Customer experience — from ease of access, frictionless service and data security — will take centre-stage for fintech leading to more collaborations and the next phase of evolution for neobanks
With many policy changes disrupting operations in 2022, we are likely to see the emergence of niche startups in regtech for financial services according to fintech investors
Cross-border payments and embedded services will be the big growth drivers for fintech companies focussed on merchants and MSMEs
If fintech in 2022 was defined by losses, layoffs impacting more than 650 employees in the sector, and of course, regulatory upheaval, then the unfortunate news is that one can expect more of the same for India’s massive fintech ecosystem in 2023.
As lending continues to remain the only viable revenue stream for fintech companies, the sector is at something of a crossroad leading to consolidation & shutdowns, slow growth, intense competition and deeper regulatory scrutiny.
Even though funding flowed into fintech, much of this capital was reserved for lending startups. In terms of funding amount, fintech topped the charts with $4.5 Bn raised across 250 deals, but over half of this or $2.3 Bn went to lending tech startups, with no other sector coming close.
With so much activity in the lending space, naturally regulators looked to tackle the grey areas in digital lending in 2022, which disrupted operations of companies such as Slice, Uni, Jupiter and others in the past year. And more such disruptions can be expected as financial regulations are tweaked to meet the maturing market.
Given this, customer experience — from ease of access, frictionless service and data security — will take centre-stage. In turn, we are likely to see the emergence of niche startups in regtech for financial services, account aggregator bridges as well as the next phase of evolution for embedded finance and API-led services.
Here’s what founders and fintech investors believe will shape the Indian fintech ecosystem in 2023.
Regulation Will Lead To Innovation
One cannot escape regulations in fintech. While many policy changes such as last year’s RBI notification on credit lines on PPIs disrupted operations, startups are appreciative of how the regulator’s role in actually addressing the problem areas.
As Rajya Sabha MP Dr Amar Patnaik said at the Inc42 Fintech Summit last year, the Indian audience is not yet digitally literate enough to adopt new and emerging technologies at their own risk and that’s why regulators have to step in.
While this led to some pain being felt by fintech players specifically in sectors like BNPL, the overall sentiment is that it will help guide accelerated growth in 2023 and beyond.
There’s no doubt that regulatory changes complicate operations for fintech companies, but it has forced innovation in the direction of risk management, underwriting and other segments. And soon compliance-related innovation will also come into the picture.
According to IIFL Fintech Fund’s Mehekka Oberoi the rise of regulation tech is imminent because of the more stringent compliance requirements for startups. “Today, there is a lot of manual bandwidth that goes into filing, complying with rules, and these things can easily be automated. In India, this trend is yet to pick up but globally it picked up very well. I think this year you should see some amount of startups coming within the regtech or legal tech space. Because regulations are becoming more stringent so compliance is also a cost.”
Consolidation Wave Imminent
Given that the fintech sector is constantly under regulatory scrutiny, disruptions in operations are quite frequent. Combined with slow growth, this can become a death blow to remains slow given the high competition, the startups being pulled into acquisition deals
Leo Capital founder and managing partner Rajul Garg believes fintech in particular will see a lot of consolidation in the year ahead. If 2022 saw a high number of M&As in ecommerce, 2023 will be about fintech giants acquiring smaller players to bolster their revenue streams.
Besides this as growth-stage and some early-stage startups struggle to raise capital, there will be the temptation to merge with better-capitalised players.
IIFL’s Oberoi added, “In terms of consolidation, those startups which are seeing a high level of NPAs would find it incredibly difficult to sustain. On the other hand, the companies that have better NPAs will attract more collaborations from banks. So NPAs will be key for lending tech companies.”
Plus, under RBI’s digital lending framework, all loan disbursals — consumer or merchant loans — will take place between the bank account of the borrower and the bank, with no passthrough of any loan will be allowed via a third party app or fintech company. This is also reducing the revenue potential for some lending apps, which is likely to lead to consolidation in this space as well.
Lendingkart cofounder and CEO Harshvardhan Lunia believes that those startups that have so far been growth focussed without profitability will find it harder to thrive and turn things around in the short to medium term.
“Access to capital is the raw material for fintech lending as a business, hence businesses which have sufficient liquidity, operational efficiency and sustainable cost to income will remain profitable Newer businesses will need to manage their costs better in the new year to be able to turn profitable,” Lunia added.
Fintech Super App: Dream Or Destiny?
One of the biggest challenges — and the reason why most companies have looked to become lenders — is that revenue generation remains slow even as digital payments continue to grow.
At the end of the calendar year 2022, the total UPI transaction value was INR 125.95 Lakh Cr, up 1.75X year-on-year (YoY), but given the zero MDR on UPI, payment apps do not stand to earn much from this growth except for consumers opening their apps multiple times a day.
This is why apps are looking to push for more services besides payments to retain consumers and increase the potential of earning revenue.
Fintech super app push will continue in 2023 with expanded insurance, investment broking services by the likes of Paytm, PhonePe, Amazon Pay, Google Pay, CRED and other companies. While Navi does not have a payments app, it is also looking at a super app approach with multiple services in one app including insurance, lending, investments and more.
Then there are the neobanks (more on this next) and large banks which are also gunning for fintech supremacy with their own super apps. SBI’s YONO and Kotak 811 are prime examples, while the likes of Open, Freo, Jupiter are challenging them through partner banks.
