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From Cash to Digital: Fintech's Disruptive Influence on India's Economy

With the aid of a favourable demographic dividend, growing digitization, excellent public infrastructure, and ongoing innovation in the field of technology, India's consumer trajectory was back on track in 2022. The Indian economy will restart its transition and return to its stable form as lower-income households rise to middle-income levels as Covid-19 worries diminish and demand in the general public has picked up. 

Due to rising demand from more than four million affluent and 33 million mass-affluent families, consumption is projected to increase in India across income levels from $1.8-$1.9 trillion in FY21 to nearly $3 trillion by FY26. Micro, small, and medium-sized companies (MSMEs), estimated to contribute $1.3 trillion in gross value added by FY26, will be crucial to the country's economy alongside individual household consumption.

Besides this tremendous estimated increase, the traditional credit system continues underserving family consumption and MSMEs' demands. For households, credit penetration in the majority of living expense segments is under 5%. Nearly two-thirds of MSMEs depend on expensive informal sources of finance since they lack access to formal credit as well. Fintech companies are anticipated to benefit strategically from this credit shortage prevailing in the country.

Financial inclusion is being driven by digital financial services (FS), which also democratizes access and promotes the personalization of customer experience and products. The pandemic has speeded up digital adoption and given a boost to digital financial services solutions by incumbents (banks, traditional NBFCs, insurers, etc.) and insurgents (fintech firms) thanks to the solid digital base provided by the Jan Dhan-Aadhaar-Mobile (JAM) trinity, Unified Payments Interface (UPI) platforms, as well as other favourable regulatory finance related frameworks. 

India is transitioning to a mobile-first economy, notably in financial services, with a projected increase in smartphone owners to over 1.1 billion until FY26, up from approximately 750 million today, and much more than 850 million people who use the internet in FY26, up from nearly 650 million as of now. 

Emergence of fintech

Indian fintech companies have advanced quickly in the payments sector during the last few years, thanks to UPI. The value of UPI monthly transactions has risen to over $135 billion (as of June 22, 22), which is astounding nine times the value of credit cards (CCs), which have been prevalent in India for more than 40 years.

Fintechs are anticipated to be crucial in boosting financial payment services and using digital technology. With roughly $35 billion spent across various sectors, India has seen a tremendous increase in fintech investment, more than twice its share of global fintech funding from 2016. Around 18 new fintech unicorns were established in 2021 and 2022, and more than $19 billion was invested in the sector.

According to estimates, the enterprise value (EV) of Indian fintech companies is now approximately $100 billion, with a projected FS EV of $1.4 trillion in the year 2021. Given that India has comparable macroeconomic fundamentals to Brazil and a lesser penetration of the majority of financial products and services, we forecasted Indian fintech companies to follow a similar trajectory to Brazilian fintech. 

Brazilian fintech and neo banks have made enormous progress in the retail banking sector, as evidenced by their growth from a 2% share of the FS market capitalization in the year 2017 to a bigger than one-third stake in FY 2021. Similarly, we anticipate that Indian fintech will account for approximately $350 billion in EVs by 2026, or greater than 15% of the nation's financial services EV. 

While established companies and new startups are expected to benefit from this financial expansion, client retention and company-to-customer engagement will continue to be a top strategic objective, opening the door for cooperation and integration among the two.

The future of fintech firms in India will be shaped by several developing advancements, even though payment service providers (PSPs) have taken up leadership in domestic payments:

Payments. Real-time account-to-account (A2A) payments' steady growth is driving out money from customers. Additionally, payment aggregators, point of sale (POS) providers and payment gateways are moving beyond accepting payments from buyers to offer a full-stack financial solution for the merchant, such as enabling them to provide UPI credit to their customers, help their customers to track the current status of the opted UPI loan. 

Lending: Decentralized finance (DeFi) experiments, the increasing number of integrated lending choices for consumers, and asset-backed lending's digitalization.

Wealth-tech: Integrating discount broking with direct distribution, AI advisory solutions integrating with personal finance management and generating standard simulation portfolios, and an increase in purchasing in nontraditional varieties of assets, specifically cryptocurrency.

Insure-tech: third-party micro-insurance providers, the growth of online platforms for providing insurance, and the growth of digital non-life insurance companies.

