More specifically, news about the government trying to sell IDBI bank has reached international headlines as well.

I’m assuming you’ve opened this newsletter to understand where it all began, or at the very least, the context behind bank privatisation. Let’s dive right in.

History

It all started on an eventful day of July 19th, 1969, when in a sudden unexpected move, the headlines looked like this:

Citing an excerpt from Raghuram Rajan’s essay “An Alternate Vision for India’s growth”,

…we have examples of decisions taken by charismatic leaders without much public (or even intra-government) debate or protest. These include the 1969 bank nationalizations, the 1975 Emergency, and the 2016 demonetization. Few would argue these turned out well for India.”

The fourteen banks that were nationalised:

What does it mean?

Nationalisation essentially means transferring a particular entity from private control to public or state-owned control. In essence, these private banks were suddenly controlled by the government, overnight.1

Why was it done?

Of course, there are a lot of political intricacies involved, but the official reasoning given by the then Prime Minister over All India Radio was that “they (the banks) served merely the interests of crony capitalists and hardly bothered with the vast farm sector.”

By having government control, the state could direct resources and impact the livelihoods of farmers and other under-banked population.

One should definitely read up on all the drama that unfolded and quirks that followed in a span of 72 hours (the duration in which this idea was planted, written and executed)":

My favourite is this one:

How was it received?

Despite the fact that economists and political leaders still debate over it, as expected, the management of these banks were furious. They even went up to the Supreme Court to challenge the decision. It was also promised that no further nationalisation would follow.

However, considering the move was pretty successful from a political angle, Indira Gandhi went on to nationalise 6 more banks eleven years later, 5 of which doesn’t even exist today (they’ve all been merged). The only one remaining is Punjab and Sind Bank.

So if they’re supposed to be a success,

Why is the government trying to privatise banks again?

Political reasons are less documented than economic ones. Hence, some members of the Opposition have called out for a white paper, asking to explain their rationale. Once we understand the motives, it becomes easier to identify which banks should be first in line for privatisation.

So it’s important to ask the right questions:

Is the privatisation driven by the desire to reduce government influence on banking? Or is it simply driven by the need to reduce the proportion of government resources going towards banking?

In this case, it would make sense to reduce the stake in weak lenders where the government keeps infusing money.

From the latest Budget Speech,

“An amount of ₹80,000 crore in 2017-18, ₹1,06,000 crore in 2018-19 and ₹65,443 crore in 2019-20 was infused for recapitalisation of Public Sector Banks (PSBs). For this purpose, a provision of ₹15,000 crore has been made in 2021-22”

This is a huge drain on government resources and cutting off the bad apples makes sense here.

However,

Is the government doing this to raise resources for its budget or is it more a signal?

If it’s raising money, then a large well-functioning bank with actual buyer interest would make sense.

As of today, the government is testing the waters with IDBI Bank, which is currently valued at ~₹47,000 crore. At this valuation, sale of 61% would fetch the government a cool ~₹29,000 crore.

However, the government (along with LIC) would still hold 34% post the sale - will any buyer take the risk of controlling an entity with such a large government stake? Will the assurance of not vetoing any resolution assuage investors?

"There should not be any such concern. If we are selling a 60.72 per cent stake and transferring management control, it should be clear to investors that we are not interested in controlling the institution and hence will not oppose any resolution," an official said. - (Source)

What does economists have to say?

A paper by economists Poonam Gupta and Arvind Panagariya released this year actually started this debate all over again.

I’ve tried to summarize the points made by the two authors below (zoom in to avoid squinting)

In essence, their conclusion is pretty straight-forward: All pubic banks are shit; private banks are the best. So the government should privatise all public banks (except SBI) as soon as possible. They leave out SBI since they realize that in a realistic situation, no government would want to let go of the single largest bank in India.

What does RBI have to say?

If you consider the Governor as the spokesperson for the central bank of India, they all had different opinions.

Urjit Patel (2016-2018) in his book Overdraft, has mentioned “meaningful privatisation” may never be possible.

“Where is the fun in owning banks if control over operations, managing them and determining their regulation is not possible?”

- Patel, Urjit. Overdraft (p. 117). Harper India.

When asked in an interview, Raghuram Rajan (2013-2016) had a more structured answer to provide,

Maybe this is why we’re yet to see a successful privatisation effort till today.

Shaktikanta Das (2018-Present) is “ownership-neutral”. Unlike the former Governors who made their statements post stepping down from their office, the present Governor’s response is more measured:

“…it is our job to ensure that regulatory guidelines are adhered to and the banking sector functions in an orderly manner… banks are robust, they are well capitalised, their financial parameters should be strong; so we are agnostic to ownership”

Nevertheless, his statement comes at the back of an article that RBI has recently published - “Privatisation of Public Sector Banks: An Alternate Perspective”

In fact, the article was a silent response to Poonam and Arvind’s paper.

The key arguments that the authors of the RBI article propose are highlighted below (mostly around financial inclusion and transmission of monetary policy):

If you notice, the RBI article pointedly contradicts almost every argument made in the economists’ paper, as if it was a direct rebuttal. The RBI authors dismissed the idea of a “big bang” approach to privatisation; instead suggesting a gradual “slow and steady” approach.

Considering this “suggestion” was against the current sentiment, RBI actually had to come out and clarify that the article did not represent the views of the RBI.

What do you think?

Bank privatisation has always been a nuanced topic, especially since you can twist data (and banking has a lot of them) to suit a particular narrative - just like any other topic.

Nevertheless, I hope this piece helped you think from both sides of a particular view.

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

I came across this ad from Yes Bank recently, promoting floating-rate Fixed Deposits. Now we’re usually familiar with the fact that FDs are fixed-rate, providing the same consistent (and often low) returns.

I felt this was a nice segue into the topic for the day, which is linked to personal finance, banking strategy, central bank regulation and of course, the economy.

Today we’ll understand:

• Why Deposit Rates are what they are today

• How Lending Rates are related

• What can you do about it?

We’ve all seen the news. There’s high inflation. Rising interest rates. Loans are in line to get more expensive for customers.

But what about deposit (FD) rates? Are we going to get more interest if we keep our money in banks?

In an environment where equity and crypto are both “crashing”, people usually flock back to more “traditional” forms of savings - hence, the question above becomes even more pertinent.

Understanding Lending Rates

In order to truly appreciate and understand deposit rates in India, we must first look at the history and mechanics of the lending rate.

You may have heard about the term “NIM” or net interest margin. Simplistically put, this is the spread or difference between the bank’s deposit rate (the rate at which it borrows funds from you) and their lending rate (the rate at which it lends money to you). The higher the difference, the more money for the bank.

So it would make sense for banks to keep increasing lending rate without ever raising the deposit rates, right?

Well, it’s a bit more nuanced than that.

Let’s start by understanding how lending rates are calculated.

I have an ongoing education loan from SBI. Considering it is a long term loan, I’ve been given a “floating” rate of interest. Like the name suggests, the interest rate floats or moves along with the interest rates in the economy.

Education loan and home loans are usually floating rate loans, considering the long periods of repayment (over 15 years).1

So if RBI hikes interest rate following a rising inflationary environment (like now), your interest rates move up as well. This benefits banks.

However, if interest rates move down, your monthly EMI payment goes down as well. This benefits you.

An economy (and interest rates) can change a lot over 15-20 years. Floating rates ensure you’re not stuck in a limbo while the world around you shifts.

It’s a win-win situation.

I mean, it’s supposed to be, in theory.

But it isn’t. I’ll explain.

RBI’s Repo Rate

When we’re talking about the central bank raising interest rates, we usually mean the repo rate. Think of it like a benchmark interest rate set by RBI.

By definition, it is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks.

When are the changes to the repo rate announced? - During RBI’s monetary policy announcements (usually six times a year).

Ever wonder why?

Because the repo rate is supposed to influence the monetary policy. This essentially means that since the central bank itself cannot lend - by tweaking the interest rate at which banks borrow money from it, it expects bank to change their lending rates promptly.

A refresher on how interest rates affect monetary policy: During COVID, when central bank lowered the repo rate, it expected banks to follow suit. Only when you, as a customer, opt for cheap loans to buy stuff, it stimulates growth of the economy. Similarly, during high inflation, by increasing interest rates, RBI wants to de-motivate you from taking fresh loans, thus taming growth and subsequently, inflation. However, when the repo rate changes don’t get quickly reflected (or transmitted) in bank interest rates, it results in inefficient monetary transmission.

So does RBI repo rates and bank lending rates move hand-in-hand?

No.

Let’s observe how the repo rate movement has been over the last 20 years.

Now for a brief period (2016-2019), let’s observe how the country's largest lender changed their interest rate compared to the repo rate:

As you can see, within a 3 year period, the gap between repo rate and SBI’s lending rate fluctuated between 1.75% and 2.75%.

Why?

1. Because of the way banks calculate interest rate (MCLR is one of the methods which I explain below)

2. Because there’s a time lag before banks’ internal rate catches up with the external rates

MCLR

While fixed rate loans seem really simple and transparent, floating-rate loans aren’t. When I opted for my education loan, the existing regime of calculating interest rates were known as MCLR (Marginal Cost of Funds based Lending Rate).

