NITI Aayog, India’s policy think tank, has recently released a comprehensive report named ‘Digital Banks: A Proposal for Licensing & Regulatory Regime for India’. The report highlights the need for establishing Digital Banks and looks into a suitable licensing and regulatory framework for these institutions.
Report Findings: Progress of Financial Inclusion in India
The report sheds light on India’s significant advancements in promoting financial inclusion over the recent years. This progress has been catalyzed by initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY), India Stack, and Unified Payments Interface (UPI). These platforms have democratized financial access and helped in integration of the economy. Notably, UPI recorded a staggering 4.2 billion transactions amounting to Rs 7.7 trillion in October 2021.
Despite these strides made in financial inclusion, credit penetration continues to be a policy challenge, particularly for the country’s 63 million MSME sector. The government’s Direct Benefit Transfer (DBT) scheme through apps like PM-KISAN and microcredit facilities for street vendors under PM-SVANIDHI have strived to address this issue.
The Concept and Importance of a Digital Bank
In its simplest form, a digital bank will have its legal existence and maintain its balance sheet. It will be enshrined in the Banking Regulation Act of 1949. The role of a digital bank is distinct from the 75 Digital Banking Units(DBUs) announced recently in the Union Budget 2022-23. These units aim to foster digital payments, banking, and fintech innovations in underserved areas.
As per the proposed regulations, Digital banks would adhere to prudential and liquidity norms on par with existing commercial banks.
Why is there a Need for Digital Banks?
One of the primary rationales behind establishing digital banks is to bridge the credit gap in India. Despite substantial advancements in payments, the country still grapples with meeting credit needs of micro, small, and medium businesses.
Digital banks could leverage technology to cater to these underserved sectors and bring them under the formal financial umbrella. Also, these banks primarily rely on digital channels with high-efficiency metrics, making them potential tools for policymakers to achieve social goals – empowering under-banked small businesses, and enhancing trust among retail consumers.
Challenges Faced by Existing Neo-Bank Models
Current neo-bank models that depend on partnerships face multiple challenges such as revenue generation and viability. Unlike digital banks, neo-banks operate without having their banking license, depending on partner banks to provide licensed services. This model restricts their revenue potential and increases the cost of capital.
NITI Aayog’s Recommendations for Digital Banking
NITI Aayog’s report indicates several recommendations for the evolution and maturation of digital banking in India. The highlights include issuing a restricted digital bank license, contingent on the licensee’s satisfactory performance in the regulatory sandbox. Other recommendations are enlisting the licensee in a regulatory sandbox framework enacted by the Reserve Bank of India, and issuance of a full-scale digital bank license after assessing prudential and technological risk management.
