The Reserve Bank of India’s Financial Inclusion Index has shown a noteworthy 16% increase from 2017 to 2023³. This growth is attributed to the increased accessibility of financial services. Fintech firms are leading the way in driving transformative change through innovations like digital wallets, mobile money, peer-to-peer lending, and inventive micro-insurance products.

Gender Disparities in Fintech Usage: Insights from Global Research

The research paper titled The Fintech Gender Gap published in the Journal of Financial Intermediation in 2023⁴ explores gender disparities in fintech usage based on user attitudes. The study utilized the 2019 EY Global Fintech Adoption Index, surveying 27,103 adults across 28 countries, with 50% female representation and an average age of 43 years. The data indicate that women, often have lower incomes than men. They are less likely to live alone, work, or hold higher education degrees. Women also exhibit greater uncertainty about future planning.

Key insights of the study:

1. Digital Usage in Developing Countries: In developing countries, the usage of mobile phones and internet access among individuals was found to be 89% and 80% respectively (Figure 1). The proportion of men using mobile phones is 2% higher than that of women. This difference is much smaller than the global gap of 6%.

Figure 1: Digital disparity in developing countries

Source: Chen, S. & Doerr, S. & Frost, J. & Gambacorta, L. & Shin, H.S., 2023. “The fintech gender gap,” Journal of Financial Intermediation, Elsevier, vol. 54(C).

2. Fintech Adoption Disparity: While fintech holds promise to narrow financial service gender gaps, the study reveals that men’s fintech adoption rate is 29%, surpassing women’s at 21%.

3. Drivers of Fintech Gender Gap: It includes attitudes towards technology especially concern for privacy and security, price sensitivity, and product suitability. These factors explain 75% of the gender gap in fintech usage (Figure 2).

Figure 2: Factors influencing the gender gap in fintech adoption

Source: Chen, S. & Doerr, S. & Frost, J. & Gambacorta, L. & Shin, H.S., 2023. “The fintech gender gap,” Journal of Financial Intermediation, Elsevier, vol. 54(C).

4. Financial Gender Dynamic: Men use traditional banks (7.1%) and fintech (5.2%) more than women. Integrating fintech with traditional services reduces the gender gap. The gender gap was approximately 50% smaller when fintech complements traditional financial services. This indicates that women are more receptive to fintech when it complements rather than substitutes traditional financial services.

Thus globally, men use fintech more than women. The study suggests that policymakers tackle underlying issues for greater inclusivity in fintech services.

Implication in the Indian Context

India made notable strides in narrowing the gender gap in mobile internet adoption between 2018 and 2020. Unfortunately, a recent surge in mobile internet adoption among men has reversed this progress, emphasizing the need for sustained efforts to promote financial inclusion (Figure 3)⁵ .

Figure 3: Mobile internet adoption in India, 2017-2022

Source: GSMA Consumer Survey, 2017-2022

To bridge the digital gender gap by 2030, over 800 million women must embrace the mobile internet, but based on prevailing patterns, the expected mobile broadband adoption is forecasted to be limited to 360 million.⁶

Fintech Bridges the Gender Gap in India

Empowering Financial Inclusion: The initiative of Pradhan Mantri Jan Dhan Yojana (PMJDY) is effectively narrowing the gender gap. India ranks 135th out of 146 countries, with a gender gap closure of only 62.9%. The LXME fintech company aims to address the market gap created by gender disparity to capitalize on the opportunity through its unique Neo Banking Platform. It intends to have a lasting impact on how Indian women manage finances⁷.

BNPL (Buy Now, Pay Later) Revolution: Additionally, the rise of BNPL solutions contributes significantly to financial inclusion, offering women easier access to credit. Fintech’s influence democratizes credit, with 66% of women finding it accessible and 51% expressing a preference for BNPL over credit cards⁸.

Tailored-made products by fintech: Fintech firms in India are adapting by developing tailored products to meet women’s specific needs. For example, Dvara SmartGold offers doorstep services for assaying gold for loans, empowering women to gain control of their finances⁹. Another key strategy involves empowering women through financial literacy programs. Initiatives such as the Saksham mobile app, by the National Bank for Agriculture and Rural Development, educate rural customers, including women on various financial topics available in multiple Indian languages. This app can be used both in online and offline mode.

Enhanced financial reach: Fintech firms leverage technology to extend financial access to underserved populations, including women. Platforms like Grameen Financial Services, aided by digital wallets like Phonepe and Paytm, enable secure cashless transactions and provide essential services to women. PayNearby has also launched a ‘zero investment plan’ for women entrepreneurs, empowering them across various PIN codes⁹.

Conclusion

Fintech companies are proactively utilizing technology to overcome barriers, enhancing the accessibility and user-friendliness of financial services for women. Strategies include tailored products, government initiatives, financial literacy programs, improved access, and a customer-centric approach. Ongoing efforts to address discrimination and societal norms are the key to significant progress. By steadfastly implementing these strategies, fintech can play a transformative role in diminishing gender disparities and fostering a more inclusive financial environment in India.

Sources:

1. https://www.boomlive.in/explainers/only-31-of-women-in-india-use-mobile-internet-says-gsma-report-22198
2. https://bfsi.economictimes.indiatimes.com/news/fintech/breaking-barriers-fintechs-role-in-achieving-gender-equality/98418216
3. https://www.statista.com/statistics/1421253/india-financial-inclusion-index/
4. Chen, S. & Doerr, S. & Frost, J. & Gambacorta, L. & Shin, H.S., 2023. “The fintech gender gap,” Journal of Financial Intermediation, Elsevier, vol. 54(C).
5. GSMA Mobile Gender Gap Report 2023
6. https://telecom.economictimes.indiatimes.com/news/industry/india-largely-drives-gender-gap-in-mobile-internet-use-across-south-asia-lmics-gsma/100652947
7. bfsi.eletsonline.com
8. https://business.outlookindia.com/news/technology-bridging-the-gender-gap-in-financial-inclusion-news-185862
9. https://blogs.adb.org/blog/how-fintech-can-enable-financial-inclusion-and-reduce-gender-gaps-india

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India’s Banking, Financial Services, and Insurance (BFSI) sector has witnessed a notable surge in mergers and acquisitions (M&A) activity. This trend is set against a global backdrop where financial services M&A is also on the rise, particularly involving fintech companies, reflecting a broader shift in the financial industry’s landscape.

