Will E-Wallets Survive? Maybe Not. But There’s No Need For RBI To Play Hangman

The Reserve Bank of India’s (RBI) new draft guidelines for pre-paid instruments, including e-wallets, suggest a schizophrenic attitude to financial inclusion. Pre-paid instruments like e-wallets, prepaid cards, giftcards, Sodexo coupons, et al, are key players in the business of financial exclusion, but they can survive and serve customers only if regulation is light and non-intrusive.

But the draft guidelines – which include raising the minimum capital to Rs 25 crore and enforcement of bank-like know-your-customer (KYC) norms – suggest that the central bank is uncomfortable regulating any entity that can’t be thought of as a bank. These guidelines will effectively nudge e-wallets to become payments banks, at a time when payment banks themselves have to figure out a viable business model.

Only two payments banks – Airtel and Paytm – have been given the RBI’s green signal so far, and even though the idea is to put licences on tap, new players may take some time to become payment banks. Since three of the 11 payments banks given licences have opted out on grounds of viability, and the rest are yet to be given a licence, the RBI, it seems, wants to pressure more entities to become payments banks.

This may explain the intention to make e-wallets jump through more hoops than before. But in making the business costlier the RBI is working against its own goal of making financial inclusion easier to achieve. E-wallets and business correspondents have been the intermediaries bridging the gap between the formal financial sector and the last man in the distant village – where banks cannot easily reach.

The RBI has also been pursuing the idea of differentiated banking by making regulations easier for payments and small banks, while creating new kinds of specialised banks (wholesale and custodial). But the goal should be differentiated financial entities, and not just differentiated banks.

It is quite possible that e-wallets are a passing phase in Indian banking, and HDFC Bank chief executive officer Aditya Puri may well be right when he wondered aloud the other day about whether they could survive purely by giving huge discounts and unsustainable cashbacks. But the demise of e-wallets (or any financial product for that matter) should be orchestrated by markets and declining customers, not heavy-handed regulation.

The history of banking in India (and abroad) suggests that financial entities arise from unmet customer needs, and they may also exit when they fail to meet newer and higher-order needs. Moreover, what sounds like a good idea in one circumstance may turn out to be bad in another.

The US had its Glass-Steagall Act that separated commercial and investment banking. But as banks grew bigger and bolder, this separation was ended, and banks became all things to all people. But after the collapse of 2008, when banks and other institutions made risky investments in instruments they did not quite understand, it is far from clear that banks must be allowed to do everything under the sun. Nor is it clear that heavier regulation and even more capital adequacy will prevent banks from doing the things that may bring them down.

In India, we had term- and project-lending institutions (IDBI and ICICI) but we thought that was a bad idea and put them out to grass. We also had specialised banks to lend to infrastructure (IDFC and IIFCL), but one of them became a bank. When term-lending went out of fashion, banks got into the same business despite the mismatch in their asset and liability tenures – and burnt their fingers. Long-term project lending is one reason why bankers are now in such a bad loans mess. In future, one could well make out a case for the return of specialised long-term lending institutions with deeper capital bases and access to long-term funding from sources like insurance and pension funds.

It is also quite possible to imagine a future where “universal banks” themselves may seem flat-footed. If money is going to be made from data and not the spread between borrowing and lending rates, banking may not quite be as hot as we now consider it to be. If peer-to-peer lending becomes the norm, and if big companies can raise their own money from issuing commercial paper and accessing equity from the markets, banks will have only the risky small and medium sector to lend to. And if depositors can invest money is cheque-issuing money market funds, they may not even need savings deposits with banks.

The market is always in turmoil, and customer needs change as technology creates new platforms for lenders and borrowers to engage with one another without the need for a banker in-between. Or at least a banker in the traditional sense of the term, with a branch, a loan committee, and a facilitator in the middle. All these jobs can well be automated based on data aggregated and held in rating agencies’ databases.

In the stock markets, for example, you don’t actually need brokers to buy or sell shares, only an electronic terminal for prices and a financial interface for money movement. So why would you actually need a bank tomorrow, if the middle function (lending, borrowing, paying and receiving money) is automated and reliable credit scores are available from rating agencies for every individual or company?

The point one is making is simple: the market will make or unmake institutions in the financial sphere. If e-wallets are to go the way of the dinosaurs, so be it. There is no need for the RBI to hasten the process. On the other hand, if e-wallets are able to reinvent and provide services at a reasonable cost, they may well survive.

Also, institutions evolve. Payment banks can well metamorphose into regular banks, and regular banks can well shrink into narrower banks based on competencies and ability to bear risks. Many public sector banks, for example, ought to be barred from making non-retail loans, given what a hash they have made of it so far.

The sobering thought is this: no institution survives forever in a competitive world. Who knows, at some point even the RBI may become redundant.

It is important for regulators to live with the humility that the markets may know better, and even if they don’t, customers certainly know if something works for them or doesn’t. E-wallets exist for the customer, not for the regulator.

Why not leave the job of determining their future to customers?