banking – Pertinent Observations

Shorting private markets

This is one of those things I’ll file in the “why didn’t I think of it before?” category.

The basic idea is that if you think there is a startup bubble, and that private companies (as a class) are being overvalued by investors, there exists a rather simple way to short the market – basically start your own company and sell equity to these investors!

The basic problem with shorting a market such as those for shares of privately held startups is that the shares are owned by a small set of investors, none of whom are likely to lend you stock that you can sell and buy back later. More importantly, markets in privately held stock can be incredibly illiquid, and it may take a long time indeed before the stocks move to what you think is their “right” level.

So what do you do? I’ll simply let the always excellent Matt Levine to provide the answer here:

We have talked a few times in the past about the difficulty of shorting unicorns: Investors can buy shares in the big venture-backed private tech companies, but they can’t sell those shares short, which arguably leads to those shares being overvalued as enthusiasts join in but skeptics are excluded. As I once said, though, “the way to profit from a bubble is by selling into it, and that people sometimes focus too narrowly on short-selling into it”: If you think that unicorns as a category are overvalued, the way to profit from that is not so much by shorting Uber as it is by founding your own dumb startup, raising a lot of money from overenthusiastic venture capitalists, paying yourself a big salary, and walking away whistling when the bubble collapses.

Same here! If you are skeptical of the ICO trend, the right thing to do is not to short all the new tokens that are coming to market. It’s to build your own token, do an initial coin offering, and walk off with the proceeds. For the sake of your own conscience, you can just go ahead and say that that’s what you’re doing, right in the ICO white paper. No one seems to mind.

Seriously! Why didn’t I think of this?

Upside down pricing in payment services

Some Indian banks charge for services that are cheap to execute, and offer for free expensive services

Last week I enddd up spending some time waiting at a teller counter at a bank. This was due to some mess up with a cheque I had received. During my time at the teller counter I had the opportunity to observe other people at the same counter.

There were a few people depositing cash into their business accounts. A few others were depositing cheques. What caught my attention, however, was this guy from a nearby business who came to deposit a large number of cheques.

He had an entire book of challan leaves (banks regularly issue those to business customers), to each of which was stapled a cheque. As I watched, the teller would put a seal on a cheque, its corresponding challan and another seal on the counter foil. This process was repeated for each challan in the book.

And this process was only to accept the cheques. Later on there would’ve been further effort on behalf of the bank to cash the cheque and actually execute the fund transfer. And then add in the effort of writing out all those cheques, writing out all those challans (they’re hard to print) and then take them to the bank.

It was a rather laborious process all round, on behalf of all parties involved. Yet, banks mostly execute this function for free for most customers.

On the other hand, they charge for account to account transfers, and the amount isn’t particularly small. Like this morning I was moving money from one account to another, a process that took me a minute and that wouldn’t have cost the bank any human minutes. And icici bank decided to charge me for it.

It seems like banks have their pricing and the valuation of their own effort all wrong. For electronic payments the cost is direct – what the banks have to pay the payments systems and any per use software costs. And this makes it easier to value and charge for such services.

The effort in transacting through cheques, on the other hand, is not directly measurable (though by no means an impossible exercise). There are back offices that do the job whose cost is easy to measure, but several employees who also do other things spend time processing cheques. And this difficulty in measurement means that most banks just don’t charge for cheques.

Around 2000 when foreign banks expanded their branch networks in india there was an attempt to charge customers for walking into the branch – customers were encouraged to do their business at ATMs or over the phone, instead. This was in recognition of the costs of customer walkins into branches.

Banks would do well now to do something similar for cheques as well – despite the cheque truncation system (CTS), the effort involved in organising payments through cheques is massive for the bank.

There is only one upside to cheques – and this is a downside for customers. Cheques result in money going into limbo. The payer doesn’t know when the funds will leave his account and can’t use the funds. The recipient can’t use it either until he has got it. So for the duration that the amount is “in transit” (and this duration can vary significantly) banks can happily use these funds without them being called.

It’s possible that the benefit to the banks from this float more than compensates for the pain of processing cheques. If not, cheques have no business existing any more!

India post payments bank

I’d once written about India Post Payments Bank, after a visit to a post office, and wondered if it will actually help foster financial inclusion. Now that the bank is about to launch, it seems to be doing some interesting thing, and mostly in terms of the intermediary it will be.

Being a payments bank, IPPB can only take deposits, and not give loans. It is trying to build a platform where it will simply act as a distributor for loans, and different lenders can make use of its customer transaction data and lend to its customers.