Fintech Infrastructure: The emergence of "banking as a service" (BaaS) vendors, the industrialization of blockchain- and distributed ledger technology (DLT)-based applications in commercial banking, the introduction of retail and wholesale Central Bank Digital Currency (CBDC), and more.

Neobanking: Growth among millennial-focused neo-banks and those targeting MSME businesses, including safeguarding from cyberattackers in this modern digital era.

Up to this point, the fintech industry has had phenomenal success and sped up digitization across various FS applications. Nevertheless, as evidenced by the Reserve Bank of India's (RBI) latest announcements, we view it as subjected to strict regulation and compliance scrutiny. This is anticipated to lead to increased cooperation with the competitors and possibly sector consolidation, especially when combined with constraining funding in the investment market.

Indian economy and customer outlook

By FY26, an increase of about 4 million affluent and approximately 33 million mass-affluent families is anticipated to result in spending that is 2-2.5 fold greater on necessities and 3-4 times higher on well-being amenities like entertainment, healthcare, and schooling, recreational activities, as well as higher consumer durables (CDs) penetration.

As this industry directly hires over 120 million Indians (roughly 20% of the total workforce), adds 49% of the country's exported goods, and accounts for 6% and 25% of the GDP of the manufacturing and service sectors, respectively, MSMEs are anticipated to continue growing at a compound annual growth rate (CAGR) of 11% by FY26, boosting the nation's overall economy.

With an improving digital economy and shifting customer preferences, more than 40% of customers are projected to switch to online platforms for financial services, travel, and other necessities.

Online purchasing is projected to rise by about 27%, outpacing offline spending by approximately 12 %. This difference is primarily due to the increasing use of digital payment methods like UPI, which could potentially make India's economy 50% non-cash by FY26.

Due to the decreasing percentage of digital wallets, expanding merchant acceptance due to low/zero merchant discount rates (MDR), the rising popularity of smartphones in Tier 2-4 areas, and advances in technology on basic cell phones, which allows the use of UPI without internet connectivity, the monthly transaction value of UPI—which has increased to nearly nine times that of CCs in the last four years—has shown potential for growth.

Other financial topics, such as wealth innovation and other investments, have also experienced rapid expansion aside from digital payments.

Evolution of fintech in India

The fintech category, which presently makes up around 7% of India's $1.4 trillion FS EV, is predicted to increase to $350 billion in EVs until 2026 and account for almost 15% of the total FS market cap. 

Fintech companies' stake in the financial services market capitalization jumped from 2% in 2017 to a whopping 35% in 2021 in the Brazilian market economy, which shares the same macroeconomic factors and demographics as India.

The covid-19 pandemic and the resulting lockdown increased the use of digital technology and caused fundamental and substantial changes in consumer behaviour:

  • Thanks to a year-over-year (YoY) surge in UPI payments of more than 75% between FY20 and FY21, non-cash payments skyrocketed to an all-level high.
  • Over 60% of loans issued by nonbank financial businesses (NBFCs) in FY21 were made through digital lending apps (DLAs).
  • Demat accounts rose to over 35 million in FY22 (until Nov. 21), bringing the total to approximately 90 million, a 63% increase against 55 million in FY21.

Nearly $10 billion in capital over more than 580 deals was given to Indian fintech ventures during FY21, more than tripling the $3.5 billion collected in FY2020, which was an all-time high of investment and deal activity for the nation as a whole. A prudent $4.2 billion has been allocated for the first half of the fiscal year 2022, which is less than H1 FY21 but nearly double as much as H1 FY20. 

Despite the fact that digital payments and loans still receive the majority of investment (60%), other sectors, such as developing sustainable financial infrastructure, wealth tech, and neo banks, are now being focused upon.

By offering additional sources of revenue and cross-selling complementary services and goods, fintech firms are attempting to increase customer retention and engagement after accumulating an extensive clientele through their introductory offers.

The rapid growth of India's top fintech unicorns can be attributed to several positive factors, such as:

  • A persistent focus on consumer requirements within the identified target segment(s) to consistently innovate and capitalize on value propositions (once they've got the initial "hook" product) with better customer experiences as the main focus.

  • Prior to emphasizing monetization, boost customer acquisition by making substantial marketing investments.

  • Measures to increase client retention and foster deeper consumer involvement, such as engagement campaigns, gamification of apps, expert-moderated social networks, and educational portals (such as tutorials, courses and discussion boards for new shareholders).

