A new realm

In­dia is tran­si­tion­ing into a dy­namic ecosys­tem of­fer­ing fin­tech star­tups a plat­form to po­ten­tially grow into bil­lion-dol­lar uni­corns. From tap­ping new seg­ments to ex­plor­ing for­eign mar­kets, fin­tech start-ups in In­dia are pur­su­ing mul­ti­ple as­pi­ra­tions. Th

The Smart Manager - - Contents - *https://as­sets.kpmg.com/con­tent/dam/kpmg/pdf/2016/06/ Fin­Tech-new.pdf

In its wake of boost­ing fi­nan­cial in­clu­sion, fin­tech may also give rise to reg­u­la­tory con­cerns. N Sawaikar, Wel­ingkar In­sti­tute of Man­age­ment, shows how to achieve a bal­ance for a more in­clu­sive and sus­tain­able fu­ture.

Al­though the term ‘fi­nan­cial in­clu­sion’ be­came the fo­cus of dis­cus­sions in In­dia only in the last decade, the un­der­ly­ing is­sue has been an im­por­tant con­cern for more than 50 years. In the 1950s and the 1960s, there was a wide-rang­ing de­bate on how to make the In­dian bank­ing sys­tem more re­spon­sive to the coun­try’s eco­nomic de­vel­op­ment needs and to the needs of the un­banked. The end re­sult was in­creased state con­trol of bank­ing, cul­mi­nat­ing in the na­tion­al­iza­tion of banks in 1969 and 1980, as well as strin­gent reg­u­la­tions forc­ing banks to lend to pri­or­ity sec­tors such as agri­cul­ture and small en­ter­prises.

These pol­icy ini­tia­tives have only been a par­tial suc­cess at best. While suc­cess­fully push­ing In­dian banks to ex­pand in new di­rec­tions, they in­creased po­lit­i­cal in­ter­fer­ence and fi­nan­cial re­pres­sion which harmed the broader econ­omy. The eco­nomic lib­er­al­iza­tion of the 1990s sig­nif­i­cantly re­duced state con­trol over bank­ing and ex­panded the role of the pri­vate sec­tor, but even to­day state own­er­ship and reg­u­la­tions are ex­ten­sive. At the same time, fi­nan­cial ex­clu­sion per­sists and hun­dreds of mil­lions of In­di­ans lack ac­cess to ser­vices such as sav­ings, in­sur­ance, and lend­ing.

A ma­jor rea­son for this fail­ure is the cost struc­ture of tra­di­tional bank­ing. A bank in­curs sig­nif­i­cant fixed costs be­fore it can of­fer its ser­vices—it needs to build a phys­i­cal branch and hire staff and man­agers. Also to re­main vi­able, it needs enough rev­enue to cover these costs which is of­ten dif­fi­cult in ru­ral ar­eas.

Se­condly, ac­cess­ing fi­nan­cial ser­vices typ­i­cally re­quires doc­u­men­ta­tion start­ing with the proof of iden­tity. This is dif­fi­cult to pro­duce for the ma­jor­ity of In­di­ans work­ing in the in­for­mal sec­tor. Dif­fi­cul­ties may range from a lack of lit­er­acy skills, prob­lems nav­i­gat­ing the bu­reau­cra­cies which is­sue doc­u­ments, and a lack of safe places to store im­por­tant doc­u­ments. Ur­ban mi­grant work­ers may also strug­gle to pro­vide proof of ad­dress. As a re­sult, the poor are forced to ei­ther forego fi­nan­cial ser­vices or rely on in­for­mal sources such as money­len­ders who charge much higher rates of in­ter­est.

This fi­nan­cial ex­clu­sion ex­acts a steep hu­man cost. A vil­lager try­ing to col­lect a sub­sidy or gov­ern­ment wage may have to waste a whole day trav­el­ing to the near­est bank branch and lose a day’s wage. A ru­ral mi­grant, work­ing in a city, may not be able to open a bank ac­count and may have to rely on ex­pen­sive and un­re­li­able meth­ods to trans­fer money to his or her fam­ily in the vil­lage. A farmer, who is un­able to ob­tain crop in­sur­ance, may have to min­i­mize risk by plant­ing rel­a­tively safe sub­sis­tence crops in­stead of riskier but more prof­itable cash crops.