Let’s look at how banks calculate MCLR:

While the calculation itself might appear standardised, banks are allowed to charge a nice little premium over this, depending on two factors:

1. Business strategy

2. Credit risk premium

These two factors are so broad and so opaque that RBI has tried to change the way banks calculate lending rate 5 times already!

The Deposit Rate Strategy

Now that we have a basic understanding of how lending rates move, the question to ask is:

Do deposit rates move as slowly and opaquely as lending rates?

Yes.

Let’s observe this chart.

As you can see above, during a brief period between February 2019 and March 2020, the lending rate moved down by 26 basis points only (RBI had slashed rates by 110 basis points during this tenure) while the deposit rate moved down by 52 basis points - double the lending rate!

1 basis point = 0.01%

While it is expected that deposit rates fall in line with lending rates (to keep the NIM same, remember?), are there no RBI guidelines or policies to streamline them, like in the case of lending rates?

No.

RBI de-regulated (stopped telling banks what interest rates to provide to their customers) all deposit rates by October 1997.2

This essentially meant that it became kind of like a free market economy, where banks decided the interest rate best suited to support their NIM and profitability.

Today, the reason why almost all banks offer the same deposit rates is because they’ve realized the following:

1. With rigidity in lending rate movement, deposit rate movement is slow as well

2. Almost all banks, irrespective of size, have moved away from rates-led growth to a branch-led growth (read my last post to understand this in detail)

3. Offering high interest rates is not sustainable for a long time (a rare few private, small finance or foreign banks may have 1-2% higher than the market briefly for acquisition of new customers, but that’s about it)

4. Their real competition is not mutual fund and their promised returns; it is actually small savings schemes (think post office) in the same risk-return curve, which currently are offering equivalent rates.

Savings Rate vs FD rate

Since we’re on the topic, let’s also briefly touch upon the finer nuance between savings account rates and FD rates.

ET publication has compiled a list of banks which have increased their FD rates post the RBI hike. While the hikes are meaningless (as little as 20bps) and doesn’t really help counter inflation, you would notice that savings account rates almost never get hiked.

Notice the green line below.

Savings account rate has been stagnant at 4% since a very long time.

Why are banks so reluctant to hike it?

This is because any change here immediately impacts the bank’s entire customer base, resulting in direct hit to their profits.

Compare this to FD, which are fixed and different in tenure. So changes in interest rates only affect for “new” incremental deposits that the bank can source.

Yes Bank’s Floating-Rate FD

Circling back to the ad that we started with, why is Yes Bank suddenly launching floating-rate FDs? Is it even a thing?

Yes.

In fact, before deposit rates were de-regulated, they were pegged to the RBI rate.

In a recent report, RBI had actually recommended that banks tie large deposits to repo rate so that it helps bank and their customers both - just like it is supposed to be for lending rates.

While the idea itself is not new or innovative, it is definitely transparent.

Investors follow the news and are informed when RBI changes rate. In a rising interest-rate environment, opting for this may make sense. Unlike loans which are still pegged to MCLR (and gets reset every 12 months), these rates will reset every 3 months, so there won’t be much delay between RBI’s rate hike and your FD interest hike.

However, this may not suit investors looking for regular monthly income as interest is only paid out on maturity. Also, banks are smart. Yes Bank is only offering this for a 1-3 year timeframe.

Are the low rates going to be a concern?

Well, our RBI governor definitely thinks so. In a recent interview with Times of India, he mentioned,

“Also, let us not forget the depositors with whose savings the banks function. In an environment of high inflation, if interest rates are kept artificially low, then the real rate of return for the depositors would become that much more negative and if that happens, depositors may turn to other assets like gold. This will impact financial savings and have an immediate impact on investment.”

This is not (yet) a personal finance newsletter, so I would refrain from suggesting WHAT you should do. However, I hope this helped to understand the WHY.

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

Just like ATMs, the debate of bank branches have been lingering for quite some time now, especially after Covid-19 and the Fintech boom; the eternal question being,

“Do we even need bank branches these days?”

It doesn’t help when clickbait-y news articles such as these start circulating around:

Let’s focus more from an Indian context.

As per RBI data, apart from India, Bangladesh and Vietnam, all major economies have shown a downward trend in the number of branches.

However, if you look at this more closely, this was primarily driven by public sector banks, who’s branches grew by 16% in 2020-21. Overall, the growth is still stagnating.

This is apparent when you read conference calls as well.

Over the last couple of quarters, Federal Bank has been explaining how their FinTech partnerships are helping them save costs with respect to running or opening a new branch.

Based on their inputs, this is how they look at it:

• A new branch takes minimum 18 months to break-even (revenue equals cost)

• The expected outcome from their FinTech partnerships is equivalent to opening 2000 new branches. They’ve also said, “when we grow 25% in incremental deposits [through FinTech partnerships], it is almost like adding 300 branches.”

When the common theme is to slow down branch expansion, why did this become a hot topic again?

Well, last week, the top guy at HDFC Bank, in their annual analyst conference, mentioned that they’re going to add about 1500-2000 branches a year, for the next three years. 🤯

Their rationale is simple - branches help bring deposits and strengthens the liability franchise of the bank.

In fact, the older the branch, the better the deposit mobilization i.e. deposits compound over time. It’s like wine. With 11% of their branches being more than 15 years old, I think they’ve realized the importance of this vintage.

To pre-empt the question regarding why they’re choosing the brick-and-mortar route in a digital age, CEO Sashidhar had to say,

“Frankly, India’s demography is different from anywhere else. Today, the average distance between branches is 6-7 kms, even within our own… all of us in this room, we all agree that we don’t travel 5-7 kms to go to a branch.. we want the concentration to come down.”

With 50% branches in SURU (semi urban and rural), the bank wants to double down on this - a few days prior to the analyst conference, it announced “Future Ready” project, a plan to open 1060 branches in these SURU regions. It does this through “catchment scoping” - a method of assessing the potential and awareness about the bank brand and offerings in nearby areas.

Social media was divided. While a set of folks believe that digital banking is the future, a few others point out that financial inclusion is best done through touch and feel.

Anand here as even explained how HDFC is able to grow at a faster rate than Federal (at a 9x base) solely because they understand the power of distribution.

Another difference between Federal and HDFC is that the customers it is trying to target through their FinTech partnerships is driven by interest rates, whereas HDFC has made it categorically clear that sourcing new deposits will be branch-led and not rates-led.

So is Federal doing something drastically different, or -

Does all large private banks follow the same strategy?

Here’s ICICI Bank, explaining how branch expansion decision lie with respective business heads to decide after observing the their own market:

When Kotak was asked the same thing in their analyst conference, Uday Kotak had a slightly nuanced answer.

According to him, individual customers are slowly moving towards digital transactions - so their branch efforts are going to be inclined towards the business customers.

In fact, during my time at ICICI, I remember colleagues telling me that one of the first questions that a prospective business customer asks the bank representative is - “how far is the nearest branch?”

Kotak also has a lower penetration in SURU regions (34%) compared to the other three top private banks (HDFC at 50%, ICICI at 50% and Axis at 46%)

On a related note, Uday Kotak’s son, Jay Kotak, recently came into the spotlight with 811 - the bank’s digital initiative. It’s a great presentation, filled with quotes from management books; but that did not stop people noticing that the savings book was ₹75Bn (or 7500 crore), which is only 6% of their overall savings book (₹124,472 crore).

Or the fact that average monthly balance for these “digital” customers is only ₹6,100.

So does branches still bring in the better set of customers?

What about public sector banks?

A close competitor to Kotak’s 811 would be SBI’s YONO - but I couldn’t find enough data on the latter to make a like to like comparison. Sad that SBI didn’t reveal the important numbers in their latest Annual Report.

SBI, the banking behemoth with over 22,000 branches, is still adding new branches every year, albeit at a much lesser pace than it used to (less than 100 a year).

It also doesn’t talk much about branch expansion, branch productivity and the likes.

On the other hand, Central Bank of India has apparently decided to shut down 600 branches by 2023 (13% of it’s total base).

It all comes down to how the bank is performing. Central Bank is loss making and has been pulled up by RBI.

Summary

I’ve tried to highlight how different banks are approaching this strategy. While some have been able to maintain costs and are confident on their distribution scale, some take a calibrated call depending on business requirements, whereas others follow a FinTech partnership model.

It is important to note a few high-income areas are still branch-led, such as wealth management, life insurance, gold, business banking.

In fact, branches act as collection centre as well.

While investing in technology is non-negotiable today, a scaled down version of the branch (small, automated) are being considered to bring down costs as well.

If you have any interesting tidbit to share here, do comment below.

Leave a comment

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

Starting a new series where I dive deep into a particular market, where digital banking adoption is reported to be on the rise. Let me know if you want to read more of these.

Today’s focus is on the Hong Kong market, which piqued my attention after reading an article on the Wall Street Journal.

