The fintech space in India is heating up. WhatsApp, the most widely used messaging app in the country, has recently started rolling out a Unified Payments Interface (UPI)-based payments feature here. Developed by the National Payments Corporation of India, UPI is an instant, real-time digital payment system for mobile-to-mobile money transfer between participating banks. With more than 200 million active users in India — the largest anywhere in the world — WhatsApp is expected to drive large volumes on peer-to-peer (P2P) payments and also become a popular platform for merchant payments. India is slated to be the first country globally to get the payments facility from WhatsApp.

Other global giants, too, are zeroing in on this space. For instance, Google has already launched its payments app Google Tez (“Tez” in Hindi means fast), while Samsung has launched Samsung Pay and Amazon has introduced Amazon Pay. While both Google Tez and Samsung Pay have been UPI-enabled for the past few months, Amazon Pay introduced the UPI feature earlier this week. Apple, too, is looking to introduce Apple Pay in the country in the near future. In a media interview a few months ago, Apple senior vice-president Eddy Cue said: “Apple Pay is something that we definitely want in India.”

Meanwhile homegrown digital payment firms like Paytm, PhonePe, MobiKwik and FreeCharge (all are UPI-enabled) are strengthening their arsenal. Paytm, India’s largest online payments and mobile wallet company, has invested Rs. 5,000 crore ($786 million) in mobile payments to date. Paytm founder Vijay Shekhar Sharma has earmarked another Rs. 5,000 crore for the next three years. In a recent media interview, Sharma said: “As a company, we have invested the most and will continue to be the largest investor in digital payments in the country.” PhonePe, the digital payment arm of India’s leading e-tailer Flipkart, is planning to invest $500 million to scale up its technology platform and expand its merchant network and consumer base. According to CEO Sameer Nigam, PhonePe grew at over 100% every two months in 2017 and this investment will help them “maintain the same aggressive growth rate for the next two years.” Interestingly, Flipkart’s backers include Chinese conglomerate Tencent which owns WeChat, the largest digital payments service in China.

A report by Google and Boston Consulting Group (BCG) titled Digital Payments 2020 predicts that digital payments in India will exceed $500 billion by 2020, up from $50 billion in 2016. Alpesh Shah, senior partner and managing director of BCG India, notes: “Global digital payments is undergoing rapid transformation and is set to grow four times in value by 2020. India is on an even more exponential growth trajectory. The smartphone explosion will usher in a new era in digital payments in India over the next few years that will see … non-cash transactions exceed cash transactions by 2023.”

Beyond Payments

The boom in India’s digital payments is a window into the fintech revolution in the country. Fintech in India – A Global Growth Story, a report by India’s software and services industry association Nasscom and consulting firm KPMG, notes that India’s fintech landscape “has witnessed strong user adoption through 2016, driven largely by the payments sector which has enjoyed a boost post the demonetization of high value currency notes.” The report estimates that around 50% of Indian fintech firms are currently “focused on payments and trade processing.”

Industry analysts expect that payments will be a pathway to other areas such as lending, insurance, wealth management and banking. “Most people in India lack credit history. Digital payments give them a credit history which can be leveraged in other areas,” explains Prantik Ray, professor of finance at XLRI – Xavier School of Management. Ravi Bapna, professor of business analytics and information systems at the Carlson School of Management, University of Minnesota, adds: “Innovative data-driven and behavioral risk management models can overcome barriers that arise from lack of widespread and robust credit scoring of individuals.”

Rajesh Kandaswamy, research director-banking and securities at Gartner, points out that in mature geographies, payment mechanisms are already evolved and basic banking services are a given. However, in countries like China and India, digital payments are evolving in tandem with the growth in ecommerce. Says Kandaswamy: “Payments can be an entry point for other financial services, especially lending and banking. For instance, an e-commerce retailer who offers payment services might find ways to lend to customers online to fund the purchases. Similarly, fintech companies that offer payment services to small businesses could offer loans based on the fintech company’s visibility into how the small business is performing. In China, payments led to areas like lending. This could happen in India, too.” Kandaswamy sees India as one of the key places for fintech growth. The only player which is “more interesting” than India at present, he says, is China, which is currently the world leader in fintech.

“Most people in India lack credit history. Digital payments give a credit history which can be leveraged in other areas.”–Prantik Ray

Fintech Trends India 2017, a report by professional services firm PwC and fintech accelerator Startupbootcamp, notes that venture capital-backed global fintech investment in 2016 was $12.7 billion. This was 13% less than $14.6 billion in 2015. On the other hand, fintech investments in Asia increased to $5.4 billion in 2016, up 12.5% from $4.8 billion in 2015. This increase was driven mainly by China and India. Further, India offers the highest expected return on investment on fintech projects at 29% versus a global average of 20%. Vivek Belgavi, partner and India fintech leader at PwC India, believes that “while in terms of market size, unicorns and investments, India is still small compared to geographies like the U.S., Singapore and Israel, it has carved a niche for itself in terms of fintech innovation.”

