Where Does the Next Evolution of Fintech Lie?

Fintech companies have seen significant growth in India over the past few years. The growth numbers suggested a very bright future for fintech. According to a report by NASSCOM, the Indian fintech market is expected to reach $150-160 billion by 2025, growing at a CAGR of 22%.

It was smooth sailing until the start of 2022 when some drastic changes occurred like Fed hikes, the Ukraine war, funding winter, ban on PPI (prepaid instruments) based lending, regulatory challenges like removal of FLDG (first loan default guarantee), PA/PG guidelines, etc.

Just when the industry thought things couldn't get any worse, this week RBI announced pre-approved credit on UPI. What this means is that if you don’t have a credit card and still want a short-term loan to make UPI transactions, it could be very much possible through your bank only. Banks don’t need to worry about the costs and hassles of issuing physical credit cards and just provide overdraft facilities through UPI. This has added another layer of worry for fintech players that were already struggling to survive.

Before we delve into the next evolution and opportunities for fintech players, let's clarify the latest notification on pre-approved loans on UPI by RBI.

Pre-approved loans on UPI: What you need to know

RBI gave the green signal to pre-approved credit lines through UPI rails. This is India's own solution to ease the friction to low-cost small ticket loans from Banks/NBFCs and this bold step will deepen the credit reach to the needy poor. UPI has already captured the majority of the payments market by virtue of being free of cost and providing credit on this could well turn out to be a gamechanger for the goal of financial inclusion.

What does this mean for banks?

Banks can now move pre-approved loans easily over UPI, allowing customers to pay bills through loans by scanning a QR code. Imagine you can pay your regular Kirana bills through pre-approved credit too just by scanning the QR. Every lender will be jumping to seize this opportunity.

DLG (digital lending guidelines) states that funds should be directed to the end borrower or marketplace's account with no nodal account in between. So, it remains to be seen how banks will act as lenders and their own LSP (lending service provider). Also, can banks charge MDR to merchants or how this will add extra income apart from interest income to banks to recover the cost of new infrastructure set up by banks and the interchange fees incurred by banks in UPI transaction?

RBI announced that more clarity on pre-approved credit on UPI will be issued separately. So It is too early to predict how pre-approved credit on UPI will shape up in the future.

What does this mean for RuPay and credit cards?

The Government's move to introduce pre-approved loans on UPI may seem like a cannibalizing move for RuPay credit cards and prepaid cards at first glance. But if you dig deeper, the Government intends to create a domestic card payment network in India, similar to Visa and Mastercard and get it globally accepted just like they are doing with UPI.

It is unlikely that pre-approved loans on UPI will completely replace credit cards but will surely eat away some share. Credit cards (CC) offer rewards like points, cashback, and discounts on eligible transactions that can be redeemed for various things like gift vouchers, merchandise, or at partner merchants, restaurants, and on selected products and services. It is unclear whether this pre-approved credit on UPI will offer the same deal or whether it can be used for any transaction like a credit card.

What does this mean for paylater fintech?

UPI can now facilitate the flow of credit and has already been adopted by customers through multiple apps. This could render the fintech model of acquiring customers and merchants and creating a credit layer obsolete. They would need to quickly pivot and reinvent to stay relevant.

Before we move ahead:

Advantage for banks: Game of scale

Banks have a larger presence in rural India than fintech. According to a 2020 report by Nasscom, around 50% of the Indian fintech startups were serving customers in rural and semi-urban areas. With a total of around 2100 fintech operating in India, only around 1100 are operating in rural areas. Banks have been successful in reaching remote parts of India and have a larger customer base in these areas.

With UPI reaching rural India, it has become easier for banks to provide lending services to people in these areas. This presents an opportunity for government banks to further expand their lending services in rural communities.

Bank’s Challenges: Reach, ticket size and underwriting

Big banks face challenges in underwriting small loans and developing new systems to cater to low-income customers, a segment traditionally occupied by local money lenders and B2C fintechs.

For example, SBI, being the largest bank in India, has to be conservative in its lending approach to maintain a healthy balance sheet. Private players have the advantage of technology but struggle to reach rural areas like public banks, while public players have difficulty producing tech solutions quickly. Both must underwrite new to credit customers while adhering to tight compliance and regulations.

