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January 03, 2008

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It is 8:45 am on 05 March 2007. Kulvinder Singh was fine tuning his presentation with his deputy Sriram Iyer. He quickly ran through the presentation, gathered his laptop and headed towards the boardroom.

Iyer wished him luck as he closed the door of his cabin. As the chief strategist of Universal, India's third largest bank he had an important role to play in the day's meeting.

He mentally reviewed the meeting he had with Vashista Rao Hegde, chairman of the bank, a week earlier. The chairman had briefed him and the other key team members about the Reserve Bank of India's [Get Quote] new guidelines and impetus on 'Financial Inclusion' plans to stir open the rural market, a potentially untapped segment.

The RBI planned to take banking to the unbanked at their doorsteps. "This segment constitutes as many as 185 million people. Needless to say this is a huge market in terms of numbers and many of our competitors have ventured into this segment hoping to garner growth and volume.

Further RBI wants banks such as ours to enter the rural market and fill the gaps highlighted during past initiatives such as thevarious deposit schemes of the 1940s and 1950s and the creation of regional rural banks in the 1970s and 1980s,"said Hegde.

"But," intervened Manda Thacher, executive director-operations, "the per-transaction value is predicted to stay thin for a long time in this segment. Though venturing into this segment will substantially increase our growth and penetration rate we may end with poor margins."

"I agree," said Anirudh Joshi, executive director-marketing, "even public sector banks with over 100 years of banking experience and with existing presence in rural areas are hesitating to rollout on a mass scale."

Hegde then asked all the members present to carry out a thorough analysis of the market and its opportunities. They were to present their findings and views in a week, based on which Hegde would decide what strategy Universal Bank should adopt to enter the rural markets.

Founded in 1958 Universal Bank was initially a small private sector bank which over the decades had developed into one of India's largest banks through a series of mergers and acquisitions.

During the 1990s it had undergone at least four major restructurings and grown to become India's third largest bank. In FY06 it had an asset base of Rs2,313bn, a network of 550 branches and extension counters, over 2100 ATMs and a 2000 seat call center. On an average the bank added 150,000 customers a month, which was amongst the highest in the country.

Lay of the land

At the 9:30 am meeting on 5 May, those present were Vashista Rao Hegde, (UB's chairman), Kulvinder Singh (chief strategist), Manda Thacher (executive director-operations), Anirudh Joshi (executive director-marketing), Aditi Ananth (executive director-finance), Nandini Srinath (executive director-HR), Keshav Balachandran (head-sales), and Kavya Pal Desai (executive director-IT).

Joshi began the discussion. "For years the Indian rural markets have had an altogether different look from those in the urban domain. What sold in the villages wasn't seen in cities and vice-versa. However just as there is no single one 'urban' customer, there is no single 'rural' customer.

Instead there are many different people with different needs. Also, like the urban counterparts, rural people today want to embrace new things, they are open and not afraid to experiment."

Balachandran chipped in, "I personally believe that two major events have triggered this transformation over the last two decades. Once satellite television started penetrating these markets, people for the first time were exposed to worlds which were vastly different from theirs.

The second major disruptive technology was mobile phones which enabled rural people to interact with others. For the first time, there were no intermediaries. Anyone could buy a handset, put in a SIM card and experience a whole new world.

Today when we go into a village, it is not unusual to see a DTH antenna over many houses and although we still remain a country of poor telecom penetration, wherever I have gone, almost all villages have at least one mobile operator live in the area."

"Moreover," interjected Ananth, "now people in villages, many of whom have scanty resources, don't envisage a similar future for their children. They have realized that they have the power to change their own destiny."

Encouraged by Ananth's observations Joshi took off from where he had left. "The rural market is getting ready for more products and services. The distinction between the rural and urban markets are blurring, may be slowly, but surely. Rural India is not just about consumption but also the production of goods and services. Over 36% of rural GDP can be traced to manufacturing."

"I want to share an interesting anecdote which a senior banker in Karnataka narrated to me," said Desai. She was highly qualified and had been with the bank for a long time.

"The banker was talking to a well-to-do farmer about his road to success. After having discussed organic farming, water harvesting, co-cultivation and milk production, the banker asked the ultimate business question. "Would you want to borrow from the bank to buy two more cows?"

"I would like to have two more cows, but I don't want to borrow from anyone," responded the farmer, and apparently nothing could convince him otherwise. The insight gleaned from the anecdote is that the rural customer is today open to new opportunities, but is also aware of the fragility of the new system. In this case though the farmer had changed his primary profession from farming to dairy, he knew his limits precisely and how much he can afford to stretch."

Kulvinder Singh was intently listening to the discussion. "What are your views, Kulvinder?" asked Hedge. Singh did not waste any time. In his booming voice he started. "I believe it is essential for us to enter this market to achieve growth.

However this strategy has its own challenges and roadblocks. I have prepared a presentation that outlines the challenges and opportunities. Most banks today carry out their operations through individuals who are appointed as agents either directly or through an intermediary organization, which acts as 'business correspondent' for the bank. These banking agents are given small handheld devices for carrying banking transactions using smart-cards.