In FY22, India’s M&A activity in the BFSI sector reached a three-year high with deals amounting to $90.4 billion in the first nine months of 2021, according to Refinitiv¹. The global financial services M&A landscape remained robust in 2022, with announcements totalling $15.47 billion by February, reflecting a significant 43.7% year-on-year increase. The US (58 deals) led the pack, followed by the UK (14 deals), and India (9 deals), underlining the country’s prominence in the global financial services M&A arena².

Deal activity by value increased ~2.5x in the Financial services sector attributable primarily to deals driven by portfolio restructuring by leveraging cross-selling opportunities and expansion of offerings through investment in fintech and digital capabilities.

The ongoing adoption of digital tools and the need for transformation is expected to continue driving M&A activity³. With India marking its presence prominently in this arena, it becomes imperative to understand the dynamics and potential outcomes of such mergers and acquisitions, especially in the context of fintech firms.

Success Factors in Bank-Fintech Mergers: Insights from a Comprehensive Study

The paper titled “When do M&As with Fintech Firms Benefit Traditional Banks?” published in the British Journal of Management in 2023⁴ aims to explore the factors that determine whether mergers and acquisitions (M&As) with fintech companies are advantageous for traditional banks. Using Refinitiv Eikon database, authors analysed 5856 deals worldwide from 2010 to March 2020, focusing on 60 Fintech M&As. The study focuses on the sustainability of the acquiring bank, the extent of minority ownership in the fintech company, and the institutional differences between the fintech’s home country and the bank’s home country.

Key findings and insights from the study:

1. Acquirer Sustainability: The sustainability of the acquiring bank has a U-shaped effect on the bank’s expected performance. Banks that prioritize environmental, social, and governance (ESG) factors tend to perform well in fintech mergers. However, the costs associated with sustainability initiatives can also negatively impact performance. Overall, a balance is needed.
2. Minority Acquisition: Acquiring a minority stake (less than 25%) in a fintech company tends to positively affect the acquiring bank’s stock prices. Gradual integration of knowledge through open innovation is a key benefit of minority acquisitions.
3. Institutional Distance: When banks merge with fintech firms from different regulatory and institutional backgrounds (institutional distance), their stock prices tend to increase. Cross-border mergers offer opportunities for innovation and knowledge diversity.

Implication of the Study

Based on the insights of the research paper, Indian banks considering M&As with fintech firms should develop a strategic approach that incorporates the following elements:

Balanced Sustainability Approach: For Indian banks, this implies a strategic approach to sustainability. Banks need to integrate ESG principles into their core operations and investment decisions, aligning them with long-term profitability and shareholder value. This could involve investing in green technologies, developing sustainable lending practices, or engaging in community development projects. However, it is critical that these initiatives are cost-effective and contribute to the bank’s overall strategic goals.

Selective Minority Investments: The study highlights the positive impact of acquiring minority stakes in fintech companies. For Indian banks, this finding offers a strategic path to innovation and digital transformation. By acquiring minority stakes, typically less than 25%, in emerging fintech firms, banks can gain access to new technologies and innovative business models without the complexities and risks associated with full ownership.

This approach allows Indian banks to tap into the agile and innovative culture of fintech start-ups. It enables a gradual integration of new technologies and business models into the traditional banking framework. This open innovation strategy can be particularly beneficial in the rapidly evolving Indian financial market, where there is a constant need for innovation to meet changing consumer demands and regulatory challenges.

Cross-Border M&A Opportunities: Cross-border fintech M&As can offer Indian banks access to advanced technologies and practices that may not yet be prevalent in India. This can provide a competitive edge in the domestic market. Additionally, these mergers can facilitate the entry of Indian banks into new geographic markets, expanding their customer base and diversifying their revenue streams.

The data on recent M&A deals in India’s BFSI sector provides a practical context to the implications of the study (Table 1).

Table 1: Recent M&A Deals in India’s BFSI sector

Source: Globaldata.com⁵

The acquisition of BillDesk by PayU and HDFC Life Insurance’s acquisition of Exide Life Insurance, both involving 100% stakes, illustrate the confidence and commitment of acquirers to fully integrate the target companies into their operations. This aligns with the strategic objective of acquiring complete technological and operational capabilities, market share, and customer base.

In contrast, the Sumitomo Mitsui Financial Group’s acquisition of a 25% stake in Fullerton India and Alphabet Inc’s acquisition of a minority stake in Bharti Airtel represent the strategic benefit of minority acquisitions as outlined in the study. These deals allow the acquirers to benefit from innovative capabilities and market presence without the complexities of full integration, as well as gradual knowledge integration and shared innovation.

Conclusion

There is significant potential for growth and innovation through strategic M&As with fintech firms. However, this requires a balanced approach to sustainability, a strategic focus on minority acquisitions, and an openness to cross-border opportunities. By carefully considering these factors, Indian banks can leverage fintech M&As to enhance their competitiveness, drive innovation, and ensure long-term profitability in an increasingly digital financial landscape.

