BS Banking Annual 2024: Fintech has tough days ahead, say experts

Late evening on January 31, Mint Road slammed the brakes on Paytm Payments Bank with a ban on raising fresh deposits and credit transactions. A Comprehensive System Audit report and subsequent compliance validation report by external auditors had thrown up “persistent non-compliance and continued material supervisory concerns in the bank, warranting further supervisory action”, said the banking regulator in a statement. The diktat would come into force after February 29; and settlement of all pipeline transactions and nodal accounts (in respect of all transactions initiated on or before February 29) were to be completed by March 15 with a no-go for further transactions after that.

In one fell swoop, the Reserve Bank of India (RBI) hit the reset button for fintech, investors and cheerleaders. The move’s secondary effects would force legacy regulated entities (REs) to take a closer look at compliance issues – both internal and when they shake hands with the new kids on the block. It once again brought into relief RBI Governor Shaktikanta Das’ plain-speak at the ‘Global Fintech Festival’ in Mumbai on September 20, 2022.

“The fintech road ahead will witness ever-growing traffic in addition to the large number of existing players who are already there. It is, therefore, imperative that every player on this road follows the traffic rules for his/her own safety and the safety of others,” Das said. It was a wake-up call for an industry high on adrenaline, where evangelists saw RBI and REs way back in their rear-view mirrors – not nimble enough to rework business models in step with the changes foisted by technology.

And to think it was just a few months ago – last November – that the Centre for Advanced Financial Research and Learning (Cafral), in its first ‘India Finance Report (IFR)’ had called attention to the immense potential of fintech. The independent body set up by the RBI noted that of the 14,000 startups born between 2016 and 2021, close to half were fintech. The IFR projected lending by these entities to exceed that of banks by 2030.

A long winter

Fuel for fintech growth has been an issue for some time now. According to Tracxn – a data intelligence platform for private market research – fintech funding, at $2 billion in 2023, represented a fall of 63 per cent and 76 per cent compared to the preceding years – at $5.4 billion in 2022 and $8.4 billion in 2021. If this was bad enough, the higher risk weights imposed by Mint Road in November 2023 on bank lending to non-banking financial companies (NBFCs) is certain to arrest fintech ability to raise debt (remember: they are an NBFC variant).

The RBI’s stance is that banks have to be cautious in lending to retail, unsecured in particular. It increased the risk weights on exposures of banks to NBFCs by 25 percentage points (over and above what is associated with the given external rating) in all cases where the extant risk weights are below 100 per cent. These were at 25 per cent, 30 per cent and 50 per cent for NBFCs rated “AAA,” “AA,” and “A.” The RBI’s circular is silent on lower-rated NBFCs (many fintech companies fall in this slot), but it is unlikely banks will indulge them. Another detail: Loans are priced to risk; and a few banks are said to be close to their exposure limits to some of even the better-run NBFCs.

“The outlook for 2024 is going to be calibrated. I think this is something which was needed as stronger business models emerge. It would mean a lot of pain in the short term,” says Ankur Bansal, co-founder of BlackSoil Capital. This, even as the RBI in its ‘Report on the Trend and Progress of Banking in India’ (FY24), appears to suggest a tighter regulatory regime is around the corner when it calls attention to some fintech companies playing off entirely on pre-set algorithms.

A report by Coatue on ‘Fintech and the pursuit of prize: who stands to win over the decade (October 2022)’ was 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.” While it’s too early to hazard a guess as to how revenue models will be tweaked, what is certain is that some of them will now have to bite the bullet. For the valuation game is over; it's all about the bottom line here on. 

Some are charitable though. “Fintech funding has fared better compared to the wider startup ecosystem. The financial sector is highly regulated and the recent changes (regulatory) had an impact with late-stage funding taking a hit,” says Neha Singh, co-founder of Tracxn. But as Rohan Lakhaiyar, partner (financial services-risk) at Grant Thornton Bharat, explains, significant funds were raised by fintech at high valuations, even as revenues and positive unit economics remained elusive. A reversion to a normalised state of funding was due. It did in the second half of 2022. Co-incidentally by then, even the share price of PayPal, Square and Tencent had crashed to their five-year lows. “My sense is that the better fintech can expect to get funded, but we are in no way going to get back to the levels (of funding) seen a few years ago,” says Lakhaiyar.

The regulatory maze

The runway interest in fintech before the reality check that Lakhaiyar refers to came about due to an uptick in digital during the pandemic. Mint Road’s Working Group’s (WG’s) ‘Report on Digital Lending through Online Platforms and Mobile Apps’ (November 18, 2021) summed it up: The pandemic-led growth of digital lending meant an unbridled extension of financial services to retail individuals, susceptible to a host of conduct and governance issues. The entry of BigTech may alter the institutional role played by existing financial and REs. The fallout: a blurring of lines between regulated and unregulated financial institutions and activities.

“Such developments, spurred by mere commercial considerations’, will pose regulatory challenges in ensuring monetary and financial stability and protecting the interests of customers,” the WG had noted. Cafral’s IFR had an interesting take as well – the Unified Payments Interface (UPI) helped catalyse fintech expansion. UPI growth picked up during the pandemic; and in the case of districts with greater UPI usage, this was mirrored in fintech lending volumes.

Compliance will come to the fore. A strong self-regulatory organisation (SRO) regime for fintech is on the anvil. “We see firms taking measures to embed principles of client-protection, market stability and regulation into their product and process designs,” says Jatinder Handoo, chief executive officer of the Digital Lenders Association of India. Guidelines for digital lending and fintech have helped the sector and provided comfort to institutional lenders and venture capitalists.

So, where are we headed on the regulatory side on which hinges fintech version 2.0? Almost a year ago, (March 10, 2023) M K Jain, then deputy governor at RBI, said within the regulatory envelope, activity-based regulation, as opposed to entity-based regulation, was gaining traction. The focus will be on attempting to apply uniform rules to activity across REs. That basically means fintech firms will have to wake up to the reality that whatever business they do undertake will be strictly monitored like in the case of legacy REs.

Tough days are ahead.