Accepts DMart Bangalore Zeta cards

Over the past three years, India has made great strides in promoting financial and digital empowerment. Millions of Indians are now online. This goes hand in hand with a positive development among fintech start-ups that have brought new products onto the market.

Some experts even say that selected fintechs represent an innovative global brand. The already attractive segment of the financial services sector is experiencing a strong tailwind from “Made in India”.

There are a total of around 2000 fintechs in the country. That is the second highest number in the world after the US. India ranks 15th in the Global Fintech Index. This is remarkable because the top positions are exclusively industrialized countries. Unlike in other countries, the high performance of Indian fintechs is not associated with the weakness of traditional banks.

Indian banks are divided into two categories according to their legal status: the “Scheduled Banks” and the “Non-scheduled Banks.” “Scheduled Banks” are credit institutions that are registered and published in the Central Bank's directory of banks. Thus the Indian “Scheduled Banks” come very close to the status of the “Member Banks” of the Federal Reserve System in the USA.

High acceptance of fintechs in a confusing banking market

All private and state commercial banks belong to the "Scheduled Banks". India has 26 public sector banks, 25 private banks, 43 foreign banks and several city and cooperative banks.

Unlike in other countries, fintechs are spread across various Indian cities. There are five Indian cities on the Asian subcontinent that are among the top 15 fintech locations. These include Bangalore (second place), Mumbai (third place), New Delhi (sixth place), Pune (13th place) and Hyderabad (15th place). In a global comparison, Bangalore and Mumbai are among the top ten.

According to the Global Fintech Adoption Index 2019 by the consultant Ernst & Young, India, together with China, leads the emerging markets with a high fintech adoption rate of 87 percent in 2019. The average adoption rate worldwide in 2019 was 64 percent. In 2017, when the index was first created, a fintech adoption rate of 52 percent (average: 33 percent) was measured for India.

Transformation of the savings and checking system - India rushes ahead

The adoption rate is the relative speed with which members of a social system embrace an innovation. It is expressed by determining the number of new adopters in relation to the group population in a certain period of time. If the adoption rate was 100 percent, the entire group would apply the innovation.

The Indian fintech ecosystem has also been boosted by the introduction of an interoperable payment system that has significantly changed mobile payments. An electronic tax registration system has been established for this purpose, which has led to an increased formalization of the economy.

And finally there are innovative systems such as the so-called Aadhar and the Account Aggregator, a manager for the joint management of financial data. As a result, India today has the lowest data prices in the world, the highest monthly data usage per smartphone, the lowest payment transaction prices, and the lowest KYC costs (see Figure 1). In the past, the Indian market has produced many innovative products and business models that are worth taking a closer look at.

Reinvent financial products

Let's start with the bank account itself. For decades, the branch network was a bank's most important location for collecting deposits and servicing savings and checking accounts. In the last few years this has changed completely.

Many Indians have not visited a bank branch for years. At traditional banks such as the Indian private bank HDFC, the channels by which customers interact with the bank have changed massively (see Figure 2). 92 percent of customer transactions are processed via the Internet or mobile.

Companies like NiYO, Open and many other neo-banking start-ups were able to redesign their savings and current accounts themselves. NiYO, for example, offers digital payroll accounts for workers (in partnership with an Indian bank).

The KYC costs of branch-based customer service have so far prevented conventional banks from serving these customers. At a typical bank, each account would cost around $ 40 to $ 50 annually. As a result, many customers are unprofitable.

With cheaper KYC and a solution that only uses the card as a bank account, NiYO can serve the customer segment profitably. Open similarly targets the funding needs of small businesses that often struggle to maintain banking links with mainstream banks.

Investment products such as mutual funds and stocks have traditionally been sold offline through financial advisors in the past. One motive was the high commissions. Startups like Groww take a commission-free platform approach.

Investors can make their own investment decisions through a simple user interface. Likewise, Zerodha has built a superior flat-fee brokerage product in a market that is largely characterized by expensive brokerage products.