Fintech on a thin line

• The Indian Government is leading innovation through Indian Stack, including Aadhaar, UPI, Digilocker, BBPS, CBDC, etc. which limits fintechs' choice to use their own infrastructure, giving the Government significant control over who can operate
• Recent events like ZestMoney and PhonePe deal falling apart exposed issues with the business model of fintech companies. The focus on growth over profitability revealed risks associated with B2C lending, particularly to new customers with a history of bad loans
• Fintechs are facing a tough time due to the impending recession, high inflation, interest rate hike, and funding difficulties
• With Pre-approved credit on UPI, the Government just hit the ball out of the park for a six for these lending institutions by cutting off fintech from the supply chain
• The insurance sector is facing challenges in achieving profitability despite the potential for technology disruption, companies such as Acko and Digit have got huge traction, but profit is still elusive

What’s next for fintech

We believe there are a lot of new opportunities where synergies can be found between fintech and different players (government, banks, merchants, MSMEs, etc.) involved which we will explore in this section.

The kirana model

According to CIBIL out of 81 crore credit eligible population in India, around 40 crore are credit unserved and more than 16 crore are credit underserved (without access to credit but with bank accounts). These numbers at least affirm that there is lots of space for innovation to increase financial inclusion.

Kirana shops in India account for more than half of all grocery purchases in the country, handling 90% of the $600 Bn grocery business. They are trusted members of the community and have established relationships with customers, making them ideal partners for fintech companies.

By enabling Kirana shops to become banking agents, fintech companies can leverage their existing customer base and distribution network to offer a variety of services including cash withdrawal, money transfer, insurance, savings, travel, digital payments, government benefits, and more, which can drive last-mile financial inclusion. Kirana shops going digital can play a crucial role in providing loans to the underserved in remote parts of India. This can help create new income streams for Kirana shop owners and boost the overall economy.

How does it work?

Launch ecosystem-specific embedded payments solutions

Fintech companies can provide tailor-made payment solutions to address the financial needs of small and medium-sized enterprises (SMEs) by creating sector-specific solutions with embedded finance. These solutions can be personalized based on market segments, digital maturity, available credit, and operating margins.

Let's take the example of a small handicrafts business in a remote area of India facing cash flow challenges due to seasonal sales and limited access to credit. Fintechs can provide a customized payment solution in collaboration with lenders with dynamic payment schedules that align with the seasonal sales cycle. The business can receive lenient payment terms during the off-season and tighter terms during the peak season to maintain cash flow throughout the year.

Unbundling and rebundling services

To provide real value to consumers and keep the business afloat, companies need to keep unbundling and rebuilding of services to provide a holistic experience to customers. In this constantly evolving world of regulations and compliances, companies must not rely on any one particular service for the business to survive

Customers and fintech players can now access information and move funds more easily. This has led to specialized providers offering single financial products, and customers choosing from a range of service providers to meet their needs. Instead of relying on a single institution for deposits, loans, and payments, customers can now pick and choose what they need. They can keep deposits in one place or more, shop around for the best loan offer, and use different payment providers for different purposes such as splitting a restaurant bill or sending money overseas. Customers can assemble their own sets of services and bundle them on their smartphone screens. These advances also allow service providers to provide single solutions and new packages of financial services, even if they don't own the whole customer financial relationship like banks used to.

The bottom line

In this fast evolving sector, pivots are necessary for survival. The opportunities demand from fintech players to change their business models adapting to changing Indian business conditions.

If they don’t act with discipline in balancing risk and growth regardless of market conditions, they can face closures. There are many examples from which we can learn. Several fintech players in India and other developing Southeast Asian countries have successfully adapted their business models to changing conditions:

• Paytm: Initially started as a mobile wallet provider, Paytm pivoted to a broader financial services platform, offering services such as bill payments, mobile recharges, and online shopping
• PolicyBazaar: Originally focused on providing insurance comparison services, PolicyBazaar has since expanded to provide loans, credit cards, and other financial product
• Razorpay: Originally a payment gateway provider, Razorpay has since expanded to offer a range of financial products and services, including loans, insurance, and accounting tools
• Zomato: Initially started as a restaurant discovery platform, Zomato pivoted to a food delivery platform to capture a larger market share. They also expanded their services to include table reservations, online ordering, and reviews

The next wave in fintech evolution - focused on MSMEs will not only ensure financial inclusion but also social inclusion, leading towards a digitally empowered, equitable, and collaborative society.

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