Sources:

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The research paper on the Impact of Fintech Firms on Bank Financial Stability in the Journal Electronic Commerce Research (2022) discusses how the growth of Fintech companies, which use technology to provide financial services, impacts the stability of traditional banks. The sample consists of 26 Islamic and conventional banks from Malaysia from 2003 to 2018¹. It was found that FinTech companies came into existence because traditional banks had problems, especially during the global financial crisis in 2007-2008. Fintech stepped in to offer solutions to these problems.

Fintech companies offer cheaper and more efficient services, impacting traditional banks’ loan profits. To stay strong, banks should invest in innovation. Banks can respond to Fintech competition by incorporating Fintech services to enhance efficiency and stability or taking risks to maintain profits. Smaller banks adapt faster due to their size and flexibility, while larger banks should protect their customer base with competitive services. Banks with weak corporate governance may be more inclined to adopt Fintech services to address governance issues.

India Perspective

In India, large banks are actively integrating with fintech companies. The future of India’s financial sector depends on these partnerships, combining traditional banking strengths with fintech innovation. We expect more such collaborations in the coming years thereby, playing a crucial role in India’s $5 trillion economy goal⁴.

Figure 1: Partnership between Banks and Fintechs

Rise of Fintechs

The rising trajectory of Fintech companies in banks seems to improve the system’s financial soundness. A recent report by CRISIL Research highlighted the various aspects that have impacted Fintech firms³.

1. Expanding Market Size

Owing to the rise of Fintechs, private banks, and brokerage players have been quick to adapt to changes. But smaller and mid-sized public sector banks have been lagging. The reason can be high initial investments and smaller customer bases which lead to slower adoption rates. Small banks have started embracing neobank architecture. This approach enables them to operate at a lower cost while maintaining compliance. But overall Fintech has pushed the traditional players to relook at their growth strategies positively.

2. Enhancing operational efficiency

Fintechs have been at the forefront of automation. Today, automation has become a crucial factor in the success of brokerage players and large private banks. Smaller NBFCs and PSUs are however lagging in embracing automation. The reason may be their risk-averse nature or scale of operations. They should consider automated solutions to streamline their loan processing workflow and improve their ability to bear risks. With advancements in technology like artificial intelligence and robotics, the initial investment in automation may seem daunting, but the long-term benefits are undeniable. The potential reduction in costs and improved efficiency will serve as a competitive advantage for smaller banks in the financial market.

3. Offering new products

The use of technology in cross-selling has become crucial for large private banks to manage and expand their product offerings. With data mining at their disposal, these banks can target existing customers and offer them personalized products such as personal loans. Small and mid-sized NBFCs and PSUs lag in this aspect due to a limited customer base and changing market demands. These banks need to take a proactive approach to increasing their product portfolio to stay competitive and ensure financial stability. By leveraging technology and data analytics, smaller banks can also tap into the potential of cross-selling and provide their customers with a wider range of services.

4. Customer service and engagement

Fintechs upended the conventional wisdom that you need a large branch presence to drive customer satisfaction. Larger new private banks have harnessed the power of digital channels to improve customer engagement and query resolution. With the implementation of AI bots and automated processes, these banks have not only enhanced efficiency but also instilled a sense of security in their customers. Small and mid-sized NBFCs and PSUs who have been lagging on this front, need to consider this an opportunity to offer personalized and relevant products.

5. Reach more unserved and underserved customers

The collaboration between large private banks and digital solution providers has led to innovative solutions for semi-urban and rural sectors. However, there is still room for growth in reaching out to more customers, especially in the small and mid-sized PSU segment. To bridge this gap, small banks must focus on expanding their reach and offerings, while also keeping up with the advancements made by fintech competitors. These banks need to evolve from focusing on payments and branching into core areas like savings and credit. With such efforts, we can expect to see increased financial stability and improved access to financial services for all segments of society.

6. Lowered Cost for unserved and underserved customers

On this front, surprisingly large new private banks are lagging in responsiveness to fintech. The brokerage players of small and & mid-sized NBFCs, and even large PSUs are more responsive towards an accelerated focus on fintechs to serve the unserved market. Large new private banks may still prioritize established markets to maintain profit margins.

Figure 2: Impact of Fintech
On a scale of 1 to 10 where 1 = Lowest adoption and 10 = Highest adoption

Source: CRISIL research

Conclusion

Overall, the growth of Fintechs has been hugely positive for India; with Fintechs providing higher accessibility and affordability of financial services. Traditional banks will need to adapt to these changes by incorporating Fintech services. Smaller banks are often quicker to adapt, and banks with low corporate governance may rely more on Fintechs to address their governance issues. With the right balance between innovation and customer protection, the industry has the potential to grow even further.

Sources:

1. Safiullah, M., Paramati, S.R., Impact of Fintech firms on bank financial stability. Electronic Commerce Research (2022).
2. The Economic Times
3. https://issuu.com/humanxdesign/docs/impact_of_digital_transformation_on_incumbents_ful
4. livemint.com

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India is expected to become the third largest economy by 2030, surpassing Japan and Germany. It is spending massively on infrastructure development to achieve this target. In the budget for the fiscal year 2023-24, the allocation for capital investment in infrastructure is set to rise by 33%, reaching Rs. 10 lakh crore (US$ 122 billion), equivalent to 3.3% of the GDP¹. Foreign investments will play a key role in making this target sustainable.

A Look Back

India started to make efforts to be included in the global bond indices in 2013 in response to the economic turbulence caused by the announcement of the possibility of quantitative easing by the U.S. Federal Reserve. The ‘taper tantrum’ episode had resulted in large withdrawal of foreign investments from the country, depreciating the Indian Rupee. To control the volatile situation, one of the measures adopted by the RBI was to increase interest rates to encourage foreign investments, resulting in high borrowing cost.