Neo-banks play a big role in India. DigiBank, Airtelbank, Paytm or FINO are the best-known Indian representatives (see Figure 3). There are a total of ten neo-banks. They all have a good refinancing base. The main focus is on payment transactions. The Neo-Bank platform Open, which combines everything from banking to invoicing to automated accounting in one place, should be highlighted.

Even though the Indian fintech ecosystem in the areas of payments, loans and investments has reached its maturity phase, the focus of most fintechs is in the area of ​​payments. The adoption rate here is 96 percent.

All other categories also show a higher adoption rate compared to the global average. The main reasons for the higher Fintech acceptance are attractive tariffs or fees, the ease of setting up an account, access to various and innovative products and services, and a high quality of service.

In India, fintechs and digital financial services are having a positive impact in removing long-standing barriers to financial participation. It is estimated that almost 90 percent of micro-businesses in India are still outside the formal credit system (see Figure 4).

However, the great geographical distances also have to be overcome. This argument is particularly heavy when it comes to providing financial services in remote rural areas. But it also applies to the participation of women, urban poor and migrants, for whom there are often no suitable financial products.

Fintechs in India are also helping to reduce information asymmetries between service providers and consumers - especially among non-banks - who lack the information necessary for risk assessment. Added to this is the lack of a verifiable identity.

Beyond payment transactions, however, the most significant effects of Indian fintechs are on lending to micro-businesses. It is estimated that around 85 percent of micro-businesses in India are not served by the formal financial system. They are financed exclusively in the informal sector through moneylenders or family financings.

Huge demand for financing products for individuals and companies

According to the 2019 India FinTech Report, the funding gap for these micro-businesses is $ 240 billion. In terms of consumer credit, it is as much as $ 300 billion. There seems to be a huge need for financial institutions as a whole, but also for fintech players.

On the B2B side, some payment gateway startups are focusing on the issuing side, where they share the fees with the banks. They are now offering other financial products such as loans to help make the business more profitable. Fintechs like RazorPay and Pine Labs are already active there.

With the advent of lending platforms, micro businesses such as retailers are given access to credit without a credit history. In addition, there is the so-called Goods and Services Tax Network (GSTN) - an electronically based system that records all tax-relevant processes of companies. More than 9.2 million micro-enterprises are currently registered.

The GSTN data are verified by a matching concept and offer a deeper and more comprehensive overview of the type of transactions and thus complement the conventional financial data.

A high number of digital loans increases the risk of over-indebtedness

Fintech lending models can be improved by more accurately verifying and validating transactional information that enables stronger underwriting processes. For example, Credolab sells a credit rating tool that uses smartphone metadata to help financial institutions draw up loans and credit cards. Fintech companies like Progcap can insure retailers and grant them GST-based loans.

The focus of these models is on the evaluation of payment flows and alternative data sources in order to evaluate the creditworthiness of customers. On the one hand, the scoring models of fintechs use a larger amount of information from other financial intermediaries or social media platforms. On the other hand, new technologies are being used: using machine learning, non-linear information is obtained from various variables.

Loans may be granted to customers with limited credit history and lack of documentation, but who have a good digital footprint and records of regular bill payments, etc. This advantage in connection with the physical distribution and the reach of the banks can have positive effects. Nevertheless, it should be pointed out that digital loans sold via mobile phones can cause high risks of poverty.

And here, too, India has had negative experiences. A large number of suicides occurred in the southern state of Andhra Prades in 2011 because the borrowers were so over-indebted that they saw no other way out. At the time, this event - well beyond the Indian borders - led to discussions about the limits of microfinance services for particularly poor people.

More than 30 percent of the Indian population are considered extremely poor

Two thirds of the people in India live in poverty: 70 percent of the Indian population have to get by on less than two US dollars a day. More than 30 percent have less than $ 1.25 a day available. They are considered extremely poor. The lockdown has exacerbated the situation: households have lost an average of 60 percent of their income.

Against the background of strong Internet growth and high mobility density, e-commerce and smartphone-based services are responsible for huge amounts of data about individuals and small businesses in India. As more and more data is being digitized, the costs, time and effort required to assess the creditworthiness of potential customers decrease at the same time. For example, Slice offers card-based products to young Indians to help them achieve better creditworthiness.