According to EY partner Harshvardhan Godugula, “They will also move to areas beyond finance, such as healthcare, ecommerce, document management to support consumer needs. This may put additional strain on single-function apps, conventional banking apps and payment methods.”
Neobanking’s Coming Of Age
The neobank segment ended 2022 with $340 Mn in funding overall, which is less than 2021’s $410 Mn figure, but these are still very early days for neobanking. This is backed by the fact that more than 85% of the total funding bagged by neobanks was raised between 2021 and 2022.
Neobanking in India is a $48 Bn market opportunity in 2022 and is set to increase 281% to reach $183 Bn by 2030. Ironically what has allowed neobanks to tap this opportunity rapidly is also what is limiting their reach to a certain extent.
Neobanks in India have to mandatorily collaborate with RBI-regulated banks to offer their services. This means that a fintech company can focus on the technology more closely, while at least some of the financial compliance burden remains with the bank.
But according to founders in the space, this means a neobank’s reputation and operations are tightly linked to the partner bank. Because a neobank is just one partner for the bank and the neobank does not always have visibility into the wider operations of the bank and its books.
“In case of any disruption to the regulated bank, neobanks are in a tight position. Changing a partner cannot be done easily or seamlessly for a neobank with millions of users. We are also dependent on the bank’s network to be up and running all the time. Some banks are changing their system,” according to one Bengaluru-based neobank cofounder.
While open banking rules have been the demand of the industry for many years, as we mentioned above, the segment is still very new. “RBI is unlikely to wade into open banking right now. It has a lot on its plate with regards to monetary policy, digital lending rules, banking regulations and more.”
Given that public sector banks are also collaborating with non-neobanks in the fintech domain, there is a competitive threat to neobanks as well. But overall, the ceiling is high for neobanks as India’s underbanked population is the second-largest in the world, with an estimated 190 Mn adults without any bank account.
“Cross-border payments are something that should see traction in the neobanking space, because MSMEs are being incentivised to export and these MSMEs are being catered to by neobanks today,” IIFL’s Oberoi added.
Bank-Fintech Collaborations To Step Up
Even as neobanks look to extend their reach, fintech companies are looking to capitalise on their user base with bank partnerships.
While this is a side-effect of the fintech super app trend, in 2023, banks are expected to play a more direct role in such collaborations. As per reports, public sector banks are eyeing a unified cloud-based digital platform to collaborate with fintech startups to facilitate loan disbursals.
This move has also come at a time when the government is looking to commence full-scale deployment of its ambitious account aggregator framework, which is expected to ease some of the hurdles around lack of adequate credit history or data for customers.
Under the bank-led idea, fintech companies will conduct preliminary credit checks through credit bureaus and account aggregators and upload this data to a platform that banks can then access, verify before disbursement.
Besides consumer loans, the platform is expected to cater to small and medium enterprise (SME) in the near future for credit underwriting, trade financing and other lending products.
Merchant Lending To Come Under Scrutiny
While the RBI has kept a close eye on fake apps, fraudulent loans and predatory lending, this has largely been in relation to consumer loans. The situation has improved slightly in the past year, but some problems remain including ghost loans and lack of KYC before approving loans.
But one vertical that has slipped under the radar is merchant or SME lending. In 2023, we expect such small-ticket B2B lending to come under the regulatory microscope.
CredAble cofounder and managing director Ram Kewalramani believes the cost of finance and cost of funding for B2B lenders is very high, which is being passed on to MSMEs who really cannot afford it.
“This is an inherent issue in merchant lending. The regulators need to encourage lending models based on cash flow as opposed to balance sheets for this segment. I think those kinds of models are yet to evolve fully which needs to be encouraged in the year ahead,” Kewalramani added.
In the past year, we have seen issues related to inadequate KYC for merchants, mis-selling as well as inauthentic customers and vendors as in the case of BharatPe, which led to fines for the fintech company.
With the emergence of the account aggregator ecosystem, there will be much more clarity around the financial data of some of these users, and discrepancies are expected to come into the light.
The AA framework has been developed by the RBI in consultation with a range of BFSI and fintech stakeholders to enable free flow of financial data and consent-based sharing for a more connected financial ecosystem.
Next-Gen Fintech: Embedded Services
As per Kewalramani, embedded finance will change the game for MSME financial services. In many ways, this allows a single company to act like a bank for these merchants.
“All the MSMEs that we currently deal with have access to an embedded finance platform that has multiple products. We allow financial institutions to cross-sell their financial products, whether it’s insurance, investment, bank account opening, or other micro services,” the CredAble cofounder said.
Besides this, embedded credit or lending is a massive opportunity that has been tapped not just by fintech companies but also consumer services giants and ecommerce platforms. Typically, this is seen through BNPL or “post-paid” services and is not only a way to increase sales and the average order value, but also goes a long way towards retention and repeat business.
IIFL’s Oberoi makes another point from the POV of maturity of embedded financial services. She believes that the past two years have seen fintech companies figure out the right revenue models and frameworks for embedded services and they will be ready to capitalise in 2023. She added that startups have figured out the monetisation model and it has to be looked at like a SaaS model, which has enough precedence in India.
“It was a testing phase through the last 18 months. We should see traction this year with momentum building up next year because the initial adoption has taken time, with a lot happening in 2022. So towards the end of 2023, you will see these platforms hitting the hockey-stick growth.”