India’s Fintech Boom: Ensuring No Man is Left Behind as the Sector Races Along
A look into why India’s Fintech growth may not be inclusive and what would it take to spur pro-poor innovation
There is unprecedented momentum for Fintech in India. Key efforts of the central government and the Reserve Bank of India (RBI) are enabling deep Fintech advancements in the country. The Prime Minister’s Jan Dhan Yojana (PMJDY) program is providing universal access to bank accounts for India’s population of over a billion people. The IndiaStack, with its set of open APIs built around the biometric-enabled Aadhaar identification system, has laid the foundation for a digital Indian ecosystem. India Stack’s presenceless (eAuth), paperless (eKYC, eSign), and cashless (Unified Payments Interface or UPI) APIs have reduced the cost of serving a customer, spurring affordable financial innovation. These same APIs have also led to new distribution models (such as business correspondents with micro-ATMs), providing Fintech firms with access to a previously untapped consumer base. To learn the basics of the vision around the India Stack and the UPI, read Wharton FinTech’s widely acclaimed prior blogposts (India Stack, UPI).
Consequently, digital financial services, especially those related to payments, have experienced disruptive growth over the past few years and are expected to continue to do so. The number of transactions through prepaid instruments has grown ~250% in just one year, rising from 77 million transactions in July 2016, to over 270 million transactions in July 2017. The recent partnership between BHIM (a UPI-based payments application championed by the central government) and Paytm (India’s largest mobile wallet) is expected to further bolster this push to mobile based payments systems.
This disruption has been fueled by growth in funding from diverse sources, including the government, large telecom providers and venture capital funds. The government, through its flagship Startup India initiative, is not only providing funding to Fintech start-ups, but is also creating a positive sentiment around launching Fintech ventures in the country. Large telecom players such as Airtel, Vodafone, Idea, and the newly launched Reliance Jio are heavily investing in Fintech too. However, a majority of funding has been driven by Venture Capital (VC) and Private Equity (PE) funds, who have betted heavily on the industry. Fintech firms have seen over $4.6 billion in PE/VC funding in the last decade, and are expected to continue this streak. The exhibit below provides an overview of the funding received by Fintech start-ups from VC and PE funds.
While the growth and investments in the Fintech sector looks extremely impressive, over 75% of the funding is concentrated on Payments and POS solutions. This isn’t necessarily a bad thing but what this funding skew implies is that financial services that are critical to low-income population segments such as insurance and credit have been left far behind, and have experienced limited growth.
What is even more worrisome is that the funding is not just skewed by Fintech subsectors, but also by income levels. Our analysis suggests that the majority of funding dollars are likely geared towards India’s rich and middle class, making us concerned that the Fintech growth in the country is not inclusive.
Let us explain how we landed at this conclusion. To start with, we segmented India’s population by household income. Under this lens, we discovered that 86% of the country’s population resides in what is now being popularly termed as India 2 and India 3. These are the “bottom of the pyramid” population segments with annual household income less than INR 3.4 lakhs (~$5,000).
Next, for each of the three population buckets above, we quantified the formal supply and the potential demand for the four basic financial services — payments, loans, deposits (savings), and insurance. The supply quantification exercise was based on determining the current penetration levels (as a percent of GDP) of financial services in India. This data was largely available through the World Bank and the RBI. To estimate the demand, we asked ourselves the following question — at penetration levels equivalent to more developed / financially inclusive economies, what would be the market size for different financial services in India? Again, we relied on benchmarks largely from the World Bank to conduct the demand estimation exercise. Where possible, we also triangulated and sense-checked our findings against alternative sources and reports. The findings from our analysis are summarized in the exhibit below.
As you can see above, the supply-demand gap for the four basic financial services is more than 50% (as a percentage of demand) across the spectrum. When we zoom in on this gap, we see that the gap is large not just for the poorer “BOP segments” (India 2,3) but also the rich and middle class (India 1). In terms of size, given that India 1 is the largest segment for financial services across the board (despite representing only 14% of the country’s population), there isn’t an incentive for Fintech companies or their underlying investors to chase growth in India 2 and India 3 at the moment. This leads us to believe that majority of Fintech players are inadvertently ignoring the country’s poor.
While Fintech companies are playing the critical role of closing the India 1 gap, there is a fear that India 2 and India 3 will be left behind in this impressive growth. Beyond the large India 1 market size, there are other reasons for why this might be the case:
- High risk of market failure: High cost of acquisition, complicated and expensive last-mile distribution, lack of supportive digital and financial regulations for the poor, lack of awareness and slow behavioral change may lead to economic failure.
- User-experience (UX) dilemma: Service providers continue to offer cheaper variants of standard financial products to the poor instead of creating customized financial products that are deeply integrated with their attitudes, beliefs, and habits.
- User-interface (UI) dilemma: Most current UIs on smartphones are not built with BoP customers in mind and assume high levels of literacy and structured financial behaviour. They assume people will change behaviour to use the app.
Given this reality, market forces alone may not be enough to address the India 2 and India 3 gap. While the impediments described above are not insurmountable, there is certainly a need for non-market catalysts to bring about inclusive growth. Catalyzing pro-poor innovation for India 2 and India 3 requires vibrant activity across three key layers.
A. “Public good” infrastructure: The high last-mile cost of serving is a big impediment for Fintech players being averse to filling the BOP gap. But with the creation of the India Stack, the Indian government has already taken a step in the right direction. Thanks to India Stack’s open APIs, acquisition costs are now as low as INR 4 per person, and verification time as low as 10 minutes.
B. Pro-poor focused funding to kick-start innovation: The funding challenge is being currently solved for, through the INR 1,000 crore ($150 million) Bharat Innovations Fund, which is a newly raised fund intended to provide funding for disruptive innovations in a range of sectors including agriculture, energy and digital technology to address some of India’s toughest challenges. In addition, increased activity by impact investing organizations such as Omidyar network and philanthropy funds such as the Bill and Melinda Gates foundation will only further fuel innovation.
C. Ecosystem development for pro-poor innovation: The sad reality is that the mere existence of infrastructure and funding is seldom enough for innovating in BOP markets. In addition, what is required is the concerted effort by “ecosystem players” that deeply understand the BOP consumer, and know how to help startups across a variety of challenges (see exhibit below). Several successful examples exist — these ecosystem catalysts can take the form of catalytic funds (such as Catalyst Fund in the US) or the form of innovation hubs (such as FCA Innovate in the UK).
It is an exciting time to be in the Indian Fintech market and witness the country lead the digital financial services innovation globally. However, as we speed along with our current momentum, let us take brief pauses to ensure that no man is left behind.
Nipun Jasuja is an MBA student at the Wharton School and heads the content platform for Wharton FinTech. Jasuja interned with Dalberg in Asia in summer 2017.
Nadeem Khan is a Senior Consultant in Dalberg’s Mumbai office and specializes in the firm’s Financial Inclusion Practice Area. His recent work at Dalberg has focused on supporting public-private initiatives to drive financial inclusion and digital payments in South Asia.