The financial sector in India has been transformed as the national digital infrastructure evolves, leading to the rapid rise of financial technology (fintech) businesses.
India began its ambitious digital journey nine years ago with the introduction of Aadhaar, the unique identification number (UID) based on each person's biometric data. Aadhar (Hindi for "base" or "foundation") and other services are powered by India Stack, a platform that unifies the application program interfaces (API) of disparate government and business services to communicate and exchange data. The developers of India Stack say their goal is to create a frictionless digital economy.
As Indian citizens became accustomed to using Aadhaar to receive state benefits and subsidies and access other public services, interest grew in digital financial services. The government saw an opportunity to give the movement toward a cashless society a further push by way of an abrupt demonetisation in late 2016.
The removal from circulation of 500- and 1,000-rupee notes, ostensibly to curb corruption, caused widespread turmoil for consumers and businesses initially, but it also got more people thinking of other ways to handle financial transactions.
As a result, a new financial ecosystem of banking, telecoms and fintech applications has emerged to offer presence-less, paperless and cashless transactions. Fintech and non-bank companies that were once held back by unclear regulations are now able to coexist with the incumbents while being more transparent and accountable.
The country's leading e-wallet company Paytm, for instance, now accounts for about one-third of the country's e-payment market share with 137 million unified payment interface (UPI) transactions this year. Launched in 2010 and backed by Alibaba and SoftBank, Paytm claims more than 300 million registered users.
While digital payment has the most customers, a host of new services are emerging, from small-business lending to insurance and wealth management, all offered on easy-to-use digital platforms.
With their profits under pressure, incumbent financial institutions have realised that they must embrace new technologies if they want to remain relevant.
In fact, more that 80% of banking activities at top private banks such as ICICI and HDFC are already taking place via digital channels.
"Initially, the banks were threatened by fintech and non-bank companies, but the trend we see today and going forward is that banks are starting to collaborate with these companies, which allows both parties to have a win-win proposition," Vijay Mani, a partner with Deloitte India, told Asia Focus.
Building a brand in financial services takes a lot of investment and resources, and not all fintech companies have the capital required to build a consumer business on a viable scale. Banks, on the other hand, find that by collaborating with fintech providers, they can introduce new technologies more quickly and efficiently, he explained.
Vivek Belgavi, a partner and India fintech leader with PwC India, said fintech firms are agile and asset-light, and thus able to quickly exploit new technology and create innovative products.
"Financial institutions, on the other hand, in their bid to cement their position, are increasingly looking at partnering with such firms to shorten the time to market of innovative offerings," he told Asia Focus.
For fintech firms, gaining market access is critical. They can tap large customer segments through established financial institutions that traditionally enjoy brand loyalty and trust.
"Things are changing at such a fast pace that it is difficult for banks to experiment with all the possible technologies or build talents around those areas," said Mr Mani.
"These fintech companies might have a wonderful product but simply don't have the appetite to make such an investment and time (to build new markets), so they also find it very beneficial to work with the banks."
But not every collaboration will be a win-win, said Varun Mittal, Asean fintech lead at Ernst & Young (EY).
"There are a lot of win-wins in many areas, but in some areas, it could be a competition and they may not want to collaborate," he said. "For collaboration to happen, both sides must be willing to work on commercial agreements and strategic prioritising that can be beneficial for both firms."
By way of example, he says, a bank wants to have access to a bigger customer base or perform activities that it couldn't do on its own. A fintech company, meanwhile, should be able to create more applications or use cases for the bank's customers.
Incumbent banks and fintech firms are pursuing winwin collaboration, says Vijay Mani, a partner with Deloitte India.
Mr Belgavi of PwC said that successful embedding of fintech solutions in mainstream financial providers depends on many factors: size, business culture, priorities, manpower, skills, project life cycle and methodology, and compliance requirements.
"For partnerships to be successful, it is necessary for fintechs and banks to find a middle ground," he said.
Both sides, he said, need to agree on basics such as revenue and cost sharing from each new service. Beyond that, banks need to take a "light touch" approach to the fintech partner except for vital requirements related to legal, risk, compliance and data security.
DIGITAL PIONEERS
Greatly improved mobile connectivity and the ubiquity of mobile phones have driven rapid adoption of digital financial services for both urban and rural populations in India.
Currently, India is home to about 780 million feature phones and 120 million smartphones, which are the sole internet gateway for 70% of the population, making the mobile channel critical for digital banking.
One of the biggest strides toward a cashless society was the launch of the UPI in 2016 by the National Payments Corporation of India (NPCI), hailed as one of the most advanced public payments systems in the world.
The system -- the model for Thailand's PromptPay -- facilitates transfers between bank accounts via smartphone without the hassle of entering card details or banking passwords -- a step closer to a cashless India.
India still has the second-largest unbanked population in the world with 191 million adults still having no bank account, but government policies have been helping to steer more people into the formal financial system.
For instance, State Bank of India (SBI), country's largest lender, now offers various zero-balance bank accounts. Previously, if a customer failed to maintain a minimum monthly balance, penalty charges would ensue.
