Payments banks and small finance banks – Differences, Conversion and Need in the Economy

Payments banks and small finance banks

In the last few months, the Indian economy has witnessed several changes in the ways payments can be being processed online. While net banking, debit cards, and NEFT-RTGS have been secure and safe ways of money transfer, some novel types of payment mechanisms have sprouted such as Airtel Money which is a payment bank, Paytm payments, Amazon wallet, etc. There have also been several small finance Banks that have come up such as Ujjivan Bank and the Janalakshmi Small Finance Bank. RBI has recently released several rules specifying conditions such as minimum capital requirement, conversion, and operational limitations for both Payments Banks and Small Finance Banks. In this post, we highlight how the two are different from each other while also enumerating essential differences, conversion, and the need for these two different financial institutions in the Indian economy. 

What is a Payments Bank and how is it different from a traditional bank? 

Based on the recommendations of the Nachiket Mor committee in 2014, the reserve bank of India sought to promote payments for small businesses and lower-income groups, in order to achieve financial inclusion and increased access to financial services. A payment bank, therefore, is the simpler version of what a regular bank does, in the sense that it can accept deposits and make payments but cannot advance loans. Following are the services that a Payments Bank is entitled to provide – 

  • Accepting deposits from customers 
  • Making payments
  • It can also offer internet banking, sell mutual funds, insurance, pensions
  • It offers attractive bill payment services for customers 
  • The payment banks are also allowed to have their own ATMs and function as a business correspondent of another bank. 

What is a small finance bank?

The basic objective behind setting up of small finance banks is to provide banking services to underserved and unserved sections of the society, as setting up of small banks in unbanked regions is often considered simpler than a large bank’s branch. The Reserve Bank of India has envisaged a small finance bank to be either state-owned or private, supplying credit to micro, small and medium industries, marginal farmers, unorganized sector entities, and providing a saving platform to small investors. While there is no restriction in the area of operation of small finance banks, they cannot extend large loans, float subsidiaries, or deal with sophisticated financial products. A small finance bank is even allowed to sell foreign currency to customers, undertake mutual funds, insurance pension, etc. It can also expand its area of serving and also convert into a full-fledged bank. 

Conditions for setting up a small finance bank – How individuals can set up their own small finance banks 

  • A small finance bank is allowed to undertake basic banking activities of deposit and lending to a certain specified sector as mentioned above. 
  • The eligible candidates for setting up a small finance bank have to be resident individuals including professionals with 10 years of experience in banking and finance. 
  • A company or society owned by residents, differential niche banks such as existing payment banks or local area banks or micro finance institutions that are owned and controlled by residents can also set up a small finance bank. 
  • The minimum paid up capital for small finance banks shall be 200 crores. 
  • At least one-fourth of the banking outlets have to compulsorily be opened in unbanked rural centres. 
  • Moreover, the bank is required to extend 75% of its net bank credit for priority sector lending as specified by the government. 
  • At least 50% of the loan portfolio has to constitute loans and advances below 25 lakhs.
  •  Another restrictive condition is that shareholding by promoters has to be brought down to below 40% if it is in excess, within a period of five years. Small finance banks are also subject to cash reserve ratio and statutory liquidity ratio specified by the RBI. 

Conversion of Payments Bank into Small Finance Bank 

The advantage of conversion of a payments bank into a small finance bank is the automatic grant of scheduled bank status as soon as a small finance bank is made. Moreover, restrictions conditions that are imposed on payments bank such as the prohibition on offering of credit card services, an extension of loans, handling cross border transfer of money or acceptance of NRI deposits are instantly lifted as soon as payments bank is converted into a small finance bank. A payment bank can also apply for conversion into a small finance bank after five years of operation and meet all the other guidelines for eligibility of small finance banks. 

The India Posts Payments Bank – delivering banking services to the last mile

The India Posts Payments Bank (IPPB) is a fully owned government company, which will now function as a small finance bank. The novelty of the IPPB lies in its linkages to rural India, the simplicity of operations and provision of citizen centric services such as banking, direct benefit transfer, insurance and payments to the 22 Crore Jan Dhan account holders in rural India. 

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