Softbank’s Massive $1.4 Bn Paytm Bet Validates Payments Bank Model

Softbank’s decision to invest $1.4 billion (over Rs 9,000 crore) in Paytm will change the nature of the game in Indian banking. The investment values Paytm at over $7 bn, a valuation of over Rs 45,000 crore for a bank that is yet to really launch.

Paytm, which is into e-wallets and will soon convert itself into a payments bank (the launch date is 23 May), aims to more than double its existing wallet base of 220 million customers after it becomes a payments bank. If it achieves a customer base of 500 million, it will be bigger than State Bank of India (SBI), though individual transaction volumes may be much lower. After merging its five subsidiaries, SBI now has a customer base of 370 million.

The Softbank investment is huge, and will bring competition to the banking industry like never before. Apart from Softbank’s money, of which $1 billion will come directly into One97, the holding company for the payments bank, founder and CEO Vijay Shekhar Sharma intends to invest another $0.6 billion in the bank over the next few years. This additional money, presumably to be generated from internal sources, will take the total investment to over Rs 10,000 crore in the payments bank. Contrast that with the Rs 10,000 crore that the government has provided for recapitalising public sector banks in 2017-18 – banks which account for 70 percent of the Indian banking system. The money is clearly insufficient.

Payments banks are banks that can take in deposits upto Rs 1 lakh per person and have to invest 75 percent of this amount in government securities of upto one year’s maturity. They can’t lend directly, but they can earn commissions by enabling purchases of mutual funds or insurance products. By using their customer databases, they can also get regular banks or financial institutions to lend money to customers.

Sharma told Mint in an interview: “Our business model is to help consumers and businesses get loans from various financial institutions like NBFCs (non-banking financial companies) and banks. We are not planning to build a loan book on the Paytm balance-sheet and payment banks are anyway not allowed to do so. We plan to build relationships with financial institutions and we have already done that with some like ICICI Bank, Bank of Baroda and firms like Capital First and Capital Float. They will help lend to customers on our behalf.”

There are three important implications of Softbank’s huge investment in Paytm.

First, it is a validation of the payments bank business model, even if the regulations currently do not allow them to do things that other banks can (mostly lending). Airtel Payments Bank is already heating up the tracks, and Kotak Mahindra Bank has created a new digital-only bank called 811, where accounts can be opened in five minutes through a downloaded app and operationalised for making payments through the use of virtual debit or credit cards, not to speak of scan-and-pay systems at merchant outlets. Effectively, the digital payments bank is seen as a cheap entry point into regular banking. As regulations ease, and as digital payments become the norm, payments banks could well be allowed to do more – and even become regular universal banks.

Second, the assumption that you need brick-and-mortar establishments to run a bank is being up-ended with payment banks. Most new entrants are non-banks, and they are entering the field riding existing customer relationships. Airtel hopes to covert many of its existing 250-million-plus mobile customers to joining its bank. Paytm is doing the same with its e-wallet base. Soon, Reliance and Idea Cellular may do the same, as will other recipients of payments banking licences. The entry of Kotak directly into this space suggests that even existing full-fledged banks see value in this foray.

Three, farm from being handicapped by not being allowed to lend, payments banks can use data to drum up fee incomes. While regular banks can also do that, payment banks have the added advantage of not having huge piles of bad debts accumulated over the long term through bad commercial decisions or by being at the wrong end of a business cycle. Payments banks can collect fee revenues without courting bad loan risks.

The nature of the banking game is changing in that lending and borrowing are fast becoming plain-vanilla activities loaded with risk and where margins may thin down as more players enter the picture. The real booty will come from using your customer database to cross-sell financial and other products for a fee, unencumbered by asset-quality worries.

Indian banking is currently overloaded with overheads – excess staff, costly branches, ATMs, and physical credit cards – when the digital world is making it possible to become a bank without any of these “assets” that could fast turn liabilities.

Masayoshi Son of Softbank is investing big in Paytm – with China’s Alibaba being the other big investor – precisely because he knows financial services are no longer about bricks and mortar, but bits and bytes.

Public sector banks are fast becoming a liability in this world of virtual banking.