The recent budget proposal seeks to incentivise digital transactions by reducing Merchant Discount Rate (MDR) for customers as well as merchants.
What was the Budget announcement?
The business establishments with annual turnover more than 50 crore shall offer such low cost digital modes of payment to their customers and no charges or MDR shall be imposed on customers as well as merchants.
In other words, the government has mandated that neither the customers nor the merchants will have to pay the so-called Merchant Discount Rate (or MDR) while transacting digital payments.
It is good news for both customers and merchants because their costs of digital payments come down.
Merchant Discount Rate
Merchant Discount Rate (alternatively referred to as the Transaction Discount Rate or TDR) is the sum total of all the charges and taxes that a digital payment entails.
Simply put, it is a charge to a merchant by a bank for accepting payment from their customers in credit and debit cards every time a card gets swiped in their stores.
Similarly, MDR also includes the processing charges that a payments aggregator has to pay to online or mobile wallets or indeed to banks for their service.
Who will bear the MDR costs?
If customers don’t pay and merchants don’t pay, some entity has to pay for the MDR costs.
In her speech, the FM has said that RBI and Banks will absorb these costs from the savings that will accrue to them on account of handling less cash as people move to these digital modes of payment.
Necessary amendments are being made in the Income Tax Act and the Payments and Settlement Systems Act, 2007 to give effect to these provisions.
Contrary to public perception, the MDR has not been made zero.
The FM’s decision has just shifted its incidence on to the RBI and banks.
However, if banks pay for the MDR it will adversely their likelihood to adopt the digital payments architecture.
Moreover, many payments providers apprehend that the banks will find a way of passing on the costs to them.
In turn, this will negatively impact the health of a sector that needs nurturing.
Mains Paper 3: Economy | Mobilization of resources
From UPSC perspective, the following things are important:
Prelims level: Payment and Settlement Systems Act, 2007
Mains level: RBI’s role in financial sector regulation and how the proposal of a new regulator to oversee payments banks will affect it
RBI’s opposition to the proposal for a new payments regulator
The Reserve Bank of India released its dissent note to clearly signal that it was opposed to an independent regulatory body to supervise India’s payments and settlements architecture and to move it out of the central bank
This reform was proposed by an inter-ministerial committee headed by the Secretary, Department of Economic Affairs for the finalisation of amendments to the Payment and Settlement Systems Act, 2007
The central bank observed that it would prefer the Payments Regulatory Board to function under the purview of the RBI Governor
The RBI stated that the activities of payments banks come well within the purview of the traditional banking system, which the central bank oversees as the overarching financial regulator
It might make better sense to have the RBI oversee the activities of payments banks as well instead of creating a brand new regulator for the growing industry
Since banks are regulated by it, a holistic oversight by the central bank would be far more effective besides ensuring lower compliance costs
RBI has experience of having regulated this segment over the last several years, marked by competition, innovation and customer protection measures, which are the main objectives under the proposed new law
There was no case for a separate regulator for payments and settlements given that there is no evidence of any inefficiency in India’s payments systems
Globally, the country was gaining recognition as a leader in payments systems with some other central banks having adopted the bank’s systems
The payments and settlements systems, according to it, are a sub-sect of currency which is regulated by the RBI and the impact of monetary policy provides support for the regulation of payments systems
Global financial infrastructure landscape
The US Federal Reserve’s Board and the dozen Federal Reserve Banks around that country have a distinct responsibility with regard to the payments system
So is the case in Australia and Canada and some other jurisdictions — with such arrangements having been put in place to support the implementation of monetary policy
There is the real risk that a brand new regulator may be unable to match the expertise of the RBI in carrying out necessary regulatory duties
At a time when there are increasing risks to the stability of the domestic financial system, both the government and the RBI must look to work together to tackle these risks instead of battling over regulatory powers
Mains Paper 3: Economy | Inclusive growth & issues arising from it.
