Over the past six to seven years, nimble Chinese fintech companies responded to consumer needs that banks had ignored. Fintech flourished. The Chinese money market fund Yu’e Bao, launched in 2013 by Ant Financial, quickly became one of the largest mutual funds in the world. It offered higher deposit rates than banks.
By Q4 2020 Ant Financial was the single largest originator of consumer loans in China issuing one-tenth of all non-mortgage consumer loans in China. It was about to be listed on the Hong Kong stock exchange as one of the largest initial public offerings of all time.
But regulators in China called a halt to the (Initial Public Offering) IPO and are now engaged in reshaping the landscape. The capital-light Chinese fintech companies are being pushed into the regulated banking sphere with greater capital requirements. The pre-IPO investors in Ant bought into a highly profitable business model that is now having that high profitability stripped away.
In contrast to Chinese banks, Indian private sector banks—regulated by the Reserve Bank of India (RBI)—have been fast to respond to consumer needs and partner with fintech startups.
While in the past five years over 400 million Indians have started to use mobile phones. The fintech revolution is just beginning. RBI has been encouraging banks and fintech companies to work together and is creating new categories of regulated entities to encourage the latter to serve the priority areas of agriculture, small and medium enterprises (SMEs), and low-income earners.
As a result, a large part of the Indian fintech world is growing up inside rather than outside the regulated banking framework. This makes regulatory shock much less likely in India in the future. A lower probability of regulatory surprise is always good news for investors.
The consumer finance juggernaut unleashed by fintech in China was tremendous. According to IPO documents dated June 2020, over 500 million users borrowed money from the consumer and SME lending units of Ant Financial. In June 2020, Ant-originated loans to consumers totalled over USD 260 billion while USD 62 billion lent to SMEs. Insurance and investment offerings to consumer though smaller in size were still significant. The rising middle class had unmet needs for financial services.
Can the same happen in India?
Indian smart phone revolution has just begun
In 2016, a vast majority of Indians came online via a smartphone revolution triggered by Jio – the wireless platform of Reliance Industries – starting in 2016. According to Statista, smartphone users in India jumped 8x between 2013 and 2019 from 76 million to 635 million. Indians today primarily access the internet through their smartphone as evidenced by total internet-connected population of 637mm.
How do internet-connected Indians access banking services? The Google Play app store rankings for the finance category provide some interesting insights here. Note that Android is the smartphone OS of choice in India, with 95% market share as of August 2020. According to App Annie, the top three apps in the finance category as of September 16, 2020 were all smartphone-based payment apps – Google Pay, PhonePe, and Paytm. These three apps allow users to send money from their bank accounts to other people as well as businesses using payment rails known as the Unified Payment Interface or UPI.
Furthermore, two out of the three payment apps mentioned above also rely primarily on private sector banks to process their transactions. According to the National Payments Corporation of India, Google Pay has partnered with Axis Bank, HDFC Bank, ICICI and State Bank of India while PhonePe has partnered with Yes Bank and ICICI Bank.
The app store data suggests that private sector banks along with State Bank of India (a public sector bank) have taken the lead in offering digital banking to customers. As more Indians come online over the next decade, they may turn to them for their banking needs, which might lead to further market share gains by the private sector banks and lead to more value creation for their shareholders.
Fintech and banking collaboration
The youthful history of the private sector banks, all of which were licensed after 1992, may make it easier for them to partner with fintechs. A recent report by Deloitte and the Confederation of Indian Industry points out that competition between banks and fintechs are giving way to collaboration. Partnerships, innovation initiatives and investments between fintech and banks are becoming more common. The report highlights eight different fintech tie-ups with HDFC Bank ranging from biometric payments, QR code payments, new/used car sales, and AI-led customer response.
But even with savvy digital partners, demand from consumers has temporarily swamped temporarily the technological capabilities of at least one bank. RBI recently required HDFC Bank to suspend all launches of its digital business generating activities and sourcing new credit card customers due to a series of recent technology failures. HDFC has put forward a solution that seems satisfactory to regulators and is expected to resume these activities by mid-2021.
Indian fintech companies are sprouting up in the form of different types of newly created categories of regulated entities such as payments banks and small finance banks. The RBI has issued eleven licenses for payments banks with only six now in business such as Airtel Payments Bank, Jio Payments Bank and Paytm Payments Bank. The payments banks can offer savings accounts up to roughly USD1365, handle payments/remittances, transfer wages/subsidies and provide ATMs. But these entities cannot issue credit cards or engage in consumer lending or offer mortgage related products to its users.
Another area of innovation is the New Umbrella Entities initiative launched by RBI in August 2020 to create alternatives to the current UPI payment system. In the light of the tremendous expansion of mobile internet-enabled commerce and banking, it is felt the RBI wanted to create some competition. To date, four major consortiums have sprung up to apply. Private sector banks are participating in at least three of the four large contenders. Fintechs are an important part of the mix, also in three of the four significant groups. The application period has been extended to the end of March.
Major regulatory changes in China
A few weeks ago, regulatory authorities in China announced new capital requirements for loan originators. The proportion of capital from any partner in a loan should not be less than 30%. This is significantly more than the 2% Ant was previously reserving.
It was good while it lasted. The capital-light business model of Chinese fintech world created high rates of return for their shareholders. Now that the Chinese fintechs must hold more capital like the banks, their rates of return will diminish significantly. Investors who expected future Chinese fintech corporate earnings to look like past earnings must be sorely disappointed.
In contrast, Indian fintechs have been let into the financial system with less scope to offer the wide range of insurance, credit and investment products that their Chinese peers were able to provide. In many cases, the fintech is a partner or adjunct to the bank and falls under the government’s regulatory purview. As a result, the regulatory surprises of China are less likely to appear in India. This is good news for investors. Decreased corporate profitability at the swipe of a bureaucratic pen is usually a rude shock.
Keeping the profits
Based on the Chinese digital economic experience we can be optimistic for India. The liberating power of mobile internet access is transformative. Without a history of legacy systems, China jumped straight into the new age of consumer finance. That revolution has just begun in India.
But thanks to the Indian oversight framework that is encompassing fintech, investors may look forward to fewer regulatory surprises like those facing the private shareholders of Ant and other fintech companies in China. This allows investors in high growth stocks of Indian private sector banks and fintechs to invest today in confidence that the rules of the game are less likely to change against them.
Amit Anand is a co-founder of NextFins, the creator of INDF, the New York Stock Exchange-traded ETF of Indian financial companies.
RoseMary Safranek is senior advisor to INDF.