Also, since payments banks can only invest their deposits in government securities, the “float” is limited by the difference between the yield on such securities and the interest offered to depositors. Competitive pressures mean that the latter needs to be high, resulting in a thin float. Consequently, a payment bank needs to make money on payments and selling third party products such as investments insurance.

A recent interview with IPPB CEO Ashok Pal Singh gives some interesting pointers about how the bank might go about this. Firstly, the bank will dispense with the investment+insurance products, and will sell pure unbundled life insurance. The logic is that since the clientele is likely to be the hitherto unbanked, they will not be able to understand complicated products, and there is a high chance of misselling. By restricting product choice to those that are highly unlikely to be missold, the bank can ensure customer protection.

Similarly, in case of mutual funds, distributors have an incentive to recommend funds with high fees since they also tend to offer higher distributor commissions. Again, given IPPB’s clientele, the chances of mis-sale are high, and so the bank has decided to sell only index funds!

This is remarkable since index funds have hitherto been non-starters in India. Benchmark Mutual Fund had managed to establish a market, but a series of acquisitions has meant that the market hasn’t really taken off. Most financial advisors in India swear by actively managed funds. So a bank, however small, announcing that it will only sell index funds can give a massive boost to that market!

Apart from selling “simple” products such as term life insurance and index funds, the way the bank is going about the process is also interesting. Rather than tying up with a single provider of these products (as most other banks have done), IPPB plans to take the “broker” route and distribute products from different asset managers and insurers. This ensures that the rates remain competitive, though it is natural that the end salesperson might choose to sell products with the highest commissions/incentives. Nevertheless, with the products being inherently simple, the rates to the end customers are still likely to be competitive.

After over a decade of slumber, the RBI licensed a few (limited) banks last year. It is interesting to see the kind of diversity this new set of licensing has unleashed. Again goes to show that removal of barriers to entry can result in significantly better markets!

During his last few speeches, former RBI Governor Raghuram Rajan kept mentioning how full-service bank licenses will be soon “put on tap”. The sooner that happens, the better it is for Indian banking customers.

Explaining UPI

I just paid my cook his salary for November. Given the cash crunch, I paid him through a bank transfer, using IMPS. Earlier today, my wife had asked him for his account details (last month I’d paid him on his wife’s account).

An hour back he sent me his account details (including account number and IFSC) via WhatsApp. I had to wait till I got home and got access to my laptop (Citibank app doesn’t let you add payees on mobile banking).

I get home, log in to Citibank Online. Add payee, which includes typing his bank account number twice. Get SMS asking me to confirm payee addition. I authorise payee. And after all this I am able to finally do the transfer – and I expect him to have got his money already.

For a long time I was wondering what the big deal with UPI was, given that IMPS is already fast enough. Having finally tried UPI earlier this week (it’s finally coming to iOS, but only available on ICICI now. And the implementation so far sucks, since you need to pull out your debit card for two factor authentication – defeating the point of UPI. I’m told it’s better on Android), I realise how much easier and safer the transaction would’ve been.

Firstly, the cook needn’t have sent me his account number. All I would need was his virtual payment address. I would then open my UPI app (in my case, iMobile) and click on “send money”. And then I’d add his virtual ID there, following which his name would appear. Two or three more clicks, and entering my PIN code, the transfer would be done.

No bank account number. Not even a mobile number or an email ID. Just a random string of characters would allow me to transfer money to him! And later I could give him my UPI ID, and next month onwards he could simply send me a request via UPI for his salary. And two clicks later it would be done!

Mint has reported that there are massive delays in merchants installing point of sale devices in response to the cash ban. Banks should instead seek to acquire merchants to accept money via UPI. It’s simple, it’s quick and it protects privacy.

In fact, if the bank sales staff now have bandwidth, it can be argued that all the planets have aligned for UPI to take off for merchant payments – people have less cash, point of sale devices are not available, and both merchants and shoppers have shown openness to cashless payments, and there is a push from the government.

If only the banks can bite…

Using my cook as an ATM

This happened ten days before high value notes were withdrawn, and suggests nothing about my cook’s political opinions or views.

On 30th October 2016, I paid my cook his salary for October. As it was the usual practice, I paid him in cash. He asked me if I could do an online transfer instead.

It was the first day of Diwali, and he needed to send money to his wife in Bihar. And it being Diwali, all banks were closed, and there was no way he could send money to her. So he asked me if I could do that. And if I were anyway transferring money to his wife’s account, could I send her a bit more, he asked – he would compensate me for the extra amount in cash.