For­tu­nately, in the last ten years a new tech­nol­o­gy­based path to fi­nan­cial in­clu­sion has emerged, made pos­si­ble by the rapidly fall­ing costs of in­for­ma­tion tech­nol­ogy and the dra­matic spread of mo­bile phones. This path is built around the in­sight that most fi­nan­cial ser­vices are about manag­ing in­for­ma­tion of one type or an­other— es­tab­lish­ing iden­tity, as­sess­ing cred­it­wor­thi­ness, pric­ing risk, etc. If in­for­ma­tion tech­nol­ogy can be har­nessed to process, an­a­lyze, and trans­mit fi­nan­cially rel­e­vant in­for­ma­tion more ef­fi­ciently, it can dra­mat­i­cally re­duce the cost of pro­vid­ing fi­nan­cial ser­vices which in turn will drive in­clu­sion.

The re­cent de­mon­e­ti­za­tion of R500 and R1000 ru­pee notes has made the in­volve­ment of fi­nan­cial tech­nol­ogy, es­pe­cially in elec­tronic pay­ments, even more ur­gent. The sharp con­trac­tion of the mon­e­tary base has led to a de­cline in eco­nomic ac­tiv­ity, par­tic­u­larly in the cashde­pen­dent un­or­ga­nized sec­tor. At the same time, it pro­vides strong in­cen­tives, at least in the short run, for peo­ple and busi­nesses to switch to elec­tronic pay­ments. Com­pa­nies like Paytm have ex­panded their mar­ket­ing ef­forts ag­gres­sively and there are re­ports of sharp in­creases in en­roll­ment for their ser­vices. How­ever, there are still enor­mous con­straints in ex­pand­ing elec­tronic pay­ments to low in­come groups—par­tic­u­larly in ru­ral In­dia—net­work connectivity, tech­no­log­i­cal knowhow, trust, etc. And these prob­lems need to be tack­led with re­newed ur­gency.

key en­ablers

Over the last decade, sev­eral key en­ablers for tech­nol­o­gy­based fi­nan­cial in­clu­sion have fallen in place in In­dia. First, there has been a rapid ex­pan­sion of mo­bile tele­phony with more than one bil­lion subscribers, in­clud­ing more than 200 mil­lion smart­phone users and more than 300 mil­lion mo­bile in­ter­net users.

Sec­ond, the Gov­ern­ment of In­dia has de­vel­oped ‘Aad­haar’, a 12-digit bio­met­ri­cally linked unique iden­tity num­ber which has been is­sued to more than a bil­lion res­i­dents. A act al­low­ing for the use of Aad­haar num­bers for the de­liv­ery of sub­si­dies and ser­vices was passed in 2016.

Fi­nally, there has been a big in­crease in the num­ber of ba­sic bank ac­counts, es­pe­cially in ru­ral In­dia. In 2005, the RBI in­tro­duced the con­cept of no-frills ac­counts with nil or very low min­i­mum bal­ances and low trans­ac­tion charges. In 2014, the gov­ern­ment launched the Prad­han Mantri Jan Dhan Yo­jana (PMJDY) un­der which 250 mil­lion bank ac­counts were opened and 190 mil­lion RuPay debit cards were is­sued over the last two years.

All these three en­ablers have come to­gether to form what has been called the ‘ JAM Trin­ity’—Jan Dhan Yo­jana, Aad­haar, and Mo­bile—which has al­lowed the gov­ern­ment to trans­fer money to the ac­counts of the poor much more ef­fi­ciently than be­fore. This is im­por­tant be­cause the gov­ern­ment spends more than 4% of the GDP on sub­si­dies for food grains, fuel, fer­til­iz­ers, etc. and also makes wage pay­ments through its pro­grams like MGNREGA.

JAM will al­low the gov­ern­ment to bet­ter the tar­get sub­si­dies to the poor by pro­vid­ing a re­li­able method of es­tab­lish­ing iden­tity. By trans­fer­ring money to bank ac­counts di­rectly, JAM also cuts out the mid­dle­men so that ben­e­fi­cia­ries can re­ceive the full amount.

