Payment banks: Premature to fear or is the threat real?

To thwart competition from small and payment banks, DCB Bank recently announced a radical expansion plan that led to a couple of downgrades and a steep cut in its stock price. Such was the ferocity of stock decline that the bank was forced to scale down its strategy of expansion.According to Lakshmi Vilas Bank the fear of small and payment banks are premature. Speaking to CNBC-TV18, Palaniappan Manickam, Chief Financial Officer at Lakshmi Vilas Bank said expansions are taking place but not in a big way. By the end of this fiscal, Lakshmi Vilas Bank plans to add 51 branches and sees a decline its its cost-to-income ratio. He believes full-fledged banks will do better despite launch of a number of payments banks. The bank's net interest margin currently stands at 2.81 percent.However, Ashvin Parekh, Managing Partner at Ashvin Parekh Advisory Services sees payment banks impacting CASA of other banks. He hints at those banks which need to focus and clear strategy and strive to clean up of books.Below is the verbatim transcript of Palaniappan Manickam and Ashvin Parekh’s interview with Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Sonia: We heard from DCB Bank how they are going to go ahead with an expansion plan. Will Lakshmi Vilas Bank also look to expand and if yes to how many branches? Manickam: We have an expansion plan but not in a great way. As of now, we have 411 branches and in the current year we propose to add another 51branches for which we are holding a Reserve Bank of India (RBI) approval. So, in total it will be about 460 branches this year. Latha: The argument that DCB was making was, this was implied argument that small banks can take away some of their borrowers and the payment banks can take away some of their current account savings account (CASA). The need for more branches was to get smaller borrowers in place as well as secure liabilities. Won’t you face a higher cost to income in the quarters to come as you go for the same borrowers? Manickam: It is true; we get into higher cost income when we open more branches. For example, last year we opened 38 branches and that pushes the cost income ratio to some extent but, at the same time, wherever we opened new branches, that adds to the CASA balance and mostly we select the branches in the rural and semi-urban areas.Latha: In the next four quarters do you expect your cost to income ratio, your cost to go up considerably compared to the last four quarters or the last eight quarters simply because you have to respond to 21 new entrants? Manickam: No, I don’t think so. In fact our cost income ratio is on the decline; only in the current quarter there is a marginal increase because of certain one-time expenditure. Otherwise, because of this increased number of branches I don’t find any increase in the cost income ratio. Sonia: What is your view because the expansion plan that DCB Bank put in place was actually a wake call for many of the other smaller banks and in Murali Natrajan’s words, he did say that we are overreacting now because we don’t want to be in a situation where we have not reacted at all to the kind of increasing competition. Do you think it will be easy for some these smaller banks to wade through this extensive competition that is going to hit them? Parekh: No, in fact quite clearly I am seeing the private sector banks, some of the old ones where the management has changed recently and to three different segments altogether, you have one segment which is a little above, quite clearly above the segment which is going to compete with the small finance banks. So, those include people like Federal Bank, Ratnakar Bank. They are quite above in that space and because they do not have too much of infrastructure loans, so, therefore quality of their books is quite good. They are raising capital, they will grow, that is a different segment altogether. The other segment where people like Lakshmi Vilas Bank, Karur Vysya Bank and the others fall in, there is going to be competition quite clearly. Some of them have to first of all clean up a lot of their own internal stuff including the quality of the books on one side and b) is make sure of their strategy in terms of what exactly they are going to run after. If they have been serving communities then small finance banks are going to compete with them in that space and then there is going to be a real issue. Payments is a little different space altogether. Payments is going to take away a lot of CASA from these banks but not the lending part. So, that is good and bad; good because at least the lending part is not taken away, the small borrowers, but getting the deposits is going to be become increasingly difficult. Two-three years later, I see some element of consolidation coming up in this particular segment. The third segment is very small old private sector banks, they are struggling as I see them now.Latha: For a lot of your customers who would have an Airtel phone or an Idea Cellular phone that is a very recognisable brand, why would they not open a deposit account with them if they are giving them 4-5 percent or even 6 percent return? You must remember that some of them have very big PE backing as well and big conglomerate backing so they can burn cash at least for some time. As well in your area, in the South, look at the number of small banks licensees, Janaagraha has got, Equitas is there, Ujjivan is there in your space – surely they have their own SME clients, why will they not eat into your clients?Manickam: I don’t deny that, there will be a competition, that is absolutely true but at the same time there needs to be some many other services. It is not only a question of having a savings bank account and having a small borrower account. There are so many other services which a full fledge bank can offer as compared to other payment and small banks; there are so many other services which are available with a commercial bank which may not be available with them. Latha: You don’t expect your margins or your cost to income in the next eight quarters to look very different?Manickam: No, in fact this quarter our net interest margin (NIM) has gone up by 20 bps. Latha: I mean a year down the line when there will be perhaps couple of big payment banks and 18 months down the line when there will be eight small banks.Manickam: There will be pressure on the margins, no denying the fact but margin will not go down. Margin will be consolidated, for example, our NIM is at 2.81 percent, it will remain consolidated at around 2.9 percent level. I don’t think it will go down. Latha: Any of the public sector banks will survive at all, midcap? Parekh: Some of the public sector banks are really going to get it difficult. You can almost see that there is a trend now emerging, the large size public banks are trying to align themselves with the payment banks. So you can see that there are already announcements coming up and they will be able to do much better. The issue will be the smaller public sector banks. They won’t know which way to go. As it is we have seen that there is going to a lot of embargo on their activities. Already one bank in the South has been asked not to increase their lending; it is going to be a big challenge I must say.