And so like that I used my cook as an ATM. He gave me his wife’s account details (it was such an obscure branch that I’d to google it to find the IFSC code – wasn’t in citibank’s lookup list). I added her as a “payee” and immediately IMPSd the amount to her. And my cook gave me the extra funds I’d transferred in cash.

Later on, I told him to install his bank’s app on his newly acquired fancy phone (with a Reliance Jio sim). I’m not sure he’s done that but considering how resourceful he is, it wouldn’t be long before he does that. And more of the Bihari cooks network in Bangalore do likewise.

Nandan Nilekani, in his championing of the UPI, likes to talk about how “anybody can be an ATM” with the new technology. This was an exemplary example of that.

The only fly in the ointment was that I didn’t need cash that day – after all I’d been to the ATM earlier that morning just so that I could get cash to pay my cook – so I ended up with a lot of cash that I didn’t need. Thankfully I was able to spend it productively before the ceased to be legal tender.

Following the withdrawal of high currency notes, I told my cook I would pay his subsequent salaries by bank transfer. He gladly agreed.

Financial inclusion and cash

Varad Pande and Nirat Bhatnagar have an interesting Op-Ed today in Mint about financial inclusion, and about how financial institutions haven’t been innovative to make products that are suited to the poor, and how better user interface can also drive financial inclusion. I found this example they took rather interesting:

Take, for instance, a daily wager who makes Rs200 on the days she gets work. Work is unpredictable, and expenses too can be volatile, so she has to borrow money for buying vegetables, or to pay the doctor’s fees when her children fall sick. Her real need is for a flexible—small ticket, variable amount, rapid approval—loan product that she can access instantly. Unfortunately, no institutional channel—neither the public sector bank where she has a “no frills” account, nor the MFI that she has previously borrowed from—offers such a product. She ends up borrowing from neighbours, often from the local moneylender.

Now, based on my experience in FinTech, it is not hard to design a loan product for someone whose cash flows are known. The bank statement is nothing but a continuing story of the account holder’s life, and if you can understand the cash flows (both in and out) for a reasonable period of time, it is straightforward to design a loan product that fits that cash flow pattern.

The key thing, however, is that you need to have full information on transactions, in terms of when cash comes in and goes out, what the cash outflow is used for, and all that. And that is where the cash economy is a bit of a bummer.

For a banker who is trying to underwrite, and decide the kind of loan product (and interest rate) to offer to a customer, the customer’s cash transactions obscure information; information that could’ve been used by the bank to design/structure/recommend the appropriate product for the customer.

For the case that Pande and Bhatnagar take, if all inflows and outflows are in cash, there is little beyond the potential borrower’s word that can convince bankers of the borrower’s creditworthiness. And so the potential borrower is excluded from the system.

If, on the other hand, the potential borrower were to have used non-cash means for all her transactions, bankers would have had a full picture of her life, and would have been able to give her an appropriate loan!

In this sense, I think so far financial inclusion has been going on ass-backwards, with most microfinance institutions (MFIs) targeting loans rather than deposits. And with little data to base credit on, it’s resulted in wide credit spreads and interest rates that might be seen as usurious.

Instead, if banks and MFIs had gone the other way, first getting customers to deposit, and then use the bank account for as much of their transactions as possible, it would have been possible to design much better financial products, and include more customers!

The current disruption in the cash economy possibly offers banks and MFIs a good chance to rectify their errors so far!

Why PayTM is winning the payments “battle” in India

For the last one year or so, ever since I started using IMPS at scale, and read up the UPI protocol, I’ve been bullish about Indian banks winning the so-called “payments battle”. If and when the adoption of electronic payments in India takes off, I’ve been expecting banks to cash in ahead of the “prepaid payments instruments” operators.

The events of the last one week, however, have made me revise this prediction. While the disruption of the cash economy by withdrawal of 85% of all notes in circulation has no doubt given a major boost to the electronic payments industry, only some are in a position to do anything about this.

The major problem for banks in the last one week has been that they’ve been tasked with the unenviable task of exchanging the now invalid currency, taking deposits and issuing new currency. With stringent know-your-customer (KYC) norms, the process hasn’t been an easy one, and banks have been working overtime (along with customers working overtime standing in line) to make sure hard currency is in the market again.

While by all accounts banks have been undertaking this task rather well, the problem has been that they’ve had little bandwidth to do anything else. This was a wonderful opportunity for banks, for example, to acquire small merchants to accept payments using UPI. It was an opportune time to push the adoption of credit card payment terminals to merchants who so far didn’t possess them. Banks could’ve also used the opportunity to open savings accounts for the hitherto unbanked, so they had a place to park their cash.