While the progress made so far has been im­pres­sive, some hur­dles re­main. Many of the bank ac­counts cre­ated through Jan Dhan Yo­jana have low bal­ances and lit­tle us­age. An­other ma­jor is­sue is the ‘last mile’ prob­lem— even if the gov­ern­ment can ef­fi­ciently trans­fer money elec­tron­i­cally to re­cip­i­ents’ bank ac­count, it may be dif­fi­cult for those in ru­ral ar­eas to col­lect the cash.

One so­lu­tion is through the ex­ist­ing busi­ness correspondent net­work of third-party agents who carry out trans­ac­tions in ru­ral ar­eas, per­haps us­ing mi­cro-ATM de­vices that can authen­ti­cate iden­tity us­ing bio­met­rics. How­ever, the lo­gis­tics of trans­port­ing and manag­ing large amounts of cash in ru­ral In­dia still re­mains a for­mi­da­ble prob­lem.

An al­ter­na­tive is a cash­less money trans­fer sys­tem like M-Pesa which was launched by Voda­fone in Kenya, which al­lows users to trans­fer money through their mo­bile phones. An im­por­tant step to­wards mo­bile money trans­fer in In­dia is the UPI (Uni­fied Pay­ment In­ter­face) which al­lows money to be trans­ferred be­tween any two bank ac­counts us­ing a smart­phone and the Aad­haar num­ber.

Pay­ments and ba­sic bank ac­counts are com­par­a­tively sim­ple ser­vices and rel­a­tively easy to dig­i­tize. In­sur­ance and lend­ing are more com­pli­cated and re­quire long-term re­la­tion­ships be­tween the fi­nan­cial in­sti­tu­tion and the client, and have deeper in­for­ma­tional re­quire­ments.

For lend­ing, the fun­da­men­tal prob­lem is as­sess­ing the cred­it­wor­thi­ness of the bor­rower which, in tra­di­tional bank­ing, re­quires an ex­pe­ri­enced loan of­fi­cer and a long drawn process. The chal­lenge is to repli­cate this process in a more ef­fi­cient and cost-ef­fec­tive way us­ing in­for­ma­tion tech­nol­ogy. For ex­am­ple, First Ac­cess, a data an­a­lyt­ics com­pany, has worked with mo­bile net­work op­er­a­tors in East Africa and used mo­bile phone his­to­ries to pro­vide credit scores to low-in­come bor­row­ers who lack a for­mal credit his­tory.

A re­lated ap­proach is peer-to-peer lend­ing (P2P), where an on­line plat­form acts as an in­ter­me­di­ary be­tween bor­row­ers and lenders, and charges a fee for the ser­vice with­out hold­ing the loans on its books like a con­ven­tional bank. While the P2P plat­form may pro­vide some anal­y­sis about the bor­rower, the fi­nal de­ci­sion and risk lie with the lender. This model seeks to use in­for­ma­tion tech­nol­ogy to re­duce the costs of in­ter­me­di­a­tion be­tween bor­row­ers and lenders so that bor­row­ers would pay a lower rate and

lenders earn a higher rate. The P2P model also has the po­ten­tial to in­crease lend­ing to farm­ers, small en­ter­prises and other un­der­fi­nanced sec­tors.

Tech­nol­ogy can also im­prove the op­er­a­tional ef­fi­ciency of sec­tors such as mi­cro­fi­nance which lend to the poor but of­ten use pa­per-in­ten­sive pro­cesses that re­quire loan of­fi­cers to visit far-flung ru­ral ar­eas be­fore sanc­tion­ing a loan. Com­pa­nies such as Ar­too work with mi­cro­fi­nance in­sti­tu­tions and im­prove their pro­cesses through bio­met­ric ver­i­fi­ca­tion, pa­per­less pro­cess­ing, and an­a­lyt­ics.