From UPSC perspective, the following things are important:
Prelims level: IPPB
Mains level: A new era of banking via payment banks and challenges faced by them
Launch of IPPB
Amidst some fanfare, PM Modi launched the India Post Payments Bank (IPPB), a financial service provider that will operate under the country’s age-old postal department
The primary rationale behind the public payments bank idea is to help in the government’s goal of achieving financial inclusion by providing savings, remittance, and payments services to the rural and unorganised sectors of the economy
It is also hoped that the payments bank idea will help reinvigorate the postal system, which has a wide network of branches across India
All the 155,000 post offices in the country are expected to be linked to the IPPB system as early as in December this year
Services that will be provided by payments bank
The government-owned payments bank will be able to accept deposits of up to ₹1 lakh from customers but without the rights to use these funds to advance risky loans at higher interest rates
It plans to offer a variety of other financial services to people
The payments bank will also have a digital platform that is expected to make financial services more accessible even from remote locations
Challenges in its operation
A big challenge facing the new public payments bank is whether it can manage to earn the profits required to survive as a standalone business entity
Given the severe restrictions imposed by the Reserve Bank of India on how payments banks, in general, can employ their funds, the odds seem to be stacked against the IPPB at the moment
The IPPB promises to pay an interest rate of 4% to its savings account customers
To generate revenues, it plans to charge fees on money transfers and other financial services while investing idle customer deposits in safe government securities in order to earn interest
The IPPB is also likely to face stiff competition from private companies, which are generally more nimble in adapting to business realities and far more customer-friendly compared to the government-owned behemoths
With increasing competition, the IPPB’s revenues and margins are also likely to come under pressure
Banks have traditionally stayed away from the business of pure deposit banking unless customers have been willing to pay for these services
The payments bank model is still untested even though prominent private companies such as Airtel and Paytm have shown interest in the space
The new payments bank could usher in a new era of rapid financial inclusion across rural India
Accelerating the penetration of financial services among low-income consumers by leveraging technology and the large, non-banking retail network without compromising the security of the financial sector.
With the Reserve Bank of India (RBI)’s in-principle approval to 11 payments banks, India has taken one big step forward on the road laid out seven years ago.
Challenges, if any?
A recent Consultative Group to Assist the Poor report titled Doing Digital Finance Right concluded that low-income consumers are hesitant to adopt digital modes for financial transactions due to:
Inability to transact due to network/service downtime
Insufficient agent liquidity or float, which also affects ability to transact
User interfaces that many find complex and confusing
Payment Banks are the new stripped-down type of banks, which are expected to reach customers mainly through their mobile phones rather than traditional bank branches. They are expected to increase the financial inclusion in the country by providing banking services to the people who are currently out of the reach of banking services.
The goal behind creating these payment banks is to bring about financial inclusion, by making it easier for anyone to get a bank account. That’s also why the cash limit in the accounts is set to just Rs. 1 lakh.
The Reserve Bank expects payment banks to target India’s migrant labourers, low-income households and small businesses, offering savings accounts and remittance services with a low transaction cost.
These banks will enable poorer citizens who transact only in cash to take their first step into formal banking. The innovation is also expected to accelerate India’s journey into a cashless economy.
How will these banks will survive, when they cannot lend?
The questions are being raised as to how these new banks will be able to survive in absence of income from lending.
The payments banks are expected to bring in to their fold millions of customers who are currently not within the fold of the formal financial system. This would lead to large volumes of transactions fetching the payments banks fees – a charge of even 1 or 2 per cent on a large volume can be lucrative on normal cash transfers, which will include government’s direct benefits transfer programmes.
Moreover, new payments banks can also earn 7.0% or so on their investments in government securities.
With no need for any provisions or losses on NPAs for these payment banks, they may become fitter banks than existing banks.
How can we make Payment Banks viable?
Payment Banks will need to be more like these innovative consumer products businesses (particularly digital businesses).
Digital technology, coupled with a rigorous approach to user interface/user experience and an asset-light strategy, making good use of cloud-based services, will play an important role in enabling Payment Banks to develop simple solutions and acquire customers at low marginal cost.
The success of payment banks will depend on low-cost technology and high volume of transactions so that charges are reasonable and yet, profits are made.
If the model is to be a success, a payment bank should neither offer fixed-deposit products nor savings bank accounts.
Payment banks should offer small-ticket loan products because these products are required in rural areas, as these will discourage borrowers from approaching local moneylenders.
If payments banks aren’t mandated to have a capital adequacy ratio, it will provide them relief.
RBI should also reconsider an entry capital of Rs 100 crore for smaller banks, since such low entry-capital requirement may let non-serious players to throw their hat in the ring. This will also help weed out non-serious players from the bank licence fray.
The concept of new payments bank is compelling as it opens another route for inclusive banking. While time will tell how successful this model will be in incremental terms, the RBI on its part has given permission to probably the best players who are capable of making this a reality.