The vast majority of traders in India are still not in the digital space. Of the seven million merchants, only a small proportion have started accepting digital payments. Hence, there is a lot of leeway to accelerate merchant adoption through mobile payments, smart point of sale (PoS) terminals and quick response (QR) codes. The Fintech Paytm processes a considerable volume of merchant payments on the basis of QR codes.

A PoS device, which typically costs around more than $ 100 to install, only pays off for high-volume retail stores. A UPI QR code, by comparison, costs less than $ 0.2 to install and can be used in the smallest of stores.

In this way, companies such as PayTM, Bharatpe, PhonePe and Google Pay reach an army of millions of small merchants and enable digital payment transactions. The Bengaluru-based fintech OKCredit provides small traders with an app with which they can track their accounts receivable and payable. Improving payment acceptance infrastructure and connectivity in areas with low digital transactions would also give a big boost to financial integration in India.

Financial participation

According to the Consultative Group to Assist the Poor (CGAP), an advisory group to the World Bank, fintechs at every stage of the financial services value chain can offer innovative products and services to low-income customers. As a result, the adoption of fintechs in India has grown exponentially over the past two years.

This development has been promoted, among other things, by government and regulatory initiatives in the direction of a more digitized economy. Based on the recently published Global Microscope 2019, India ranks fifth in terms of financial inclusion among developing and emerging countries.

The Indian Central Bank (RBI) presented a “National Strategy for Financial Participation in India 2019 - 24” last year. It aims to make formal financial services available, accessible and affordable for all citizens in a safe and transparent manner. A high priority is given to data analysis and machine learning in connection with alternative data sources.

Central database stores biometric and biographical data of all citizens

The aim is to build digital and financial identities. They are designed to enable every citizen of India to demonstrate creditworthiness and eligibility for a range of financial services that were previously inaccessible.

The introduction of Aadhaar has significantly streamlined the KYC processes for opening bank accounts and electronic wallets. Aadhaar (German: Fundament) is a personal identification number for every citizen of India. This twelve-digit number is used to store biometric and biographical data in a central database at the Unique Identification Authority of India (UIDAI).

The system was introduced in 2009 on a voluntary basis. It has been mandatory since 2016 in order to be able to use all government services. With over 1.2 billion registered members, Aadhaar is the largest biometric database in the world. This covers 99 percent of the population over the age of 18 (see Figure 5).

E-KYC and biometrics support the next wave of inclusion. There is a central KYC register. Around 100 million applications for the use of digital financial services are managed here. The start-up EzeSmart has launched a platform for Aadhaar and E-KYC services.

After health data are gradually being recorded in the Aadhaar, the identification process is also used as a payment system (Aadhaar-enabled Payment System, AePS). This is how people in rural areas make deposits, withdrawals and transfers. This means that micro-ATMs can now be set up in rural areas, because with Aadhaar the identity of customers can be checked digitally and their accounts can be managed.

Regulatory Initiatives

In parallel to the technological innovations, RBI has continuously adapted its regulatory and supervisory framework. It should be possible to use the fintech development to expand and facilitate the access of the excluded population to finance. Among other things, she presented a framework for a regulatory sandbox last year.

Such a sandbox usually refers to live testing of new products or services in a controlled / tested regulatory environment for which regulators can allow certain relaxations for the limited purpose of the testing.

The first use cases related to payment transactions started at the end of the year. In this way, digital payment transactions are to be promoted and contribute to offering payment services for the unserved part of the population.

The advances in digital technology for use in financial services (e.g. payments, loans or other financial services) are based on the digital infrastructure built by the government and RBI.

The goal of a cashless society: a bank account for all smartphone owners

Various measures have also been taken on the supply side to make inexpensive financial services available to everyone. A bank account, an Aadhaar identity linked to biometric data and mobile connectivity are available to millions of Indians.

The advances in an open, interoperable payment system in the form of the Unified Payments Interface (UPI), which can be used by anyone with a smartphone and a bank account, have revolutionized the payment system in India.The UPI payment system processes an average of one billion transactions per month.

