The fintech market in India, valued at about INR 1920 billion in 2019, is expected to climb up to INR 6207 billion in 2025. India is a hungry market for Fintech start-ups, evident from the country’s 87% rate of fintech adoption, as opposed to the average global rate of 64%. This can be attributed not just to government’s initiatives, such as Jan Dhan Yojna, India Stack and Start-up India aimed at enhancing financial inclusion and boosting start-up activity, but also to the presence of a favourable demography, large scale penetration of internet and smartphones and change in customer expectations in favour of a more personalized approach to services. The fintech wave that has engulfed India is prepared to revolutionize the banking sector with its next innovation: Neo-Banking.
Neobanks: An overview
A neo-bank offers virtual financial services, and operates completely online, without the presence of a physical location or branches. However, it must not be confused with a digital bank which is generally an online subsidiary of an already existing, regulated bank. Neo-banking offers a wide range of financial services: from creation of accounts, payments, transfers, and credit to additional services like budgeting and expense management. What sets it apart from conventional banking is a smoother offering of services to customers, with a more personalized touch. Since these services are completed by the neo-bank on the go, the customer needs to spend about the same time as that spent on filing, documentation and other clerical tasks in the traditional banking set up; in some instances, the customer also ends up saving time. Further, the lower marginal costs incurred by these neo-banks translate into lower fees for customers as well. Some customers might have apprehensions about weak customer support, but by deploying chatbots and robo-advisors, neo-banks are expected to offer more round-the-clock assistance, as compared to traditional banks which usually adopt a “one-size-fits-all” approach. With a strong artificial intelligence and machine learning based foundation, services provided by neo-banks are more analytical and detail-oriented and usually provide insights into the finances of the customers, which are well-appreciated. Accordingly, neo-banks also gather deeper insights into their customers’ behaviours, enabling them to understand customers’ needs better.
A Look at the Global Neo-Banking Space
Globally, neo-banking is booming, evident from its 39 million users, as estimated by Business Insider. With an exciting range of personalized financial products, offered at attractive pricing, neo-banks are favourites among users. There are players such as England’s Revolut and Tide and Varo in the US, which operate as front-end, customer-focussed banks who must partner with legacy banks due to lack of a banking license. But there are also players like N26, a German neo-bank and Starling and Monzo, based in the United Kingdom, which are equipped with a banking license and can offer their customers a full suite of financial products.
How strongly neo-banks gain a foothold in other markets depends strongly on individual banking landscapes; for example, the existing perceptions of incumbent banks, how friendly Fintech regulations are and whether these neo-banks have a niche customer segment that they can serve. However, adapting to a sustainable profitability model is a challenge that most neo-banks face. The need to stand out through effective marketing and to bring out disruptive features pushes up operating costs, while revenues brought in are still low due to small-scale operations.
Neo-banking in India
The current regulations in India do not allow these neo-banks to hold licenses, so most neo-banks partner with existing banks to offer licensed services. The two types of banking setups complement each other well: neo-banks offer services over and above the services provided by traditional banks, and magnetise customers impressed by cutting-edge technology, while the traditional banks, apart from having access to a large customer base, also navigate through regulatory compliances in the country.
SME financing: A crucial pain point that must be addressed
India’s micro, small and medium-sized enterprises (MSMES) are its “missing middle”. A highly underserved segment, often missed out by large banks, the Indian MSME sector is characterized by a liquidity crunch, exacerbated by the COVID-19 crisis. In 2019, an IFC-Intellecap report gauged the credit gap faced by MSMEs to be a whopping Rs 16.66 lakh crore. MSMEs employ more than 110 million Indians and contribute a third to the GDP and 45% to the manufacturing output of the country. Keeping India’s current growth ambitions in mind, it is necessary to sustain growth in these MSMEs, which requires tending to their credit needs.