As it stands, the demands of cash management have been so overwhelming that the above are literally last priorities for the bank. Leave alone expand their networks, banks are even unable to service the existing point of sale machines on their network, as one distraught shopkeeper mentioned to me on Saturday.

This is where the opportunity for the likes of PayTM lies. Freed of the responsibilities of branch banking and currency exchange, they’ve been far better placed to acquire customers and merchants and improve their volume of sales. Of course, their big problem is that they’re not interoperable – I can’t pay using Mobikwik wallet to a merchant who can accept using PayTM. Nevertheless, they’ve had the sales and operational bandwidth to press on with their network expansion, and by the time the banks can get back to focussing on this, it might be too late.

And among the Prepaid Payment Instrument (PPI) operators again, PayTM is better poised to exploit the opportunity than its peers, mainly thanks to recall. Thanks to the Uber deal, they have a foothold in the premium market unlike the likes of Freecharge which are only in the low-end mobile recharge market. And PayTM has also had cash to burn to create recall – with deals such as sponsorship of Indian cricket matches.

It’s no surprise that soon after the announcement of withdrawal of large currency was made, PayTM took out full page ads in all major newspapers. They correctly guessed that this was an opportunity they could not afford to miss.

PS: PayTM has a payments bank license, so once they start those operations, they’ll become interoperable with the banking system, with IMPS and UPI and all that.

Financial Inclusion

Matt Levine had a superb newsletter recently on whether asset managers and pension funds who push customers towards buying high-cost retirement savings plans are doing a good thing or a bad thing. As Levine expertly explained, it all depends upon the context.

Is bad retirement advice worse than no retirement advice? Like here is a simple hierarchy of things you could do to save for retirement, from best to worst:

Save for retirement in an efficient portfolio of index funds with very low fees.

Save for retirement in a mediocre product with very high fees.

Not save for retirement.

…

So if some slick-talking hustler shows up at your place of employment and talks you into option 2, has he done you a favor, or done you harm? The answer depends on what you would have done if he hadn’t shown up. If you were on your way to Vanguard to buy index funds when he waylaid you, he has moved you from option 1 to option 2, and made you poorer in retirement. If you were on your way to blow your paycheck on lattes at Starbucks, he has moved you from option 3 to option 2, and made you richer in retirement. The context is key.

Earlier today, I was at a post office, trying to cash a National Savings Certificate that my parents had somehow bullied me into investing in, and was reminded of how inefficient post offices are. For a long time, India Post has allowed people to maintain deposits, in so-called “savings accounts” (though India Post is itself not a bank).

And as I’ve experienced while trying to operate such accounts on behalf of sundry relatives, it’s incredibly inefficient. Lines are long. Post offices are understaffed, and staff mostly overworked. Computerisation is minimal – while finally they have a way to print out pass books, it still lags significantly behind even nationalised banks. Things we take for granted at most banks – such as ATM cards – are absent. You need to line up to take your cash out.

The reason I’m describing this is that the “Post Office Savings Bank” has recently received a license to formalise its banking, to become a so-called “payment bank“. The “bank” won’t be able to lend, but can facilitate payments and movement of money. The amount of money in the savings accounts is capped at Rs. 1 Lakh.

The intention behind the license is sound – India Post has a network that goes into all sorts of nooks and corners of the country, and now people in those nooks and corners can have a bank account, and send money to each other! Which is a wonderful thing.

But then, India Post is a really large and slow-moving operations, so it’s unlikely that they’ll adapt much towards modern ways of banking after they become a proper (small) bank. So the customers they’ve “financially included” will need to wait in line to put or get out money, perhaps fill forms in order to be able to transfer funds, and face other inconveniences to be able to “bank”. So is the financial inclusion worth it?

To paraphrase Levine, it all depends on the context. To continue paraphrasing Levine, if India Post Payments Bank (as it will be called) were to waylay a customer who was on his way to opening a PayTM account, it has done a disservice, by replacing an easy-to-use electronic account with one where he will have to face lines, which might dissuade him from banking altogether.

If on the other hand IPPB were to waylay a customer who was on his way to the post office (!) to send a money order to a relative, they are actually doing him a service, providing him a more efficient method for transferring funds.

It all depends upon the context.

