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How neo-banks are ushering a new age of digital banking in India

India ranks second after China among developing countries where residents don’t have a bank account or access to financial services.

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When Keshav Pandit, a 22-year-old college student, wanted to go for a weekend trip with friends, he took a loan of INR 2,000 (USD 28) from mPokket, a mobile platform for instant loans. For nearly last one year, Pandit, a full time employee of a private bank has depended on mPokket for his discretionary expenses.

“It doesn’t matter how much one earns, expenses always overshoot income. Getting loan from platforms like mPokket is always convenient,” he said.

Over the last two years, dozens of fintech companies—also known as neo-banks—have been offering instant loans over mobile phones. Neo-banks such as NiYo, Open, Razorpay, Epifi, Yelo, InstantPay, Hylo, and PayZello among others have partnered with banks or non-banking finance companies (NBFCs) to offer financial services. One common factor among their users—millennials and people from the low-income group—is that they either have no credit score or a bad credit score.

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Despite India’s numerous initiatives towards financial inclusiveness, 190 million Indians are still unbanked, opening an opportunity for neo-banks to thrive. According to World Bank, India ranks second after China among developing countries where residents don’t have a bank account or access to financial services.

Although, in the last couple of years, traditional banks in India have been focusing on enhancing their digital presence through mobile banking, they have not done much in terms of offering products for new set of customers. People in the low-income group, including students, fresh graduates, and blue-collared workers have been devoid of banking services.

For traditional banks, acquiring a customer who has a loan requirement of as low as INR 1,000 (USD 13) that too without any credit history, is not only economically unviable, but also risky.

“Opening a salary account in income segment between INR 15,000 to 20,000 a month is not a financially attractive business for banks. Fintech players like us provide this service at a low cost compared to banks. Our cost of operations is less as we are technology-driven,” Vinay Bagri, CEO and co-founder, NiYo told KrASIA.

NiYo’s flagship product, Bharat Prepaid Card is aimed at blue-collar workers, that provides zero-balance prepaid card allowing unlimited and free money transfer.

While traditional banks outright deny loans to blue-collar employees and college students, neo-banks use data such as banking history, online shopping behavior, EMI payments, among others to ascertain users’ credit score. Armed with technology such as artificial intelligence (AI) and machine learning (ML), digital banking entities can analyze user’s financial capabilities and accordingly deny or give loans.

In some cases, neo-banks also give these users different investment options to improve their credit score.

“Payzello not only provides them banking facility, but also provides data on spending analytics, help them build small investment portfolio, which banks do not do,” Pruthiraj Rath, co-founder of PayZello, told KrASIA.

Bagri believes that in the next few years, “the biggest beneficiaries of digital banking would be financially excluded as there is a huge demand in the market.”

Traditional banks and neo-banks: a symbiotic relationship

Although, neo-banks have technological edge, Indian regulator requires them to partner with either banks or NBFCs to function. Banks have also understood the benefits of working with fintech companies as the partnership not only helps them offer novel products but add new users.

“Customer acquisition is a key element of partnering with a neo-bank. They bring differentiated experience for a niche segment of customers,” Jithesh P V, deputy vice-president and head digital, Federal Bank, told KrASIA.

It saw a remarkable shift in banking habits in customers over the last three to four years. The share of digital transactions in overall transactions increased from about 40% in 2016 to about 85% currently. Federal Bank is expecting to formalize tie-ups with at least two neo-banks in the present quarter.

Last month, Bengaluru-based neo-bank FamPay partnered with IDFC bank to launch what it claims to be India’s first number-less card for teenagers, ‘FamCard’. Using this, parents can send money to their children on the app, which they can use to make payments without referring to physical card as all the account details are stored in the app.

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A handful of neo-banks also cater to small and medium enterprises (SMEs) that struggle to get working capital loan from banks. In the absence of proper documents and bookkeeping, this segment traditionally depends on moneylenders for their loan requirement.

The roll-out of GST has further perpetuated the need for documentation. Thus, neo-banks serve the dual purpose—they act as virtual accountant for SMEs and help them properly document their transactions, which in turn help them get working loans from banks. This not only helps SMEs, but gives traditional banks an opportunity to not lose out on potential customers who it earlier considered unserviceable.

The add-on services provided by neo-banks include automated accounts and bookkeeping, invoicing, payroll management, and business loans.

Few months ago, Razorpay launched a new service called RazorpayX, under which it provides banking solutions to small businesses. Recently, it started on-boarding small shopkeepers from tier 1 and 2 cities who never had access to digital banking.

“Large SMEs are more remunerative, but small SMEs and shopkeepers in tier 1 and 3 cities are important from the point of view of customer acquisition and volumes,” said Harshil Mathur, CEO and Co-founder, Razorpay.

Chasing moolah

Fast user adoption as well as multiple partnerships with banks has brought neo-banks to limelight among global as well as local investors.

Few prominent fundraisers include NiYo, which received USD 35 million as a part of its Series B funding round led by Horizons Ventures and Tencent, with participation from JS Capital, its existing investor. Last year, Razorpay also raised USD 75 million in Series C round of funding co-led by Ribbit Capital and Sequoia Capital.

The VC funding in this space has continued in this year as well. In April, Amica Financial Technologies, that raised USD 24 million in November last year, received a check of USD 2 million in a funding round led by UK-based Hummingbird Ventures and US-based Bedrock Capital. In July, Bengaluru-based neo-bank Walrus, that provides banking solutions to teens and young adults, raised an undisclosed amount of pre-seed funding led by Better Capital. Around the same time, Unicorn India Ventures, PointOne Capital, and Astir Ventures made an undisclosed amount of investment in Finin.

It should be noted that so far, revenue generation for non-traditional banks have been a struggle in India.

To widen the spread of payment and financial services to the unbanked population, Reserve Bank of India gave payments bank licenses to about 11 entities in 2015. Payments banks provide all the services that a traditional bank offers, except giving loans or credit cards.

The limited operational space available to them and the large initial costs involved in setting up the infrastructure have constrained payments banks. Their source of revenue is largely from interests on investments in government securities, transaction charges, and fees.

At the end of March 2019, there were only seven payments banks operational in India. Their collective loss in March 2019 was INR 627 crore (USD 84 million), against INR 516 crore (USD 69 million) a year ago, according to RBI.

For neo-banks too, transaction charges and fee from selling third party products constitute major part of fees.

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According to Rath of PayZello, in the B2C segment, only those neo-banks which have deep integration with core banking services (CBS) of a full-fledged bank would succeed.

CBS is the networking system of various bank branches through an IT infrastructure. With CBS integration, neo-banks can earn commission for every banking service a customer uses—from loans to cash withdrawals. In API-based integration, the revenue is limited to transaction fee, which varies between 0.2% to 0.6% per transaction.

“The advantage with CBS integration is that the fintech gets commission on whatever banking activity the bank undertakes, like interest on credit and forex transactions,” said Rath.

Companies operating in B2B segment, would earn revenue from services like managing the payroll for businesses, automating their accounts, and invoicing. Going forward, support from full-fledged banks, stable funding, and innovative business models are likely to be a key determinant of success for Indian neo-banks.

Rath believes over the next five to six years “at least two to three fintech companies from India will dominate Southeast Asian neo-banking space.”