Closely linked to mi­cro­fi­nance is mi­croin­sur­ance wherein, for ex­am­ple, small farm­ers may be pro­vided crop in­sur­ance to pro­tect them from de­fi­cient rain­fall. Tra­di­tional in­sur­ance mod­els that re­quire ex­pen­sive farm vis­its do not work in de­vel­op­ing coun­tries where the farm­ers can only af­ford a pre­mium of a few dol­lars. Syn­genta Foun­da­tion, an NGO, pi­o­neered an al­ter­na­tive ap­proach by team­ing with mi­cro­fi­nance lenders and seed com­pa­nies in Kenya to bun­dle low-cost in­sur­ance plans with their prod­ucts. In­stead of farm vis­its, they used satel­lite data and au­to­mated weather sta­tions to de­cide when to pay out money, which was done through mo­bile phones.

scal­ing up

Star­tups and NGOs are good at ex­per­i­ment­ing with new tech­nolo­gies and busi­ness mod­els but scal­ing up these new ideas ef­fi­ciently is of­ten done best by large com­mer­cial or­ga­ni­za­tions. Banks and other fi­nan­cial com­pa­nies are of course im­por­tant but large com­pa­nies from other sec­tors such as tele­com and re­tail can also play a valu­able role in this space.

Tele­com com­pa­nies are al­ready im­por­tant in fi­nan­cial in­clu­sion be­cause of their vi­tal role in com­mu­ni­ca­tion ser­vices but their large dis­tri­bu­tion net­works and ex­per­tise in data anal­y­sis make them spe­cially suited to pro­vide fi­nan­cial ser­vices di­rectly. Voda­fone is a pi­o­neer in this area and its M-Pesa ser­vice launched in 2007 has moved beyond money trans­fer into ser­vices like in­ter­na­tional re­mit­tances, sav­ing, and bor­row­ing.

Ecom­merce com­pa­nies too have highly rel­e­vant ex­per­tise in pay­ments and data anal­y­sis. Alibaba, the Chi­nese ecom­merce gi­ant, has been suc­cess­ful in ex­pand­ing into fi­nan­cial ser­vices through its on­line pay­ment plat­form Ali­pay. In 2013, Ali­pay al­lowed subscribers to in­vest in a money mar­ket mu­tual fund. Alibaba also cre­ated AliFi­nance which pro­vided loans to ven­dors on its plat­forms and also cre­ated its own credit scor­ing model by an­a­lyz­ing on­line us­age pat­terns.

In­dia Post is an­other non-fi­nan­cial or­ga­ni­za­tion with a ma­jor role in fi­nan­cial in­clu­sion. With its mas­sive net­work of 150,000 of­fices, 90% of which are in ru­ral ar­eas, it is es­pe­cially well placed to solve the ‘last mile’ prob­lem in ru­ral In­dia.

The RBI has rec­og­nized the po­ten­tial of such non­fi­nan­cial or­ga­ni­za­tions, and has de­vel­oped the con­cept of pay­ments banks that are al­lowed to ac­cept de­posits up to

R1 lakh, and can dis­trib­ute mu­tual funds and in­sur­ance prod­ucts though they are not al­lowed to of­fer loans or credit cards. Tele­com com­pa­nies such as Air­tel and Voda­fone, ecom­merce com­pa­nies like Paytm, and the De­part­ment of Posts have ob­tained li­censes to start pay­ments banks.

threat or op­por­tu­nity?

Are these new tech­nolo­gies a threat or an op­por­tu­nity for tra­di­tional banks? Per­haps, a bit of both. In the short term, they make it pos­si­ble for banks to greatly ex­pand their cus­tomer base and of­fer a deeper set of fi­nan­cial ser­vices at a lower cost. New in­sti­tu­tions such as pay­ments banks may be a com­ple­ment rather than a sub­sti­tute, and the new cus­tomers they at­tract may even­tu­ally move to tra­di­tional banks to use their richer set of ser­vices.

How­ever, in the long run, as new busi­ness mod­els like peer-to-peer lend­ing ma­ture and con­sumers be­come more

used to us­ing fi­nan­cial ser­vices on­line, banks may find them­selves get­ting grad­u­ally eclipsed. The key for banks is to closely fol­low new trends in fi­nan­cial tech­nol­ogy, ex­plor­ing pos­si­ble op­por­tu­ni­ties for co­op­er­a­tion while also stay­ing alert to com­pet­i­tive threats. A good ex­am­ple is State Bank of In­dia which has started a R200 crore fund to in­vest in fi­nan­cial tech­nol­ogy star­tups.

