From 1 January, the subsidy amount for 29 of 42 welfare schemes of Indian government will go directly into the bank accounts of the beneficiaries in 51 districts across 16 states. The electronic cash transfers will be based on the 12-digit unique identification number or Aadhaar, a proof of identity and address anywhere in the country.

The districts being covered in the first phase include five each in Andhra Pradesh and Maharashtra; four each in Himachal Pradesh and Jharkhand; three each in Karnataka, Madhya Pradesh, Rajasthan and Tripura; and two each in Haryana, Kerala and Sikkim. The basis for selecting these districts is 80% coverage of the Aadhaar scheme. The second roll-out at more districts will be launched in April.

The plan is to cover the entire country by the end of next year. If implemented well, the scheme will enhance efficiency of welfare schemes as the government will be able to reach out to identified beneficiaries and plug leakages.

Subsidies on cooking gas and kerosene, pension payments, scholarships and employment guarantee scheme payments and quite a few other benefits under welfare programmes will be directly transferred into the bank accounts of the beneficiaries. Food and fertilizer subsidy is not yet covered under this scheme. The beneficiaries are expected to use the money to buy goods and services from the market.

The pilot projects for the so-called electronic benefit transfer (EBT) have already begun in Andhra Pradesh, Chhattisgarh, Punjab, Rajasthan, Tamil Nadu, West Bengal, Karnataka, Puducherry and Sikkim and, going by the government's version, the results are encouraging.

Two issues are critical for the success of this ambitious programme. One, only Aadhaar cardholders will be entitled to the get the cash transfer facility, but at this point only 220 million Indians have Aadhaar cards. And, two, is the lack of banking facility. Nandan Nilekani, who drives the Aadhaar initiative, is confident that it is achievable. According to him, in three years since the launch of the project, it has enrolled 270 million people. At the moment, at least a million Indians get enrolled a day.

Finance minister P.Chidambaram said the database of the beneficiaries will be digitized by the respective ministries and money will reach the targeted people through business correspondents, including women self-help groups, panchayats and even individuals like a school teacher. The banking correspondents, according to him, will carry hand-held automated teller machines (ATMs) to enable the beneficiary to withdraw cash. Is the banking sector prepared for this?

Let's take a look at the data. Indeed, penetration of banking services has been improving. For instance, the number of bank branches multiplied 12-fold-from about 8,000 in 1969, when the first set of banks was nationalized, to at least 99,000 now. And there are at least 110,000 ATMs. The average population covered by a bank branch was 15,583 in 2001. In 2012, it has come down to 12,601. Going by the latest census report, 58.7%

Indian households had access to banking services in 2011, up from 35.5% a decade ago. For every 100 new branches opened in fiscal 2012, close to 70 branches were in rural and semi-urban pockets. The comparable figure was 23.2 in fiscal 2005.

So, the scene is improving, but is the system ready to move to the cash transfer scheme? It will be the biggest challenge for the Indian banking sector in recent history. A cross-country analysis of financial inclusion by the International Monetary Fund shows 100,000 adult Indians were covered by 10.64 bank branches and 8.90 ATMs against Brazil's 46.15 bank branches and 119.63 ATMs in 2011. Household loan accounts with banks per 1,000 Indian adults have been 21 against Brazil's 747 in 2011. Brazil runs a successful programme that provides monthly cash payments to poor households if their children are enrolled in school.

The Reserve Bank of India (RBI) has been trying hard to expand banking services across the nation. Till June this year, about 147 million basic accounts or the so-called no-frills account have been opened and 121,000 banking correspondents have been appointed. Despite these, about 40% of India's adult population still does not have access to banking services.

About 13% Indians are using debit cards and only 2% credit cards. The efficacy of the banking correspondent model, on which the success of the cash transfer scheme depends, is not proved as yet for various reasons, including the fees that banks pay to such representatives.

One way of meeting the challenge could be allowing new banks to open shops. The banking regulator is not willing to do so unless the law that governs banking regulation in India is amended and RBI is empowered to supersede the board of a rogue bank. It is insisting on this as a precondition to allowing industrial houses to open banks as it feels that without this power, it will be difficult to supervise smart corporations who can divert money to their own group companies and deny funds to competition. Incidentally, among the first set of banks that was allowed to set shops in 1994 there was at least one corporate house.

If the amendment to the law takes time, there are other ways to tackle the industrial houses who want to enter banking. For instance, the supersession clause can be part of the licensing norms. Also, it will take years for a new bank to get the confidence to fool the regulator and by that time, the law-one can expect-will surely be amended. India needs many banks to cover its 1.2 billion population.

If the regulator is not confident of its ability to supervise large business houses, at the first stage it can allow relatively smaller firms such as non-banking financial companies and microfinance institutions-if they are found fit and proper-to set up banks with small capital base in rural pockets.
Tamal Bandyopadhyay keeps a close eye on everything banking from his perch as Mint's deputy managing editor in Mumbai. He is the author of A Bank for the Buck, a book on HDFC Bank.