However, until 2020, the Indian Government bond market was dominated by domestic investors (Figure 1). This was primarily due to government-imposed restrictions on the extent of foreign ownership allowed for its domestic debt. Specifically, the government had enforced a 6% cap on foreign ownership of outstanding government securities, along with a limitation restricting total foreign investment in any security to 30% of the outstanding amount². This provided little incentive to foreign investors to include Indian Government bonds in their portfolio. Moreover, foreign investors were unable to monitor the performance of Indian G-Secs because they were not included in any indices. This was a result of India’s inability to meet the stringent criteria set by global bond indices such as the JP Morgan Emerging Markets (EM) Bond Index.

Figure 1: Ownership Pattern of Government of India Dated Securities

Source: Public Debt Management Quarterly Report, Jan-Mar 2022 & Apr-Jun 2023 (Department of Economic Affairs)

Hence, in 2020, when government expenditure soared due to the pandemic and the Indian Government sought ways to source funds and reduce its cost of borrowing, RBI introduced a separate channel, Fully Accessible Route (FAR). FAR made foreign investment in specific bonds possible without any regulatory restrictions. At present, there are 31 securities worth US$ 400 billion that can be traded under FAR.

Current Scenario

The Government of India’s persistent efforts to secure a place in the JP Morgan Emerging Markets Bond Index yielded positive results, with the index providers officially declaring India’s inclusion effective from 28 June, 2024. This inclusion will be phased gradually over a span of 10 months, with an approximate monthly weightage of 1%, culminating in a maximum weightage of 10%. The inclusion reinforces India’s stable economic conditions, also reflected in its consistent BBB-/Baa3 sovereign credit rating by Fitch and Moody’s. “According to the JP Morgan team, almost three-quarters of benchmark investors surveyed were in favour of India’s addition to the index³”.

Upcoming Trajectory

Higher Capital Inflows

The initial expected capital inflow of US$20-30 billion is just the beginning. India’s relatively higher yields compared to other emerging markets in the index could make it an attractive choice for managers seeking to overweight their portfolios (Figure 2). Moreover, JP Morgan’s inclusion has the potential to set a precedent for other emerging market indices, such as the Bloomberg-Barclays Local Currency Government Index and the FTSE Government Bond Index, which could lead to a further increase in portfolio inflows.

Figure 2: Average Yields of BBB+/BBB/BBB- Rated Large EM Markets

Source: Srinivasan, M., & Furey, D. (2023). India Sovereign Bonds: Announcement of Index Inclusion. White Paper, State Street Global Advisors

Stronger Rupee

Higher capital inflows potentially lead to greater demand for the Indian rupee as investors need to convert their foreign currencies into rupees to purchase these bonds. Increased demand for the rupee typically leads to its appreciation. A stronger rupee can also result from improved trade balances. The additional capital can be used to finance trade and current account deficits, reducing the need for rupee depreciation to maintain competitiveness.

A stronger rupee may lead to reduced intervention by India’s central bank to support the currency. When the central bank doesn’t need to continually sell rupees to stabilize its value, it can reduce currency supply, contributing to appreciation. A stronger currency can have positive effects on India’s economic indicators. It can lead to lower inflationary pressures by making imports cheaper, which, in turn, can encourage the central bank to adopt more accommodative monetary policies.

Lower Yields

According to an article by the Bank of Baroda⁴, securities in 5-10 year range are poised to experience the most significant benefits. This is due to the fact that, as of 25 September, 2023, this particular range within the FAR holdings represents the largest share. Consequently, we may observe a downward shift in the entire yield curve within this segment.

Reduced Pressure on Commercial Banks

India’s inclusion in the global bond index is expected to alleviate the burden on commercial banks, which have historically shouldered the majority of government bonds (Figure 1). As foreign investors gain easier access to India’s government bonds, there will likely be a more diversified investor base. This diversification could reduce pressure on domestic banks to absorb government debt, offering them greater flexibility in managing their portfolios and freeing up capital for other lending activities.

Increased Volatility

India’s bond market will become more closely tied to global market sentiment. Any adverse global developments, such as changes in U.S. Federal Reserve policies or geopolitical events, can lead to sudden shifts in investor sentiment, affecting bond prices and yields. Sudden shifts in investor sentiment or changes in global economic conditions can lead to abrupt inflows or outflows of capital, contributing to market volatility. A surge in foreign investment can lead to rupee appreciation, while sudden outflows can result in depreciation. These currency fluctuations can affect the competitiveness of Indian exports and may require intervention from the central bank to stabilize the currency.

Conclusion

India’s inclusion in JP Morgan Emerging Market Bond Index is a positive development and an attestation to India’s stable economic growth. The potential benefits of the inclusion can have a long term impact on the Indian economy. However, the RBI and the government will need to closely monitor market conditions and be prepared to implement measures to ensure stability.

Source:
1. IBEF (May 2023). Advantage India
2. Srinivasan, M., & Furey, D. (2023). India Sovereign Bonds: Announcement of Index Inclusion. White Paper, State Street Global Advisors
3. The Washington Post
4. Mazumdar, D & Gupta, A. (26 September 2023). Impact of India’s inclusion in JP Morgan bond index

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Banks can adopt innovations in the following ways:

a) Internal research and development of the products and services
b) Collaborations with the fintech companies for their specific product(s)
c) Investment or M&A with fintech companies
d) Multiple banks collaboration to develop a fintech solution

The research paper titled “How do banks invest in fintechs? Evidence from advanced economies”, published in 2022 in the Journal of International Financial Markets, Institutions and Money, studies banks’ response to the growing fintech competition by empirically analysing their investment strategy in fintech companies. The research paper uses a sample of 623 fintech companies from developed countries engaged in 803 investment rounds from 2008 to 2018. A total of 263 banks participated in the 803 investment rounds. The fintech companies were categorized into fin-native and tech-native. Fin-native companies’ businesses were based on open banking, deposit and lending, including real estate finance, investment management, capital raising (including crowdfunding), market provisioning (of new platforms for financial instruments that could not be traded before), digital wallets and payments and insurtech. Tech-native companies’ businesses were based on Blockchain, AI, big data and machine learning, cybersecurity and software & services.

