A digital finance revolution for a Digital India
It is hard to overstate the impact of a strong financial services industry as a driver of economic growth. Deep capital markets and strong financial institutions give consumers easy ways to save, invest, borrow and plan for their future. Enterprises and small businesses, in turn, depend on financial institutions to raise capital for growth, efficiency, and infrastructure expansion. This cycle of saving, investing and lending is crucial for emerging economies like India to sustain economic growth.
It is common knowledge that India does not score very well in this regard. Over half the population does not have an active bank account, only 23% of all Indians have usable credit history, and 80% of 40M + small business do not have a banking relationship.
Addressing these issues is a priority for both the government and the RBI who have been experimenting with various initiatives, including Jan Dhan Yojana, creation of payment banks, and Rupay to enable domestic card payments systems among other initiatives. But policy alone cannot deliver the promise of financial inclusion. Technology-led innovation in financial services is needed to enable rapid, large-scale, and positive change.
Technology driven financial services innovation
There are 500+ financial technology (fin-tech) start-ups in India who have collectively attracted over $1.4B in funding since 2012. While mobile payment start-ups have garnered a lot of attention, there are many others attacking a range of services that have been the bailiwick of banks and traditional financial services providers – consumer and small business lending, remittances, wealth management, personal finance and related areas such as credit scoring and stock trading. Together, these make financial services the single largest market opportunity for start-ups in terms of economic value. The big question is if the market is ready for change and if these firms can deliver and scale.
There are a few key ingredients that have come together to create a fertile environment for disruptive solutions:
Unprecedented reach: While less than half the population may have a bank account; over 90% of consumers own a mobile phone. Smart phone sales have taken off and expected to touch 500M units in five years, providing unprecedented mobile Internet access. From start-ups to banks, every player in the financial ecosystem suddenly has reach and consumer access that was impossible even five years ago.
User behavior of a digital generation: In less than a decade, there has been a massive shift in consumer behavior among a young Indian population. Starting with e-commerce, consumers are embracing a new generation of mobile Internet solutions for services ranging from taxis, music, movies and food ordering to medical care and furniture purchase, among others. It’s not hard to see this extend to financial services, fundamentally changing the way Indians expect these services to be found and delivered.
Targeted high impact solutions: Most start-ups are focusing on a specific pain point and attempting to deliver value, cost reduction, and efficiency enhancement that can attract consumers. Take lending, for example. Getting a consumer or a small business loan is a complex, frustrating, and broken process. There are start-ups reimagining the loan search and fulfillment process to make it more efficient for consumers while reducing the cost of customer acquisition for banks. Another category of fin-tech providers are building lending platforms for small business working capital loans as well as pioneering peer-to-peer lending. Lending by itself is a massive market ($500B in 2014). Digital lending is less than 2% of the market today. There is enough promising innovation in this category to tackle the core issue of broadening credit access and banking reach for consumers and small businesses.
Innovation is also not limited to areas with legacy inefficiency. There is a major opportunity to provide a new generation of consumers with easy to use personal finance and wealth management services.Retail consumers have less than $200B in mutual funds compared to $16T in the US. The AUM (Assets Under Management) to GDP ratio in India is only 7% compared to a global average of 37% and 45% for a country like Brazil. There are multiple new fin-tech start-ups with low cost, mobile-first, easy-to-use solutions targeting this green field opportunity.
These are just a couple of examples. There is significant start-up momentum in a range of other areas such as mobile payments, online insurance, remittances, robo-advisory, and credit scoring that promise to bring disruptive change.
However, to succeed, there are a few challenges unique to India that these start-ups and the overall ecosystem have to address.
Data access and quality: Unlike developed markets, there are still significant gaps in financial and operational data availability in India. Lending start-ups, for example, have built impressive credit underwriting models. But they need regular access to trustworthy and high quality data to have impact. There are two issues – one of coverage (three quarters of the population does not have a credit score) and data access (many small businesses do not have reporting systems to tap into).
Co-opetition with banks: Incumbent Indian banks are not fading away anytime soon. The reality for any fin-tech start up is the need to work with a range of banks and financial institutions. They need understanding of and access to Indian banking systems and also have to differentiate themselves from dozens of start-up peers who are lining up with the same requirements. This calls for both sales skills and domain understanding to persuade banks, in addition to great technology.
Regulations:The good news is that both the government and the RBI view start-ups as being able to bring new ideas and technology to the table. That said, navigating the regulatory maze and securing licenses is challenging for small start-ups. A recommended way is to proactively meet and educate the regulator (SEBI, IRDA, RBI depending on the solution) and stay abreast of evolving viewpoints.
Trust: Banks may have a lot of inefficiencies and are often lagging in technology. However, consumers do trust them. Start-ups will need to win this trust by ensuring a high quality, transparent, and safe transaction experience. To scale beyond being a niche provider, these firms will also have to raise significant capital to build a national brand and a broad set of services.
These challenges while non-trivial, can be overcome. With many of the same constraints as in India, Chinese Internet finance companies have made major inroads into payments, consumer credit, and small business lending by leveraging mobile and Internet technologies. Alibaba’s payment platform, Alipay, has 300 million users and manages over $700 B in transactions annually. Alibaba’s money market fund (Yue ‘bao) manages over $100B, making it the fourth largest money market fund in the world. Tencent recently launched Webank – China’s first Internet bank to offer low cost banking services and leverage its 400 million Wechat users. In India too, we are likely to see established Internet players such as Flipkart and Snapdeal leverage their technology prowess and consumer reach to make inroads into digital finance by building, buying, or partnering.
At Kalaari, we are excited about the potential of this space. We believe technology led innovation in financial services will drive revolutionary change. It’s a large market with multiple white spaces. We see smart entrepreneurs building large and successful companies that contribute to social and economic progress.