Before we understand what the article points towards, let’s try to understand Hong Kong’s banking landscape.

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Hong Kong’s Banking Structure

Hong Kong’s population is tiny. Based on estimates, it is about 75 lacs. However, what’s interesting is that there are over 170 licensed banks catering to this tiny population - resulting in the fact that only 5% of their population remain unbanked today.

Compare that to India - we have about 138 “scheduled” banks for a population ~200x that of Hong Kong. Of course, a large part of our population is also catered by banks which do not make it to this list, such as co-operative banks, but that doesn’t help the fact that our percentage of unbanked remain as high as 20%.

Despite the abundance of banks, HK’s banking is dominated by 3 major banks - HSBC, Bank of China (HK) and Standard Chartered Bank.

Did you know that these are the only three banks which has the authority to issue bank notes (cash) in HK?

Unlike India and most other sovereign nations, where the central bank (RBI) has the sole authority to print notes, a few countries like HK, UK and Macao allow commercial banks to issue banknotes.

HK is not only “overbanked”, but is also considered a very important financial hub, with their banks posting millions of dollars in profit each year.

Of course, these numbers don’t mean anything on first glance. So for comparison, The most profitable bank in India generated ~HK$ 31,000 million in profits last year.

Lenders in this autonomous Chinese territory are exceptionally profitable, thanks to a wealthy customer base and high population density, which allows banks to operate with relatively few branches.

The important aspect of highlighting these figures is to ask - how does a virtual bank compete in such a competitive banking landscape?

Regulation

The de-facto central bank authority of Hong Kong is HKMA (Hong Kong Monetary Authority).

The way HKMA has introduced virtual banks in the region has garnered some mixed opinions.

While everyone appreciated the speed (it announced virtual banks in 2017 and started providing licenses by 2019), the structure and the scope has been questioned by a few.

• A research paper on this topic noted that HKMA did not consider the suggestion of lowering the minimum capital requirement for these branchless banks and kept it at par with other licensed banks, at HK$ 300 million. For comparison, the minimum regulatory capital for UK neobanks is only ~HK$ 45 million.

• The paper stated that HKMA also did not set clear expectations or make suggestions for the innovative financial services that virtual banks could provide.

Broadly HKMA wanted these players to promote the application of fintech and innovation, offer new customer experience and promote financial inclusion, covering retail and SME segments.

This is quite vague to be honest. For example, I think we over-use the phrase “financial inclusion” as it can mean different things for different nations.

For India, RBI had a somewhat clear purpose of financial inclusion when it incorporated small finance banks, by restricting three-fourths of their advances to the priority sector and certain restrictions in the location of bank branches.

In an interview, former co-founder of Mox, one of the virtual banks currently operational in HK, defined financial inclusion as,

“serving everyone equally.. in Hong Kong, people are not unbanked.. they are underbanked. Are the current options providing you an easy way of growing your HK $500?” (loose translation)

This particular interpretation wouldn’t have arised at all if only HKMA had been more clear. Similarly, there are consequences for keeping the high regulatory capital as well, which we will now understand as we understand the background of the virtual banks in HK.

The Virtual Banks in Hong Kong

There are 8 virtual banks in HK.

Before we dive into the leaders (Za Bank and Mox Bank), let’s understand their background.

As you can see, most players are backed by known names from the industry, worth billions of dollars. I believe this is a direct result of the high capital barrier.

While this ensures some sort of trust for customers, it prohibits young FinTech companies to innovate in this space.

It is now a race towards to the bottom, with the larger players spending the most in customer acquisition, with minimal sources of revenue and large losses.

So why does Wall Street Journal feel differently?

Like all newspaper headlines, it merely prompts you to read the article, which clearly writes how these banks are yet to catch up to their traditional peers.

Here’s an excerpt,

“As of Sept. 30, the eight digital banks collectively had 1.1 million accounts in a city of 7.4 million people, according to the Hong Kong Monetary Authority. Total deposits at the eight banks add up to around 24 billion Hong Kong dollars ($3.08 billion), accounting for just 0.2% of the city’s total. That reflects how the average account balance at a digital bank tends to be smaller than the average account balance at a traditional consumer bank.”

The article does go on to highlight all the stuff that these new players are doing to catch and retain customer retention.

• For example, Za Bank’s PowerDraw gives users a chance to win upto 200% cashback on their spending transactions. Some users have liked these game-like features which are meant to drive engagement.

Here in India as well, gold-saving app Jar is trying to achieve the same thing, nudging people to spend more, so that they can… save more?

Credit card bill payments app CRED has a separate screen for playing jackpots. Companies pay CRED to get featured here.

• Other virtual banks provide the usual - higher interest rates, faster and online onboarding, swanky numberless credit cards (HK has a low penetration of debit cards) etc.

• A few others are trying to bring in nifty loan practices from their parent company. For example, Ant Bank in January rolled out a loan program aimed at small-business owners that offers flexible terms such as the ability to pay off the loan’s interest first before settling the principal when the debt matures. WeLab offers flexible loans and group saving plans that allow users to earn higher interest rates as more users place deposits.

But is all of this enough to retain users? Or even bring in new ones?

Virtual banks, if they want to crack the retail population, need to garner enough users so that at scale, the unit economics makes sense.

The other way to get new users is to expand to the Greater Bay Area, which has 10x the population of Hong Kong.

The two leading virtual banks in HK

ZA Bank, backed by ZhongAn Insurance, is interestingly a much smaller business than PingAn Insurance, which is backing PAO Bank (PingAn OneConnect). It would seem that the latter should also be the bigger virtual bank.

However, ZA not only had a headstart (first virtual bank to launch), but it was also the only one which had a mandate to deploy cash payouts during coronavirus. The quick branchless account opening process made people sign up just for the payouts.

As of today, ZA boasts over 500,000 accounts.

Meanwhile, it’s close competitor Mox, is backed by Standard Chartered. So Mox never had an issue with establishing “trust”. It’s website clearly indicates the name of the parent company. The best part about Mox though is that despite having a traditional bank as their backer, it did not build its systems using the CBS (core banking system) - instead, it adopted blockchain and smart contracts to build it out from scratch.

As per the interview cited earlier, Mox has about 200,000 customers today.

OG Rahul Mathur (CEO of Verak Insurance) has been tracking these exact companies since March, 2020.

Summary

Considering RBI hasn’t even published a discussion paper (NITI Aayog had to do that) on neobanks, HK has shown massive speed in adopting and launching it.

However, more deliberations on their objectives and goals would have been appreciated.

For example, Singapore has launched two separate digital bank license (one for retail and one for SMEs) in order to keep a narrow focus on the outcome of introducing these banks.

In the next episode, we’ll dive deep into Singapore’s virtual banks. Stay tuned.

Unfortunately, HK’s digital banks are not listed on any exchange (in case you wanted to get in on the action early). However, the traditional ones with all the profits sure are.

On Vested, you can view all the details of any US listed stock, including their fundamental data, ratios, as well as the trending news.

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

Just as an example, consider banks which have a significant presence in the south. Don’t be surprised if you see a large exposure to gold loans.

While some smaller private banks still manage to grow well despite the large concentration in certain products, public sector banks (PSBs) typically tend to struggle.

The article by Scroll talks about the many perils of lending by PSB, but the following excerpt is a good summary:

“In a world flush with cheap capital from pension funds, sovereign wealth funds, private equity investors.. many of India’s startups and business groups are choosing to exit the borrowing system of public banks, preferring to raise capital from foreign sources.. rather than subject themselves to the politicised financing that often accompanied the public sector banks’ debt.”

(Of course, there are always exceptions like SBI).

Let’s consider another scenario. Here’s an opinion piece by a retired banker.

Talking about our Prime Minister’s plea to banks to finance start-ups so that they can build the country’s balance sheet, the author writes,

“The proposal to finance start-ups out of deposits mobilised by commercial banks is a dangerous one. There is no doubt that start-ups are good and required for the economic growth of the country, but financing them out of banks’ deposits is an entirely different proposition.”

While the former does highlight how startups have access to capital, that may not always be “cheap”. Founders, reluctantly, have to dilute their stake (and a lot of rights) just to get access to the money - of course, there are multiple lawyers involved and one round of funding could take months to close.

The second article talks about how bankers, despite a push from the government, remain reluctant to lend depositors’ money to startups. The core issue remains - “risk”. Most bankers neither have the proficiency nor appetite to evaluate startups’ balance sheets.

What if there’s something in the middle?

That neither requires companies to dilute “equity” or raise “debt”. That provides instant capital.

Introducing BridgeUp.1

BridgeUp’s pitch is that for companies, revenue is their best asset. Especially if it’s recurring (fixed cash flows over a period of time).

Business Model

Before we deep dive into BridgeUp’s business model, we need to understand that it’s a marketplace… a broker… a matchmaker. As it comfortably sits in between, it enables business to be conducted by the parties on either side.

Sell Side (Borrower)

It seems this is the segment that the website primarily pitches to.

“Access instant capital by encashing your recurring revenue
contracts and receive upfront payments.”