One of the key findings of the paper is that out of the 803 rounds of investments, 52% were aimed at fin-native companies, of which 79% were made through equity and 21% through debt. The study also highlights the following factors impacting a bank’s decision to invest in a fintech company:

1) Deal Size: The deal size increases if more banks participate in the round. An additional bank can increase the amount raised between 3.5% and 7.6%.

2) Age of the fintech company: As the fintech companies mature, the rate at which they attract larger investments decreases.

3) Fintech company’s specialization: Banks tend to prefer investing in fin-native companies. However, as the company’s age increases, the likelihood of it being fin-native decreases.

4) Bank features: Larger Banks tend to invest more in fintech companies. Also, less efficient banks, i.e., banks with higher cost-to-income ratios, are more inclined to invest in the innovation of fin-native companies.

5) Equity Deals: A larger deal size reduces the probability of equity financing. An additional bank in the investors’ pool increases the probability of primarily equity-based funding. Larger banks are more likely to invest through equity rather than extending credit lines. Likelihood of equity financing reduces with the age of fintech. Harsher competition from unlicensed lenders in certain countries may push banks to pursue riskier strategies, including choosing equity investments. In contrast, in regulated environments, banks lean more towards credit.

Implications

In the current ecosystem in India, fintech companies play more of a collaborative role with the banks². The Indian start-up funding landscape is dominated by venture capitalists, angel investors and private equity investors. Banks are yet to emerge as key players. However, big banks like Axis Bank, HDFC Bank, ICICI Bank and State Bank of India are cautiously investing in fintech companies (Figure 1)³ . This is consistent with the results of the study that larger banks tend to invest more in fintech companies. However, the absence of public sector banks from Figure 1, other than State Bank of India, with a higher cost-to-income ratio, contradicts the conclusion that inefficient banks tend to invest more in fintech companies. India is expected to become the third-largest domestic banking sector by 2050⁴ . In 2020,

“the Government of India merged ten public sector banks into four banks to drive credit growth, lift the slowing economy and boost the government’s target of a US $5-trillion economy by 2024”⁴. This consolidation has resulted in an approximately 10% reduction in the NPAs of the weaker banks⁵ . Driven by phenomenal demand and government policies, public sector banks are expected to perform better and become more competitive in the market.

According to Tech Start-up Funding Report, Q1, 2023 by Inc42, debt financing was preferred over equity funding for late-stage deals in Q1 2023. The number of debt financing deals was 40% higher in Q1 2023 than in Q1 2022 (Figure 2). This data is again in line with the results of the above study that chances of equity financing reduce as the age of fintech rises.

Figure 1: Total number of start-ups invested in by the Indian Banks as of July 2023

Source: Author’s calculation derived from CB Insights, Expert Collection.

Figure 2: Number of late-stage investment deals in India from Q1 2020 – Q1 2023

Source: Inc42

Conclusion

In the current scenario, any collaboration between banks and fintech firms should not be a zero-sum game⁶ . With licenses from sectoral regulators and years of experience in regulated environments, banks and financial institutions in India have established significant expertise in regulation and compliance. Fintech companies deliver their financial services directly or indirectly by collaborating with these seasoned banks/financial institutions to tap into the formal financial market. Such collaborations can take various forms, including SaaS engagements, technology service provisions, or agency partnerships. Even when fintech firms compete head-on with the banks in the Business-to-Consumer (B2C) domain, the end product often comes from the banks, leading customers to maintain direct relationships with them².

Source:
1. Invest India, National Investment Promotion and Facilitation Agency of India
2. Grant Thornton Bharat LLP (2023). BFSI-fintech Collaboration. An India Perspective
3. CB Insight lists 892 Indian fintech companies with investor information. Of these 892 companies, Figure 1 includes only those with investments received from Indian Banks.
4. Indian Brand Equity Foundation: Banking (May 2023)
5. The Economic Times (29 May 2023)
6. Murinde, V., et.al. (2022). The Impact of Fintech Revolution on the Future of Banking: Opportunities and Risks

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One of the major technological innovations that has found its application in the credit markets is machine learning. According to Oracle, ‘machine learning focuses on building systems that learn – or improve performance – based on the data they consume’. It is a subset of artificial intelligence. Machine learning algorithms are pieces of code that help people explore, analyse, and find meaning in complex data sets. Each algorithm is a finite set of unambiguous step-by-step instructions that a machine can follow to achieve a certain goal². Machine learning algorithms use parameters that are based on training data—a subset of data that represents the larger set. As the training data expand to represent the world more realistically, the algorithm calculates results that are more accurate³.

Source: LinkedIn

Machine learning has the potential to enhance credit allocation, enabling lenders to effectively extend credit. However, according to a research paper titled ‘Predictably Unequal? The Effects of Machine Learning on Credit Markets’ published in 2022 in The Journal of Finance, machine learning lending models would provide higher interest rates to under privileged racial groups. The gains from new technology are skewed in favour of racial groups that have socio-economic advantage.

The research paper used a dataset of 10 million loans disbursed between 2009 and 2013 in the US mortgage market to compare the predictive outcomes, probability of defaulting on a loan, of traditional statistical models with the machine learning models. The results indicate that 65% of White Non-Hispanic and Asian borrowers benefit from the new technology as compared to 50% of Black and Hispanic borrowers. The interesting aspect of the result is that race is not included in the set of variables used to predict the default probabilities.