Traditional banks are unable to finance credit for these companies due to several limitations. The transactions of SMEs are largely cash-based, which means that a large volume of these transactions is not documented properly. Moreover, SMEs face difficulties disclosing information required for risk assessment due to lack of proper documentation. Lenders try to substitute the lack of information with higher collateral, but SMEs do not possess sufficient assets for the same. SMEs also face cascading effects due to any fluctuations in demand and their sensitivity to economic uncertainties. This makes them high-risk borrowers from the perspective of a traditional bank, which does not have the risk appetite to accommodate them. A high transaction cost, resulting in lower margins, and procedural delays hinder a timely and adequate financing of SME credit, which discourages these enterprises from resorting to banks for loans.
This is where neo-banks enter the picture: SME financing is a crucial pain point that neo-banks have the ability to address. .A greater focus on digitization in recent years has enabled neo-banks to cater to the needs of SMEs. Collateral-free loans offered with flexible repayment options come as a relief for SMEs. A simplified application process is a game-changer, as it saves these enterprises time and money, which is highly valued. Further, neo-banks combat the problem of lack of credit history by developing alternate credit risk models, which can assess risk by using social media insights and cash-flow transactions. Neo-banks also aid these SMEs by automating all their accounting and providing them insights into their costs, so as to increase their margins. By integrating multiple payment accounts into a single gateway, neo-banks enable business owners to view all their expenses categorically. Through application programming interfaces (APIs) and plug-ins, neo-banks also facilitate integration with third-party applications that are being used in transactions.
Some Examples of Indian Neo-Banks
Bengaluru-based neo-bank Open, which has partnered with at least 15 banks, offers to digitise the entire banking operations for SMEs and start-ups. Through its partnership with a traditional bank, Open provides these businesses with a current account, which has tools for payment gateways, expense management, invoicing, and accounting all in one place. With Open’s “Founder’s Card”, a product launched in partnership with Visa, companies can seamlessly manage their expenses and pay-outs.
Niyo Solutions, another Bengaluru-based neo-bank, tends to salaried employees and blue-collar workers by helping them access company benefits and other financial services such as credit and insurance. With its travel card, users can pay bills, transfer money, shop online or access ATMs anywhere in the world, and track their spending habits at the same time. The start-up, which is in a partnership with YES Bank, DCB Bank and ICICI Bank, also caters to SMEs through services like salary processing, employee loan management, assistance in loan availment, financial and tax management etc.
Walrus, which is also based in Bengaluru, is a neo-bank serving only teenagers; only individuals aged 13 to 22 years can avail its services. The platform, which aims to provide a ‘Gen-Z’ like banking solution to India’s 253 million teenagers, allows parents to use the app to transfer money to their children instantly. These teenagers can then spend this money without any hassle, as the app helps them to manage it in a secure manner, and also cultivates good financial habits among these teenagers. Yodaa and FamPay are some other neo-banks aiming to include teenagers in the digital financial revolution that is inundating the country.
Challenges Faced and Future of the Industry
With their low-cost structure and hyper-personalized consumer experience, neo-banks seem ready to take over traditional banks. But their entry into the Indian banking space comes with its own share of challenges. With more and more fintech players establishing themselves in the market, RBI would not be handing out licenses to any more players for the next two to three years, as most of the small players in the market have to struggle to make their presence felt. Instead, it would allow existing players to stabilize, which means that neo-banks would have to continue their partnership with licensed banks to be able to provide services. The recent move of cutting the UPI interchange fees by NPCI also spells bad news for players in the digital banking segment. Further, existing banks like SBI and ICICI have been stepping up their game when it comes to digital offerings, and their size and scale will only work to their benefit.
However, neo-banks are targeting segments which traditional banks are unable to tend to. The two set-ups should work in collaboration, rather than in competition, to create a win-win situation for everybody. In any case, neo-banks in India are here to stay. The evidence lies in the fact that neo-banks raised $116 million in 2019, funds raised on paper ideas alone, and not the actual products. Indian neo-banks have yet to gain a sizable portion of India’s banking population, like their global peers have. Although Fintech has taken Indian banking by storm, a larger proportion of the population is still getting comfortable with it. The COVID-19 crisis may have only expedited the growth and reach of neo-banks. Digital finance in India is an exciting space, and neo-banks are the next innovation, set to change the game.
By: Tanya Jain