Let’s start with a simple example. Take this newsletter.

Of course, it’s free. I don’t take money from readers (not even from folks who voluntarily offer to buy me a coffee). However, I do earn when brands decide to feature their products at the top. This is sporadic and unpredictable.

But what if it was actually predictable?

What if I had a constant (say monthly) stream of revenue from brands looking to collaborate? BridgeUp could then possibly help me raise upfront capital based on these “guaranteed” recurring revenues that I receive from my clients.

Sounds too good to be true?

This is exactly what Anthony Pompliano (who runs a popular crypto newsletter) did through Pipe, which is what BridgeUp is trying to do here in India.

Of course, BridgeUp isn’t targeting niche customers like myself.

Their sell-side clients could be any private or public listed entity, which has some sort of predictability embedded in their cash flows.

Based on their website,

If you notice, all these sectors have some form of recurring revenue:

1. B2B and/or Enterprise SaaS: Monthly, quarterly or yearly payments

2. Services Companies: Digital marketing companies, IT services, etc., have contracts with their clients which pay out periodically

3. Insurance - premiums

4. OTT - monthly/yearly subscriptions on Hotstar, SonyLiv

5. Online pharmacies - patients who have chronic ailments and order the same set of medicines every month

6. Ed-Tech - recurring fees for platform access

7. Media - Consider all these premium media publications (Ken, Morning Context, CapTable) and the yearly subscriptions they charge

How does this work exactly?

In a world of cheap capital, I think the best value that BridgeUp brings to the table is convenience.

Consider the huge time spent by lawyers and accountants digging into your books before investors/bankers give you money for your business - compared to a simple 4 step onboarding process that BridgeUp has.

If you have genuine recurring revenue, what’s there to hide?

Take any Indian startup with Razorpay as their payment partner (quite common these days) - they can simply link it and BridgeUp will automatically pull up transaction history for all their clients.

Same goes for bank statements (automatically fetched for banks on the Account Aggregator system) as well as accounting statements (automatically fetched from any accounting solution such as Tally).

Hereon, BridgeUp’s algorithm starts running and within just 48 hours, you get your own sweet dashboard with a visual representation of your cash flows and a bid for your recurring revenue.

Without going into too many details, let’s consider SonyLiv as an example of a sell side customer. SonyLiv has tons of paying customers (17.9 million as per media reports). All of these details are already fetched, as explained above. SonyLiv can then decide to “trade” these customers. A selection of “X” number of tradeable customers will make up a “contract”.

Buy Side (Lenders)

Who do you think are buying all these contracts?

Exactly!

This is where the financial institutions/investors (or the buy side) come in.

Let’s take the example of a NBFC which is keen to invest. It can log into BridgeUp and browse through contracts from SonyLiv (and all the other sell-side players on the platform).

If they like the results of the analysis carried out by BridgeUp on Sony Liv’s recurring revenues, they can proceed to “bid” for these contracts. In most cases, a multitude of other investors bid for the same SonyLiv’s contract and that ensures that SonyLiv receives the best bid (offer) price, displayed at the top right of their dashboard.

Creating competition amongst the financial institutions for high growth companies with predictable revenues like SonyLiv allows these companies to receive the most competitive price (cost of capital) as opposed to a fixed (mostly non-negotiable) price generally offered by lenders or other revenue based financing (RBF) companies.

Once SonyLiv accepts the offer, a successful trade occurs - money from the investor goes straight to SonyLiv’s bank. SonyLiv will now just make monthly payments to the investor.

Where does BridgeUp make money in this?

The best part about this platform is that BridgeUp takes a flat percentage fee of the traded value of the contract - so you’re never in for a surprise. Also, no haggling with VCs for lower dilution or with bankers for lesser interest payments or pledging collateral.

This is unlike RBF, a concept which had also recently picked up in India. RBF companies like Velocity usually take a percentage of your future revenues along with the principal repayment and interest.

Take this screenshot from their FAQ section:

As you can see, the problem with RBF is that for companies which have growing recurring revenues (for example, number of people subscribing to SonyLiv can go up next month), they can never accurately estimate the quantum of revenue that they would have to share with the RBF platform on an ongoing basis. For high growth sectors like SaaS and others mentioned above, RBF simply does not make sense as their monthly repayments would increase in proportion to their revenues. 🤷‍♂️

BridgeUp, on the other hand, is more like subscription based financing (SBF).

Final Thoughts

By acting as a true marketplace, BridgeUp is basically facilitating the transaction (matching the borrowers and lenders), but without the judgement. Here is why it makes sense for both parties:

For the lender:

• Recurring revenue is an unbiased honest source of cash flows

• Lender has access to a new asset class (recurring revenue) with fixed returns which remain unaffected by fluctuations in equity markets

• A detailed analysis (checking actual cash flows, operational metrics, BridgeUp Score) is already done by BridgeUp

For the borrower:

• For SonyLiv, this entire process is digital, quick and easy. Finance team can own this end to end without bothering other stakeholders

• SonyLiv can choose to trade it’s best customers to get the best offer price

• Money hits your bank account in less than a week from signup.

• No equity dilution or pledging collateral for the companies or its founders

Considering there’s no real competitor to BridgeUp’s business model in India, the company has huge potential in changing the way companies with recurring revenue raise money.

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

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Tweet of the Week

It seems RBI setting up a FinTech Department has opened more questions than when it was just a small unit, such as:

• Who will FinTech NBFCs report to?

• Will this also regulate BNPL (which is still unregulated)?

Hopefully, we’ll get the answers soon directly from the source.

From the Financial Stability Report…

Last year, around this time, I’d done a deep dive on RBI’s bi-annual Financial Stability Report (FSR).

Quick Recap: FSR’s main highlight is RBI’s projections of NPAs for the next couple of months. We also find out that RBI horribly gets it wrong each time. 🤦‍♂️ But it also makes a good document to read granular data of NPAs and credit growth across loan categories. So there’s that!

This time, the projection of NPAs for September 2022 for all SCBs (scheduled commercial banks) is 8.1%-9.5% (baseline to extreme).

If you go through the last year data, RBI had projected a whopping NPA of 13.5% in the baseline scenario. That’s the minimum amount of industry-wide NPAs the central bank was expecting due to Covid related stress.

The actual number?
Almost half of that - 6.9%.

Here’s where it gets interesting though. RBI has introduced new information into my favourite chart - a breakdown of NPA ratios of Personal Loans by Category.

Couple of things that seem interesting here:

1. NPA ratios for vehicle/auto Loans for Foreign Banks have been unusually high during the middle of last year - I’m yet to find an explanation or an exact source for this

2. NPA ratios for Credit Cards are higher for Public Sector Banks than any other category of banks (12.7% vs an average of 3% for private and foreign banks)

In fact, this data actually spurred a cautionary article from Moneycontrol:

While the difference in GNPA ratios is stark, lets analyse if it really going to affect the entire credit card industry.

Here’s a breakdown of Credit Cards issued by different banks - their category has been color-coded for easier identification.

As you can see, public sector banks make up less than 1/4th of the industry outstanding. If you remove SBI, that number drops to just 4.4%.

For context, SBI has a GNPA ratio of just 3.36% as on September 2021.

It means the other Public Banks share the bulk of the bad loans. That’s not surprising. These banks have bad loans across most categories, not just credit cards.

Their loan approval rates are almost the same as Private Banks - which indicates lack of due diligence.

This point is proved further if you notice the quality of borrowers they have on their books.

Before you jump onto this chart, a primer on borrower categories:

Do you recall your credit score? CIBIL categorises them in the following way:

Subprime borrowers: 300-680
Near prime borrowers: 681-730
Prime borrowers: 731-770
Prime plus borrowers: 771-790
Super prime borrowers: 791-900.

“Below Prime” includes “Near Prime” and “Subprime” borrowers and are treated as low quality.

As per this data, public banks have the highest share of below prime borrowers in the entire industry.

One final chart that I’ll like to point out from the FSR today is called “Borrower Risk Migration”

It indicates the movement of borrowers across risk categories over a time period. I’ve highlighted the portion that you should look into. If you notice, compared to September 2019, “Below Prime” categories shot up in June 2020. However, within the last year (Sep 2020 to Sep 2021), they have more or less stabilised.

Summary:

If all of this went over your head or was simply too boring, here’s the TLDR:

• RBI failed to project GNPA ratios correctly again

• Public sector banks have a higher GNPA ratio in credit cards (among personal loans) compared to other categories of banks - this has minimal impact on credit card industry but nevertheless, indicates that it is high time they tighten their loan approval process

• This is a caution for not only public banks, but also other banks because over the past two years, lower quality of borrowers have creeped into the system and have access to personal loans.

