Digital Banks: The new paradigm

On July 20th, 2022, NITI Aayog released a new report on digital banks in India. It has recommended a new framework, regulatory regime, and licensing of digital banks. In this article, we will discuss these NITI Aayog directives in detail along with the potential of digital banking in India and the various challenges it’s facing in this dramatic evolution. 

  • NITI Aayog suggests new regulatory reforms and licensing of digital banks through its recent report titled: Proposals for Digital Banks in India: Regulatory Regime and licensing. 
  • The launch of Aadhaar, Jan-Dhan-Aadhaar-Mobile, and UPI has turned into a reality in modern India. 
  • UPI transactions crossed the mark of INR 10 lakh crore in June. Notably, it’s the second month in a row. 
  • The recommendations and proposals made by NITI Aayog are projected to help the underserved niches of the domain, including the MSMEs. 

The apex government think-tank NITI Aayog recently released a report on digital banks, recommending a roadmap and new reforms for regulatory regime and licensing in India. The report offers a fair playing ground for both incumbents and competitors. Given the increasing demands for digital banking, it is very important to understand its evolution and the challenges it’s facing to cater to these demands. 

Parameswaran Iyer, the CEO of NITI Aayog said during the release of the report (titled — Proposals for Digital Banks in India: Regulatory Regime and licensing): 

Looking at the need for efficiently leveraging the technology to meet the banking needs in the country, this report states the gaps that are prevailing, sectors that remain underserved, and the best practices for licensing digital banks in India.

Before proceeding further, let’s understand what is a digital bank in India? 

So, a digital bank will be a bank that will have its own legal existence and balance sheet, and shall be defined under the Banking Regulation Act of 1949. This type of bank will set itself apart from the other 75 DBUs (Digital Banking Units) that were announced by Ms Nirmala Sitharaman (Finance Minister) in the Union Budget 2022-23.

Recommendations Made by NITI Aayog 

Coming to the key recommendations offered by NITI Aayog via this digital banking report, these state the following:

  • Issuing a restricted digital bank licence to an applicant. This licence will be restricted in terms of value as well as volumes of the customers serviced by the applicant. 
  • Enlistment of all the digital bank licensees in an RBI enacted regulatory framework. 
  • Issue of full-scale digital bank licence to the licensees on satisfactory performance in terms of prudential, salient and technological risk management.

Besides, this NITI Aayog report also highlights the active business models in this sector. Moreover, it points out challenges imposed by neo-banking’s partnership model. It’s important to note that this model has emerged mainly due to the lack of a digital bank licence and the presence of a regulatory vacuum. 

Furthermore, the methodology for a regulatory roadmap and licensing proposed by this report is based on the digital bank regulatory index, which combines the following four key factors:

  • Competition 
  • Entry Barriers
  • Business Restrictions 
  • Technological Incompatibility 

Also, the elements of these factors are mapped against the benchmark jurisdictions of five countries namely Singapore, Australia, Hong Kong, South Korea and Malaysia.

Challenges in the Evolution of Digital Banks 

NITI Aayog prepared this digital bank report on the basis of inter-ministerial consultations. This report states that the recent rise of financial inclusions in the country was accelerated by the Pradhan Mantri Jan Dhan Yojana. However, the credit gap remains the biggest challenge in the evolution of banks. This is especially true for 63 million MSMEs that contribute 40% to exports, 45% to the manufacturing sector, and 30% to the GDP of a country, while also creating job opportunities for a huge number of people.

Moreover, the NITI Aayog report also mentioned that the success gained by the country on the digital payments front is yet to be mirrored when it comes to credit requirements of the country’s MSMEs. Policy and business constraints along with a significant credit gap showcase the need for leveraging technology to meet the needs of these underserved niches in the sector. 

Some other challenges involved in the evolution of digital banks are as follows:

  1. Evolution from Traditional Banking System 

Ancient banking systems are mostly written in COBOL programming language, which is very hard to convert or adapt to modern technology. Switching from these systems imposes a big challenge in the evolution of digital banks

  1. Confusion between Brick and Mortar Banks and Fully Digitised Banks 

While the concept of digital banks is greatly supported by a huge portion of the population in the country, a portion of people still want brick and mortar banks to be there. This imposes a major dilemma on existing banks in terms of whether or not to go fully digitised. 

  1. Competition from Non-financial Institutions 

Digital banks are also facing fierce competition from non-financial institutions facilitating customers. For example — platforms like Facebook and Whatsapp are allowing their users to transfer money online

  1. Internal Barriers within Bank Departments 

Banks are departmentalised in a different way. To leverage the technologies to the fullest, financial institutions need to provide effective training to their various departments and staff. This will require a great deal of time, resources and money. 

How Digital Banks Can Offer Greater Financial Inclusion & Customer Satisfaction?

Digital banking in India isn’t a new thing. It has been there for a long time. However, its importance came to light during the COVID-19 pandemic. Now, the question is how digital banking can aid higher customer satisfaction and bring more financial inclusion? Following are the ways in which digital banks can be very beneficial for the customers as well as the financial institutions in India:

For Customers

  • Offers a higher sense of control over their funds. 
  • Access from anywhere, anytime; No timing and branch  constraints 
  • Faster processing as compared to traditional banking 
  • Hassle-free and safe transactions 
  • Higher security 

For Financial Institutions

  • Automate repetitive tasks
  • Keeps customers up-to-date regarding the changes and technological advancements 
  • Higher customer satisfaction that turns into more financial inclusion 
  • Higher customer retention 
  • Reduced risk of fake currency via cashless economy 
  • Better penetration in rural areas 
  • Secure access to customer data to design personalized products

Potential of Digital Banks in India 

Digital banking users in the world are expected to exceed 3.6 billion by the end of 2024

Talking specifically about the potential of digital banks in India, the share of digital bank customers in the country is 26% as of now. What’s more? This figure is expected to cross 46% by 2027

This data isn’t really surprising given the technologically advanced world we are living in. It is clear that digitalization is the future of banking, not just in India but all over the world. A clear example of this is the advent of open banking, the introduction of BaaS (Banking as a Service), and the dramatic rise of the Indian Fintech sector. 

But here is the question: what accelerated this transformation towards digital banking? What encouraged the shift to banking technology? 

Although it’s no hidden fact that the pandemic has widely encouraged digitalisation across all types of industries, the global lockdown has highlighted the massive increase in the usage of digital payment platforms. Moreover, competition from non-financial institutions has also played a significant role in accelerating the development of digital banking. 

Apart from these factors, Government initiatives like PMJDY and digital India played a major role in the development of the digital banking sector in the country. 

References:

https://www.techfunnel.com/fintech/digital-banking-challenges-opportunities/

https://m.economictimes.com/industry/banking/finance/banking/the-future-of-banking-is-digital/amp_articleshow/90050828.cms

https://www.businesstoday.in/amp/industry/banks/story/niti-aayog-releases-report-on-digital-banks-proposes-licensing-regulatory-regime-342163-2022-07-20

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