Financial services have seen a tectonic shift, across businesses, technology, engagement, regulation and services. This sector, which was once monopolised by banks and NBFCs is undergoing an exercise of systematic unbundling, facilitating specialised players and market evolution. Prior to the Jan Dhan initiative, 60 per cent of Indians were unbanked and 90 per cent of small businesses did not have access to formal financing. As 75 per cent of Indians own mobile phones today, it is clear that digital banking will outperform web banking. Wellintended drive towards Jan Dhan, Aadhaar, along with a financial system strongly integrated digitally on Mobile phones, forms the JAM trinity, through which members are expected to bank the unbanked in the most cost-effective manner; and financial businesses are leveraging technology to meet this objective. FinTech is a matter of natural progression for India. FinTech has resulted in a large number of Techbased startups successfully disrupting the traditional financial landscape. With high service standards, lean operating structure and digital technology at the helm, these players are setting new benchmarks in customer acquisition and user experience. This has not only caused positive disturbances in the FinTech space, but has also brought about an intrinsic change in the way banks operate. On one hand, banks have scale and risk management expertise. On the other hand, FinTech firms have innovation and disruptive thinking. Therefore, it is wiser for the two actors to collaborate than compete. Coupling ease of operations with sustainable business models could be seen as the best of both worlds, and as a means of co-existence by both the actors. The FinTech ecosystem can be classified into four categories; namely Payments, Personal Finance Management, Lending, and Technology. These may engage with each other to give rise to innovative products and services. Payments The Payments use case caters to three types of customers; Government, business, and individuals. It can facilitate flow of funds in any direction to any of them. This perpetuates the need for standardization, interoperability, merchant management, and sustaining customer experience.
Technology today allows one to track one’s finances and financial planning more effectively. This vertical also caters to insurance products, which are gaining increasing importance with changing lifestyles and evolving needs of the common man. InsurTech found a latent audience, which the insurance players have thus far not engaged with on account of regulatory restrictions, high distribution costs and high investment requirements. Changing customer habits, Big Data and injecting InsurTech into traditional business models will help financial service providers attain greater heights.
Online lending platforms have been able to meet the need for timely credit using technology and innovation. Quick turnaround time, flexible loan repayment terms, algorithms that use social media behaviour, culture, lifestyle, spending habits among other tools to compute credit worthiness enable FinTech firms to provide timely credit to businesses and individuals compared to traditional institutions. Platforms and algorithms, that match lenders to a single/syndicate of borrowers are called Peer-to-Peer (P2P) networks. However, P2P lending platforms do not have a robust regulatory framework. Notwithstanding this, peer-to-peer lending in India is expected to grow to USD 5 billion and online lending market is expected to grow to USD 9 billion in the next three years.
Technology is being used extensively for credit scoring by FinTech firms. Globally, credit history is used as a critical variable to make decisions. Unfortunately, this serves as a tool of exclusion, counterintuitive to the very idea of financial inclusion. This highlighted the need for an alternate credit scoring model which would take into account variables such as behaviour, willingness, ability, social media, cultural preferences etc. Technological innovations today allow for all these factors to be considered for financial decision making process. Similarly, technology is playing its part in customer acquisition, innovative risk modelling, mitigating cyber lapses through encryption, block chain for data storage etc. While fully recognising the importance of Government projects such as JAM, this report also recognises that Government entities alone cannot not fulfil the task of financial inclusion. Private sector participation and startups must be encouraged. It is also important that there is semblance of regulatory parity between all market participants.
Indian policymakers have a challenging task at hand. They have to identify the specific needs for India, and work towards eliminating the corresponding regulatory hurdles. Key ingredients to develop a FinTech ecosystem include talent (financial acumen, technical know-how, and entrepreneurial bent), funding (seed capital, venture capital, public capital), demand (consumer, enterprise, financial institutions), enabling regulatory regime, and infrastructure (connectivity, digital inclusion, digital identity, data). Policymakers will need to rank and prioritize the ecosystem based on these variables. For FinTech startups to continue to grow, they need to engage with financial sector regulators and policy makers that minimizes economic and financial risk without increasing regulatory cost. The Payments space needs to be addressed from the point of view of infrastructure sharing, distribution, and products on the supply side while ensuring adequate interoperable access, connectivity, and usage on the demand side. A macro prudential regulatory framework should be one that regulates risk and not the entity. This calls for a philosophical shift in rule making. Interoperable and digitised Centralized KYC (CKYC) will allow single number/verification for all purposes for the service provider and the customer can aid in cutting down a lot of paperwork and duplication for financial services and technology companies.