With the entry of Google Pay, it is now the largest UPI platform. UPI is significantly promoting the digital provision of government services. The Direct Benefit Transfer, which has existed since 2013, is particularly important. This program aims to send government transfers directly to beneficiaries via Aadhaar-linked bank accounts.

The RBI has also taken measures to encourage greater use of electronic payments. The goal is a “more cashless” society. This ties in with the monetization ("demonetization") initiated in 2016. In it, the Indian government announced, completely surprising, that all 500 and 1000 rupee notes in circulation are no longer legal tender with immediate effect and must be exchanged for new 500 and 2000 rupee notes. 86 percent of the money in circulation in India was affected.

The extensive abolition of cash is now considered to be hasty

With monetary devaluation, the public has been forced to switch to digital payments and online transactions en masse. This event can actually be seen as the birth of many Indian fintechs - even if fintechs such as Paytm, MobiKwik, Oxigen, PhonePe, PolicyBazaar etc. have already existed.

This completely hasty abolition of cash in favor of digital payment systems failed to take into account that cash is usually not only the only means of payment available, but also the cheapest, for people who work in the informal sector. 90 percent of India's economic output is still generated in the informal sector.

Increasingly, non-banks cooperate and compete with banks. Either the non-banks act as technology service providers for banks or offer electronic retail payment services directly. RBI has made enormous efforts to develop a state-of-the-art national payment infrastructure and technology platforms.

Retail payments: total volume nine-fold in five years

Here are the Immediate Payments Service (IMPS), a unified interface for payments (UPI), the Bharat Interface for Money (BHIM), the Bharat Bill Pay System (BBPS) or to highlight the Aadhaar-enabled payment system (AePS). All of these initiatives have driven the retail payments market in India, increasing the total volume nine-fold over the past five years.

The RBI has also licensed a few institutions to operate peer-to-peer lending platforms (P2P). Finally, the Trade Receivables Discounting System (TReDs) has also been set up. This is an electronic platform for trade finance for small businesses. There are three TReDS exchanges in India. However, the trading volumes are still quite manageable.

There are currently ten Small Finance Banks (SFB) with a banking license. Your business model consists of lending and depositing to small business units, small farmers and micro and small industries. Some of them are already on the stock exchange, the others are planning to do so in the near future. However, these banks in particular are particularly affected by the corona crisis. RBI has also issued licenses to seven digital-only lending companies for operation via mobile applications.

Global expansion

The financial services industry is traditionally country-specific. The banking systems of India, Indonesia, Thailand and Vietnam, for example, all differ from one another. National regulation also plays a role in this. That is changing now.

A number of Indian fintech companies such as Pine Labs, Ezetap, Paytm, Zeta and PolicyBazaar have reached a certain level of market maturity. They use their experience from the domestic market to refine their products and operate globally.

Unlike in the past, customer preferences today seem more and more similar around the world. Products developed and refined in Bangalore work equally well in Ho Chi Minh City or Jakarta.

Happay, a platform for managing company cards and expenses, has signed banking partnerships to launch its product in several countries. The National Payments Corporation of India (NPCI) recently set up an international subsidiary to sell the technology behind its RuPay network to other countries. RuPay is the largest card network in India. Drip Capital finances many international trading companies beyond India.

On the international markets, these companies work together with existing financial institutions, use their licenses and offer their services to consumers and companies as technical solutions.

Huge market with high levels of fragmentation and heterogeneity

Conversely, fintechs from other countries have started to conquer the Indian market. Foreign fintechs such as Payoneer or Transferwise have long since arrived in India. But East African fintechs also want to conquer the Indian market.

Commonly one thinks of the 1.2 billion English-speaking Indians and tech talents. India is a huge, but highly fragmented market, comprising 29 states and 22 regional languages.

The states are united by a federal government, but there are significant differences in business regulations, tax structures, and reporting requirements between states.

For example, sales tax rates and categories vary from state to state. Some states even waived the use of a sales tax in favor of a sales tax for a short period of time.

