Branch Expansion Vs Digital Infra: Indian Banks Are Faced With A Dilemma

Passbook-holding customers of the South 24 Parganas branch of a public service bank in West Bengal feel hassled. Many of them haven’t been able to update their passbooks because of the non-functional printing machine. A source at the bank, requesting anonymity, told The Core that around 1,500 to 2,000 requests for printing machines from different branches are pending with the bank. 

“It has been more than a year (since the requests were made) for most branches, but the head office has not been able to allot (machines),” the source said.   

Maintaining a passbook printer in each branch comes with a cost. It typically entails a one-time installation expense of Rs 25,000. After initial costs, cartridges need replacement and components such as the sensors need servicing. Sometimes a dysfunctional machine may have to be replaced as well. To save this cost, banks in India, public and private, have been nudging their customers to opt for online statements instead of the traditional passbook that needs to be physically updated. 

Rapid digitalisation combined with India’s financial inclusion goals are forcing banks to spend on technology upgradation yet absorb a major chunk of the cost. Banks such as Kotak Mahindra Bank, Bank of Baroda and HDFC Bank, which failed to keep their tech systems up to date, have been pulled up by the Reserve Bank of India (RBI). UCO Bank, which got into a soup after a glitch in its systems wrongly credited accounts with Rs 820 crore last year, has hiked its technology budget by 42% this year. On average, enhancing digital banking and reinforcing tech infrastructure to handle rapidly rising volumes of transactions will cost banks 8-10% of their operating expenses. The cost escalations could not have come at a worse time for banks. The Core had reported earlier, banks’ net interest margins are shrinking as deposit growth slows while credit demand rises.  

 

Digital Spending In The Slow Lane

The 2016 demonetisation and later the pandemic quickened the pace of digitalisation of the economy. Transactions volumes skyrocketed with the rapid adoption and wide spread of apps such as Google Pay, PhonePe, and BHIM built on the Unified Payments Interface or UPI. The RBI’s Digital Payments Index, which maps the reach of India’s digital banking, surged from 153.47 in March 2019 to 418.77 in September 2023. Banks’ spending on the technology that enables digital banking rose from 2-5% to 8-10% during this period. The costs typically comprise money spent on infrastructure, licences and subscriptions, development, customisation, customer support, security, and analytics.

“Unlike their counterparts in other industries where using online services incurs a subscription or membership fee, banks have traditionally steered away from directly charging their customers for using online services,” said Narendra Ganpule, partner at advisory firm Grant Thornton Bharat.

In the West, technology has been found to directly boost the topline. A recent survey by American research firm Fiserv found that following enrollment on a bank's net/mobile banking platform, monthly revenue per customer increased by 10.7%, coupled with a 12.8% increase in volume of credit transactions and a 12.9% increase in transaction frequency. It found that customer attrition following digital sign-ups also dropped by over 35% within 15 months. 

US customers pay an average of $24 per month in banking fees, of which anywhere between $2 and $15 is for various online banking facilities. In India, the RBI has mandated a low cap on online banking services. 

 

Between The Devil And The Deep Sea

Indian banks believe they can bolster revenues by onboarding more customers on their apps and online banking and selling them different products and services such as insurance, mutual funds and other investments online.   

“We are mostly generating revenues for online banking through products like insurance and also through digital lending,” said Satyanarayana Raju, the MD of Canara Bank. 

However, the cost to onboard customers and the money banks make on the products are not adding up. Multiple tech platforms and vendors need to work in sync to offer such a wide range of services and products online. That requires a robust digital infrastructure that can handle heavy traffic, a costly investment for banks.

Soaring digital transactions — surging more than five-fold since 2017, as per government estimates — are putting tremendous strain on backend systems. UPI transactions surged more than 80 times between 2017 and 2023, growing from 14.564 crore in December 2017 to 1202.023 crore in December 2023. A McKinsey & Company report found that Indian banks lacked the requisite infrastructure and protocols to adequately safeguard customer data and prevent data breaches. The report underscores that the backend infrastructure of most banks still relies on outdated "legacy systems."

The RBI has increased the cap for e-mandates used for digital payments from Rs 15,000 to Rs 1 lakh and UPI transactions made through prepaid payment instruments, such as wallets, come with an interchange fee of up to 1.1% for certain merchant payments above Rs 2,000. 

So while each transaction made online is costing banks money, the fees barely cover them. 

 

Digital At The Cost Of What? 

During the quarterly results announcements, those at the helm of several banks announced that they were trying to manage funds allocation by improving digital infrastructure. 

“In the previous year, we spent around Rs 700 crore on IT. Now, we are planning to spend around Rs 1,000 crore on IT this year wherein we are going for the upgrade of our various servers, virtual market solutions as well as technological integration of treasury systems," said Ashwani Kumar, MD and CEO, UCO Bank replying to a question from The Core, while addressing the media during the quarterly results announcement.

Aside from cross-selling products on digital platforms, banks don’t seem to have a clear game plan of how they will cut costs or divert funds to improve digital infrastructure and earn money from digitisation. 

Kumar believes that spending on infrastructure will bring down the cost of online transactions as well. “So the opex is likely to come down going forward if not in the immediate future. With spending on IT infrastructure, though there will be no direct income, there will be indirect savings in various costs. Income could also be added from the cross-selling of products through digital mode,” he said. He is betting on digitisation to bring down cost per transaction, the acquisition of customers at the branch level, and loan disbursal and collection. 

When banks digitised core banking processes such as passbook printing and account opening, they eliminated a number of low level staff and clerks, The Core has reported earlier. RBI data shows that between 2017-18 and 2022-23, the number of clerks and sub-staff at scheduled commercial banks fell by 8.6% and 7.2% respectively. 

 

 

The CASA Problem

At the heart of banking is mobilising deposits at a low cost and lending to borrowers at a higher interest rate and pocketing the margin. Therein lies the quandary for banks. While CASA growth is stagnant or falling, credit growth is strong. Soaring stock markets are luring bank customers, who are emptying their savings accounts to invest in mutual funds. 

To fix this problem, banks need to open brick-and-mortar branches in areas where they were not previously present. Perhaps this explains the addition of more than 13,000 new branches in India between March 2019 and December 2023. In the past year, HDFC Bank expanded its branch network by 27% to address the temporary assets-liability imbalance that happened after the merger. It still required money and it went to the offshore market in GIFT City to raise funds. It raised US $750 million through two overseas bonds .The cost of deposits for all banks has also increased by 1-2% in the last one year. 

Meanwhile, ICICI Bank witnessed an 8% rise in branches over the past year, compared to a 2.3% increase in the preceding year. UCO Bank plans to open 130 new branches this year. 

 

But extending bank branches also means increasing costs for the banks to run those branches. That means banks will have to learn to live with narrow margins.