August 16, 2024
Small Finance Banks in India: Leveraging ONDC for Financial Inclusion
Small Finance Banks are transforming the landscape of financial services in India, offering a lifeline to underserved communities and small businesses. These specialized institutions are bridging the gap between traditional banking and the needs of micro-enterprises, leveraging digital technology to expand their reach and impact. As the financial sector evolves, Small Finance Banks are at the forefront of driving financial inclusion and supporting the growth of MSMEs across the country.
The Open Network for Digital Commerce (ONDC) is set to revolutionize the way Small Finance Banks operate and serve their customers. This digital infrastructure opens up new possibilities for these banks to offer innovative financial products and services to a wider audience. By tapping into ONDC’s potential, Small Finance Banks can enhance their digital footprint, streamline operations, and create tailored solutions for small businesses.
The Landscape of Small Finance Banks in India
Small Finance Banks (SFBs) in India operate under a specific mandate to expand financial inclusion and cater to underserved segments, including micro, small, and medium enterprises (MSMEs) and the agricultural sector. These niche banks are governed by the Banking Regulation Act 1949 and various RBI regulations. The Reserve Bank of India (RBI) has set stringent guidelines to safeguard and boost the credibility of SFBs, requiring them to direct 75% of their loans to the priority sector, compared to 40% for other scheduled commercial banks.
Regulatory framework and objectives
The RBI’s guidelines stipulate that SFBs must maintain a capital adequacy ratio of 15%, higher than the 9% required for scheduled commercial banks. Additionally, SFBs are required to go public within three years of reaching a net worth of Rs 500 crore. These regulations underscore India’s preference for financial stability and economic inclusiveness.
Current challenges and limitations
SFBs face several challenges in their operations. One significant hurdle is the high cost of transformation from microfinance institutions (MFIs) to banks, including infrastructure, human resources, and organizational changes. They also struggle with deposit mobilization due to limited experience in handling deposits. Competition from existing banks and non-bank financial companies (NBFCs) poses another challenge. Moreover, SFBs grapple with controlling non-performing assets (NPAs), especially in sectors vulnerable to economic fluctuations.
Opportunities for growth and expansion
Despite these challenges, SFBs have shown promising growth. In FY2022-23, their combined profit rose to Rs 4,162 crore, more than four-fold from the previous year. The non-performing asset level stood at a reasonable 4.8% for the same period. To capitalize on growth opportunities, SFBs are focusing on diversifying their portfolios and client base, with an emphasis on secured products like home, vehicle, and gold loans. Adopting technology and developing efficient risk management frameworks are crucial for their future success.
ONDC: Bridging the Gap in Financial Services
The Open Network for Digital Commerce (ONDC) is set to transform financial services in India. Its dedicated financial services portal has the potential to reshape how these services are accessed and used within the digital economy. This platform offers a range of benefits for various stakeholders, including small businesses, consumers, and banks.
Democratizing access to financial products
ONDC aims to simplify access to credit and ensure transparent financial transactions, contributing to greater financial inclusion. It integrates loans into its ecosystem, streamlining the process for small businesses to access credit. The platform also simplifies the purchase and management of insurance policies, allowing consumers to compare policies, calculate premiums, and make claims with ease.
Reducing operational costs for banks
ONDC’s system costs are expected to be lower as it is not locked to a captive ecosystem and does not run proprietary protocols. This reduction in costs benefits both buyers and sellers. Banks can leverage ONDC to offer solutions to both sellers/merchants and buyers/consumers, efficiently monetizing their customer relationships.
Enhancing transparency and trust
ONDC’s blockchain-powered infrastructure enhances efficiency in settling transactions and managing records, leading to faster approvals, lower costs, and a more seamless user experience. This increased transparency and efficiency can help build trust among users and drive the growth of digital commerce in India.
Innovative Financial Products Enabled by ONDC
Micro-lending and peer-to-peer platforms
ONDC is set to revolutionize micro-lending by integrating banks and fintech platforms. This integration aims to offer unsecured personal loans and GST-based invoice loans to small merchants and retailers in underserved regions. The platform streamlines the loan application process, reducing it from days to just hours. In some cases, loan sanctions can be obtained in as little as six to seven minutes, with disbursals following within an hour.
Insurance and investment solutions
ONDC is expanding into insurance and investment segments, offering Life Insurance, marine, health, and motor insurance initially. The platform recently conducted a pilot transaction for marine insurance with InsuranceDekho and Bajaj Allianz. In the investment sector, ONDC plans to launch mutual fund offerings within a month, starting with passive funds like index funds and liquid funds. This approach aims to provide simple wealth-building opportunities to a population accustomed to chit funds and fixed deposits.
Supply chain financing for MSMEs
ONDC bridges the credit gap for MSMEs by offering fair access to finance and integrating financial institutions into one digital platform. The platform enables MSMEs to demonstrate their creditworthiness faster using their digital footprint, streamlining the loan application process. ONDC also plans to introduce B2B credit services, offering large loans of Rs 1-1.5 crore, with protocols expected to be published soon and a pilot launch set for December.
My Views
Small Finance Banks in India can make significant strides to boost financial inclusion, and their integration with ONDC can have impact on their reach and effectiveness. This partnership will allows Small Finance Banks to offer innovative financial products, like micro-lending and supply chain financing, to underserved communities and MSMEs. What’s more, the reduced operational costs and enhanced transparency enabled by ONDC mean Small Finance Banks can provide more competitive and accessible services to their customers.
This synergy creates a more inclusive and efficient banking system, giving small businesses and individuals better access to credit, insurance, and investment opportunities.
References
PS. I have gathered insights from various articles and used AI tools to structure my thoughts on the integration of Small Finance Banks and ONDC, including generating relevant images.
- https://www.thoughtworks.com/en-au/insights/blog/platforms/ondc-financial-services-India
- https://byjus.com/ias-questions/what-are-the-laws-governing-small-finance-banks/
- https://www.investopedia.com/articles/investing/112714/regulations-govern-banking-india.asp
- https://eprajournals.com/IJSR/article/1663/download
- https://www.frankbanker.com/ondc-potential-impact-on-the-digital-marketplace/
- https://www.linkedin.com/pulse/potential-open-finance-enabled-ondc-blockchain-sharat-chandra
- https://www.ey.com/en_in/technology/how-ondc-can-democratize-e-commerce
- https://wibmo.co/understanding-ondc-and-what-banks-must-do-to-benefit-from-it/
- https://m.economictimes.com/tech/technology/ondc-to-add-banks-fintechs-to-take-credit-services-to-last-mile/articleshow/111467157.cms
- https://www.finverv.com/posts/ondc-solution-to-bridge-indias-msme-credit-gap/
- https://theprint.in/ani-press-releases/branchx-becomes-indias-first-neobank-to-launch-ondc-loans-for-financial-inclusion/2168232/
