India’s Neobanking Revolution: Changing The Game Or Just Watching From The Sidelines?

The term neobank first came into prominence in 2017 when fintech players and digital financial services providers were looking to challenge the hegemony of the traditional banking system. Drawing inspiration from the march of financial services and payments into a digital future, many startups looked to change the face of banking with their bold ideas and design-led approach to finance.

Startups in the UK, US, China, Germany, Argentina, Brazil, Australia and other markets kicked off the neobanking wave, which is all set to crash on India this year.

While India already has neobanking startups and companies, things are still at an early stage from the regulatory point of view, the bandwagon of players is still emerging from the depths of the market. And with customer needs evolving, neobanking models are also being tailored to suit the needs of the pockets of markets where they operate. The list includes Open, Namaste Credit, NiYO, SBI YONO, Kotak 811, Hylo, PayZello, InstaDApp, 0.5Bn FinHealth (YeLo), Forex-Kart, Walrus, Neo-Bank, Fin.in, RazorPay X among others.

Nilesh Agarwal, CEO and cofounder of 0.5Bn FinHealth’s YeLo, prefers to offer a simple definition for neobanks. He says a neobank is a digital-only mobile-first banking experience having deep integration with traditional banks. That last bit is very crucial in the Indian context as we will see.

Agarwal says that by virtue of their strong modern branding and design-led approach, neobanks combine the innovation, speed and customer service quality of a startup with the trust, scale economies, regulation and network access of a traditional bank.

“Traditional banking has been very ripe for unbundling and disruption. Fintech has made banks wake up and compete in the areas of payments, credit or remittances, and the neobanks are a new threat in potentially breaking their hold on the core customer or account relationship itself,” said Nitin Sharma, founder of blockchain startup Incrypt and angel investor who has backed multiple fintech startups.

Inc42 reached out to a few of these players recently. While the founders are quite enthusiastic considering the new possibilities neobanking can create, there are concerns around the stringent and specific regulations in the banking and finance industry that is holding back this sector.  In the Indian context, neobanking is considered a financial jargon with a very little of the target market even understanding the differentiated offerings these bring. So the first step is understanding the difference.

When Does A Fintech Startup Become A Neobank?

In terms of the neobanking models around the world, there are two primary options — neobanks operating independently and those working in partnership with a traditional bank while offering banking services digitally. Both models work without a physical bank branch that one gets from the conventional banking system. And it’s also well-differentiated from the internet banking services offered by online-only subsidiaries of established and regulated player in the banking sector.

Bhavin Turakhia, founder of neobanking platform Zeta, which offers an end-to-end technology stack for neobanking operations, explained that while fintech products and services unbundle the banking experience, neobanking startups are like a bank-replacement service or product.

“This means that a fintech can provide a small service as a layer on top of a bank’s existing account such as a personal expense management app, investment app, and other models. A neobank, on the other hand, gives users the modernised version of an existing bank service,” Turakhia said.

The modern experience implies distinctive features that are created for an audience spoilt by digital convenience. Simply put, neobanking is about finding an alternative to the one-size-fits-all approach that traditional banks have been built around.

For example, neobanks can issue special cards to customers, where the spending limits can be tailored for different use-cases within the family, such as a children-specific card or one for senior citizens. Customers can get interest credited to the savings account on a daily basis and more. On the business front, neobanks address needs such as centralising cash flow, enabling banking activities and offering tailor-made products through a single window to businesses and more.

Namaste Credit founder Gaurav Anand said neobanks are like the swiss-knife of the fintech world.

Suman Gandham, founder of the recently-launched Finin, added, “From a bird’s-eye view, the services might look similar. But when we move closer, in the case of traditional banking apps, it’s the analogue world.”

The passbook, the statement, the transaction, the forms filled-in: nothing is physical. It’s like a digital newspaper or magazine. So the difference which is fundamental to neobanks is digital virtues, according to Gandham. “Those virtues being real-time, intelligent, contextual, being behavioural, being extendible into other APIs. and those virtues to all the financial products ranging from savings accounts to insurances any many more. And that makes for a really interesting difference.”