Other Cool Stuff I’ve Read

• HDFC Bank seems to be in trouble: Finshots has put together an easy-breezy read on what’s troubling the top bank in the country. Apart from tech issues, it seems to be struggling with hiding it’s larger-than-usual “restructured book” - which, if you add up to their actual loan defaults, bring NPA ratio to as high as 3.5%. I’ve previously explained how restructuring works - in short, there are multiple ways to dress up a loan book - if history is any indication, the skeletons do come out one day. The bank has also performed worse than a Fixed Deposit (in terms of returns) in 2021 - does the market know more than us? 🤔
  

• Federal Bank ED talks about their FinTech strategy: My favourite FinTech journalist Arti Singh has interviewed Shalini Warrier (this is going to be a familiar name if you follow Federal Bank concalls). Shalini looks into digital banking and FinTech partnerships at the bank. Couple of things that she wants Federal to focus on: high-margin unsecured lending products (through FinTechs such as OneCard, Paisabazaar, Pine Labs), having a distributed deposit base (through neobanks such as Jupiter and epiFi), gold loans (through Rupeek) and non-resident customer base (through remittances - will find out who they partner with here).
  

• On Capital Small Finance Bank (SFB): Shiven Tandon returns to writing with a banger piece on Capital SFB, which recently published it’s IPO Document on SEBI. Did you know Capital is the only SFB that had its roots as a Local Area Bank? It can only operate in three adjacent districts, while focusing on rural and semi-urban areas. Shiven goes on to explain how this restriction could have been a blessing a disguise for the bank. As always, if you need a refresher on Small Finance Banks, you can always read it here.
  

• Bringing Offline Digital Payments to 500Mn people: Prince Jain from Unit Economics writes a well-rounded piece on RBI’s attempt to solve offline digital payments. Imagine 39% of India’s population is still without internet. My uncle works in one of the companies trying to innovate in this space (Ubona). It offers UPI transactions over IVR. If your UPI is registered, each transaction takes about 1.5minutes of call duration to complete. While that may seem like a nightmare to us - it is going to make a difference to the target market. But will it really replace cash?

Introducing Banking 2.0

For the longest while, I’ve wondered how to expand “Bank on Basak”. The objective has always remained the same - to expand my own understanding and hopefully, help the ecosystem in a better way.

With this thought, I’ve started a new live webinar series lazily titled “Banking 2.0”, in partnership with a friend who also runs her own platform.

Theme: To highlight niche FinTech startups who are innovating at the intersection of Banking and FinTech.

It’s a new thing and we’ve done three episodes till now. If you’re a FinTech operator/founder who’s innovating in this space, do fill out this interest form and we’ll get back to you.

Here are the links to the past three episodes:

E1: Dissecting No-Code Embedded Finance

E2: Credit Cards vs. BNPL

E3: Exploring Social Distributed Finance

If you want to receive updates before the next episode, the only way to track it is through this Whatsapp group.1 (please read the disclaimer at the bottom of this post/email before you join)

Wish me luck!

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

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Understanding Navi’s Home Loan Strategy

Home loan demand is back.

Amidst Kotak Mahindra Bank running the lowest home-loan rates (6.5%) during the festive period (September - November 2021) in about a decade, the sector is seeing a great amount of interest from home buyers.

From Kotak’s latest conference call,

“We had our best ever quarter on fresh volumes for both home loan and LAP (loan against property). Like Uday mentioned, we launched a price leadership campaign for a limited period of 6.5%. This has helped us acquire quality customers, strengthen our market share and widen our distribution. This will be a focus area.”

Do you know who’s offering a better price than this?

None other than Navi Finserv, at 6.4%.

It was actually the digital lender’s foray into this segment that got me piqued. When most FinTech digital lending platforms stick to personal loans, why was Navi branching out to home loans?

For the uninitiated, Navi is former Flipkart boss Sachin Bansal’s second venture. According to a recent interview with Moneycontrol, he seemed averse to calling Navi a FinTech company.

“We are now comparing ourselves with banks and NBFCs.  That’s why I don’t call ourselves a fintech company.  That is why we describe ourselves as a financial services company that happens to be good in technology. I don’t like the word fintech, lot of fintech don’t have their own books… fintech sounds a little less serious”

What does he mean by “lot of fintech don’t have their own books”?

In essence, true fintech digital lenders (without a NBFC license) are not supposed to lend from their own balance sheet anyway. The ones who do, eventually get caught in an ED investigation. ⬇️

Recently, RBI put out a report which listed the number of “illegal” apps in India, which in some form or the other were bypassing regulations.

In such a scenario, having a NBFC or a banking license is a moat. Sachin is aware of what the regulator wants and is careful to choose his words accordingly.

“We are not a neo bank, I think neo banks are a customer funnel for some big banks. That is not a very attractive proposition for us. We are trying to work backwards and see what a bank for a billion people looks like.”

Armed with a NBFC license, Navi’s next ambition is to receive a universal banking license from RBI (Navi has already applied for it early this year under the name “Chaitanya India Fin Credit” - I’ve covered all about banking licensing earlier here)

Back in April, I wrote about Navi’s two key challenges:

• Navi has a high target of disbursing ₹4200 crores by March 2022. Retail lending has seen increasing NPAs since Covid. There are ways in which Sachin is trying to mitigate it, such as having an approval rate of 5% compared to industry figures of 10%+ and focusing on high ticket long duration loans to quality borrowers, but everything would boil down to repayments. As of December 2020, gross NPA figures were around 4%, almost fully provisioned.

• Navi is trying to diversify Chaitanya’s micro finance-heavy loan book, by expanding into home loans. This segment, although lucrative, is very difficult to leverage technology due to manual onboarding processes (resulting in high costs). More on this later.

As per numbers provided to Moneycontrol, their target is on track.

For someone aspiring for a universal banking license, expansion into home loans will also look good in the regulator’s eyes. If they want to maintain a loan book mix equivalent to their current growth rate (assuming all of the non-microfinance book consists of home loans and LAP), they would need to disburse an additional 900-1100 crores in home loans within the next six months.

For some context, if I take Kotak’s example, it grew its home loan portfolio by ~7000 crore in the same duration (April-September 2021). However, Kotak wouldn’t be the right example.

Let’s take CSB Bank, who’s current Home Loan book (including LAP) is approximately 600 crore, around the same book size as Navi (some reports claim that Navi’s home loan book is only 60 crores).

Unlike Kotak, CSB is not very enthusiastic about this product now. Here are a few snippets from their latest conference call:

“Now considering the inflation, there is a negative return for depositors, which cannot be sustained for a longer period. Deposit rates will go up and at that time if you start raising home loans, defaults will also increase. So this is not the right time to launch home loans. We do have home loan products.”

Why is Kotak Bank bullish on home loans and CSB bearish?

A good understanding of this dichotomy will help us understand Navi’s strategy better.

From reading management commentary, I understood three things affecting home loan strategy:

1. Cost of Funds

2. Outsourcing vs In-house

3. Cross-Sell Opportunities

1. Cost of Funds

This is the cost at which the financial institution is able to raise funds from the market (or customers). For Kotak, that’s freakishly low. CASA (current account and savings account), the cheapest form of funds for a bank, is as high as ~60%. Kotak provides a measly 3.69% on their savings account. Thus, they can afford to launch a price leadership campaign at 6.5% and still afford to make a decent margin. Additionally, this is the rate that they would offer to the highest quality borrowers. Apparently, they’re getting a lot of NTB (new to bank) customers as well - so it’s a growth strategy and its working well. I’ll soon address why NTB customers are important.

For CSB, cost of funds are higher at 4.3%. Additionally, CASA is only 33%, which the bank is trying hard to grow. Thus, CSB offers rates anywhere between 8-9% for home loans. At this higher interest range, they will usually get customers with a higher risk profile (As an example, imagine yourself knocking on Kotak’s doors for a home loan; if you’re rejected for some reason, you’d naturally end up at CSB’s offices). This is evident from the concall. A significant portion of CSB’s NPA come from home loans:

For Navi, their NBFC license wouldn’t be able to attract such low rates that banks can command. It is only Sachin Bansal’s capital infusion that the company is able to launch a price war with leading banks. This may provide some immediate growth, but will definitely be hard to sustain.

Outsourcing

Recall that Navi doesn’t compete on price with personal loans, it competes on experience. Why doesn’t it do the same for home loans?

This is because a significant portion of the home loan journey is difficult to bring online. The Ken has made a beautiful infographic to explain this.

Because of the complicated steps involved, very few banks do it completely in-house. Even with Kotak’s prowess, 45% of home loans is outsourced. For smaller banks such as CSB, almost the entire home loan business is handled through HDFC.

“…We are signed up with HDFC Limited, for selling their home loans for the time being. It will help us to streamline our processes and train our people and work along with HDFC to gain enough experience. This will be useful for future when we reduce our cost of deposit substantially by increasing the CASA proportion and are in a position to sell home loans aggressively.” - CSB management

Cracking home loans is tough. Smaller entities usually dip their feet by giving leads to larger players or originating the loan for them.

Just like everyone else, Navi will have a tough time building relationships with developers (usually the place where most deals are closed), attracting customers (through the lowest rates) as well as evaluating customers (same logic holds true here as well - only the top borrowers would receive the 6.4% offer).