Figure 2 shows the results of the comparison. As you move from left to right on the x-axis, default probabilities predicted by the machine learning models becomes higher than the traditional statistical models. On the y-axis, as you move from bottom to top, share of borrowers rises. This means that borrowers on the left side of the solid black line are ‘low risk borrowers’ according to machine learning methods.

Source: Fuster, A., et.al (2022). Predictably Unequal? The Effects of Machine Learning on Credit Markets, The Journal of Finance, Vol LXXVII (1).

One of the reasons for these results might be the fact that when the variables under machine learning models interact with each other to predict the outcomes, they bring out the vulnerabilities of the less privileged in the society even when race is not included as an explanatory variable.

Another possibility is that due to societal structure, data itself is skewed against the less privileged, thus increasing their chances of default and charging a higher interest rate. According to the authors’ analysis, since machine learning algorithms are more efficient, they aid the societal bias in the historical data used to predict the default probabilities by further increasing the default probabilities of the Black and Hispanic borrowers. In comparison, the traditional statistical techniques do not significantly impact the default probabilities.

Implications of the Results

Private banks in India have reached 50%-60% automated decision making⁴. If banks buy machine learning models from vendors without thoroughly reviewing them, it can worsen fairness concerns. Machine learning algorithm learns from a large amount of data that represents the real world. If the training data contains any biased information, the resulting algorithm will also incorporate and reinforce that bias. To address this concern, developers need to have a deep understanding of the input and output variables and be knowledgeable about how the chosen algorithm works. However, not all Fintech firms serving the financial industry have this expertise at the moment. As a result, some third-party solutions may create machine learning algorithms that appear to be unbiased, however actually produce biased predictions. Therefore, only experts with the right market knowledge and technical skills can recognize this. Additionally, if the bank doesn’t have direct insight into how the features for the algorithm are selected, the algorithm’s ability to predict accurately may come at the expense of it being too narrowly focused on specific factors, potentially leading to incorrect decisions⁵.

Although qualified analysts and data scientists can explain how machine learning algorithms work with full access to the model, it is more complex to understand how individual decisions are made. The lack of transparency in machine learning models raises additional concerns regarding fair lending practices and regulatory compliance for banks. Compliance specialists cannot review independent variables and coefficients for machine learning models in the same way as they can with regression models because machine learning models lack explicit specifications. This concern becomes particularly relevant when alternative data sources are used to enhance prediction accuracy. Unlike traditional financial data from credit bureaus, alternative data sources introduce more unknowns and uncertainties, making it challenging to understand their impact on decisions.

Conclusion

Artificial intelligence and machine learning algorithms are designed to find hidden patterns in data, allowing computers to make decisions quickly and often more accurately than humans. Unlike traditional models based on economic or social science theories, machine learning models are valued based on their predictive abilities rather than their ability to confirm existing relationships⁶. With the growing volume of data, machine learning will play a significant role for the Banks and financial services providers. However, implementing machine learning into business processes requires careful consideration. It will be a challenging task, but it is essential to be adequately prepared, and have confidence in the quality of the data.

Source:
1. BFSI.com
2. Machine learning algorithms can help people explore, analyze and find meaning in complex data sets
3. Microsoft.com
4. Business Today
5. Brotcke, L. (2020). Time to Assess Bias in Machine Learning Models for Credit Decisions, Journal of Risk and Financial Management, 15(4)
6. BLDS LLC, Discover Financial Services, and H2O.ai

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This is a white paper originally published by The Infravision Foundation.

Link to the white paper: https://justwordsdigital.com/infravision/wp-content/uploads/2023/12/Surety-Bond-White-Paper.pdf

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In the past five years, the Indian Start-up ecosystem has raked in around $100 billion in venture capital funding. However, FY22 witnessed a drop in Indian VC funding to $25.7Bn (0.7x of 2021 funding) possibly due to the market pullback by VC funds that were picky about their investments. Nonetheless, FY22 investments were still 50% higher than investments in Start-ups in 2019.

Impact of SVB Crisis on the Indian Start-ups ecosystem

As per our research, the SVB crisis can potentially have both negative and positive spillover impacts on Indian start-ups as outlined below:

• Reduced funding from international investors
  Due to increased caution and risk aversion among many international investors as a direct result of the SVB crisis, investments in Indian start-ups could possibly decline. The start-ups can become vulnerable to a funding crunch which can result in a scale-down of operations or shutdown. International investors are important for late-stage start-ups, the unicorns & decacorns, and so the slowdown in international investors can adversely affect the scaling-up plan of late-stage start-ups.
• Increased scrutiny of start-ups’ financial standing and its effect on innovation
  The current crisis may result in investors giving more consideration to the financial stability and risk profile of Start-ups and giving more weightage to their revenue, profitability, and cash flows. Also, we expect a stronger emphasis from investors toward joint ventures & consolidations between new Start-ups and established ones.
• Potential positive spillover impact of the US economy
  Despite the negative impacts, there are potential positive spillover effects from the risk of a slowdown in the US economy driven by high inflation, and the US investors are eventually forced to seek out higher growth regions such as India. Indian Start-ups especially late-stage Start-ups just need to navigate the brief period of volatility and slowdown in International capital. A slowdown in the US economy is expected to be positive in the medium to long term with a higher influx of capital into the Indian venture market.
• Positive impact on new opportunities for Financial Service Providers
  There are many financial service companies in India that offer the same services as SVB, albeit on a smaller scale, and the collapse presents a chance for new businesses to offer new products and services. For instance, some of the active private sector banks in the Start-up space such as HDFC Bank, ICICI Bank, IDFC Bank, and Kotak Mahindra Bank, through their branches in Gujarat International Finance Tec-City (“GIFT City”), can use this opportunity to replace SVB as a safer home for the foreign currency Start-up capital that has been raised.
• Regulatory oversight and reporting
  The SVB problem is expected to lead to further regulatory control and scrutiny of financial institutions, making sure that other banks and financial services providers are properly managing and disclosing their risks. However, in the near term, this would also throw up more opportunities for RegTech Start-ups.
• There could be a shift in investment focus to later-stage Start-ups
  Investors may wish to change their focus from early-stage to later-stage Start-ups with tested business models and stronger revenue-generating skills as they become more risk-averse. One can also argue that a reduction in international funding and a shift of investment focus to later-stage Start-ups can put to risk the rate of innovation in India. However, we do not foresee this risk at this stage. There are officially 82,000 Start-ups and counting, along with a multitude of investors, Incubators, Accelerators & Government supported programs. So, we believe that the Indian start-up ecosystem has attained critical mass to sustain global shocks. From a funding perspective, India has a vibrant ecosystem of Government supported players & Angel investors; who have hitherto been largely unaffected by the SVB crisis. So, innovation at the founding stage is unlikely to be significantly affected.

