Explained: Are fintech companies unmindful of Mint Road's message?

A survey by the Fintech Association for Consumer Empowerment (FACE) — in collaboration with the Center for Financial Inclusion — saw respondents according very low priority to governance risk. Defined as “weakness at the board level leading to poor oversight and control”, it was ranked 19th by non-lenders and 22nd by lenders.

This is surprising, given that it is at the top of Mint Road’s agenda.

Shaktikanta Das, while speaking at the Global Fintech Festival in Mumbai last September, said “we would expect the ecosystem to pay attention to governance, business conduct, regulatory compliance and risk-mitigation frameworks.” The Reserve Bank of India (RBI) governor noted that even as the fintech traffic is set to go up, it is imperative that “every player on this road follows the traffic rules for his/her own safety and the safety of others.”

So, what explains the low rank accorded to governance risks?

The survey report argued that the responses were received at a time when other factors were top of the mind, “which could explain the lower ranking.” It doesn’t flesh out what these “other factors” were. 

Surprisingly, the survey (Fintech Lending Risk Barometer 2022-2023: Understanding the Perception of Risks in the Fintech Lending Sector) was conducted in November 2022 — two months after Das had voiced his concerns, even though it was made public only in mid-January.

Fintechs’ attitude towards governance has major implications.

A funding winter is on the cards due to the sharp rise in global interest rates. Now, data-tracking of fintech funding is proprietary — consultancies and private equity firms do it — and we have nothing that mirrors bank credit tabulation.

According to Bain & Company (India Fintech Report 2022: Sailing Through Turbulent Tides), the sector has guzzled $35 billion since 2000. It estimated that inflows in 2022 would be $8.4 billion (lower than the $10 billion in 2021.) The fall of $1.6 billion may be seen as a blip, but two RBI circulars may also have played a part: One stipulated that pre-paid instruments were not to be funded from credit lines from shadow banks (issued on June 20 last year), while the other, issued on August 10, tightened digital lending norms.

More moves by the banking regulator are on the cards; and there are reasons to believe that the fintech valuation game may be over in favour of governance. The executive summary of the RBI Working Group’s Report on Digital Lending through Online Platforms and Mobile Apps (November 2021) could not have been more upfront.

The report said the pandemic-led growth of digital lending led to unbridled extension of financial services to retail individuals, “susceptible to a host of conduct and governance issues”. Digital innovations along with the possible entry of Big Tech may alter the institutional role played by existing financial and regulated entities, it added.

The fallout may be reflected in the blurring of regulated and unregulated financial institutions and activities. “Such developments spurred by mere commercial considerations would pose regulatory challenges in ensuring monetary and financial stability and in protecting the interests of customers.”

What this amounts to is that business models of many fintechs will have to be reworked, even as funding sources dry up — relatively. Coatue Management, a US-based hedge fund, in its report, Fintech and the Pursuit of Prize: Who Stands to Win Over the Decade, is categorical that “the next generation of enduring fintech requires a focus on owning the balance sheet, maniacal re-bundling, a business-to-business leaning, and building high-margin sub-verticals”.

Fintechs will soon realise that being privately held is very different from being publicly listed; issues such as related-party transactions will soon be taken up by financial sector regulators. The Articles of Association of several of these companies, which state that their promoters can continue to be on the board for eternity, will not be valid much longer. Governance for all entities regulated by the RBI will move towards uniformity.

The exit route for fintechs and their backers is set to narrow. The Securities and Exchange Board of India is looking at capital float norms for start-ups. The grapevine has it that an insistence on a three-year dividend-paying record — ahead of listing — could be back on the discussion table.

View from the ground

The priorities: The top three risks identified by lending fintechs were unscrupulous fintech lenders, cyber fraud and crime, and funding. Non-lenders named unscrupulous fintech lenders, data privacy, and cyber fraud and crime

Funding: Capital concerns are on the rise. The uptick in global interest rates may lead to a fall in private equity flows

The regulatory front: Mint Road will cut out all avenues of regulatory arbitrage. Business models will have to be reworked in line with regulatory changes

Exit options: The Securities and Exchange Board of India is looking afresh at capital float norms for start-ups. Moderation in fintech valuations and narrower exit options for investors are likely