Mr Belgavi said India Stack has been one of the most exciting developments and a critical cog in the digital India story. Its developers have worked with the Unique Identity Authority of India (UIAI), the developer of Aadhaar, and the NCPI, among others, to help make numerous services work together and create a platform for more services to be added.
The UIAI first introduced electronic Know Your Customer (eKYC), promoting paperless customer acquisition, and the National E-Governance Division (NEGD) created digital lockers that allow paperless storage of documents. The UPI, meanwhile, has allowed diverse players such as Amazon, Google, Paytm, incumbent banks and WhatsApp to enter the payment space.
"We expect many cities and states to actively participate in the India Stack story. We may have solutions and APIs built on top of the India Stack, which may lead to city and state-level innovation hubs," said Mr Belgavi.
Many states also have opened regulatory "sandboxes" for testing innovations before they go to market, and have are supporting fintechs through dedicated startup policies.
"These are definitely a step in the right direction," he said, adding that solutions developed in sandboxes "should be provided adequate support for mass rollout to realise the intended benefits".
‘MANAGED' DISRUPTION
While fintech is perceived as disruptive, the regulatory framework in India allows for disruption but in a rather contained manner, said Nirupama Soundararajan.
"India's banking system has been and will in all probability continue to remain the mainstay of the financial system," she said. "This is probably due to the fact that India has many public sector enterprises in the financial sector. It is therefore not surprising the government too has launched payment platforms."
For this reason, the relationship between traditional players and fintech players has largely been collaborative rather than competitive, she added.
As well, there are multiple regulators that oversee fintech companies, be it for insurance, banking or capital markets. The Ministry of Electronics and Information Technology also plays a role, through the NEGD.
"Multiple regulators often cause more harm than good for a nascent sector that is trying to grow," she said. "Furthermore, regulations cannot keep pace with innovation and hence regulators tend to take a more severe stance rather than a more consultative one in the interest of protecting the consumer and for averting any type if crisis that may arise."
"This attitude will need to change. A single regulatory sandbox is necessary rather than multiple ones. Also, regulators must focus on market growth and development as much as they focus on regulation."
RISING STARS
Fintech companies in India are playing an active role in delivering enhanced financial services across a wide spectrum, with small-business lending, merchant payments and customer servicing gaining the most traction.
Owing to the ease of the KYC process, user interface and seamless customer experience, digital payment companies have rapidly gained popularity.
"Customers have found wallet technology extremely convenient. Customers are able to create a wallet account within a few minutes, compared to opening a bank account which will take seven days. Payments can also be made far more easily through the wallet instrument, compared with the traditional banking system," said Deloitte's Mr Mani.
Payments and lending have dominated the fintech landscape for the last three years. The main players in lending include CreditVidya, Capital Float, MoneyTap, Neogrowth, simpl, zest and klarna; and in payment they are Paytm, PhonePe, Razorpay, PayU, ezetap, itzcash and instamojo.
"A few emerging segments that are showing increased traction are in insuretech and wealthtech (wealth management) as well as within payment and lending areas that focus on the SME sector," said Mr Belgavi.
Digital insurers that are gaining popularity include Acko, Coverfox, Toffee, MyInsuranceclub, insuringindia; and wealthtech providers include Scripbox, Fisdom, Tauro, FundsIndia, Goalwise, BharosaClub and ArthaYantra.
Some firms are positioning themselves as marketplaces offering multiple financial services from multiple parties rather than offering everything themselves, rather like old-fashioned insurance brokerages.
Ms Soundararajan says fintech is helping to lower the cost of financial inclusion and that is having a big impact in rural India.
"Fintech players are as keen to tap the rural market as they are the urban market. For rural India, most fintech firms have been concentrating on providing financial services, especially in the credit segment, to the last mile," she said.
For urban India, she says, fintech innovation in credit is constantly evolving, mostly in peer-to-peer lending and crowdfunding.
CREDIT EVOLUTION
According to Deloitte, fintech players are keen to target financially excluded customers for loans by radically changing the approach to credit profiling to evaluate customers' income generating capability.
"There's a lot of action around digital lending in which alternative information sources are being used by fintech companies. There is a clear and remarkable shift in this segment with growth expected to be very significant," Mr Mani said.
Traditional methods such as income tax information, proof of income, and financial statements are still being used, but more fintech companies are starting to utilise data such as SMS and email account information, e-commerce spending and social media data to evaluate and predict customer creditworthiness, he said.
That said, Mr Mittal of EY says credit evaluation models are always evolving. Lenders today potentially have access to vast amounts of data, but how much of that data should they be allowed to see and use? Regulations are needed to strike the right balance, he said.
"It goes back to what is the right level between a breach of privacy versus what would be comfortable for the person who provides the lending, given that they are the person bearing the risk," he said.
Bringing in new methods doesn't mean the old ones will die, he added.
"It will take some years for the best practices to emerge as we need to ensure that we are not creating more problems than what we are trying to solve."