  • Having a view of the future on customer lifetime value (CLTV) and customer acquisition cost (CAC) since the beginning, which leads to concentrating on organic growth and the creation of an attractive value proposition that boosts average revenue per user (ARPU).

  • Progressive growth into the development of all-in-one apps and integrated financial ecosystems across a broader range of financial services (particularly by UPI providers and business-to-business [B2B]] FS companies) for increased customer engagement and to generate lateral revenue streams.

  • Inorganic growth methods, which include mergers and acquisitions (M&A) to broaden the range of a potential product or its target market, add revenue cooperation, improve skills, and exemptions if necessary for growth and expansion without hampering valuation multiples (for instance, separating NBFC from the central IT business).

  • Collaborations with market leaders to gain ownership of the necessary licenses and authorizations, cost-effective capital, risk mitigation expertise, and bank systems for building up (BaaS), particularly for neo-banks and independent lenders.

By extending their primary value proposition to encourage greater customer engagement and ARPU, top fintech startups, unicorns, and dec acorns have succeeded in putting together integrated financial ecosystems.

  • In the payments industry, UPI companies like PhonePe have grown in size and customer base by encouraging app usage with rewards, and discounts, building an ecosystem of integrated apps, and promoting hyperlocal trade through their well-knitted merchant network. These players have begun to utilize their size to cross-sell other FS products and services.

  • Wealth tech companies like Groww and Zerodha bet on their unique low-brokerage offering to draw in new customers and investors, simultaneously boosting activation through community interaction platforms and instructional materials.

  • FS apps for CC bill payments: To ultimately make money from its client base through loans, CRED focused more on developing a prime-plus clientele on its platform and increasing customer engagement through its online retail store, gamified rewards, subscriptions, etc.

  • Companies that specialize in payments for merchants, including Pine Labs and Razorpay, are developing comprehensive centralized solutions for these businesses. They began with accepting digital payments, provision to customer loans at the point of sale, financing for retailer working capital, and business management tools for retailers. Currently, they are moving from online to offline and the other way around, as well as into emerging sectors such as neo-banks.

  • Neobanks like Jupiter, NiyoX, and Fi began with developing a hook product geared towards millennials and Gen z's or MSMEs that are either credit-based, deposit-based, or software-related (for MSMEs), and they are currently branching into other FS areas as they gain scale in the customer base.

Voice of Industry

Leaders in the finance sector, including those from traditional financial institutions, rivals, and private equity/venture capital companies, think that excellent macroeconomic fundamentals, like low financial services adoption and rising use of digital technology such as smartphones, combined with high customer demand for superior products, services and consumer experiences are pushing the adoption of fintech and digital technology in the Indian ecosystem.

Fintech architecture (for Banking as a Service, aka BaaS), consumer financing, and neo-banking have been recognized as the leading three fintech fundamentals that business executives are most optimistic about for current and future projections. In addition to the top three topics, industry elites see the development of full-service ecosystems as a critical theme. 

In contrast, startups think insure-tech would be revolutionary in the upcoming years.

Redesigning present consumer experiences is among 96% of CEOs at established banks, NBFCs, and insurers' main three objectives. The provision of developing embedded finance through collaborations with fintech companies was also mentioned by 61% of traditional players, and roughly 57% of industry leaders believe redesigning distribution patterns by switching from physical to digital distribution will be the central area of priority over the upcoming five years.

68% of fintech incumbents regard consumer retention and engagement as their top goals. Almost 60% of respondents think that acquiring the necessary licences, authorizations and core competencies will be crucial for promoting long-term relevance and maintaining sustainable growth. Additionally, surfacing as top strategic concerns for fintech leaders are monetization, capital and profitability.

The majority of industry leaders—roughly 75%—have named partnerships with fintech companies as a critical enabler for retaining dominance in digital financial services. For both established players (65%) and newcomers (79%), hiring and maintaining the right individuals (product owners, data scientists, developers, designers, enterprise architects, etc.) has become essential.

While most fintech companies aim to collaborate with traditional players for legal expertise, necessary permits and authorizations, and access to low-cost finance, more than 65% of industry leaders claimed that they are working with startups to increase their customer base and provide a premium user experience.

