RBIs recent decisions

The recent decisions by the RBI with respect to cash withdrawals  are completely bereft of economic and financial reasoning.

Two recent decisions of the Reserve Bank of India are retrogade in the sense that they encourage people to withdraw and use more cash rather than transacting with money within the banking system. The first case is that of two-factor authentication for Indian credit cards. The RBI rules state that an Indian entity can accept payment via credit card only if it has undergone two factor authorisation. For offline payments that means a PIN. For online payments that usually means a one time password. While this is a good move in terms of ensuring consumer protection and preventing misuse, the downside is that it is out of whack with global credit card practices and that adversely affects Indian companies.

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Indian Software as a service (SaaS) companies, for example, cannot automatically bill their clients every month – unlike their competitors from abroad. This significantly affects the competitive capacity of Indian SaaS players. While this two-factor authorisation has been in place for a while now, it is RBI’s recent decision regarding Uber that deserves condemnation. Unlike Indian taxi aggregators, Uber is a foreign company and was thus using a US-based payment gateway in order to bill customers automatically for their rides. Their Indian competitors, seeing a natural disadvantage, decided to set up their own gateways abroad, at which point the RBI intervened and directed Uber to follow two factor authentication, too.

While this might have been a positive step in creating a level playing field, it is not the optimal level playing field. The RBI might have done better by creating a framework that would enable Uber’s Indian competitors to offer seamless payment options, too – by, for instance, creating limits at the card-vendor level up to which the second factor of authorization would not be required. This would have resulted in an increase in credit card transactions while not compromising on customer protection. Credit card transactions, it might be instructive to note, keep the money within the banking system.

The other false move by the RBI in recent times is the directive to limit the number of non home-bank ATM transactions. From November, one can use a non-home bank ATM for free of cost only three times a month, beyond which a charge will be levied. Currently, while banks charge other banks for the use of their ATMs, the charges are not passed on to the customers.

This ruling by the RBI is flawed on two counts. First, and most important, limiting the number of withdrawals will result in larger withdrawals each time someone withdraws. This will lead to greater amount of cash in the economy, and take money out of the banking system. That in itself is reason to not have such limits.

Related to this is the fact that this regulated pricing might result in fewer withdrawals from non home-bank ATMs and that could result in reduction of incentives for banks to set up new ATMs. Considering that it is widely accepted that ATMs are a good thing (former US Federal Reserve Chairman Paul Volcker famously remarked that the ATM is the last financial innovation to add value), framing policies that result in slower growth in the number of ATMs , makes little sense.  Consequent to this, there will be a multiplier effect in terms of the amount of cash that will go out of the banking system (fewer ATMs means fewer opportunity to withdraw, even at a price. So people will hoard more cash).

Second, while the RBI is the banking regulator, it is simply wrong for the RBI to interfere in what should essentially be a transaction between a bank and its client. While it makes sense for the RBI to ensure appropriate inter-bank interchanges for usage of ATMs, how much a client should be charged should be left as a business decision to the bank. The bank might, for example, choose to give certain high-value customers a larger number of free withdrawals, or charge only for withdrawals from ATMs of some banks – left to the market the pricing possibilities are endless, and given that the era where the RBI regulated interest rates on savings bank accounts is long beyond us, it is bizarre that the RBI is one again indulging in price regulation.

There is perhaps only one idea (more a conspiracy theory) that possibly explains the above decisions from the RBI. Both these decisions, it might be noticed, help push up the usage of hard currency and decrease the levels of bank deposits. Less bank deposits means less money available for banks to lend out, which means that the cost of borrowing from a bank implicitly goes up. Could it be that the above regulations are a move by the RBI to curtail money supply without necessarily doing the politically tricky task of raising interest rates?

If it is (and it is a very remote possibility), we should commend the RBI for what will then amount to be a sneaky decision. If not, it must be mentioned that though noble in thought, the two decisions are completely bereft of economic and financial reasoning. We hope that the RBI will realise its mistakes and correct course before these decisions have too much of an impact on the economy.

Photo: William Grootonk