The PwC-Startupbootcamp report puts the number of fintech startups in India at around 1,500. Almost half of these were setup in the past two years. According to information and analysis firm Venture Intelligence, in 2016 and 2017 there were around 103 private equity/venture capital investments in the fintech sector in India amounting to $2.39 billion. The biggest investment in 2017 was $1.4 billion in Paytm by the Japanese conglomerate SoftBank. Others who received funding include insurance marketplace PolicyBazaar ($77 million), SME lending platform Capital Float ($45 million) and payments firms Mswipe Technologies ($31 million) and Razorpay ($20 million).

The Nasscom-KPMG report estimates that the total fintech software and services market in India was around $8 billion in 2016 and likely to grow 1.7 times by 2020. The Indian fintech software market alone is expected to touch $2.4 billion by 2020. The report adds that the transaction value for the Indian fintech sector was approximately $33 billion in 2016 and slated to reach $73 billion in 2020 growing at a five-year compound annual growth rate (CAGR) of 22%. The report describes payments as “quite mature in India,” P2P lending, robo-advisory, bank-in-a-box, security and biometrics as “striding fast towards mass market implementation,” and blockchain as having a “promising future.”

Firing on Multiple Cylinders

Multiple factors are driving fintech growth in India. These include inefficiencies in the country’s banking system, a large unbanked and underserved population, steep smartphone penetration, increasing access to the internet, a booming ecommerce market, and availability of a large talent pool which understands both technology and financial services. A key pillar is the strong support from the government by way of initiatives such as the financial inclusion program Jan-Dhan which aims to ensure that every Indian has a bank account, the biometric and iris-based Aadhaar which aims to give every Indian resident a unique identification number, and the Unified Payments Interface.

Launched two years ago by the National Payments Corporation of India, a not for profit organization owned by a consortium of major banks, UPI has emerged as one of the fastest-growing payments instruments since the demonetization of high value bank notes in November 2016. UPI reported 145 million transactions in December 2017. At the time of its launch, describing UPI as “the most sophisticated public payments infrastructure in the world,” the then RBI governor Raghuram Rajan said: “For a number of years, we have been saying we need a revolution in banking in India. I think we can confidently say the revolution is upon us.”

“The challenge is to innovate at different income levels and be able to customize at scale.”–Nadeem Khan

Industry analysts agree. Says PwC’s Belgavi: “The national payments structure we have is world class. The low-cost, large scale interoperability is unparalleled.” Pointing out that large chunks of the population in India have been underserved because they were deemed to be unprofitable, he adds: “Now there is an opportunity to crack that with innovative business models and make it profitable and sustainable.” According to Gartner’s Kandaswamy, with initiatives such as UPI, Jan-Dhan and Aadhaar, “India now has an underlying infrastructure core on which many fintech firms can blossom and a lot of innovation can happen.” Adds XLRI’s Ray: “These provide a good foundation for fintech companies to permeate last-mile touchpoints.”

Nadeem Khan, senior consultant at Dalberg Global Development Advisors, elaborates: “The shared infrastructure network will drive the next wave of fintech adoption in India because it gives fintech players ready and free access to a huge customer base. For instance, they don’t need to do anything around identification because they can leverage Aadhaar. They don’t need to build any payments technology because they can leverage the UPI. And thanks to the Jan-Dhan program there a large number of people with bank accounts.”

Ravi Aron, associate professor of information systems at the Johns Hopkins Carey Business School, says in order to lend to small and medium businesses and bring new retail financial services online, it is important for fintech service providers to be able to connect to an ecosystem online. “The need for an application programing interface (API) to allow deep linking between multiple categories of service providers is paramount. Robust and widely adopted APIs transform disparate services into linked ecosystems and enable the emergence of highly versatile platforms. UPI plays a vital role in this, as does the India Stack.” (India Stack is the world’s largest application programming interface. It allows the government, the citizens and entrepreneurs to interact with each other through an open digital platform and is being developed to enable Indians to get access to goods and services digitally.)

Aron goes on to point out that while a large percentage of India’s population is unbanked and roughly 80% of transactions are carried out by cash, at the same time, India has about 800 million mobile phones with over 430 million having Internet connectivity. By 2027 the Internet users in India will amount to more than 900 million. Says Aron: “There is no compelling reason why new retail financial customers must go through the same sequence of physical banking channels, credit and debit cards, Internet and mobile financial services such as ewallets, apps, and money transfer mechanisms. An entire generation of Indians leapfrogged the use of personal computers and laptops to connect to the Internet via mobile devices. A similar leapfrogging could take place in certain categories of financial services such as payments, lending and wealth management.” Carlson’s Bapna adds that with the increasing penetration of low-cost smartphones India has the potential to get “an additional 100 million plus people in the next few years into relationships with financial institutions such as those that provide working capital loans against transactional data mortgage providers, insurance and brokerage. This is a major boom that is unique to India at this time.”

A report titled Fintech in India: Ready for Breakout by consulting firm Deloitte says that fintech firms can reshape the financial services landscape in the country in three critical ways. One, they can reduce costs and improve quality. These firms are not burdened with legacy operations, IT systems, and expensive physical networks and can pass on the benefits of leaner operating models to customers. Two, they can develop unique and innovative models of assessing risks. By leveraging big data, machine learning, and alternative data to underwrite credit and develop credit scores for customers with limited credit history, they can improve the penetration of financial services. Three, being less homogenous than incumbent banks, fintech firms can “create a more diverse, secured and stable financial services landscape.”