Cross-Selling

Here again I would like to quote straight from CSB’s concall,

“The standalone home loan is profitable only when cross selling is very effective. We do not have the entire range of products for cross selling. Once we increase the number of products offered to retail segment and we are good at cross selling, then only we must think of launching home loan on our own on a larger scale.”

Compare this with Kotak’s management:

“Our asset cross-sell in Q2 was strong across retail asset products, led by home loans, LAP…”

As you see, because CSB has a limited number of retail offerings it can offer (compared to Kotak), it doesn’t make sense for CSB to go big on home loans NOW. It can always change its strategy later.

Navi too, doesn’t have a huge retail portfolio to cross-sell now. Existing products such as insurance are primarily push products, while index mutual funds are hardly income-generating.

Remember the importance of NTB customers? Since they do not have products with other existing players, it is easier to sell stuff to them. So an important question to ask is - Is Navi targeting existing or NTB customers?

Out of the three areas that I discovered to be key to home loan strategy, as a reader, you might not seem very convinced of Navi’s growth prospects. Reports mention that while evaluating the next product after personal loans, Navi’s management chose home loans over credit cards. So what’s happening here?

I reckon that a lot of it has to do with the housing market in general. Navi’s presence in South and West is what contributes ~70% of total home loan outstanding.

In terms of volume, Navi’s target segment (above 10 lacs) constitutes almost half the market size (contrary to the popular opinion that affordable housing has a greater pie).

Even in terms of GNPA, larger HFCs (housing finance companies) tend to have lower defaults than medium or small HFCs. Housing finance as an asset class has the lowest annual credit losses amongst all large financial asset classes mainly on account of the collateral and the secured nature of the funding.

Even collections are the best for home loans (along with gold loans)

All of these factors may have convinced Navi to push the bar here. Of course, Sachin is extremely ambitious and may just surprise everyone!

“I think at Navi we are very new, still early but very excited if we are given the opportunity to build a bank by RBI. We will do a tremendous job, of building something completely new that the world has never seen. India is the place for this.” - Sachin Bansal

Other Cool Stuff I’ve Read

• More bankers join well-funded FinTechs (link): While reading this, I was surprised that Nilufer Mullanfiroze, who played a crucial role in building the cards and partnership business for Federal Bank. She recently joined as the Head of Banking at a wealth-tech startup. This is a trend that is only going to blow up moving forward. (I remember when I started this newsletter, I had a section titled “Movers and Shakers” which highlighted bankers moving between banks). Almost every FinTech startup, which has operations or sales or requires heavy partnership with traditional banks, would want to hire smart folks with experience. They could help with regulations, building teams as well as contacts.

• India's Banking Revolution Has Started Without the Banks (link): Andy Mukherjee elucidates this well in his opinion piece. It draws on Niti Aayog’s discussion paper on digital banking (which I’ll separately cover soon) and highlights the lethargy in the transformation of technological services for one of the world’s most valuable lender - HDFC Bank. Yet, digital giants like PayTM, PhonePe, GPay are held back due to an archaic regulatory regime. When will this change?

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want your brand to get featured, write a guest post or simply want to say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, please like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

I’ve already covered the details on how this merger arrived here.

Cut short to this week, where RBI has published a Draft Scheme of Amalgamation between PMC Bank and Unity Small Finance Bank. For the uninitiated, here’s a quick recap:

Recap: After a huge fraud got exposed at PMC (Punjab and Maharashtra Co-operative) Bank, RBI had put restrictions on deposit withdrawals way back in September, 2019. The bank's liquidation/amalgamation has been in limbo for about two years now. Earlier this year, a joint venture between Centrum Financial Services Ltd. and BharatPe resulted in the creation of a small finance bank (called Unity) with whom PMC Bank is going to be merged. Remember, our deposit insurance authority Deposit Insurance and Credit Guarantee Corporation (DICGC) will only pay out ₹5 lacs of insurance after a successful liquidation/amalgamation/merger event. Two days ago, RBI published the draft scheme. The scheme is yet to be notified by the Government.

Now that the SFB is operational and scheme is published, the next leg of the takeover can officially begin. However, it is very important to understand the details of the scheme as it sets a precedent for Indian Banking.

To make it simple, I’ve explained the scheme with 10 frequently asked questions: 

Q1: Is everyone going to get their money back?

A: Short answer - yes.

Long answer - yes, but it is going to be a painfully long wait for depositors who have a large deposit at the bank (such as over ₹15 lacs).

Q2: I have ₹5 lacs spread across different branches of PMC Bank. Will I get my money immediately?

A: Your wait will definitely be much lesser than other large-value depositors, but not immediately. Ideally, Deposit Insurance and Credit Guarantee Corporation (DICGC) is supposed to pay out the insured amount within a maximum period of 90 days. However, they have invoked a special provision where they can take an additional 90 days to pay the amount to Unity. So you can expect this latest by April 2022. Having deposits in multiple branches is not an issue - they will be aggregated to arrive at the total amount.

Q3: I have ₹16 lacs deposited in PMC. When will I get my money?

A: Beyond the initial ₹5 lacs that you're going to get before April next year, here's the timeline for the additional amount that you're due:

After 2 years: ₹0.5 lac (at this point, you've received ₹5.5 lacs)
After 3 years: ₹1 lac (at this point, you've received ₹6.5 lacs)
After 4 years: ₹3 lacs (at this point, you've received ₹9.5 lacs)
After 5 years: ₹5.5 lacs (at this point, you've received ₹15 lacs)

Any remaining amount (in this example, ₹1 lac) is going to be paid after a period of 10 years. For clarity, all these dates are since the day the scheme is notified by the Government (which is pending).

Q4: But Unity is claiming 99% of the depositors will get back their money in 5 years? That's not a bad thing right?

A: 99% may seem like a big number; for context, 20,645 unique depositors have deposits more than ₹10 lacs. 37% of PMC's depositors are senior citizens. Imagine waiting for 5 years for your own money. (7 years if you count since the time RBI put the restrictions). Twitter and Facebook is filled with stories of depositors protesting and some even taking their own lives without access to money.

Q5: Oh shit. That's bad. Could this have been avoided?

A: Yes and yes. If RBI had chosen a stronger lender for the merger (like in the case of Yes Bank or Lakshmi Vilas Bank amalgamation), depositors could have accessed all of their deposits within a matter of a few days. Unity Small Finance Bank has just been brought to existence. If it pays out all the depositors immediately, it will have to start with a blank balance sheet.

Q6: Why didn’t RBI choose a bigger and stronger lender?

A: Well, there’s a couple of things to note here. PMC, at the end of the day, is NOT a scheduled commercial bank. As I’ve mentioned before, not all banks are same. Your deposits are much safer in a scheduled commercial bank (check the official list here) compared to a co-operative bank. Also apparently, PMC is not the only co-operative bank where depositors have had to wait for such a long time to access their funds. It was only on the aftermath of such a huge crisis that the Government amended the Banking Regulation Act to allow RBI greater control over co-operative banks.

Q7: So will the next co-operative bank fall be handled better?

A: No clue.

The biggest complaint from these amalgamations is that there’s no SOP (standard operating protocol). Absence of it allows the central bank to come up with a different solution each time. Some of them work, while some, like the PMC scheme, leaves everyone longing for more.

Q8: What about corporate deposits? Will they suffer the same fate as retail deposits?

A: Well, when it comes to a bank, the common depositor almost always gets a preference over institutional depositors, just like in this case. I’ve pictorially represented what happens to these:

Q9: Wait, what about the interest on these deposits?

A: No interest shall accrue on any deposit for a period of 5 years from the appointed date. Post that period, interest rate of 2.75% will accrue on eligible accounts (i.e. savings, not current accounts). Based on initial response on the draft scheme (RBI is accepting suggestions and objections up to 5.00 PM on December 10, 2021), there’s a small chance this might be rolled back. If lack of funds is an issue, we have Sucheta Dalal asking the hard questions.

According to her report, a few thousand crores of assets have been recovered by the Directorate of Enforcement from the Wadhawan family (the fraudulent promoter group that led to PMC’s collapse). RBI has not mentioned this in the draft scheme.

Finally,

Q10: What’s next for Unity?

A: As far as the scheme details go, Unity doesn’t have to pay anything now. DICGC is paying the insured amount, to the tune of ₹3100 crore, to 8,80,000 depositors. Unity will however, have 20 years to repay this amount to DICGC.

In terms of employees, all 1,100 of PMC Bank will continue to remain employed with Unity, under the same remuneration and terms and conditions of service for a period of 3 years from the appointed date.

One of Unity’s biggest achievement, I feel, has been the ability to rope in ex-SBI chairman Rajnish Kumar as the Chairman of this merged entity. Rajnish has boatloads of experience:

• 40 years in SBI

• Ramping up their digital arm YONO to what it is today

• Managing the merger of Yes Bank with SBI

Unity is going to pitch itself as a technology-first merchant-focused bank. BharatPe has an extensive network of merchants (over 60 lacs) which it can ready tap into to offer small loans.