The principles behind regulatory sandboxes can be unbundled and enhanced by introducing the concepts of Minimum Regulatory Obligations, while Recovery and Resolution Plans (RRPs) should be adapted to fit startups. This will lend the much needed regulatory support to innovation. The speed of FinTech innovation warrants not only that RegTech be used to make financial regulation more effective and affordable, but also, that RegTech be used to reconceptualise and redesign financial regulation in line with the transformation of financial market infrastructure.
Banking has been the most profitable sector for the last many centuries. From the time of the Medici in Florence to the House of Morgan in 1900 well into the 21st century. During this time, many industries have arisen and fallen. Emerging technology and technology landscape evolution is finally pressuring banks to change their ways or risk bank branches becoming a relic of a bygone era. The role of financial services is to produce, trade and settle financial contracts that can be used to pool funds, share risks, transfer resources, produce information and provide incentives.1 Banks accept deposits from customers and then use that money to make loans, buy securities and provide other financial services to its customers. In addition to the intermediation of funds and financial assets, a bank also provides payment, asset management and other related services. It collectivizes and manages both, liquidity and risk. For these services, the income received as fees and spreads by financial services firms can be termed as the cost of financial intermediation. The cost of financial intermediation affects the cost of funds for all other firms in an economy.
The cost of financial services is the sum of returns to savers and the cost of intermediation. The cost of intermediation is the ratio of the income of financial intermediaries to the quantity of intermediated assets. The income to financial services compensates for managing duration and credit risk, wages and others (including trading profits, asset management fees etc.). Savers and borrowers are all heterogenous. The composition of borrowers affects the cost of intermediation, while improvements in financial intermediation reduces cost of intermediation and provides access to credit to borrowers who were previously priced out. Average cost of financial intermediation has been around 1.87 per cent of the transaction size in the United States of America. However, despite advances in information technology and changes in the financial services industry, the unit cost of intermediation has not decreased significantly in recent years. Similarly, the unit cost of banking in other developed countries has not declined. The cost of financial intermediation in Germany and United Kingdom has also varied between 1.5 per cent to 2 per cent through the last century. (Bazot, 2013). This implies that the increased revenue from efficiency gains has been absorbed by the financial services firms as profits, and not been passed to savers (in the form of either higher returns) or borrowers (in the form of lower borrowing costs).
As a result of regulation and to increase capital efficiency, banks have been unbundling their bouquet of services. Like in other industries, unbundling of financial services was done in response to increasingly complex regulations and investor demands, which consequently lead to increase in efficiency and profits. This started in the early 1990s when products were placed in silos (cards, home loans, personal loans, auto loans, etc.). Unbundling resulted in individual profit and loss by business line, thereby improving product management and marketing focus, efficiencies, and profitability. Unbundling has led to greater efficiencies and products like housing loans, cards and has driven the commoditization of personal loans. Unbundling has also laid the foundation of the current round of disruption that is being caused by FinTech companies. Banks have complex operations and are focused on managing risk and compliance. They lack the flexibility of startups. There is not a single business unit in a bank that is not being challenged in some form or fashion by a startup from outside. Online lenders, for example, are offering an alternative for small business owners who otherwise wait for weeks to get a bank loan. By looking at different data points and evaluating a business’ financials in a more systematic way, new lenders are able to lend to people within a few hours, whom banks would otherwise not deem creditworthy. This efficiency does make a difference.
FinTech companies are broadening the type of product offerings focused on money management and building wealth today, from robo advisors like Betterment and WealthFront to automated savings tools like Digit, Seed, and QCapital. Technology companies cannot compete directly with banks on the whole gamut of financial services they provide but they are now pressuring banks to become more efficient by targeting specific services provided by banks. FinTech covers digital innovations and technology-enabled business model innovations in the financial sector. Disruptive innovations in finance includes crypto-currencies, digital trade advisory, peer-topeer lending platforms and innovative payment systems. Hundreds of startups now offer easier ways to pay, save and borrow for consumers. They take advantage of being more technologically savvy, unburdened by stringent regulations, more efficient in their services and offering lower costs. Disruption in banking sector is coming later than other areas because of the complexity of the regulations and the amount of trust required. Given how much consumers dislike the opacity of banks, FinTech companies have found a steady stream of consumers willing to try out their services. Financial services are ripe for a disruption where technology firms leverage data from messaging, e-commerce, social media and other internet services to personalize customer experience, provide new services and achieve operational efficiencies. The emphasis is on acquiring customer data to support other revenue streams like lending, insurance and investments. With their business under threat, financial services players are responding with their own competing products and are increasingly collaborating with FinTech firms to leverage new technologies and business models.
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