India to nurture ‘model banking of the future’ riding on open stack technology

Indian banking has the opportunity to be the poster child for modern banking paradigm globally. India has already shown the way in payments via UPI. The same approach needs to permeate lending and data. Retail payments today, match the heft of Indian software services in bringing global acclaim to India. Over half of the valuation for Fintech is accounted for by payments.  Conversations on UPIs have gained momentum, pointing to the potential scale and growth that is yet to be explored with regards to the platform. In the next 5 years, as Indian banks extend UPI’s underlying open stack philosophy from payments to lending and daily banking, they would be nurturing the “model banking of the future”, according to the latest report by Boston Consulting Group (BCG), in collaboration with FICCI and IBA, titled, “The Poster Child”.

While the rise of small ticket digital transactions and the growing popularity of QR codes at small merchants catches headlines, the real transformative change can be witnessed with the rising number of digital payments received by them from identifiable repeat customers. BCG’s view is that the introduction of aggregators can make financial data easily available to any lender of a customer’s choice, thereby creating a step change in access and eligibility for loans for small business, since the machine-readable data available for credit approval, monitoring and collections per customer grows 100X with impact of aggregators and digital footprint.

“The banking sector in the country is undergoing a massive transformation. With technology permeating every aspect of banking operation and with new partnerships getting developed with Fintech’s, one can be sure that the delivery of credit and other financial services will see an improvement with time. The report lists out some of the key developments that we are seeing and provides a rich set of recommendations for consideration by the regulator and government as they work together to strengthen the Indian banking sector and make it future ready for meeting the requirements of a fast-growing economy like India”, said Jyoti Vij, Deputy Secretary General, FICCI.

UPI is also proof of the concept that banking can be envisaged as an open tech stack interconnected to each other and to external entities to reach customers for sales and service. “We already notice 95% payments on UPI being originated on 3rd party Payment Service Providers (PSP) that are digital platforms with large customer traffic,” said Saurabh Tripathi, a BCG Managing Director and Senior Partner, and a co-author of the report. “The next phase of evolution will witness a shift to lending, with the introduction of Lending Service Providers (LSP) who can leverage API to connect potential borrowers to all possible lenders onboarded onto the Open Credit Enablement Network (OCEN). This will be highly advantageous to players with advanced data capabilities, like Fintech, through access to data that was previously confined to a bank’s closed systems.

The study also emphasizes on extending open architecture beyond lending to daily banking. We are already seeing many Neo banks that provide “daily banking” to customers with a bank operating as utility in the background. We envisage over 75% of all digital payments and digital loans and 25% of digitally opened accounts to be on 3rd party platforms in the next 5 years. The power of 3rd parties to originate banking transactions will grow manifold as number of digital platforms with sizeable customer traffic grows rapidly. “Digitization of banking sector is very important, especially for retail, which contributes as a key to growth of the ecosystem. Further, Ease of doing business for MSME and corporate will help in achieve $5 trillion economy”said Sunil Mehta, Chief Executive, India Banks’ Association.

The report lays out 3 imperatives for bank, that can fast track their evolution to the banks of the future, and safeguard them from redundancy:

1. Partnership business model and embedded finance

• Banks need to invest aggressively in partnership business models with 3rd party platforms and NBFC to harness the entire spectrum of opportunities in consumer & SME. Public Sector Banks have had poor debt experience in small business finance resulting in their declining growth and receding relevance in the important segment.  Public sector would benefit, from partnerships with 3rd party platforms and NBFCs/Fintechs with last mile reach. Rising affluence of semi urban India is already starting to reflect in share of non-agriculture retail finance disbursals in semiurban and rural markets inching up (35% to 42% of total between FY18 to FY21).  The handicap of scattered demand in hinterland can be addressed through partnerships with entities and networks that have high customer aggregation.
• Embedded finance in corporate digital supply chain ecosystems would be a major theme in corporate bank 2.0. Corporate Bank 2.0 would have higher exposure to consumer and tech industries on their books and consequently more transaction solution oriented and less balance sheet centric demand. Banks would need to pivot to sector specialized digital ecosystem solutions that address pain points in supply chains of the sectors.

1. Need to accelerate talent induction and capacity building in technology

• Technology investment by Indian banks is roughly a half lower than global comparable benchmarks and % of net revenues are stagnant at industry level (1% rise in private sector over 2 years). There is need to accelerate talent induction and capacity building in tech, AI and digital domains. Number of tech, analytics and digital employees are growing at 5X industry FTE growth but there is a long way to go.
• Financial holding structure that unbundles their fintech capabilities and tech platforms out of their traditional ringfenced banking business can unlock the premiums in financial markets. Banks can then reap “Fintech Premium” in their valuations and in their appeal to tech talent.

1. Industry wide initiatives to strengthen their position

• The banking industry needs to come together to introduce initiatives like promoting Open National Digital Commerce platform (ONDC) for digital commerce to blunt the edge of BigTech platforms, increasing digital financial literacy among customers as well as introducing industry level cyber fusion centres to combat cybercrimes.

Imperatives for regulator and government

There are four imperatives for attention of regulator and government.

1. Co-lending framework is a great enabler for flow of credit to SME with NBFC bridging the last mile.
   • RBI should reimagine co-lending as an extension of the OCEN framework into the secured lending domain with standardized protocols.   First Loss Default Guarantee (FLDG) is a powerful enabler of partnerships. We need to institutionalize a regulatory framework to establish FLDG by LSP to a lender with provision of appropriate mandatory regulatory capital to back it.  A separate NBFC (FLDG) license may be created for specific purpose of regulating such LSP.

1. Regulatory arbitrage between banks and 3rd party service providers (LSP/ PSP / Neo Banks)

• Banks effectively compete with the 3rd parties for same customer service on their platform Vs 3rd party platform. However, 3rd parties have an advantage in being able to incentivize customers with deals and offers on which banks has regulatory restrictions.  This arbitrage has to be addressed along with checks and balances to ensure 3rd parties respect customer data privacy to same extent as banks are expected to do by regulation.

1. Prepare ground for digitization in secured credit

• Secured credit currently follows a cumbersome process.  Digitization of property / land records and a digital process for creation of mortgage on assets can disrupt the secured lending space in same way as unsecured credit is being disrupted today.  Dematerialization of financial assets (including Bank FD) can be leveraged to ensure secured lending against financial assets can be activated on LSP platforms in a purely digital journey.

1. Unlock potential in blockchain

• Due to already existing open stack banking empowering customer with consent-based control over data and choice of service providers based on interoperability, Crypto and Defi will not be able to unlock 10X disruptive impact. However, block chain applications that enable fractional ownership of otherwise inaccessible assets and can democratize investments by enabling mass market to have access to a diverse range of investment options.  We should have a regulatory framework to facilitate orderly deployment of block chain applications like NFT to deepen and broaden financial inclusion.