“We want to be technology first. People should get loans basis their numbers. The same philosophy we would like to translate into the bank as well.” - Ashneer Grover, in an interview to Moneycontrol

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want to get featured, write a guest post or wanna simply say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

From flat-out refusing to acknowledge them to setting up separate teams to evaluate partnerships, we’ve come a long way.

Somewhere between this transition, our regulator provided their stamp of approval as well. 👇

FinTech is so important now that RBI has been actively conducting sandbox experiments with young startups in several themes such as:

1. Retail Payments

2. Cross-Border Payments

3. MSME Lending, and

4. Prevention and Mitigation of Financial Frauds

I love how our Deputy Governor Rabi Sankar has defined the role of banks and fintechs:

…Banks bridge gaps in space and time between savers and borrowers. The spatial gap occurs when a saver and a borrower do not know each other, or are in different locations. The temporal gap occurs when the needs of the borrower and the lender arise at different points in time - borrower needs money after a month but the saver has money now.

He goes on to explain how FinTech can solve for the spatial gap, but not for the temporal gap - as banks are the only financial institutions uniquely placed to be the liquidity (money) providers to the economy.

There are two key messages that arise from his speech:

• The ideal approach is for banks to partner with FinTech for improving efficiency, speed and reach.

• FinTechs that try to become banks should be regulated like them

So yes, smart banks (from small to big) are trying to leverage FinTech better.

The Big Guns

Take HDFC Bank for example. When asked what it sought to achieve with the recent partnership with PayTM, the management mentioned three things:

1. Embed HDFC Bank’s credit card QR into PayTM’s QR so that they can broaden the base of the merchants that HDFC can tap into (Remember PayTM has over 21 million merchants on its platform)

2. Cross-sell and up-sell banking products to these wide set of merchants

3. Provide Business Credit Cards to these merchants in partnership with VISA

Similarly, for Axis Bank and ICICI Bank, partnership with Flipkart and Amazon (not exactly a startup anymore) respectively, has proved immensely beneficial in terms of credit card acquisition.

Here’s what each has to say,

Axis:

The Axis - Flipkart cobranded Card saw highest ever monthly acquisitions through Flipkart platform in Sep’21. We see growth continuing through both organic acquisitions and partnerships. On the back of increased card spends, the cards book was up 11% QoQ.

ICICI:

The tie up that we have with Amazon has really worked well for us. In terms of growth again, you have seen the growth that we have seen in the cards in force or the credit cards spends and the market shares have also improved for us

The Underdogs

My favourite one in this list is Federal Bank. I’ve already covered some of their partnerships, such as the one with BharatPe, in a previous post.

In their latest analyst conference call, the CEO had a very bullish view on their FinTech partnerships,

The last part and important point, which you may have all observed, we have a fetish and a feverish pitch on digital and fintech. I have personally spent disproportionate time and Shalini as an Executive Director, probably spending a large part of our time on getting this going. We've created exclusive teams that are focused on this. At this point in time, there's a cost element to it. But we are willing to take that cost because we believe that in the long run, this is going to be a Federal Bank, completely differentiating from many other banks. 

They’re adding roughly 7500 accounts per day with just two fintech partners (Jupiter, Fi Money).

Federal Bank has also recently launched credit cards (around May 2021) and has been adding around 7000 cards per month. They’re doing this with a partnership through OneCard, which is taking care of the acquisition and servicing.

No numbers were revealed in terms of revenue and costs, but the cost structure is primarily of two types:

1. Where the FinTech partner is an acquirer (like OneCard) - this is treated as BC cost (Business Correspondent)

2. Where Federal is a service provider to FinTech - so there’s an acquisition cost that Federal bears

Not just Federal, here’s what South Indian Bank has to say:

We should not really look at Fintechs as competition. We should look at Fintechs as partners. Towards that we have already started associating with the Fintech for our gold loan and we are as I am talking to you we are exploring couple of such opportunities where they are wanting to tie up with people so that we can leverage on their technology capabilities and we can use our distribution spend.

And DCB Bank:

On a monthly basis, we are meeting several fintechs. Some of the fintech companies are good and they can scale up. We are trying our best to make sure that how can we make available APIs so that the fintech company can consume it and we can consume their APIs, such that we can have almost seamless kind of delivery to customers.

Concluding thoughts:

What I’ve covered is a small sample from recent concalls on how management truly feel about FinTech firms. There’s a lot more deals that is happening every. single. day!

A few quarters down the line, banks would soon start revealing numbers as well - and we would have a better clarity on the quality of these relationships.

As DG Rabi Sankar rightly pointed out, “Competition for banks comes not from FinTech firms but from other banks which leverage FinTech better.”

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want to get featured, write a guest post or wanna simply say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

Apologise for taking an unscheduled break for three weeks! Hopefully things get more regular hereon.

Meanwhile, here is what we were busy building at work:

Dhan is an invite-only platform for those investors/traders who are tired of their existing options and want to try something better. To make sure you’re on the list, signup below:1

Register for Early Access

Onto today’s topic!

Yesterday, one of the most buzzing fintech companies in India launched a new feature:

For the uninitiated, the technical term for CRED Mint is “P2P lending” or peer-to-peer lending. Even though the name might sound new and fancy, this industry is actually a bit old, even for India.

It all started with a discussion paper by RBI in 2016, which in fact came as a result of proliferation of unregistered P2P lending players across India. RBI quickly brought out the consultation paper so as not to repeat a China fiasco.

In the heydays of P2P lending in China, there were as many as 3,433 companies operating in 2015. That came down to 1,900 by 2018 and 343 by 2019, once China introduced regulations. Regulations were brought in due to a combination of mismanagement and widespread defaults.

The Master Directions (official template guide to register as a P2P player) were brought in 2017. It has since been updated four times.

In the beginning, the largest (and the only registered) P2P player was Faircent.

As of today, there are over 20.

Unfortunately, the transparency ends here.

After repeated attempts by journalists to gather more information through RTI, our central bank has nothing to show for it.

Without individual company data, it is difficult to compare the top players and also map the growth of the industry. Faircent, obviously, claims it has 80% of the Indian P2P lending market, with months disbursals of ~120 crores, but how do we verify?

Other known names include Monexo, i-Lend, i2i Funding, Finzy, LenDen Club and finally LiquiLoans, which is the partner for CRED.

Basics first

Let’s step back for a bit now.

What exactly is P2P lending and how does it work?

Think of it as something sandwiched between organised lending (banks, NBFCs) and unorganised lending (actual human moneylenders).

Just like Uber/Ola matches a rider with a driver (keeping a cut in between), a P2P player acts like a marketplace, matching eligible borrowers with willing lenders.

Let’s take the homepage of Faircent as an example, for simplicity.

As of today, it has registered lenders on its platform with an intent to lend upto 165 crores. Registered borrowers are willing to borrow 252 crores. It is Faircent’s job to match lenders with borrowers. The matching needs to be line with what RBI has prescribed in their rulebook:

1. No lender can have individual borrower exposure over ₹50,000 (across all P2Ps)

2. The total exposure of an individual lender cannot be more than ₹50L (across all P2Ps)

3. The loan taken by an individual borrower, has a cap of ₹10L (across all P2Ps)

4. The maturity of the loans shall not exceed 3 years.

Amit More, founder of Finzy, another P2P platform, had appeared on a podcast and explained how this looks realistically:

“We have a single borrower of ₹5L who has received money from 131 different lenders. Similarly, one lender of ₹10L has his money spread across 330 different loan accounts”

Quality over Quantity

The match-making itself is quite simple - a decent underlying technology can solve it. The real difference comes in the quality of borrowers that the platform attracts.

How good is the verification standard?
What is the borrower profile?
How many borrowers are on the platform? (a higher number can ensure better diversification for lenders)

All these things play out over a market cycle and that is why you can never know if your money is truly safe, at least, not in the beginning. For example, in the first 21 months of its existence, Finzy did not have a single NPA. CRED is promising almost the same thing (NPA figures of less than 1%).

But look at the feedback for these players today:

This is not surprising, as the model itself is skewed in favour of borrowers rather than lenders. Imagine yourself to be a middle guy. You introduce the borrower to the lender. You take a matchmaking fee and then you can forget about the deal altogether.

RBI regulation does not mandate recovery on behalf of the lender. In fact, P2P lenders are NOT supposed to provide any assurance of recovery of principal/interest. Even RBI doesn’t want any involvement. The central bank has asked P2P platforms to display this message on their website:

“Reserve Bank of India does not accept any responsibility for the correctness of any of the statements or representations made or opinions expressed by the NBFC-P2P, and does not provide any assurance for repayment of the loans lent on it”

RBI has also mandated that P2Ps cannot harass the borrower for collections at all.

Yes, it helps the P2P company’s fate if borrowers don’t flee with the money - but if they were REALLY good with collections and recovery - they would be better off as lenders themselves (bank, NBFC) rather than a marketplace.

We will now understand how having a robust large loan book BEFORE you delve into P2P (like in the case of CRED) is actually advantageous compared to starting out directly as a P2P player - which includes constantly tweaking borrower side (by lowering your borrower standards) or lending side (bringing in institutional money) until you arrive at a favourable number on either side.

