How Payment Banks Are A Failed Experiment In Financial Inclusion In India

The recent regulatory action by the Reserve Bank of India (RBI) against Paytm Payments Bank, the digital lending division of fintech giant Paytm, has put the payment bank model in India under the spotlight. 

In 2015, the RBI had initially granted licences to 11 payment banks. However, after eight years, only five of them are still operational, with Paytm Payment Bank being the largest, with 300 million wallets and 30 million bank accounts, to cease its operations. The RBI formed an external advisory committee in 2015 to evaluate applicants for payment bank licences, with a particular focus on telecom companies because of their extensive reach.

“Telecom operators were given preferences as it was assumed that they already have a huge customer base, so it would be easier to onboard customers for the payment bank. But those who are the existing customers of the telecom service providers already have a functional bank account,” Sanjay Agarwal, senior director at rating agency CARE Ratings and head of BFSI, said.

India's payment bank model can be traced back to the success stories of similar ventures in Africa. The primary aim behind launching payment banks in India was to cater to the underbanked population. However, these payment banks faced stiff competition from various other financial products such as Unified Payments Interface (UPI), digital banking services provided by traditional banks, wallet services, and other digital banking solutions offered by fintech companies and non-banking financial institutions. As a result, it became increasingly challenging for Indian payment banks to expand their operations significantly and generate substantial profits.

Payments Bank In India Vs Other Countries 

India's payment bank model draws inspiration from its successful African counterparts, particularly in mobile banking. Sub-Saharan Africa leads in mobile banking globally, with M-PESA, launched in 2007 by telecom companies Vodafone and Safaricom in Kenya, pioneering the field. 

“Like African countries gave licences to the telecom operators for setting up payments banks, so did India. The idea was that the telecom operators already have a huge customer base and it would be convenient to on-board more customers for the payments banks. This model was a huge success in African countries, however, it didn’t work well for India,” Agarwal said. 

While M-Pesa Payment Bank was a success story of Africa’s digital payments ecosystem, M-Pesa Payment Bank in India shut down on July 15, 2019, a couple of years after its launch due to regulatory constraints and sectoral pressures.

In both India and African countries, the aim of launching payment banks was to cater to the underbanked population, yet the execution varied. The term "underbanked" refers to households with savings accounts but frequently using alternative financial services. Historically, in India, migrant workers, daily labourers, and vendors were significantly underbanked, relying mainly on cash for daily transactions. 

However, the introduction of UPI, especially after demonetisation, transformed this landscape. UPI reached grassroots levels, with local stores and auto drivers adopting it for transactions, leading to increased savings account usage. Payment banks further simplified remittance processes, allowing funds deposited via UPI to be transferred to other bank accounts easily. Paytm played a pioneering role in this field around 2017.

In Africa, the payment banks, which are comparatively new in the banking ecosystem, focus on particular offerings such as wealth management, where the bank can innovate and take advantage of its customer insight, cater to a particular section of customers, and grow their business, according to a report of Boston Consulting Group (BCG). But the same could not be replicated for the Indian customer. 

“The markets are structurally very different in India and Kenya. With the advent of other fintechs, the market was hyper-competitive in terms of financial transactions and it was difficult for Indian companies to make money on each transaction in India. But Kenya doesn’t have that structural challenge,” said Rohan Lakhaiyar, partner of financial services at advisory firm Grant Thornton Bharat. 

In India, UPI posed a major challenge to payments banks. “UPI is free in India, but there is no such regime in Kenya. So, all payment companies in India are struggling with profitability, thus they are moving on to do value-added services like lending,” said Lakhaiyar. 

Payment Banks, A Failed Experiment?

As RBI was keen on telecom companies driving the payment bank ecosystem because of their reach, in 2016, Airtel Payments Bank became the first entity in India to secure a payment bank licence from the central bank. However, several setbacks affected the growth of the industry. Dilip Sanghvi of pharma major Sun Pharma and financial service provider Cholamandalam Investment and Finance Company Limited surrendered their payment bank licences before operational commencement. Despite having both financial and technological backing, information technology company Tech Mahindra also surrendered its licence in the same year.

While telecom service providers in India failed to do much in the payment bank business, a fintech leader emerged as a success story. Thus began the rise of Paytm Payments Bank. 

Paytm's success was primarily due to the effective integration of financial services, leveraging its existing customer base to onboard users for newly launched products, according to Celent, a global financial research and advisory firm. The company's fortunes surged after demonetisation in November 2016, with Paytm QR code payments becoming immensely popular overnight, resulting in a rapid increase to 320 million registered users within months. This surge led to the creation of over 42 million savings accounts for Paytm Payments Bank. Paytm's digital debit card service, with minimal or zero transaction charges, also enhanced its appeal. Unlike the typical 2% card interchange fee, Paytm transactions for small merchants were free, while larger "organised" merchants had to incur a fee of 1.0–1.5%. This platform also enabled underbanked merchants to build transaction histories, improving their access to credit facilities.

Following Paytm’s success, Reliance-owned Jio Payments Bank, one of the latest entrants to the payment bank sector, debuted in the payment bank space in 2018 through a partnership with State Bank of India (SBI), with SBI initially holding a 30% stake. However, SBI's ownership decreased to 23% by FY23, signalling a waning interest in Jio Payments Bank's operational model. While specific performance data for Jio Payments Bank is currently inaccessible as it operates under Jio Financial Service, statistics from the National Payment Corporation of India (NPCI) reveal that Jio Payment Bank had only 11.33 million transactions in February 2024. The Core reached out to Jio Payments Bank to get a better understanding of their business plan, but they refused to comment.    

“This (launch of payment banks) was just a financial experiment as the government was trying to promote financial inclusion. During that time a lot of technological advancements and experiments happened. But within a few quarters, the payment banks realised they were not generating enough revenues for a sustainable business model, so many of them voluntarily gave up the licence,” a senior official of the Federation of Indian Chambers of Commerce and Industry, who worked closely with the fintech, telecom companies, and the government during the early days of the payment banks, said requesting anonymity.

Other bankers have also highlighted the same. Former chairman of the State Bank of India Rajnish Kumar had said that payment banks in India are a flawed business model that needs to be relooked.

Why It Failed?

Since its inception, payment banks in India have struggled to generate revenue. Unlike traditional banks, which profit from interest earned on lending, payment banks, with their 'differentiated' licence from the RBI, cannot lend or issue credit cards. Additionally, they've struggled to attract depositors, as Indian consumers still prefer universal banks for their deposits. According to RBI data, the payment bank sector has consistently incurred losses since 2018, reaching an all-time high that year with losses exceeding Rs 930 crore.

“The model (of payment banks) is not self-sustainable and it is also about perception. A scheduled commercial bank or a universal bank has far more appeal to customers when they have to park money. Even small finance banks struggle with deposit growth for the same reason,” said Anand Dama, senior analyst, BFSI, Emkay Global Financial Services. He also said that the small finance banks could still manage to attract some customers as they offer better interest rates on their deposits and have higher interest rates on their lending too, but such options are not available for the payments banks.