Moneylenders to Payment Banks

On August 19, RBI gave nod to 11 private parties to set up “payment banks”. A payment bank is the same as a regular savings bank and can perform functions such as taking deposits, pay bills, issue cheques etc. When I hear difference is that payment banks cannot issue loans, I am thinking where does income come for payment banks to pay interests on deposits?

payment

Earlier saving banks existed to enable people to save money. What is significance of payment banks and not micro-savings bank? Will payment banks encourage savings? Payments come from government spending or spending by people. Are we looking at India transforming from savings economy to spending economy? What is impact on common man?
While business welcome payment banks,blog walks through the evolution from moneylenders to payment banks(from Savings to spending).

Moneylenders helped merchants to look after their surplus cash. They gave a receipt to the merchants for the cash deposited with them by the merchant. Money lenders provided this money to others as loan, earning an interest. On earning interest, they shared with merchant as incentive(interest) to not withdraw money. The initial people receiving loan were also people in business. This was initial stage of banks.

Some times one merchant wanted to pay another merchant and wrote letters to bank to make payment with deposited money. To support merchants were travelling and not able to come in person, the “cheque” got introduced, where merchant can provide cheque and need not come in person to bank to transfer money. Banks provided merchant with cheque instrument and we are in the starting point for today’s savings bank.

savings

Keep in mind that savings and transfers were focus at start and not purchase payments. The savings banks focused to enables savings, provide loans and facilitate money transfer(P2P transfer). Over time, non-business individuals leveraged the savings & transfer facility of banks.

Merchants were comfortable to accept cheque issued by another merchant and were not comfortable to take from unknown merchants or purchasers of goods. There was fear not to be in status “Goods supplied, Payment not received”. On other hand,customers with money in bank & no cheque book(in hand) did not make purchase of goods after enquiry.

While merchants and banks were aware that “Purchase any time” did not happen, it benefited customer by providing more time to research about need for the product, the product features and the suitability of the product for their needs.

In earlier days if a customer has deposits earning interest and loan paying interest, banks advised customer to pay off loan with deposit and save customer from unnecessary interest charges. To facilitate merchant’s immediate needs of money for business, concept of “current account” got introduced and one could get short term loan without any additional effort. The loan was limited to worthiness or deposits of the customer.

Let us come to banks after introducing start of credit cards.

Surprisingly credit cards were introduced to support needs of the farming communities for early credit in early 20th century. The farmers were enabled consumer credit via department stores. Department stores made credit available to middle-income customer and implement a method to track customer accounts. The first cards were simply made of cardboard or paper,called charge card. The balance needs to be paid by the month end.

To start with, cards were provided on charge and were not free. The banks made merchants to offer reward points for transaction done by customer. Some of the reward points could be discounted by customer for future purchase from the same merchant. Effectively more customers got attracted to sign up to obtain reward points. Presence of more customers attracted more merchants to sign up and circulation cycle started .

Here was ecosystem evolving where merchants are enabled to collect money on sale & customers are enabled to pay money on purchase. Early in the game, banks realized potential of the ecosystem and leveraged ecosystem to their self advantage. The primary focus became more to create self value and less to create value for merchants/customers

To enable convenience, banks charged percentage of transaction to both merchant and customer. Fees turned out to be pretty lucrative for credit card companies, and they never looked back. When customers failed to pay the credit card dues, the banks earned interest from the customer and late fees. Money to merchant was paid only 3 days post purchase and bank had access to purchase money, available free at bank’s disposal.

Banks have identified new source of income(not savings). Soon every bank got involved to offer own cards or offer partnering with VISA/MASTER. Over time governments found new source of income charging service tax on late fees/charges paid by customers.

While enabling merchants and customers was the original focus, with more competition, the target became users who were lucrative enough to earn money for banks and people carrying balance from month to month, paying interest. Some of them started to offer teaser interest rates of zero percent for balance transfers to acquire new customers and credit card users took them up on their offers to save money.

creditcard
I would continue beyond credit card evolution to payment banks in following blog