Intermediation and the battle for data

The Financial Times reports ($) that thanks to the rise of AliPay and WeChat’s payment system, China’s banks are losing significantly in terms of access to customer data. This is on top of the $20Billion or so they’re losing directly in terms of fees because of these intermediaries.

But when a consumer uses Alipay or WeChat for payment, banks do not receive data on the merchant’s name and location. Instead, the bank record simply shows the recipient as Alipay or WeChat.

The loss of data poses a challenge to Chinese banks at a time when their traditional lending business is under pressure from interest-rate deregulation, rising defaults, and the need to curb loan growth following the credit binge. Big data are seen as vital to lenders’ ability to expand into new business lines.

I had written about this earlier on my blog about how intermediaries such as Swiggy or Grofers, by offering a layer between the restaurant/shop and consumer, now have access to the consumer’s data which earlier resided with the retailer.

What is interesting is that before businesses realised the value of customer data, they had plenty of access to such data and were doing little to leverage and capitalise on it. And now that people are realising the value of data, new intermediaries that are coming in are capturing the data instead.

From this perspective, the Universal Payment Interface (UPI) that launched last week is a key step for Indian banks to hold on to customer data which they could have otherwise lost to payment wallet companies.

Already, some online payments are listed on my credit card statement in the name of the payment gateway rather than in the name of the merchant, denying the credit card issuers data on the customer’s spending patterns. If the UPI can truly take off as a successor to credit cards (rather than wallets), banks can continue to harness customer data.

Big data at HDFC Bank?

I had a bit of a creepy moment today – I must admit that, despite being a “data guy” and recommending clients to use data to make superior decisions (including customisations), it does appear creepy when you as a customer figure that your service provider has used data to customise your experience.

I’m in Barcelona, and wanted to withdraw cash from my Citibank account in India. Withdrew once, but when I wanted to withdraw more, the transaction didn’t go through (this happened multiple times, at multiple ATMs).

Frustrated, I figured that this might be due to some limits (on how much I could transact per day), and then decided to get around the limitations by transferring some money to my HDFC Bank account (since I’m carrying that debit card as well).

An hour after I’d transferred the money by IMPS, I put my HDFC Debit Card in my wallet and walk out, when I see an email from the bank informing me that my Debit Card is valid only in India, and with a link through which I could activate international transactions on it.

I’d never received such emails from HDFC Bank before, so this was surely in the “creepy” category. It might have been sent to me by the bank at “random”, but the odds of that are extremely low. So how did the bank anticipate that I might want to use my debit card here, and send me this email?

I have one possible explanation, and if this is indeed the case, I would be very very impressed with HDFC Bank. Apart from my debit card, I also have a credit card from HDFC Bank, which I’ve been using fairly regularly during my time in Europe (that my only other credit card is an AmEx, which is hardly accepted in Europe, makes this inevitable).

My last transaction on this credit card was to pay for lunch today, and so if HDFC Bank is tracking my transactions there, it knows that I’m currently in Europe (given the large number of EUR transactions recently, if not anything else).

Maybe the bank figured out that if I’m abroad, and have transferred money by IMPS (which implies urgency) into my account, then it is for the purpose of using my debit card here? And hence they sent me the email?

The counterargument to this is that this is not the first time I’ve IMPSd to my HDFC Bank account during this trip – the Income Tax and Service Tax websites don’t accept Citibank, so I routinely transfer to HDFC to make my tax payments. So my argument is not watertight.

Yet, if the above explanation as to why HDFC Bank guessed I was going to use my debit card is true, then there are several things that HDFC Bank has got right:

Linkage between my bank account and credit card. While I’ve associated both with the same customer ID, my experience with legacy systems in Indian financial institutions means actually associating them is really impressive
Tracking of my transactions on my credit card to know my whereabouts. If HDFC has done a diligent job of this, they know where exactly I’ve been over the last few months (provided I’ve used my card in these destinations of course).
Understanding why I use my account. While I’ve IMPSd several times in the past (as explained above), it’s all been in either the “service tax season” or “advance/self-assessment income tax season”. Mid-May is neither. So maybe HDFC Bank is guessing that this time it may not be for tax reasons?
Recognising I might want to use my debit card. If I’ve put money into my account and it’s not tax season, maybe they recognised I might want to use my debit card?

Maybe I might be giving them too much credit, and it just happened that the randomly sent out email came at the time when I’d just put the money into the account.

And the link they sent to enable international transactions worked! I had to use my laptop (it didn’t work on either the app or mobile web, so that’s one point deducted for them), but with a few clicks after logging into my bank account, I was able to enable the transactions!

So maybe there is reason to be impressed!