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At a time when global investors are hyper-aware of rising inflation, an impending global recession and rising geo-political tensions, Indian investors are cautiously bullish about funding the start-up ecosystem. Particularly fintech, which sees to be the most preferred sector. In the H1 of 2022 alone, fintech startups have raised $3.4 billion from 159 deals, a 35% and 39% rise in funding amount and number of deals respectively, compared to H1 2021. This, despite the RBI’s recent crackdown on PPI credit lines, constant chatter about a crypto ban and lingering regulatory uncertainty that's become an occupational hazard for the industry.
Private equity and venture capital investments in the fintech sector in India from 2013 to 2021
Source: Statista Research Department
In most industries, this would mean incumbents would struggle to keep up with disruptors. But, in financial services, banks still have the upper hand - the license to bank. That might not be an exclusive advantage for too long, however.
The Center’s policy think-tank NITI Aayoghas made a case for digital banks, which would accept deposits and advance loans through digital means, and suggested a licensing and regulatory framework for such lenders. This may spell trouble for traditional banks that aren’t looking at fintechs as potential collaborators, and more importantly, are looking at turning customer data into their most valuable asset. In short, banks that aren’t embracing the platform model might lose out on precious dollars.
A platform business is simple - it’s a business that facilitates exchange. Traditionally, banks own a vertically integrated value chain - from production, and distribution to sales and servicing. While banks could always outsource components of this value chain, the cost structure remained fixed and bloated. The threat of disintermediation has threatened the old ways of banking. For their part, banks are adapting to the platform model to grow their business and service their customers better.
A typical approach to platform thinking is an exercise in automating various processes, to put it simply. One way to do that for banks is by adopting the account aggregator (AA) framework - all information about customers can be leveraged to apply algorithms and optimize the offering specific to customer needs.
For instance, banks can use the AA framework to determine spending patterns. Let’s say customer A buys a lot of video games - banks would be better positioned to offer personalized offers to customer A with a platform-thinking approach.
A McKinsey survey shows companies with an offensive platform strategy yield a better payoff in both revenue and growth and make them flexible to move across markets.
The risk of disintermediation
The risk of disintermediation for banks is imminent. They risk losing 30% of revenues as more and more customers expect personalized banking services. With the investment appetite for fintechs only growing (see fig 1), banks need to transform to survive the onslaught of platform players - via partnerships with fintechs that can help build an ecosystem strategy that can aid in providing alternative revenue streams.
Banks face a threat not just from fintechs, but also third-party aggregators who’re driving customers to easily manage all their banking needs on one platform and turning banks into a pipe model.
Even non-bank players could potentially disintermediate traditional banking - by placing themselves in the banking value chain and eating into traditional banks’ market share in areas like investments and financing.
Look at Banks ROE from 2016 - it stood at 8.6%. A basic ecosystem strategy, multiple partnerships, and a data monetisation model later, banks’ ROE can catapult to about 10%; creating their own platforms can also increase their ROE to about 14%.
The bank of tomorrow
Historically, banks have invested heavily in security and not as much into optimizing user experience. The platform environment is going to change that - the bank of tomorrow will be a customer-centric platform where e-commerce, social media and retail payments come together. Customers will increasingly demand seamless switching across digital platforms from banks.
According to research by McKinsey in 2018, banking returns (between 8-10% at the time of the research), could improve significantly in an ecosystem environment. And banks naturally have a competitive edge thanks to customer trust, regulatory experience, large customer base, and unexploited data.
Banks of tomorrow will benefit from the platform model in terms of revenues, profitability and customer satisfaction. Platform-oriented banks are being called visionary as they’re in a better position to compete with platform players.
The Big Tech threat?
Big Tech became big tech due to its business model that enables direct interaction among users. Companies like Alibaba, Amazon, Facebook, Google and Tencent have processed petabytes of consumer data and leveraged the network effect to offer bespoke services. They’ve also successfully created more activity for users with their platform-first approach and therefore generate more data. This same network effect has allowed big tech’s foray into financial services, including payments, money management and lending.
One of the main advantages that have allowed for scale for big techs in financial services is their low cost of operations. They’ve anchored their growth on big data and analytics to penetrate the unbanked/underbanked, ensuring a healthy risk profile and low rate of default.
India’s digital lending market represents a $1 trillion opportunity in the next five years - essentially making it a no man's land with scores of players attempting to capitalize on it. But, lending is risky. In a country with a bad loan ratio in double digits, mitigating risk is a priority. But one would think that tech companies are perhaps the most ideally positioned to analyze data to best assess risk. No? Big tech especially has an advantage thanks to the massive scale of its operations, cash-rich reserves, brand identities, and cross-industry presence. What they don’t have is regulatory approvals, insights into the ground zero of India’s credit market, and the required years that it takes to continuously optimize credit risk models and fine-tune them.
Financial services are severely more complicated a space than a cab booking service but if Uber and Airbnb have taught us something - it’s that regulatory grey zones don’t last for long and end up hurting more than helping. That being said, banks have an inherent advantage by virtue of being legacy organizations. But resistance to change might do more harm than good.
As this McKinsey article succinctly puts it -
“Executing on a platform operating model is arduous. However, when done correctly, it has the potential to deliver four main benefits to all stakeholders: value-oriented business-technology partnerships, stronger performance (speed, efficiency, and productivity), transparency, and a future-ready business model.”
Fintechs will continue to get investor attention for their agility, ease, convenience and speed - and that’s truly the value proposition of the bank of the future.