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:

The post Strategic Mergers: Capitalizing on Fintech Opportunities appeared first on SPJIMR-CFI.

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

The post Will Fintechs Improve Banking Stability? appeared first on SPJIMR-CFI.