Can Digital Banking Units Change The Financial Services Landscape In India?

Last week, Finance Minister Nirmala Sitharaman, during her visit to the US, reiterated that 75 digital-only units of banks and non-banking finance companies would be set up in 75 districts across the country.

The concept of digital-only banks was first mentioned by the finance minister during her Budget 2022 speech, and is a welcome move for the fintech ecosystem. It is expected that the digital banking units (DBUs) will accelerate the delivery of financial products, besides improving access to finance for small businesses.

In fact, DBU-type of set-ups already exist. SBI Yono is a prime example. Kotak 811 is another. The government is probably aiming to formalise the idea of digital banking on a larger scale.

DBUs are also seen as nudging some of the PSU legacy banks to think beyond what they have been doing all these years. Some of the top-line banks may not need this push because they’re already into this space, but there are hundreds of banks in India, including cooperative banks, and they would benefit from this, said  Arjun Abraham Zacharia, Founder, EximPe, which is firming up plans to enter the neobank space.

Fintech Is Central To DBUs

The constantly-evolving fintech sector has provided a big push to digitisation of banking and lending. Preceding the finance minister’s Budget announcement, the Reserve Bank of India (RBI) in January allowed fintech companies to access credit bureaus, a decision that further enabled digital lending using fintech.

Now, the DBUs present another vista for greater association between banks, NBFCs and fintech startups.

The RBI’s broad guidelines for the DBUs say that minimum products and services to be offered by them include account opening – saving bank accounts and current accounts, FD and RD accounts. The digital kits would include mobile banking, internet banking, debit card, credit card and mass transit system cards. The digital kits for merchants would include UPI QR code, BHIM Aadhaar, POS, among others. 

The DBUs will make applications for and onboarding of customers for identified retail and MSME loans, including end-to-end digital processing, from online application to disbursal.

“Digital banking units will definitely help small businesses access banking services, which otherwise might be a luxury for many,” said Zacharia. 

Rohit Taneja, founder & CEO of Decentro, a full-stack API banking platform, said lenders will start building out their labs and eventually DBUs. “So, for us, what we see as a value add could be like entering as a potential tech partner. So, technically we can help them streamline their APIs, develop their APIs, give them access to KYC APIs, enable them to issue cards much faster in the market with co-branding partners, etc.”

According to the RBI, the API layer used to connect with external third-party application providers should be tested in an isolated/ test environment before being integrated to the bank’s core systems.

Taneja further said that there is also a lot of scope for fintech from a distribution perspective, and helping and streamlining business and process.

DBUs Not New Type Of Banks

The broad contours as to who all can set up the DBUs initially and in which districts are not clear yet. According to the banking regulator, scheduled commercial banks (other than RRBs, PBs and LABs) with past digital banking experience are permitted to open the DBUs in tier-I to tier-VI centres, unless otherwise specifically restricted, without having the need to take permission in each case.

As it looks now, setting up a DBU is like spinning up a subsidiary or scaling a unit inside the same bank but technically separate. The DBUs will be using the same tech of existing digital banking, which is different from a full-fledged, pure-play digital bank. They will remain under the purview of banks, perhaps with a different team altogether.

DBUs have to definitely be vernacular, and they also have to be simpler, Zacharia said, adding that the “version that we see today will not be what we will see in future”. 

It is to be seen whether DBUs will adopt the same tech of digital banking or it will be different. According to Zacharia, it is too early to say how it will evolve. “But I think it will be some format of a thin layer of a huge monolith banking business service that they provide today. Because when you’re onboarding these customers for the first time, you can’t give them complicated tech.” 

This could be an ATM-kind of a kiosk model that evolves into something a little more bigger, he added.

“The real game changer is getting the UX right. I don’t think we will get it on the first attempt for sure. A few iterations, or maybe iterations will come as a combination of expertise that fintechs have. With that, I think, much more greater handshake between a lot of fintechs and the banks in rolling out this DBUs,” he said.

The Tech Cost of DBUs

The RBI defines a DBU as a specialised, fixed-point business unit/hub housing a certain minimum digital infrastructure for delivering digital banking products and services in both self-service and assisted mode. Most services should be available in self-service mode at any time and throughout the year.

Setting up a DBU would cost banks and NBFCs a few million dollars for sure from the tech side alone.

Taneja said there are two parts to the cost. One is capex, the DBUs will have to invest a certain specific amount initially to set up the cloud. “What will happen is either your CVS (cloud volume service) will be on the cloud, your data will be on the cloud as well. And that’s an initial cost, which, depending on your scale, can vary anywhere from a few hundred dollars to a couple of million dollars (for a co-operative bank or small bank),” he said, adding that for larger banks the cost is much higher.

The second cost is more on the opex font. “Once they launch the DBU, they will have to make sure APIs are integrated on solutions that they’re using from a tech perspective or integrate them. Maintaining and running the DBUs itself will consume some cost, much similar to the way a fintech is. So, I think, if I look at an average spend, from a small bank perspective, a few million dollars on a quarterly basis.”

DBUs And Changing NBFC Regulations

The DBUs hold extra significance in the context of evolving regulatory frameworks for NBFCs.

As the RBI has been tightening up the regulatory framework for NBFCs, the line that differentiates a bank from an NBFC is increasingly blurring. This is best evident in the proposed merger between HDFC and its offspring HDFC Bank.

The fintech ecosystem as a whole, however, need not be unduly worried, according to Mohit Ralhan, managing partner at TIW Capital Group.

“The regulatory framework is proposed to use a four-tier structure to identify non-systemically important and systemically important NBFCs. Most of the fintech startups should fall in the base layer and therefore in the early phase of their lifecycle, the compliance requirement will be basic,” Ralhan said.

While there are thousands of registered NBFCs in India, the central bank says only a few hundred are “systemically important”.

“I don’t think that there will be any adverse impact on the fintech startup ecosystem. Of course, once these companies cross the threshold to become systemically important, the compliance requirement will go up. This is likely to trigger mergers with established banks and NBFCs,” he said,

Overall, the industry can evolve where there will be a few larger consolidated players at one end and while at the other end, there will be a continuous stream of fintech startups promoting new innovations.

The DBUs perhaps herald the beginning of this churning.  

DBUs—The New Digital Lender

The DBUs cannot be seen in isolation from digital lending, a space plagued by many issues.

Digital lending, practised predominantly through NBFC-fintech alliance, is still in its nascent stage but faces many headwinds. Problems range from slack KYC compliance to poor data security to recurring frauds to unregulated entities (not all NBFCs are regulated by the RBI). Complex products and tie-ups with e-commerce players, edtech startups, among others, leave much to be desired too.

Most digital lenders of repute follow stringent KYC norms that have in-built checks and balances though, said Utkarsh Sinha, managing director of Bexley Advisors.

“The online lending regime is evolving faster than anticipated; the fintech infrastructure that the RBI has created with UPI and KYC is world-class, but it still has holes that can be exploited, particularly on the KYC front for digital lending,” said Sinha, who was earlier the convenor of the fintech committee of the Internet and Mobile Association of India (IAMAI).

Will the DBUs distinguish themselves from other sets of digital lenders on matters of governance and ethics? Only time will tell. For now, the new kid on the digital lending block will be keenly watched for its performance and adherence to compliance norms, data privacy, among others.