Partnership Model Holding Back Neobanks

The first and foremost hurdle for neobanks in India is that they must establish a relationship with one or multiple traditional banks to start operations in India. Banking institutions provide the connectivity and the APIs needed for one to develop neobanking capabilities further. This makes it complicated for neobanks to start off independently and create innovations outside the traditional system. Namaste Credit founder Gaurav Anand said that having a trustworthy startup that traditional banks are comfortable engaging with is essential for neobanks in India.

Fundamentally, a neobank operates in tandem with ‘open banking’ or ‘API banking’ provided by the registered banks, which is essentially a “banking as a service’ model. The access to core banking infrastructure such as  clearing system access, current accounts, pool accounts, interbank settlement mechanism and more only come once these partnerships are established. Banks provide access to infrastructure and architecture as neatly consumable APIs for separate customer-facing propositions so that neobanks can customise these products. The neobank then manages all other aspects of the customer journey from acquisition to providing the banking service, the user experience and the customer service.

Depending on the type of products or services being offered by the neobank and its partnership agreements with the traditional banks, a neobank may operate as a technology platform without any separate approval from the banking regulator. In that case, it will function as a distributor of banking and financial products and services and may need to apply for various distributor licences separately such as mutual fund distributor or insurance distributor, besides striking deals with banks.

This is a lot of legwork for eventually getting very little autonomy. Vinay Bagri, cofounder of NiYo, a Bengaluru-based neobanking startup added,

“A neobank may also choose to apply for licenses such as for wallets or certain payment card models, or NBFC for lending. But globally, the UK and Singapore are allowing neobanks to apply for digital banking licenses.”

As far as the monetisation model is concerned, neobanks charge fees for different product and services just like a bank, with revenue shared with the partner bank. Neobank services are designed, sold and fulfilled via digital channels predominantly smartphone apps, web and IVR for phone calls. Given the digital nature, neobanking services are typically said to be cheaper than traditional bank offerings, Yelo’s founder Agarwal added.

Full-Fledged Neobanks: A Distant Dream

Unlike the UK, parts of Europe, Singapore and other markets, India still does not offer virtual banking licences. This means that existing neobanks in India are not allowed to offer any of the key banking services such as deposits, loans, mortgage and others. Also as the Banking Regulation Act, 1949 bars companies or partnerships or sole proprietorships from even using the word ‘bank’ or ‘banking’ or ‘banking company” in the registered name. This puts many existing players in the segment at a regulatory risk right at the beginning and leaves them in a weaker spot as far as customer perception is concerned.

Worse, RBI’s 2014 Guidelines for Licensing of Payments Banks did not foresee payment banks becoming “virtual” or branchless banks. This is the key hurdle for any neobank looking to operate as a truly autonomous virtual bank. With neobanking hamstrung by such regulations, the questions about their future in the Indian context cannot be simply swept under the rug.

Even though neobanking startup founders are optimistic, they confess that unless things change quickly, other markets will have a leg up on India.

“Regulations in India are very stringent but they’re getting better. Singapore recently started issuing digital banking licenses and I think India will follow soon. Neobanks becoming fully functional banks is very long shot until and unless the regulations change,” admitted Finin’s Gandham.

But other startups think that given the nascent stage of the neobanking sector, a full-fledged bank is a handy partner to actively manage the duration and quality of assets and liabilities, as well as the significant oversight and reporting requirements. Let’s face it, no startups want the same regulatory and compliance burden as a full-fledged bank. So many believe that the better method is to work with existing banks and focus on customer experience rather than trying to become a bank directly.

NiYO’s Bagri appreciated the RBI’s willingness to consider digital or branchless banking licenses in the future, but the fact that it’s taking so long is holding back the market. In the meanwhile, the regulatory and capital requirements to apply for a full-fledged universal bank license are too stringent for neobanks to consider applying in the interim.