Strategies for Indian Start-ups

In response to the potentially changing investment landscape, Indian Start-ups can adopt various strategies to navigate the challenges posed by the SVB crisis.

• Focus on profitability and sustainable growth
  Start-ups will need to prioritize revenue, streamline operations, and make wise financial decisions while focusing even more on profitability and sustainable growth, and also consider securing funds from multiple sources such as Angel Investors, Venture Capitalists, or Crowdfunding Platforms to minimize the risk of relying on a single source and increase chances of long-term sustainability.
• Improve operational efficiency
  Improving operational efficiency results in enhanced financial stability and attractiveness to investors. Start-ups will need to pay special attention to reducing their overheads and optimizing their marketing and supply chain strategy.
• Diversify funding sources
  Indian Start-ups must look for alternate sources of finance and growth, such as forming alliances with other businesses, signing contracts with clients, accessing Venture Debt, and participating in government-sponsored programmes.
• Transparent governance and risk management
  Start-ups will need to be more transparent to demonstrate their overall strength as an operational firm in order to assuage investor fears and improve their reputation.
• Government and Institutional support
  Indian government should respond more aggressively to the SVB crisis to ensure there is no materially adverse impact on Indian Start-ups. The last 5 to 7 years have shown tremendous benefits to Start-up ecosystem from various visionary initiatives of the Government such as The Atal Innovation Mission, Start-up India, and the National Start-up Awards. Government should enhance the budget allocation to Start-up ecosystems & Start-up Seed Funds. Moreover, the government should create incremental discretionary allocations to invest in incubators and to make further capital available for investment in early-stage Start-ups. Incubators & Accelerators are force multipliers that catapult Start-ups to the next level.

In conclusion, the SVB issue may significantly impact Indian start-ups, investors, and the venture capital industry as a whole. Start-ups will be able to overcome many obstacles by focusing on profitability, operational efficiency, finding alternative sources of finance, and enhancing governance standards.

This article was originally published in Times of India.

Link to the article: https://timesofindia.indiatimes.com/blogs/voices/impact-of-svb-crisis-on-the-indian-start-up-ecosystem-a-comprehensive-analysis

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Tokenization of real estate assets, a new application of Blockchain, is expected to tap into this ever-growing market by simplifying and securing the administrative processes of real estate transactions and making commercial and residential properties accessible to a broader investor base (Figure 1).

The tokenization of real estate is the process of fractionalizing a physical property into digital tokens created on Blockchain platforms.

However, a formal regulatory framework must be established before introducing the technology in the Indian market. Some of the key areas where regulatory compliance is required are:

1. Unregulated cryptocurrency market
The transactions of digital real estate tokens will be carried out on Blockchain platforms like Bitcoin and Ethereum. However, in India, cryptocurrency markets are largely unregulated and volatile. Therefore, a stable, regulated digital currency is needed to encourage serious investors. This makes a case for CBDC, which can become a viable option for trading in real estate tokens.

2. Registration and Stamp Duty
When a property is bought, and the ownership is changed, it is registered at the registrar’s office, and stamp duty is paid. If the payment of the stamp duty and registration process is integrated into the smart contract, is the registrar’s role rendered useless? Another issue in this scenario is that the Government will have limited access to the data related to the registered properties. The companies owning & managing the properties will hold the data.

3. Digital Infrastructure
National Payments Corporation of India (NPCI) launched the NPCI Tokenization system (NTS) in December 2021. Currently, this platform is for the tokenization of cards only. For real estate, either the same platform can be used, or another exclusive platform has to be built since the technology is now domestically available. In either case, there is a need for a licensed platform for tokenization.
Also, large-scale tokenizing real estate in India requires massive IT and power infrastructure. To ensure operational efficiency, high bandwidth internet, data storage capacity, and uninterrupted power supply are essential for the system’s effective functioning.

4. Property Taxation
The Indian Government has brought virtual digital assets (VDA) under the Income Tax Act 1961. If real estate is tokenized, then as per the definition of VDA, property tokens should be considered as VDA. According to the tax laws, a 1% withholding tax is levied at the time of buying the VDA, and a flat rate of 30% is charged on the income from the transfer of the VDA. However, if one buys a non-tokenized property, it is taxed based on the size of the property and profit from selling the property is also taxable. The key difference between VDA taxation and property taxation is that the interest paid on the housing loan is a deductible expense from the taxable income. However, in the case of VDA, no deductions are permissible apart from the acquisition cost. Hence, should this deduction be permissible if a token holder is considered a property owner?

5. Security of Digital Tokens
Blockchain is a safe platform for storing crucial information. However, with respect to the custody of tokens, there have been concerns regarding the security of vaults and other custody solutions. Some of the hacking heists worth millions of dollars have made international news. Regulators must ensure that history is not repeated by providing secure custody solutions for the real estate tokens.
If regulatory and legal compliances are in place, real estate tokenization can potentially transform investments in the sector. Since it is a popular investment instrument, if the benefits of tokenization are realized, it can also pave the way for the tokenization of other assets, particularly the illiquid asset class.