The transactions captured in the handheld devices are transmitted using the telecommunication network to the core banking server of the bank, mostly as a batch upload at the end of the day."

"This helps the bank in two ways. First, the branch does not get crowded by people wanting to do small transactions. Second, dormant accounts have started showing activity, thanks to this new accessibility to banking for the customers. Encouraged by the response, banks today are planning to expand the business by offering asset products to these customers on the same platform."

Desai, who had a conducted a rigorous study on the technology used, interrupted Singh. "Let me explain this clearly. The technology piece in most cases runs on smart-cards, either RFID based contact-less cards or the more familiar smart-chip based contact cards, such as the ones used as SIM in mobile phones. Each of these cards can hold multiple accounts for one person or a group of people.

I say group of people meaning accommodating accounts like that of self-help-groups (SHG) and joint-liability-groups (JLG).These smart-cards talk to handheld terminals, which usually vary in size from vendor to vendor, starting from the size of a mobile phone and going up to the size of a small vanity box. These systems mostly use bio-metric (finger-print based) verification of the customer and thus removes the need for remembering PIN numbers for authentication as used in normal ATMs."

"In last three years," continued Desai, "ever since RBI coined the term Financial Inclusion, every banking conference as well as every banking-technology conference has seen the presence of technology geeks trying to prove suitability of their respective platforms for this business.

"Several banks including National Bank of India, IFIFI Bank and the South Royal Bank, are experimenting the these technology vendors. A dozen pilots are being undertaken across the country, overcoming initial teething problems, eliminating doubts regarding the use of technology gadgets in the rugged terrains of rural India. Prima-facie many of these new technology models seem to work and the results have by-and-large been positive."

After Desai's explanation Singh continued, "However some banks are moving into rural markets without using these new technologies, and seem to be doing pretty well It's likely they may invest in technology later to scale up the business. So where rest our challenges? The roadblocks for expansion come primarily from three areas: channel development, operational control and financial viability. I will now go through each of these in some detail." He switched on the projector and the first slide came up.

Slide 01: channel development

"As you can see, every village needs at least one banking agent but none of the current players are ready to develop deep channels. As Anirudh rightly pointed out in last week's meeting, when faced with the magnanimity of the task, even banks with over a hundred years of banking experience and with an existing presence in rural areas, are hesitating to roll out a network of agents, servicing these transaction points and performing physical cash management. Under the current pilots, most banks have appointed only a few agents. Technology providers are directly servicing the transaction points and the cash management piece is happening directly between the branch and the agent, " explained Singh

"The branch leaves some cash with the agent, which is used for performing transactions," he continued.

"Whenever the agent receives excess cash, she deposits the excess amount in the branch and when her balance goes below a certain limit she recoups the same from the branch. Reconciliation is performed based on the transactions received through handheld devices at the end of the day or the next day. Similarly for service support. The agent informs the branch manager, who in turn calls the technology provider, who delegates his staff to attend to the call."

"However this localized arrangement is unlikely to work once the banks plan a mass market rollout, say with each rural branch having at least eight to ten agents catering to the banking requirements of villages spread across 3.3mn square kilometers covering twenty-eight states and seven union territories across the country. In that scenario an institutional framework would have to be evolved."

"The question here is who would do that? Most banks claim that they do not have the requisite manpower to do it, and with low value and high volume it is not easy to hire vendors who specialize both in cash management and maintenance support. Banks are looking for channel partners who could be willing to take the plunge," said Singh.

Hedge cut Singh short, "Having anticipated this requirement, the RBI has allowed banks to appoint Business Correspondents (BC), which can be Micro-Finance Institutions (MFI), NGOs or similar not-for-profit Section 25 companies. These entities through their representatives, who work as banking agents on the field, can accept and disburse cash on behalf of the banks. Of these entities, MFIs have experience of managing cash."

"NGOs have a deep rooted presence but are wary of handling cash. Currently different banks are trying out different options. The Royal South Bank has tied up with MFIs. However most are still to come up with a sound model. Recently a leading bank published an advertisement in the newspapers inviting proposals for being its channel partner for this business."

Singh continued unperturbed, "Realizing that the want of a channel partner might stall the progress, technology vendors are trying to provide a solution by forming their own Section 25 companies and taking up the task of cash management as well."

"With the initial business roll-out and post-delivery maintenance support already falling under their domain, this additional responsibility might be seen as a logical add-on to complete the value chain. However these companies are just starting their first phase of roll-outs. With no precedence available, it would be interesting to watch how they shape up for field delivery over the months to come."

"But I do have a plan that might work," said Balachandran. "When there are no precedences in one's own industry, the best way forward is to draw inspiration from something closely similar. In this instance I have been inspired by the FMCG industry which operates through a cluttered deliver chain right up to the last mile."

"The new Section 25 companies g up would do well organizing their operations through a chain of intermediaries for business roll-out, cash management and service support. The business would have to work through a hierarchy of agents, supporting these three functions simultaneously."

