Towards digital banking

Mark Carney, governor of the Bank of England, is in his last year as head of the central bank, but has lost little of his appetite for financial innovation. Speaking at the annual dinner hosted by the Lord Mayor of London, Mr Carney — a former head of the Financial Stability Board in Basel — addressed in particular the increasing digitisation of banking. Facebook's planned new currency, Libra, he said, would face many regulatory hurdles but he implied it would not find those insurmountable: “The Bank of England approaches Libra with an open mind but not an open door.” (Mr Carney controversially met Facebook’s founder, Mark Zuckerberg, recently.) The governor pointed out that e-commerce was changing the nature of trade, that an increasing amount of sales was online, and economies were reducing their proportion of cash payments. While these trends are noticeable in the United Kingdom, they are even more powerful elsewhere, including in India. The prevalence of these trends was clearly part of the reason he announced that digital-only financial companies would have access to the overnight deposit facilities of the Bank of England, hitherto a privilege restricted in the United Kingdom — as elsewhere — for traditional banks. Mr Carney argued this move would “empower a host of new innovation” and hopefully cut costs for payment transactions as well as extend lending to smaller businesses in the services sector and start-ups that were under-served by traditional banking. He also bucked conventional wisdom by insisting opening up the financial sector and central bank support to digital banking would improve financial stability.

These aims are also those of the Reserve Bank of India. The RBI has sought in particular to improve financial inclusion and promote innovation in the banking sector. Many of these changes have been consequential. Licences are now available on tap and payments banks have been introduced. But it is also true that the payments bank experiment has not succeeded as hoped. Blame need not attach to the RBI for this. Part of the underperformance of payments banks is certainly due to the success of other digital payments infrastructure innovations, including the UPI interface. Instead of relying on payments banks with a truncated business model — they are not allowed to lend — to expand financial inclusion, it may be time for the RBI to look elsewhere. The regular non-banking financial company (NBFC) sector is also facing a crisis, thanks in part to misplaced lending. In comparison, digital banks will be cheaper to set up, and India, with its thriving start-up sector and rapidly expanding digital infrastructure, is well placed to leapfrog in this area. KYC requirements have been onerous for payments banks, but Aadhaar-enabled infrastructure could significantly reduce this in future, alongside supportive regulations. However, it must not stop there. Reducing digital finance’s cost of capital is an important step in support of this endeavour.

The question is whether the RBI is prepared to take the sort of leap that Mr Carney advises. He is no revolutionary, but it is worth noting that he is far from alone in urging such changes. Delivering the C D Deshmukh Memorial Lecture at the RBI in April, Agustin Carstens of the Bank of International Settlements argued for “regulatory sandboxes”, which would “let innovators test their new products under regulatory oversight”. The RBI is indeed moving forward on such a sandbox. In March, however, the RBI governor said while the central bank had approved seven “purely digital loan companies” to operate, they had not taken off. The Small Industries Development Bank of India is running a pilot that experiments with financial assistance to digital NBFCs, but there is a cap of Rs 10 crore. Perhaps it is time for the RBI to experiment further and to examine the modalities of providing the sort of support for digital banks that it does for regular commercial banks.

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