Digital Disruption: Is India Ready for Neo-banking Solutions?

By Bhavin Turakhia, Co-founder and CEO, Zeta

The Covid-19 crisis sped up the digital transformation of banks, as branch operations were limited due to safety norms. Banks had to find a solution to carry out customer facing operations remotely. E-wallet companies and digital payment service providers flourished during the pandemic. India also saw the emergence of new micro loan providers and fintechs that offered credit and forex solutions without the need for a bank account.

There was a time, not so long ago, when banks fit the stereotype of bureaucracy built on seemingly endless paperwork. Until 2015, the banking system in India did not have facilities such as video KYC and digital lending. The push for digital banking and cashless payments was also not as aggressive.

Neo banking, as a concept, began to gain popularity around 2017, when digitizing financial activities became a serious priority, thanks to demonetization. The advent of Aadhar and push for UPI also accelerated this disruption in the digital banking space.

So, what is neo banking? Plainly put, neo banking is about building an entire bank in the cloud. Instead of a brick and mortar setup, it is present completely online with the aim of offering seamless banking experiences and simpler solutions that traditional banks cannot.

In the last few years, the number of players entering the neo banking space has been skyrocketing. There are currently about fifteen established neo banks in the country functioning on three models: Digital Only Direct banks, Digital Only Challenger banks and the Over The Top (OTT) model, where a FinTech company partners with a bank to offer banking services driving on the bank’s license.

Most neo banks in India fall under the OTT model, partly because India’s regulatory structure is very different from its Western and Southeast Asian counterparts. Start-up neo banks partner with traditional banks due to local license restrictions for all digital banks. So far, traditional banks have capitalized on this opportunity. They work on a comprehensive API stack through which they have brought some neo banking use cases to life for their existing customers.

These neo banks that have emerged are focusing on the retail and MSME markets. In the retail category, neo banks primarily gun for two things: powering the underbanked segment by promoting digital inclusion and financial literacy, and offering an enhanced experience to the already banked. There are many fintech companies that have established their dominance in the former and their prime focus is on the millennial and Gen-Z market.

As MSMEs become digitally savvy, their dissatisfaction with existing services is apparent. This is where neo banking solutions come in. They offer one platform where an MSME’s entire business can be managed. Such services include accounting, invoicing, tracking payables and receivables, expense management, etc. Players in this space also have a strong line of investors backing them.

Another exciting and booming market is kirana tech. Several newly emerging players offer mobile first solutions to these small and medium grocery store owners to ease the process of managing their books, handling their supply chains, and tracking credit offered to customers. This serves as an advantage to the company providing the service, as they can get access to granular cash flow data, which can be further leveraged to provide working capital loans to these kirana store owners. Players in this segment are typically not known as neo banks, but they can turn into one any day. Fintech providers in this space have also been attracting an impressive group of angel investors.

Scope for neo banks in India
The various neo banks and financial institutions that have sprung up cater to a niche market and thrive on trusted relationships. This has led to banks and financial institutions also narrowing their focus to the convenience of banking and the people they serve.

The advent and constant development of new age technologies such as AI and ML, big data, blockchain, cloud computing, robotic process automation, and others has enabled the banking industry to offer customer friendly services, empowering them to tap into diverse markets.

Big data helps banks extrapolate insights from unstructured data collected from various sources which in turn helps them come up with customer centric offerings and expand their banking operations. With the help of artificial intelligence and machine learning, banks are able to automate their core-banking services which simplifies and strengthens the customer relationship. Several banks have also started to open their doors to powerful new technology such as blockchain, which ensures the development of efficient distributed ledgers to record transactions thereby securing the financial data from leaks.

Neo banking is cost-efficient as it relieves the banks of two of their major expenses – infrastructure and human resources. Banks are then able to pass on these benefits to their customers. It is this low-cost structure and real time services that has driven the growth potential of neo banks in India and is paving the way for digital and financial inclusion in the country. 75 million MSMEs in India contribute to 38% of the country’s GDP. Neo-banks can play an instrumental role in their upliftment by digitizing their business processes.

For bigger enterprises, most neobanks provide dashboard solutions with simplified interfaces and easy to understand and valuable insights for services such as payments, payables and receivables, and bank statements. Hence, it is beneficial for organisations with significant expenditure and an appropriate number of employees, to have such insights which reduce expenditure and boost productivity and revenue.

The best way for neo-banking to flourish in India is by encouraging legacy banks to invest in new age technology and re-engineer processes, not only because they turn out to be cost efficient but also because they make the customer’s banking experience smooth and seamless.

In 2019, neo banks attracted an investment of $5-20 million on paper ideas alone in seed funding rounds. The way India consumes financial services is bound to change post COVID-19. Netizens have been embracing digital modes of transactions now more than ever. In this fiercely competitive landscape, the player who triumphs over his competitors is the one who is likely to capture this large, tech savvy customer base.

Foreseeable challenges
On the flip side, rampant digital transformation have also given a window for various cybercrimes. Banks in India are already grappling with cyber attacks and data thefts. The Indian government and regulatory bodies are introducing new frameworks and guidelines for banks to comply with and banks will need to align their digital transformation strategies from time-to-time as our collective understanding evolves. Neo banks in India are operating under two guidelines — the outsourcing guideline and the business correspondence license. In this entire setup, the onus of regulatory compliance falls completely on the partner bank. Globally, regulators are either creating a separate license for neo banks or tweaking the existing set of regulations for banks to better serve digital banks. Countries like Hong Kong, Singapore, and South Korea have already rolled out a dedicated digital banking framework.

Since there isn’t any rigid framework of regulations to manage digital banks in India, neo banks are currently overseen by traditional banking laws. However, the RBI has announced to prioritize digitalization and has rolled out a slew of new laws to support it.