"For cash management, which is the riskiest of the three, the hierarchy of agents would have to be visualized at a national level, starting with the head office of the BC at the top of the chain, serving its offices in zones, which in turn services states, down to regions, districts, talukas, to blocks and finally to the end-customer serving banking agent in the village."

"Every level has a minimum and maximum limit of cash it can hold. Any agent who receives more, deposits the excess amount to her designated supervisor. And when the sum goes below a specific level, the agent is reimbursed by the same supervisor. The remuneration drawn by the agent could be a fixed amount for liabilities products, plus certain percentage commission on collections made for asset products such as loan repayments," continued Balachandran.

"The entire chain of operations can be controlled using technology tools, either handheld devices or cards or by providing instances of core banking software over a web based platform. The top end of the supply chain could use traditional banking channels for funds transfer."

"Only the last one or two links of the chain would require cash to be physically drawn from some bank account in the branch or ATM and carried to the agent in the village. On routine days this amount is not likely to be high. Besides the risk of theft or loss could always be covered through insurance. This could be one possible delivery model," recommended Balachandran.

Nandini Srinath spoke for the first time. "It is not necessary for the channel partner to employ these many people. Instead it could develop the chain using existing operators in the field, people like SHG leaders, cooperative bodies, local merchants and NGO representatives."

"There is a tremendous opportunity for current cash management companies who service banks and ATMs to design solutions for this segment. Also if these companies can double in as hardware and software maintenance support utility using the same channel, they would become instantly attractive to those technology vendors who might be wary of building their channels in-house."

Slide 02: operational control

Singh continued with his presentation. "With technology providers working as channel partners for cash management, we can easily deploy a large network of agents furnished with hardware. However we would require adequate tools to manage this huge operation. As the numbers increase in terms of clients, customers, agents and geographies, operations would become more complex."

"Further currently the RBI is not stringent on compliance norms as far as rural markets are concerned as it appreciates the difficulties of taking banking to the unbanked. However, going forward compliance guidelines would come in place and all the three, viz the banks, their technology providers and channel partners would be subjected to several regulations. As far as we are concerned, a robust core banking system at the backend should suffice. However we may still require some additional tools which our technology providers and channel partners could provide.

Singh turned to Desai for support. Desai obliged. "For example, a customer card might accommodate different accounts such as savings bank account, fixed loan, recurring loan, recurring deposit, health insurance, general insurance and salary account. The core banking software (CBS) of the bank would double-in as the front end CRM and the backend switching system. However, currently there's nothing that works as the middle-layer OSS."

"Banks need to adopt a system that tracks details such as, which card is issued to which customer, number and nature of accounts that it contains, mapped to which agent, talking to which handheld machine with what kind of transaction limit and serving under which supervisor hierarchy and so on," Desai continued.

"Current pilot projects being small and limited in scope can be managed through routine software tools including several manual interventions. Going forward the technology providers will have to deploy their own OSS to support and keep running this business and as well comply with the statutory requirements."

"This would be mean major investment and I am not sure how many players are actually visualizing it at this stage. Still, all major players would look out in this direction, may be, starting with rudimentary web-based application tools to subsequently designing full-fledged operations support systems," she ended

Slide 03: financial viability

"Aditi will now handle this part of the discussion," said Singh. Ananth came straight to the point. "A dedicated distribution network, a versatile OSS, glitzy handhelds devices with vernacular support, high-end smartcards with multiple product holding capacity and all the paraphernalia - everything is so good - but where's the money? Is it all workable for a transaction worth Rs10 once a week? How can banks possibly cover the costs, leave aside generating profits out of this business in the near run? Who foots the bill till the break even is reached? And how long would that be. well to this, no one any clear answer."

"However it is certain that today we are standing before a great opportunity and if there is any way ahead then that is the way forward, even if that might mean inventing a new model for financial viability. The MFI business could have served as some sort of a benchmark, however as it runs mostly asset products where the lending rate can be decided by the MFI and is usually double the market rate to allow MFIs to cover their costs but the same model cannot be adopted for this business. So, what's the possible way out to reach these 185mn possible customers?" she ended, looking for confirmation around the room.

"In product terms, while the micro-finance businesses run on the asset products, banks and other financial institutions would have to evolve this business around liability and insurance products. People want to save and be secure. This is the first basic need. Once this has been met they get more enterprising and borrow. Encouraging people to save more would create a lever strong enough to propel long term growth for a stable ecosystem incorporating diverse value added services," chipped in Joshi.

Hegde summed up succinctly. "We have to understand that first it's about gaining customer's confidence. This business has to be viewed as a basic infrastructural backbone, around which other value added services can be offered.

Today a customer can charge her pre-paid mobile phone from the ATM of a bank different from the one which issued her debit card and the entire transaction is completed in seconds. Similar offerings may be required for the rural markets to make the business viable. This is a business which cannot be built small but has to be thought big from the word go. "

The question that you have to answer:

Given the above context, how should Universal Bank enter the rural market?

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