As India becomes digital, neobanks will be a norm in India

On the eve of 2020 when India was battling strains in our financial system, little did we know that the Yes Bank and PMC Bank crises were not one-time events.

With India staring at geo-political tensions, ranking first in confirmed Covid-19 cases as on 16 August (averaging at 62,000: 7-day average), witnessing rising levels of unemployment (9.1%) in the first half of August 2020 and the expectation of gross NPAs of the banking sector expected to rise as high as 14.7% by March 2021 – we must observe how the consolidated financial strain of these factors impacts not just the contraction of our GDP but also the confidence of our people (perhaps we can learn from the outcomes of RBI’s Consumer Confidence survey that was released in July 2020).

Taking cognizance of the existing financial strain on our economy, it is riveting to see how our domestic public financial markets play musical chairs with bullish and bearish sentiments while India’s fiscal deficit widens to 83% of the Budget Estimates in Q1 FY21.

In such cases when consumer confidence is low, CPI inflation is rising and the economy is replete with uncertainty – citizens are bound to be cautious, cut their discretionary spends and build up an emergency fund (strong bank deposits growth at 11% in July 2020 highlight this precautionary saving theory).

Amidst this cobweb of financial strain and economic uncertainty, we must not lose sight of the digital transformation that our financial services industry is undergoing. Digital transactions grew by 383 % over a twelve-month period ending March 2019, and have risen 23% in June 2020 itself on the gradual re-opening of our economy.

The unlocking of the economy, though not uniform, has aided digital payments recover to ~92% of their pre-Covid run rate. This rise in such fintech products in India has been supported by the consistent drive to achieve financial inclusion in India (Jan Dhan Yojana) and has grown due to policy decisions like demonetisation. This fintech market is expected to grow at CAGR of 22% to reach ~INR 6,207 Bn by 2025. However, fintech encapsulates a host of sub-segments and products.

Amidst these fintech products, we believe neobanking is a sunrise sector that is silently raising funds. Neobanks are digital-only banks without any physical branches. These are of two types. One which has obtained a fully operational banking license, such as the German neobank -- N26.

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Second are digital-only platforms that offer either a standalone product or a basket of services by partnering with financial institutions and licensed lenders such as banks and NBFCs. Two home-grown neobanks like Open and Jupiter come in the second category.

We believe that neobanks will create a banking product that is less dependent on fees, will offer personalised rewards and cater to the millennial audience. Despite the grey areas that surround the functioning of neobanks in India, home-grown neobanks have raised funding to the tune of ~ US $ 200 Mn to ~ US $ 250 Mn over the last two years.

These insurgent challenger banks (the landscape for challenger banking is an amalgamation of neobanks, digital initiatives of traditional banks and marketplaces), like neobanks, will be able to achieve scale due to their asset light online-only model, competitive pricing, real-time advisory (that ensures a healthy customer experience) and the effective implementation of AI in the BFSI space.

Given that India is the only country apart from China to have a fintech adoption rate of ~87% (as on March 2020), we are expected to witness a healthy growth in neobanks going forward.

In addition to neobanks looking to capitalise on the social distancing trend in the post-Covid era, they also aim to provide transparency and insights into a customer’s personal finances (within the conventional set-up these details are available only on request) – both of which are needed in India’s banking system from the perspective of a consumer.

Thus, neo and challenger banks are slowly developing a niche in India and their market was valued at ~ US $ 475 Mn in FY19. Despite the constant tug-of-war between neobanks and traditional banks in their quest to acquire new customers, the market for neo and challenger banks is expected to reach ~ US $ 15,000 Mn by FY27.

Nikhil Kamath, Co-founder and Chief Investment Officer at Zerodha said, “The brokerage industry in India has also seen a significant digital shift and transformation. With several brokers moving towards a discounted fee model, the key differentiator has now become technology and a more digitalised customer experience.

Neobanks combine a more user-friendly, tech-savvy interface with reduced fees and an ability to cater to smaller businesses that are often overlooked and considered unlucrative by traditional banks.

This bodes well for their future.”

With a CAGR of ~54 percent in sight, we believe neobanks provide a unique opportunity for the Indian government to ensure their goal of financial inclusion is met and simultaneously offers retail customers an option to reduce their banking fees (thereby giving them an option to save more).

With traditional global banks like Goldman Sachs (Marcus) and JPMorgan Chase (Finn) venturing into challenger banks (like neobanks) quietly, we must realise that as India digitises not only will its transaction become digital but so will its banking. Consequently, we expect the adoption of this sector to surge in the next 36 months.

With a larger customer base, these fintech firms will slowly start seeing IPO listing in India in the next 5-year horizon. We believe such fintech listing in the public markets will not only provide institutional investors the confidence to generate a healthy IRR but it will also provide retail investor an opportunity to invest in the home-grown fintech majors – in a way paving the way to attain an Atmanirbhar Bharat when it comes to digital finance too.