While the race to become the best digital bank is definitely on, as startups wait for the right licenses, they have to become more and more like the very beast they are trying to tame. At least in the near future, from a licensing point of view, neobanks that achieve scale would expand their physical footprint through branches and become more like traditional banks. Those with successful business operations may even apply for the universal bank license. Small finance bank licenses can be an interesting option for neobanks to consider in future, but again these have their own restrictions.

Closed To Open Banking

Despite opening up pretty much every other sector by embracing technology and fostering innovation, India is playing it pretty close to its chest when it comes to banking. The industry remains closed and centralised while enabling innovation in the periphery. Zeta’s Turakhia considers the progress made by fintech products such as PoS, mobile wallets, SME lending, consumer lending as the first wave of neobanking in India. He believes that large-scale adoption of open banking standards and government regulations in this regard will drive this wave significantly higher.

Now in this current era when machines talk to machines, everything is packaged in an API, India’s banking and finance industry needs to embrace open banking standards in a secure manner.

“It is important to allow for consumers to be able to use data with other applications and service providers in a meaningful way to obtain services that a bank itself cant provide,” Turakhia added.

India has the right infrastructure with IndiaStack — Aadhaar, UPI, eKYC, Digilocker and eSign — in place. Not many other countries come close to having this kind of sophistication in the public technology stack. But open banking standards will foster localised innovation and offer better behavioural and contextual offerings. It will also allow companies to create value-added services with real-time data and information access. In time, will help neobanks become net data contributors to open banking standards.

Open banking standards by the regulator have been critical for the emergence and success of neobanks in countries such as the UK, Singapore and others. However, RBI has warmed up towards the idea of an open banking environment, through steps such as the regulatory sandbox, which startups say will provide a great boost for neobanks.

“The sandbox will help neobanks collaborate with their banking partners and experiment on product and business model innovation in a restricted environment,” said NiYO’s Bagri.

But the ultimate challenge for neobanks is one that even demonetisation could not solve. One of the stated objectives of the November 2016 demonetisation move was that the government wanted to push more Indians towards digital payments and reduce cash transactions. Three years down the line, cash in circulation has actually grown. According to the annual report of the Reserve Bank of India (RBI) for the financial year ended 2018-19, the amount of currency in circulation rose to INR 21.1 Lakh Crore as on FY19 from INR 17.9 Lakh Crore on November 4, 2016, a week before the note ban came into force.

Also, as NiYO’s Bagri indicates, most payment banks have either surrendered their licenses or are struggling for business viability, and RBI is unlikely to issue further payment bank licenses in the near future, as the licensing process has not being made ‘on-tap’ yet as well.

From the customer side, the biggest resistance is surprisingly coming from those who are already using the digital products provided by traditional banks. As a result, a fully virtual banking experience is not something that customers with existing bank accounts are moving towards. But neobanks can certainly prove a viable option for India’s large unbanked population with access to smartphones and the internet. It also has the potential to deliver the customer experience that customers new to banking demand that traditional banks are not able to provide. And India’s booming gig economy and rising startup ecosystem have opened up a large customer base for neobanks.

Neobanking startups have a higher ceiling to grow by innovating around SMB-focussed products which are finding a new audience in the market or addressing the needs of the underserved groups such as students, young professionals and senior citizens for credit. But that’s not something that only neobanks can do, and this is where the real problem lies. Even as PSU banks are being put under pressure to manage their loan books, larger private banks are looking to innovate, invest or even acquire technology. The deeper pockets of private banks allow them to focus on all customer segments, so neobanks cannot wait too long for the right regulations and market environment. This has resulted in half-baked models and tall claims.

“A lot of startups are just using the term “neobank” for fundraising and valuation purposes, and are just providing an endpoint solution or feature. Unless there is true ownership of the customer experience, it won’t be as easy to make the economics work,” said Incrypt’s Nitin.