The COVID-19 pandemic heralded a golden age for financial technology, accelerating the global adoption of fintech products of all kinds. Driven by fears of contamination, contactless and cashless transaction modes were encouraged at all levels. The lockdowns put a strain on household finances, pushing consumers to borrow from digital banks. Central banks once again cut interest rates to near zero with no end in sight. Cryptocurrencies hit all-time highs and Bitcoin gained a foothold in the mainstream financial sector, even being adopted as the national currency in El Salvador and the Central African Republic. Persistently low yields and sky-high valuations in US equities pushed investors into new markets, and emerging-market fintechs were suddenly flush with cash and resources. All over the world, $125 billion of venture capital was invested in fintechs in 2021.
Much of this $125 billion went to US and European mega rounds, but $14 billion went to the jewel in the emerging markets fintech crown: India, which now has 21 fintech unicorns out of a total of 2,000, 6,000 or 10,000 fintechs, depending on the source. On the consumer side, the pace of fintech adoption in India is impressive. In 2019, 75 percent of all point-of-sale payments were made in cash. By 2020, this figure was just 38 percent, with the balance routed through payment systems, wallets, credit cards, and debit cards, according to Fitch. Indian Prime Minister Modi said in May this year that 40 percent of digital transactions in 2021 took place in India, home to 16 percent of the world’s population.
Globally, governments have encouraged the growth of fintech ecosystems for various reasons. First, the digitization of the economy simplifies tracking and taxation (in case you haven’t heard, the Tax collector comes for your Venmo account). The rise of digital payment infrastructure has contributed to a cut in half of India’s informal economy, according to the chief economist of the State Bank of India. Second, locally owned and operated rails and payment systems are preferable from a security standpoint. Third, reduced payment and settlement times mean faster capital cycles, invigorating the economy.
Few large governments have been as enthusiastic about fintech as India, which laid the groundwork for its modern fintech infrastructure in 2014 by linking the so-called JAM Trinity: zero-minimum bank accounts for the unbanked (known as Jan Dhan). , linked with Aadhaar (India’s national biometric identification system), linked with mobile phone numbers. In the past decade, the government has funded fintech-friendly initiatives, including e-RUPI, India Stack and Unified Payments Interface (UPI), and supported the fintech sector with guarantees, grants and reforms, allocating 15 billion Indian rupees (USD 200). million) to further incentivize digital payments in 2021 Union Budget.
Indian fintechs are becoming more systemically important to the broader financial system. Far from the simple bank versus fintech framework of the modern financial services sector, Indian banks and fintechs are collaborating to realize their respective advantages. Banks provide regulatory knowledge and balance sheet weight; Fintechs provide novel underwriting and risk scoring analytics, better UX, and greater flexibility. But as foreign capital pours into fintech coffers and new products and partnerships blur the lines between banks and non-banks, the Reserve Bank of India (RBI), originally a staunch supporter of fintech, has started to put his weight on the other side.
Fintech services are developed on a spectrum that corresponds to the consumer’s overall financial sophistication, spending and lending habits, and smartphone penetration. In rich countries, investment and neo-banking fintechs (Ally, SoFi, Robinhood) are dominant, but the digitization of payments is the starting point for fintechs in low-income countries. Breaking the exclusive trust of consumers in cash (usually through payment services) is the first hurdle to fintech adoption, with other services typically following.
India’s fintech space is especially unique. India is home to UPI, the world’s busiest real-time payment system. Established by the RBI in 2016 and managed by the country’s leading banks, UPI enables real-time transfer of customer funds between participating banks via mobile phones, including via flip phones. UPI is an open network, which allows non-bank technology companies to build applications on top of it, fostering an ecosystem of interrelated networks that are even used for interbank transfers and IPO Allocations, as well as texting a friend your share of the dinner bill. In every way, it has been extremely successful, so much so that Google urged the Federal Reserve to create a similar system.
UPI enabled India’s massive digital payment market and has spawned thousands of payment startups. It has attracted the attention of American corporate heavyweights, and the two major payment providers in India today are Google Pay and Wal-Mart’s PhonePe, who combined have a 83 percent market shareahead of bids from Amazon, Facebook, Alibaba and local players (a federal company antitrust investigation against Google Pay is underway).
However, being a payment provider in India just doesn’t “pay”. By government mandate, all UPI transactions are free; meaning that payment fintechs (including those operated by Google and Wal-Mart) have ancillary offerings to generate revenue, typically loan and buy-now-pay-later (BNPL) services. Credit issuance in India is tightly regulated, so payment providers and other non-bank fintechs partner with licensed lenders to provide digital consumer loans, which tend to be small, short term and unique.
India’s digital credit market has exploded in recent years. Total volume of loans duplicate from 2017 to 2021, but total digital loans grew staggeringly twelve times during the same period, according to the 2021 RBI Digital Lending Working Group Report. In particular, unsecured loans (not backed by collateral) grew twice as fast as secured loans for the same period. Boston Consulting Group estimates that digital loans will represent 50 percent of all retail loans by 2023, a total market of $300 billion. The same RBI task force found that of the 1,100 digital lending apps available in app stores, 600 were illegal by RBI definitions. Several of these illegal applications were operated by chinese shell companies (India is not a welcoming environment for Chinese apps, with 273 apps banned at most recent count, including TikTok).
Unlicensed fintechs were originally limited to issuing one-off consumer loans. But in recent years, fintechs have entered the credit card market by loading prepaid purchase instruments (PPIs) with lines of credit provided by licensed lenders. These instruments often bordered certain Know-Your-Customer (KYC) regulations and charged above-market fees. According to the Payments Council of India, 600,000 such cards are issued every month, mostly to young Indians who would not otherwise be able to access credit.
These businesses, which technically operate in a legal gray area, since PPIs were not designated as credit instruments, it suspended operations in June 2022 when the RBI banned the issuance of credit PPIs. Taken alone, this is a minor development (although directly affected fintechs have raised more than $700 million, mainly from US investors), but the move indicates cooler relations between the fintech community and the government.
Theories about anticipated regulatory adjustment abound. First, there is suspicion that the RBI is putting a finger in the balance for India’s traditional banking system. There’s a assumption that as the fintech market matures, participants will be shaped in the form of traditional banks and subject to comparable regulations. More importantly, given the meteoric growth of digital credit, there is a sense that consumer lending could spiral out of control, burdening consumers with unserviceable debt incurred in legal gray areas and far from the watchful eye of the RBI.
The Indian government is among friends as it takes a more critical look at digital lending. China’s crackdown in late 2020 was ahead of the curve, sending a clear message with the last-minute takedown of the credit giant. IPO of Ant Group and later disappearance of its founder, Jack Ma. In October 2021, the Indonesian Police raided lending fintech offices and have closed 5,000 illegal loan operations since 2018, according to Fitch. Kenya passed a bill regulating credit practices in February 2021, backed by the financial services industry. even the IMF has called for more oversight of high-growth fintechs.
So far, restrictions in other countries have boosted Indian fintech investment as investors prioritized markets with lower risk of regulatory disruption. But even a worm will turn, and the RBI’s rumors about improving loan regulation in february 2022 have crystallized in their first significant action. Bank stocks rose after the June announcement, signaling expectations of further tightening.
“The treasure is based on mining, the army on the treasure; he who has army and treasure can conquer all the wide earth.” So wrote Kautilya in the Arthashastra, a treatise on political economy written during the Mauryan dynasty of India (321-185 BC). Taken together, these crackdowns are a reminder that while high-flying fintechs may have the treasure, they don’t have the army, and until they do, they’re subject to those who do.