“India now has an underlying infrastructure core on which many fintech firms can blossom.”–Rajesh Kandaswamy

Interestingly, while regulators are typically seen as hindering innovation, in India it seems to be less of a challenge at present. Gartner’s Kandaswamy feels that because of how regulators view financial services companies in mature markets, they are more risk averse than firms in a growth market. The willingness to innovate in India and China, he says, is much higher. PWC’s Belgavi adds that while traditionally the Indian regulator is quite conventional, in the case of fintech “they have allowed experiments to flourish and when they have seen that it is working they have brought in the required guidelines.” Citing the example of P2P guidelines introduced in last October by the RBI, he says: “In this space, the absence of regulations can make things complex and be a deterrent. Guidelines give the players credibility.”

Obstacles to Growth

XLRI’s Ray however feels that “lack of proper regulations is a major obstacle” for fintech in India. Pointing out that the RBI and Securities & Exchange Board of India (SEBI) are yet to come out with a comprehensive and separate guideline for the fintech industry, Ray says: “The fintech sector is still regulated by banking regulations. Although RBI has allowed small banks and payment banks in the recent past, a lot of impediments still remain in the path of innovative fintech players. It’s like asking them to operate with one hand tied behind their backs.”

Ray thinks that most fintech players can sustain in the long run only if they collaborate with the big banks. The banks, he says, can leverage the technical know-how and flexible structure of the fintechs and reduce their costs substantially whereas the fintechs can scale and reach out to a wider audience at minimal investment. “Alone, the fintech companies, excepting a few big players, can only operate at the fringes.”

Aron agrees that banks and fintech firms can be partners and amplify each other’s strengths. But he cautions that for this happen, “the behemoth government-owned banks need to work with fintech companies. They must not try to seize the emerging business through regulatory capture.” Regulations can be a double-edged sword, he warns. “Regulations that increase transparency, lower risk of fraud and increase trust will accelerate the adoption of fintech. However, regulations that protect the business turf of public sector banks and seek to route more profitable fintech businesses to government banks, will greatly impede the growth of fintech.” Another challenge that Aron sees for fintech growth in India is around telecom infrastructure. He points out that cloud-based systems can deliver significant efficiency gains in processing lending requests, automating transactions and assessing risk, but these systems are “only as good as the connections to them.”

PwC’s Belgavi lists three areas of concern. One, literacy, both in terms of adoption and security. Citing the example of mutual funds, he says that most people don’t understand the digital model and have security concerns. As a result, they prefer to go to a financial consultant who is given commissions by the mutual fund companies rather than trust a digital platform which gives unbiased advice. Two, most of the funding at present is going to the top few players. It needs to be more broad-based. Three, while India has a strong IT services DNA, fintech is a lot about innovative products and India’s record in creating world-class product organizations is not very strong. “It requires a different mindset and a lot of patience from all stakeholders,” says Belgavi.

Bapna notes that India still lags the rest of the world in democratizing the access to capital to entrepreneurs. “For instance, there is no majorly active equity crowdfunding platform in India. This could be a barrier for fintech entrepreneurs.” XLRI’s Ray adds: “Raising series B and C funds at regular intervals, giving the investors above average returns and keeping the cost low will be prove to be challenging in the medium to long run.”

“India is an important and significant test bed for frugal innovation.” –Vivek Belgavi

Dalberg’s Khan points to another aspect. Fintech innovation and adoption at present, he feels, is primarily targeted towards the urban elite and the rich and “the same products are being shoved down” to consumers of lower income levels. Says Khan: “That will not work. India has a huge diversity in terms of income levels and financial needs. The challenge is to innovate at different income levels and be able to customize at scale. The success of fintech and the ability to drive financial inclusion at scale through fintech will depend on that.”

Can Indian fintech players serve other geographies? Not neccesarily, says Kandaswamy. “There is no strong evidence of this as yet. At present, fintech is growing in India to serve the domestic market. This is good for the firms and for the country.” Not in the near future, says Sudhir Sethi, founder-chairman of IDG Ventures India which has invested in fintech firms such as PolicyBazaar (insurance), Lets Venture (crowdfunding) and CreditMantri (credit scoring). “Indian companies need to scale first to a global level. Only Paytm has achieved that scale so far,” add Sethi.

Does India have the potential to be a global hub for fintech innovation? “Absolutely,” says Belgavi. Pointing to areas such as UPI, immediate payment service (IMPS) for real time transfer of money, ewallets, and the use of sound waves for last-mile payments, Belgavi says that India is “carving out a niche for itself in low-cost, large-value product distribution as well as transactions.” He adds: “Around eight to 10 global banks are actively engaged with the fintech ecosystem in India. It is an important and significant test bed for frugal innovation.” Ray of XLRI however injects a caveat. “India has made a good beginning and is moving in the right direction, but to be a powerful force in fintech innovation globally we need to develop a strong ecosystem.”