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“Tokenization refers to the replacement of actual card details with an alternate code called the “token”, which shall be unique for a combination of cards, the token requestor (i.e., the entity which accepts the request from the customer for tokenization of a card and passes it on to the card network to issue a corresponding token) and device (referred hereafter as “identified device”).¹

In simpler words, the token will function as the card at Point of Sale (POS) terminals and Quick Response (QR) code payment systems in place of the card’s information.

How does Tokenization work?

In order for Tokenization to operate, the user data must be removed and replaced with these tokens. Whether it’s credit card information, personal health information, Social Security numbers, or any other type of sensitive data that has to be secured and protected, the majority of organisations store at least part of this information in their systems. By using Tokenization, businesses can continue to use this data for their operations without running the risk of breaking compliance regulations by keeping sensitive data on-site.

Enhancing the safety and security of payments is the key objective of the entire process. When a customer enters their card information with the business offering the transaction service, the process is initiated to swap out the credit card information for a token. The organisation that obtains the credit card data utilises a service to convert the credit card number into a token, which is effectively handled like a real credit card number. After receiving the token, the merchant will give it to the commercial acquirer so that the transaction may be completed. The token will be taken from the acquirer by the token’s issuer, who will check its validity by comparing it to their database. The merchant will remain anonymous during this entire process and won’t see the card number.

The process is complete once everything has been approved and the card company’s account is used to send money to the merchant. The customer will then receive the products or services they ordered in exchange.

What are the benefits of Payment Tokenisation?

In accordance with the Indian context, the pandemic has accelerated the pace of digital transactions. Businesses developed improved technologies that supported online transactions as digital commerce grew in order to address consumer desires. ‘The volume of debit card payments in India for the financial year 2022 is estimated to be close to around 4 billion, while the volume of credit card payments was estimated at over 2.24 billion during the same time period.’ ^{2} This shows very high volumes in the payment industry and hence, security is always at risk due to improved levels of digital transactions. While consumers are concerned that various internet platforms may be able to access their sensitive data, businesses are anxious about losing devoted customers. Hence, Tokenization provides an extra layer of security to all the stakeholders involved

In addition to banking, Tokenization has various other benefits over its technical partner – Encryption:

1. Enhanced PCI compliance: Payment Tokenisation implies that fewer devices own card data.
2. Centralized management: The bank that issued the card keeps the token.
3. Flexibility of digital payments processing: The ability to return the money and set up recurring payments.
4. Low transaction cost: There is no need to allocate servers for clients’ data.

When comparing encryption to Tokenization, it should also be noted that tokenization only substitutes the information that is simply hidden by encryption. In most websites and applications, especially those with integrated payment processing, Tokenization has therefore taken the place of encryption. Payment Tokenisation’s benefits make it possible to improve PCI DSS compliance and protect user data while also decreasing the cost and inconvenience of security system maintenance. Also, “Card Tokenization” fosters trust since it easily safeguards the money:

1. Enhanced internal security
2. Increased profitability through improved client experience
3. Avoiding financial loss due to fines
4. Forming dependable connections with customers

Why do we need Payment Tokenization?

In the last 10 years, the financial services industry has experienced a significant technology surge. Online shoppers are growing every day thanks to cardless transactions, UPI payments, payment gateways, etc. One cannot ignore the reality that data is exposed to “Social Engineering” even as one benefits from the convenience of one-click transactions in digital banking. The fact that even if a hacker manages to break into the network, all that would be seen are random alphanumeric characters that have nothing to do with the original data, makes Payment Tokenization the most sought decision in major economies.

To perceive payment tokenisation from a stakeholder perspective, one must understand that the primary objective is to ensure that the actual payment information is not exposed during transactions, which in turn will ensure enhanced security and safety. From an Indian market diaspora, the Tokenization of card payments offers several benefits to different stakeholders involved in the payment process:

Cardholders: By swapping out sensitive payment information with an exclusive digital identity or token, tokenization increases security for cardholders. The fact that real payment information is not disclosed during transactions, helps to lower the risk of fraud. Also, since cardholders do not need to enter their card information each time they make a payment, it streamlines the payment process.

Banks and Payment Service Providers (PSPs): Banks and PSPs gain from tokenization since it adds another level of protection to card payments for them. They may safeguard their clients’ data and lower the likelihood of fraudulent transactions by substituting tokens for real payment information. With less sensitive payment information to maintain and monitor, tokenization also makes the payment process simpler for banks and PSPs.

Merchants: Tokenization offers businesses a number of advantages, including increased security and a decreased chance of chargebacks. Merchants may lower the risk of fraudulent transactions and safeguard the data of their consumers by accepting tokenized payments. As businesses no longer need to retain and handle sensitive payment information, tokenization also makes accepting payments simpler for them.

Payment Gateway Providers: Payment gateway providers benefit from a more secure payment processing system thanks to tokenization since they no longer need to retain and handle sensitive payment information. Payment gateway providers may lower the risk of fraud and make the payment process simpler for users and merchants by accepting tokenized payments.

To sum up, all the parties engaged in the payment process gain from the tokenization of card payments in India, since, it increases security, streamlines the payment process and lowers the possibility of fraudulent transactions. Tanya Naik, Head of Omnichannel, Pine Labs mentions – ‘Given the increasing use of digital payments, it is encouraging to see the regulator take efforts to improve payment security. Tokenization not only helps to make the financial transaction experience more secure for the end user, but it also helps merchants create a consistent user experience and greater transaction approval rates with speed and security. ³’

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