However, 79% of startups say that tech adaptability and digital methods of collaborating between startups and established companies will be a significant obstacle during working together, and 83% of industry leaders believe that managing risks will pose the most critical hurdle when working with startups. Although both sides want to work together more, there is a mismatch in objectives and expectations in certain vital domains, including company culture and working methods, business models, risk management procedures, and tech adaptability.

Due to the availability of a sizable, untapped target market, 88% of the capitalists who participated in the poll find the fintech industry in India to be an appealing option. The second-largest crucial aspect influencing investments, according to investors, is the ability of fintech companies to scale up the deployment of a distinct and unique value proposition.

About 80% of the poll participants anticipate increasing insurgent and incumbent cooperation across the nation in the near future. The majority of the poll participants also expect market integration through mergers and acquisitions (M&A) among fintech firms and between incumbents and fintech companies, as well as a rise of "also-rans" and clear winners within each sub-sector/fintech subject matter, because of apparent distinctions in the value proposition.

Unsecured retail lending and the rise of consumption finance

Unsecured retail lending has increased continuously at approximately 25% during the last three years (FY19-FY22), regardless of the Covid-19 pandemic:

  • At a 19% CAGR, credit cards (CCs) demonstrated resiliency.
  • Personal loans (PLs) increased rapidly at a remarkable CAGR of 29%.
  • Consumer durable (CD) loans also increased at a 13% CAGR and reached their pre-covid levels.

During the last three years, semi-urban economies have been the main driver of increase for unsecured retail lending goods, with a 32% CAGR in Tier four areas compared to an estimated 18% CAGR in Tier 1 locations.

Since there is a greater emphasis on small-ticket-size financing, spearheaded by fintech companies and NBFC financiers, average ticket sizes for different types of loans, particularly PLs and CDs, are dropping. In the last two years, the average ticket size for NBFCs in the PL sector has shrunk by almost 70%.

Lower than $650 in ticket size, CCs have demonstrated a remarkable increase of 12% CAGR over the previous three years, with no apparent effect on asset quality and expansion predominantly driven by semi-urban areas.

Similar to CCs, where cities and semi-urban regions have been the main driver of improvement, PLs exhibited a substantial increase of 120% CAGR in the small-ticket-size ($650) segment, with 85% of distributions in small ticket size ($650) going to customers and users under the age of 35.

Additionally, growing at an 11% CAGR during the previous three years, small-ticket CD loans are back to their pre-pandemic levels. The fact that more than 70% of payments and funds have gone to people under 40, 36% to people in the 30–40-year-old spectrum, and 37% to people under 30 shows how much Gen Z and millennials are in need of consumer financing. Consumers new to credit (NTC) have exhibited outstanding credit behaviour in CCs, while in the case of Pls and CD loans, performance has been inconsistent.

The abovementioned elements show a noticeable move towards bite-sized consumer financing solutions and techniques, mainly fueled by Gen Z and millennials. Development in semi-urban areas and the NTC sector also demonstrates that lenders are starting to take advantage of different data sources for underwriting and assessments and successfully extending their customer base through various digital platforms.

The popularity of short-term, low-cost personal loan solutions that provide ease and improved customer service has snowballed. Additionally, CC proposals centred around equated monthly instalments (EMI) have begun to gain popularity in the small-ticket size sectors. From a fintech company's point of view, we observed the creation and scaling-up of card-based loan solutions, low-cost BNPL (like ZestMoney), and convenience BNPL (like Simpl and LazyPay).

The recently implemented digital lending standards and new limits on prepaid payment instruments (PPIs) providing credit lines, in particular, will have a detrimental effect on these companies' current business strategies and revenue streams, notably those that involve card-based lending and BNPL providers offering recurrent lines of credit for online purchasing.

The foundations for consumer financing and lending continue to be robust and resilient, despite the fact that the regulatory framework will become more restrictive and fintech companies will grow slower in the short-term consumer financing sector. With a growing partnership between fintech firms and banks on consumer financing (such as co-branded cards) and an increasing number of low-limit credit cards with creative and adaptable reimbursement alternatives, we anticipate that certain finance factors and elements will change to comply with regulatory standards. 

We also anticipate that end-use-specific loans offered by POS providers and payment aggregators at the point of sale will gain tremendous momentum. Furthermore, regulatory scrutiny of fintech companies in general and headed explicitly by DLAs or loan service providers (LSPs) is projected to increase, with RBI planning to create a fintech sector in the country.

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