its sell-by date. Innovative solutions are out there but require regulation.

New technologies are reshaping the financing landscape. From nothing five years ago, Indians now pay and receive Rs 7.7 lakh crore ($102 billion) a month via apps running over a shared public utility. Soon 440 million owners of cheaper feature phones will be able to conduct cashless transactions. But because innovation originated in payments, financiers didn’t pay attention. As Uday Kotak, chairman of Kotak Mahindra Bank, said recently in a speech, “Bankers were short-sighted. Their standard response was, ‘Oh, there’s no money in payments.’”

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But there is now. About 20 per cent of online payments over the shared public network are being collected by merchants. They’re shunning costly credit-card systems, but are keen to use their online sales data as information collateral to get working-capital loans. Fintech players seized this chance, with deposit-taking institutions passively supplying the funds. “The principal beast of burden for credit delivery and issuance of demand deposits, i.e. the incumbent bank, has remained undisrupted,” says NITI Aayog, the government's think tank.

That needs to change. The NITI discussion paper on digital banks argues that the funding cost of India’s top nonbank consumer lender last year was more than 7 per cent, while it was less than 4 per cent for a well-capitalized bank. Why not license internet-only banks to take advantage of low-cost deposits, too, especially if they can use technology to fill $400 billion in unmet credit needs of small business owners?

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If banks keep squatting on their entitlements, customers will up and leave. Walmart Inc.’s PhonePe app moves 47 per cent of online money in India, while homegrown Paytm has a 10 per cent share. Alphabet Inc.’s Google Pay, which controls 37 per cent of the market, is using its search expertise to influence customers’ choice of bank deposits. HDFC Bank and its bigger state-owned rival State Bank of India still have a stranglehold on savings. So they’re the top remitters by default in phone payments. However, when it comes to receiving money, the leader is Paytm Payments Bank. It’s a narrow bank with a limit on deposits per customer. It can neither make loans, nor issue credit cards, though it has finally got access to the central bank’s emergency liquidity window.

Not allowed to function as a proper bank, Paytm hawks credit for others. Last quarter, third-party loans disbursed by the unprofitable fintech jumped six-fold from a year earlier. Still, the Paytm stock is languishing 27 per cent below its recent initial public offering price. Instead of earning fees by creating $1 billion in yearly credit opportunities for partners like HDFC Bank, the app may be more valuable as a digital bank, lending on its own.

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A licensing regime that has fallen behind technological innovation has caused a regulatory vacuum. An RBI working group estimates the number of illegal digital lending apps in India at 600. Many of them “are collecting users’ entire phone contacts, media, gallery, etc.” and using that information “to harass borrowers and their contacts,” the group said.

The outmoded licensing regime in India needs to be brought up to date with digitization trends in the broader economy. It’ll force traditional players to shed their lethargy, and show a a more certain path to profitability to well-capitalized fintech. Small businesses will get cheaper credit, and savers won’t be left at the mercy of blackmailers masquerading as lending apps.

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