India Has The Most Sophisticated Payments System In The World – And Six Men Made It Happen

Technology is changing the financial sector of the Indian economy at jet speed, thanks to the ubiquity of Jan Dhan bank accounts (215 million accounts and counting – which means nearly all households covered), the spread of mobile phones (one billion mobile users in a population of 1.25 billion), and the Aadhaar unique ID (again, one billion IDs this month).

This means that with one click, information and money can move to the last mile and the last Indian living in a remote village. India now has the most sophisticated payments system in the world, and six men were responsible for it: Manmohan Singh and Nandan Nilekani (for creating Aadhaar), Arun Shourie and A Raja (for making mobile phones affordable, through policy and crookery respectively), and Narendra Modi and Raghuram Rajan, who tied it all together. Modi deserves extra praise for making Jan Dhan bank accounts universal and making Aadhaar the route to subsidy and payments reform.

There is obviously a gap between what is possible in terms of technology and what the last man will use regularly and comfortably. But with a focused approach to financial and digital literacy over the next three years of the Modi government, every Indian family can technically be part of the formal money economy. It should be possible for any Indian to be paid or pay anyone anywhere with just a mobile phone and a few clicks or pushes on the mobile phone.

Apart from the JAM trio (Jan Dhan, Aadhaar, Mobile), enabling this transformation is the creation of new forms of differentiated banking entities, of which two are already underway: payment banks and small banks. The former will use mobile technology for enabling everyday retail and bill payments, including peer-to-peer payments, and the latter will take credit to small businesses, the backbone of job creation.

Two more types of banks are also underway, though we still don’t have the details. In his last monetary policy on 5 April, Rajan said wholesale or long-term financing banks will be licensed, apart from custodian banks. Normal banks are in trouble in part because they made long-term infrastructure loans when their deposit bases are short-term in nature. They thus borrowed short to lend long. The arrival of wholesale banks could change all that.

Yesterday (11 April), Raghuram Rajan released a new unified payments interface (UPI) for mobile telephones, which will move money between mobile phones linked to unique IDs. Today, when you move money from your bank account through the internet, you have to use branch and IFSC codes, a process which can take hours. Each beneficiary also has to be separately registered. But with UPI, once downloaded on your phone, you can send money to any unique ID, irrespective of bank details, instantly. UPI effectively makes mobile smartphones into mini banks.

Nandan Nilekani, the father of the Unique ID, could not have been more pleased. He was quoted by Mint newspaper as saying: “Payments have evolved in different ways. You had a card system, mobile money, internet e-wallets. But completely mobile interoperable person-to-person instant real-time with push and pull really didn’t exist anywhere. So I think that is where this is a leapfrog.”

Consider the revolutions unleashed.

#1: Once unique ID-based money transactions are possible, and after enough companies and individuals are linked to the system, you won’t need even a credit card to make payments anywhere in India. Bill payments, cabbies, autos, kirana expenses and even online and offline retail payments can shift to the mobile easily. The limit for UPI transactions is Rs 1 lakh – an adequate limit for almost any conceivable transaction barring property or car purchases.

Not for nothing did Rajan boast: “What we have in India is the most sophisticated public payments infrastructure in the world. [But] it is not just the payments that are part of the revolution; it is a whole new set of banks that are coming in.”

#2: Payment banks will bring down bank transaction costs as they will force regular banks to fight for deposits and retaining customers. Small banks, which are supposed to lend the bulk of their resources to small borrowers (upto Rs 25 lakh), will bring down the cost of borrowing for small businesses.

#3: The arrival of wholesale banks will turn the clock back on universal banking – which came with liberalisation, when long-term lenders lost their special access to funds and became regular commercial banks to raise deposits. With wholesale banks being empowered to raise cheaper long-term resources from the likes of insurance and pension funds, and if regulatory requirements allow such banks to lend without parking funds in government securities (what banks call statutory liquidity ratio, or SLR), long-term lending costs will be streamlined.

The fast pace of change must have left some of the early movers with red faces.

Take the case of Bandhan Bank, a small business lender which got a universal banking licence two years ago. Logically, its operations would have been cheaper if it had waited for the licensing of small banks, which have lower capital requirements than universal banks. IDFC Bank, which converted itself from a focused infrastructure lender to a universal bank, paid the price in terms of a huge loss of short-term profitability as it moved resources to maintain SLR and CRR. It must be kicking itself now. It could have become a wholesale bank instead of a universal bank, where the competition is fierce – and getting fiercer.

The biggest losers in the changing game may be the public sector banks, which are too slow to insure themselves against competition by moving as fast as the HDFCs, ICICIs and Axis Banks can do.

They may not be kicking themselves, but the finance ministry should be kicking butt with some degree of urgency here. It has to move towards privatisation – come hell or high water. Else, it will be stuck with many losers who will bleed the exchequer dry.