Sim­i­larly, fi­nan­cial tech­nol­ogy cre­ates some new con­cerns for gov­ern­ments and reg­u­la­tors. One set of con­cerns is around the po­ten­tial con­trol of data by a small group of com­pa­nies. Globally, tech­nol­ogy com­pa­nies such as Google and Face­book have built ex­traor­di­nar­ily suc­cess­ful busi­ness mod­els around col­lect­ing enor­mous amounts of data about con­sumers in re­turn for pro­vid­ing a rich set of ser­vices. One con­cern about this model is the im­pact on con­sumer pri­vacy. An­other is that these enor­mous data sets will be­come a bar­rier to en­try for newer com­pa­nies, al­low­ing tech­nol­ogy giants to pre­serve their mo­nop­oly in­def­i­nitely into the fu­ture.

A sim­i­lar con­cern ex­ists with fi­nan­cial tech­nol­ogy. There are economies of scope in data, so the more data sources are pooled to­gether, the richer the insights that are pos­si­ble. How­ever, if this data is con­trolled by a small group of com­pa­nies, it can be a threat to both com­pe­ti­tion and pri­vacy. The chal­lenge for the gov­ern­ment is to build a reg­u­la­tory ar­chi­tec­ture for data which al­lows many com­pet­ing com­pa­nies to tap into rich data sets in or­der to de­liver fi­nan­cial ser­vices while at the same time min­i­miz­ing the loss of con­sumer pri­vacy.

An­other ma­jor con­cern is cy­ber­crime and cy­ber­war. As more and more fi­nan­cial ser­vices are dig­i­tized and net­worked, they be­come vul­ner­a­ble to crim­i­nals who want to steal money and hos­tile pow­ers which may want to dis­rupt the econ­omy by trig­ger­ing a fi­nan­cial cri­sis. The gov­ern­ment needs to de­velop the high­est level of tech­no­log­i­cal ca­pa­bil­i­ties within its ranks to mon­i­tor and neu­tral­ize such threats.

Ul­ti­mately, how­ever, the threats are dwarfed by the op­por­tu­ni­ties. Prac­ti­cally ev­ery sec­tor of the econ­omy can ben­e­fit from the ex­pan­sion of fi­nan­cial ser­vices through tech­nol­ogy.

Low-in­come savers will have a wider range of sav­ings prod­ucts and will be less likely to buy gold or just stuff cash un­der a mat­tress. These sav­ings can be chan­neled by the fi­nan­cial sys­tem into pro­duc­tive cap­i­tal ac­cu­mu­la­tion, in­clud­ing in­fra­struc­ture which will drive eco­nomic growth.

Small en­ter­prises in the un­or­ga­nized sec­tor—which are starved of funds—will de­velop a dig­i­tal trail, mak­ing it eas­ier for them to ac­cess loans and other fi­nan­cial ser­vices. The best of them will ex­pand cre­at­ing mil­lions of jobs.

Farm­ers will gain bet­ter ac­cess to loans and in­sur­ance al­low­ing them to in­crease re­turns by tak­ing cal­cu­lated risks and in­vest­ing in agri­cul­tural tech­nol­ogy. Dig­i­ti­za­tion of land records will strengthen land mar­kets and make it eas­ier to use land as col­lat­eral.

Fi­nance is the lifeblood of the econ­omy and the more chan­nels it flows into, the more it will en­rich the dif­fer­ent cor­ners of the econ­omy. ■

N SAWAIKAR IS CORE FAC­ULTY IN ECO­NOM­ICS AT THE WEL­INGKAR IN­STI­TUTE OF MAN­AGE­MENT.

The re­cent de­mon­e­ti­za­tion of R500 and R1000 ru­pee notes has made the in­volve­ment of fi­nan­cial tech­nol­ogy, es­pe­cially in elec­tronic pay­ments, even more ur­gent.

JAM will al­low the gov­ern­ment to bet­ter the tar­get sub­si­dies to the poor by pro­vid­ing a re­li­able method of es­tab­lish­ing iden­tity.

With its mas­sive net­work of 150,000 of­fices, 90% of which are in ru­ral ar­eas, In­dia Post is es­pe­cially well placed to solve the ‘last mile’ prob­lem in ru­ral In­dia.

The enor­mous data sets will be­come a bar­rier to en­try for newer com­pa­nies, al­low­ing tech­nol­ogy giants to pre­serve their mo­nop­oly in­def­i­nitely into the fu­ture.

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