Digital Banks

Why in News?

Recently, NITI Aayog has released a Report titled- 'Digital Banks: A Proposal for Licensing & Regulatory Regime for India'.

• It suggested setting up Digital Banks and a licensing and regulatory framework for such Banks.

What are the Findings of the Report?

• In recent years, India has made rapid strides in furthering Financial Inclusion (FI), catalysed by the Pradhan Mantri Jan Dhan Yojana (PMJDY) and India Stack.
• However, credit penetration remains a policy challenge, especially for the nation’s 63-million-odd MSME (Micro, Small and Medium Enterprises).
• The FI has been furthered by the Unified Payments Interface (UPI), which has witnessed extraordinary adoption.
  • UPI recorded over 4.2 billion transactions worth Rs 7.7 trillion in October 2021.
• The FI also resulted in Direct Benefit Transfer (DBT) through apps such as PM-KISAN and extending microcredit facilities to street vendors through PM-SVANIDHI.
• India is at the cusp of operationalizing its own open banking framework.
• Creating a blueprint for digital banking regulatory framework and policy offers India the opportunity to cement her position as the global leader in Fintech at the same time as solving the several public policy challenges she faces.

What are the Recommendations?

• Issue of a restricted digital bank licence, the license would be restricted in terms of volume/value of customers serviced and the like.
• Enlistment of the licensee in a regulatory sandbox framework enacted by the Reserve Bank of India.
• Issue of a ‘full-scale’ digital bank licence, contingent on satisfactory performance of the licensee in the regulatory sandbox, including salient, prudential and technological risk management.

What is Digital Bank and What is its Need?

• Digital Bank:
  • It will be defined in the Banking Regulation Act, 1949, and shall have its own balance sheet and legal existence.
  • It will be different from the 75 Digital Banking Units (DBUs) -- announced by Finance Minister in Union Budget 2022-23 -- which are being set up to push digital payments, banking and fintech innovations in underserved areas.
    • A DBU is a specialised fixed point business unit or hub housing certain minimum digital infrastructure for delivering digital banking products and services as well as servicing existing financial products and services digitally in self-service mode at any time.
  • Digital banks will be subject to prudential and liquidity norms on a par with existing commercial banks.
• Need:
  • Credit Gap:
    • The success India has witnessed on the payments front is yet to be replicated in meeting the credit needs of its micro, small and medium businesses.
    • The credit gap reveals a need for leveraging technology effectively to cater to these needs and bring the underserved further within the formal financial fold.
  • Reliance on Digital channels:
    • Banks and fintech businesses that offer digital banking services rely primarily on digital channels that organically have high-efficiency metrics relative to incumbent commercial banks.
    • This structural feature makes them a potentially effective channel through which policymakers can achieve social goals like empowering the under-banked small businesses, and enhancing trust among retail consumers.
  • Neo-Bank Models Face Challenges:
    • Existing partnership-based neo-bank models face several challenges, such as revenue generation and viability.
      • Neobanks don’t have a bank license of their own but count on bank partners to provide bank licensed services.
    • They have limited revenue potential, high cost of capital, and offer products of only partner banks.

Source: PIB