This fragmentation also extends to languages: while 41 percent of the population speak Hindi (and its subgroups) as their mother tongue, start-ups have to integrate these regional languages ​​into their interfaces.

Only half to three quarters of Indians are considered literate

In addition, it is not as easy to design linguistic interfaces correctly as a direct translation. Because the Indians tend to use a mixture of English vocabulary and numbers in addition to local words and slangs (for example Hinglish).

In addition, literacy rates are low in India. It is between 55 and 75 percent. Therefore, start-ups cannot rely on people to be able to read and write, not even in the local languages.

India's strong oral tradition means that users would rather listen, watch and speak than read and write. This makes customer loyalty both a linguistic and a media challenge.

In addition, there are many competent authorities in India, all of which affect the fintech business. This starts with the RBI, the telecommunications regulator, insurance regulator and development agency, as well as other institutions responsible for non-bank financial institutions or payment banks.

Eleven Chinese fintechs are already licensed, others are withdrawing

This high number of authorities contributes to a general feeling of political uncertainty. Government agencies each have different views on the value of startups and fintech companies. As demonstrated by the demonetization in 2016, changes in ESign regulations and the use of Aadhaar data, regulations can change overnight.

Still, Chinese fintech firms like Xiaomi are making significant strides in online lending in India. They quickly expanded their loan portfolio and gained up to 10,000 customers in just two to four weeks.

So far, RBI has licensed eleven Chinese companies. It remains to be seen how the portfolio quality of the Chinese start-ups will develop and whether they will establish themselves in the Indian market. Originally, the Chinese assumed that they could easily replicate the Alipay model in India.

The first fintechs are already withdrawing. For example, China's WeCash pulled the plug before it even really started in India. But US companies such as WePay, an online payment provider, have now left the subcontinent again.

However, some observers point out that Chinese firms are taking a phased approach and that they are looking at the sector from an ecosystem perspective. So your future in India could be brighter than it currently appears.

Conclusion: Awareness of financial technology is increasing

Fintechs in India are increasingly becoming an indispensable part of everyday business. They can act as a catalyst for financial participation by creating many opportunities for people and institutions who have previously been excluded from the financial sector.

Moving from traditional to digital payments has paid off for both individuals and businesses. This is particularly true of the micro-enterprises in rural areas.

In a country with the second largest population in the world without any banking access, fintechs have a crucial role to play in overcoming barriers such as a lack of financial knowledge or the high costs of traditional banking services.

The euphoria must not hide the fact that many Indians are worried about the family's next meal and cannot afford education and sanitation. Even convenient financial services are of no help here.

The micro and small businesses are the backbone of the Indian economy. Despite playing such an important role in the country's economic growth, they still face many challenges. The lack of capital is particularly noteworthy.

This is where fintechs come in. They have the potential to begin to solve credit availability issues. They offer easier and faster access to credit for the target group.

The fintech industry in India has thus grown and grown up. Once only consisting of start-ups, this sector is now taking on established companies and banks in the public and private sectors.

Corona consequences: Small businesses in particular could be affected

Awareness of financial technology has also increased: a large proportion of consumers now know that fintech platforms are available to make payments and transfer funds. This indicates a positive change and represents enormous growth potential for the entire industry. In the meantime, fintechs are expected to continuously innovate in the areas of products, services and delivery.

While the Indian banks have had to struggle with a flood of loan defaults time and again in recent years, the situation has worsened massively as a result of Corona. One can seriously speak of a credit crunch. The banks are grappling with enormous loan defaults. Approximately $ 9 billion in defaulted corporate bank loans are written off.

Smaller businesses could be hardest hit by the economic impact. It creates a funding shortage for smaller businesses at a time when they need money most to counter the financial effects of the crisis.

Silvio Andrae has been dealing with questions in the field of development finance for more than 20 years and has gained practical experience in Latin America, Africa and Asia. In the “Fintechs Worldwide” series, the author presents selected regions. Published so far:

Fintechs worldwide (1): Regional diversity (overview)
Fintechs worldwide (2): Brazil: Eldorado for financial experiments

- September 18, 2020