The Lending Model

Remember, P2P players cannot lend on their own. They cannot raise deposits, nor provide any credit enhancement/guarantee. They cannot permit secured lending (lending against collateral), they cannot even cross-sell any other product (except loan specific insurance products).

Lastly, they cannot hold any funds on its balance sheet - not funds received from lender and not funds received from borrowers (interest/principal repayment).

So where do the funds reside?

In an escrow (third-party) account. RBI has illustrated how the model should look like:

As you can see, the platform (in this case, the P2P company), should only have “view access” to the funds from the borrower and lender. The escrow account is maintained with a scheduled commercial bank and a trust (promoted by the bank) will operate it based on instructions by the borrower and lender (and the algorithm set by the P2P).

For instance, some platforms allow you to pick and choose which borrowers you want to lend to (this is anonymous and you can only see the category and the rate of return- a riskier category will fetch you higher returns). Other platforms do not give you an option and do the matchmaking themselves. Heck, you can even be a borrower and lender at the same time on these platforms, but the algo and the trust will make sure you don’t end up lending to yourself.

Where does CRED sit here?

CRED is the FinTech layer on top of a registered P2P (LiquiLoans). The pool of lenders and borrowers that CRED uses is its own - not of LiquiLoans - thus it is free to set its own T&C. For example, the minimum investment for a lender, if you directly invest via LiquiLoans is ₹50,000. On CRED, it is ₹1,00,000, Similarly, the maximum amount through LiquiLoans is ₹50L. On CRED, it is ₹10L.

In it’s own words,

Considering the fact that CRED Mint is invite only and they can track each new lender closely, the match-making between lenders and borrowers should not be a concern right now.

In terms of income, honestly, I do not have the expertise to accurately estimate it, but if I take just my profile, I can lend to CRED and get 9% (maximum), but I can borrow only at 17% (not sure why I would - apart from convenience). I am assuming this borrower rate is not uniform for all their customers - but the spread is quite large.

Also, disclosure: I have invested in CRED Mint - mostly because I want to experiment with this platform and because they are allowing me to withdraw my full amount any time I wish to (most P2P lenders DO NOT allow this).

Additional info: Their banking partner for the lending side is IDFC First Bank and the trustee managing the escrow account is IDBI.

The Pitch

I think the biggest pet peeve for most folks is the way P2P is pitched to gullible investors.

For example, at one point, BharatPe (which actually came up with the idea of partnering with a P2P player even before CRED) came into the limelight because their sales force tried to mis-sell this product to its merchants as a “savings” product. Merchants were “guaranteed” 12% returns. Compare this to a 4% return on their savings account (or even 0% for merchants in their current account), this seemed like a godsend.

To be clear, pitching this product in such a way is clearly prohibited by RBI - but then again, RBI wants to keep its hands clean anyway.

The Future

P2P players had received a lot of investor interest between 2018-19. Any guesses why it died down? 😉

In any case, now that CRED has picked it up, the industry “might” revive again. I see one other listed player (5 Paisa) also being bullish on this space based on management commentary.

They recently introduced it as a segment, so let’s see how much this contributes to the topline.

That’s it for this week.

P.S. I love feedback. If you want me to cover a particular news, want to get featured, write a guest post or wanna simply say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.

CBDC - Is this the Future of Money?

While I strongly recommend reading the full 9 page article by RBI, here’s some context if you are new to this.

What is CBDC?

To put it very simply, think of CBDC as money. Only the form is different than what you’ve experienced it in since childhood - paper/coins vs digital.

Now the next obvious question is,

We already have digital money, how is CBDC any different?

This question become even more relevant for countries which have fully functional RTP (real-time payments) or FPS (fast payment system) - think TIPS in Euro, Pix in Brazil, CoDi in Mexico, FedNow in US - or - just think of our very own UPI in India!

Thankfully, RBI has addressed this question already. In a survey sponsored by the central bank, it has been found that cash is still predominantly used for paying and receiving money for regular expenses (~50%). Even within this, it is seen that this % keeps increasing as you go down the ticket - High value transactions (above ₹500) are mostly digital, whereas low-value transactions (₹100-₹500) have as high as 70-80% being conducted through cash.

All these numbers might be difficult to grasp for the majority of readers of this newsletter, but India indeed has a unique scenario of:

“increasing proliferation of digital payments in the country coupled with sustained interest in cash usage”

So now the question becomes:

If these people are not using digital payments in the first place, why will they go for CBDC (which is just another digital form of money)?

This question cannot be really answered in a straight-forward manner because RBI’s survey does not reveal WHY people use cash predominantly.

There could be two reasons for it:

1. People have some form of discomfort towards digital payment

2. People want anonymity - which only cash provides

CBDC cannot solve for (1) but can definitely solve for (2).

Wait, my UPI transactions aren’t anonymous. How can CBDC be?

Unlike UPI, CBDCs can be configured to be anonymous, so that it doesn’t reveal your identity to third parties (the diagram below offers a good visual explanation of how this will work)

There are of course challenges to anonymous CBDCs which are similar to crypto (what if you lose your private key?) which are still being solved by other countries.

There is another reason why CBDCs have a good case over RTPs like UPI:

Herstatt Risk (or Settlement Risk)

When you transfer money through UPI, there are multiple parties involved - your bank, receiver’s bank (if it is different), RBI, NPCI, the fintech layer/app you are using etc. Although the technology is instantaneous, it is not devoid of settlement risk - the risk of one party not paying the other - in such instances, reconciliation (checking bank records to verify and rectify the transaction) occurs - all this adds up costs.

Imagine you could remove all of this with CBDC. Unlike UPI (which is a technology), CBDC is real money. Unlike UPI, where bank balances get transacted, CBDC can be transacted directly, removing the need for inter-bank settlements.

A related advantage of transacting directly with CBDCs is:

Global Payments

Today, you cannot use UPI to transfer money to USA. However, CBDC makes this possible. RBI goes on to elaborate:

“It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over.. Time zone difference would no longer matter in currency settlements”

However, this is not as simple as it sounds. Unlike crypto, which is truly global, CBDCs, as the name states, is unique to one central bank. So if Indian CBDC is going to be accepted in USA (or vice versa), both RBI and the Federal Reserve need to figure out the HOW.

This is exactly what Project Inthanon-LionRock is trying to achieve, where the central banks of Hong Kong and Thailand are participating.

This is wonderful! How does it affect banks?

Banks won’t go away, don’t worry.

Let’s take a bank’s basic need to be in the economic system:

1. Deposits

2. Loans

CBDCs can remove (1) but not (2). Why? Because the central bank cannot directly lend to you. Banks will continue to be the intermediary.

Additionally, CBDCs replacing deposits is not entirely simple. In order to do that, they need to offer interest, which is not exactly true to its form (Remember we are comparing CBDCs to cash, which also doesn’t provide any interest if you keep it with you).

Got it! So when is RBI going forward with this?

That will take time. A lot of time actually.

This week’s publication is actually the first broad acknowledgement that RBI is even thinking about this. Remember that other countries have worked on this for less than 5 years - you are only hearing about this now because the recent rise of cryptocurrency is actually a threat to fiat money (government issued currency). RBI clearly hates it.

CBDC itself, has multiple options to choose from. A few things which RBI will be considering are:

• Should they introduce only retail CBDC (which we just described) or also wholesale CBDC (think of heavyweight financial institutions who directly keep money with RBI)?

• Should they use a distributed ledger (think of blockchain) or a centralized ledger (all control with RBI only)?

• Should they use token based (anonymous) or account based (identifiable) verification? If they go with the former, how anonymous should the transaction be?

• Should RBI directly issue CBDC or allow banks to do it?

Pilot projects considering all these will be started soon, but before that, the RBI Act needs to be modified too. When it was written in 1934, nobody had thought that currency could emerge in any other form.

“Perhaps the time for CBDCs is nigh.”

Finally, what is the state of CBDCs around the world?

To make my job easier, PwC has started publishing the CBDC Global Index from this year, which tracks the progress of each type of CBDC around the world (retail, wholesale, cross-border).

PwC CBDC Global Index

Through this report, I actually discovered that the Bahamas (Sand Dollar) and Cambodia (Project Bakong) are far ahead in their CBDC maturity than China (DC/EP).

That’s all folks!

Considering how important this topic is going to be, I tried to cover the basics first. If you want to go deeper, you can always read all the links embedded in the sources.

As always, share it with someone you think should read up on this.

Share

See you next week! :)

I love feedback. If you want me to cover a particular news, want to get featured, write a guest post or wanna simply say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, like this post and share it around?

Share Bank on Basak

All views and opinions shared in this article and throughout this blog solely represent that of the author and not his employer. All information shared here will contain source links to establish that the author is not sharing any material non-public information to his readers. His opinion or remarks on any news are based on the assumption that the source is genuine; thus he is not liable for any information that may turn out to be incorrect. This blog is purely for educational purposes and no part of it should be treated as investment advice. Using any portion of the article without context and proper authorisation will ensue legal action.