Fintech, The Wake Up Call For Banks Before Banks Rest in Peace.

Legacy banking system runs the risk of institutional obsolescence in the long term to the extent that its role might shrink into nothing more than just a repository of money, bereft of any financial services to offer. Courtesy, the small yet fast growing threat from digitally enabled financial services providers called fintech.

The growth of fintech space in India, which kicked off last year, is a wake-up call for banks to either re-imagine themselves digitally or face the biggest upset in financial sector.

"Banking is boring, clumsy, complex and time consuming…it is not as cool as recharging my phone through an app," said a student pursuing MBA from the audience during a session on opportunity in the fintech segment in India at a startup event in Mumbai. That's largely the sentiment among upwardly mobile Indians.

They are ditching banks for basic services in lending, payments and personal finance on both B2B and B2C sides offered by fintech startups with customer experience of quality and speed at suboptimal price. The three categories, where the disruption lies currently, saw the highest fund-raising activity globally in 2015. In India, the growth of fintech shot up in 2015 with record $1.2 billion funding, up from $145.1 million in 2014.

Although around $900 million of the total funding in 2015 was raised by e-commerce-cum-payments major Paytm. "Banking will remain traditional. The products from the consumer, merchant, SME or even corporate side are not going to change. However, the fundamental access to products and fundamental change in behavior are through technology. The front-end technology is mobile and with that taking over, the access channel is changing fundamentally. So financial apps are the next big thing," says H Srikrishnan, CEO, Proposed Payments Bank, Reliance Industries.

Reliance was among the 11 entities to receive payment bank licenses in 2015 and is expected to launch its digital service Reliance Jio in April 2016, which also includes its wallet service Jio Money.

Front-end Disconnect?

The current wave of disruption is largely led by wallet services offered by companies leading the space including Paytm, MobiKwik and Oxigen Services, attacking the payment side of the banks.

Wallets have come up as an attractive alternative payment mechanism for consumers who are unwilling to use their debit cards electronically online or offline. Moreover it helps them overcome the trust deficit in putting their card details every time they use it vis a vis a one-click check out kind of an experience through wallets.

"This is a major disruption for banks as they always wanted to have the front-end relationship with customers for payments through their cards. So future would be wallets in smartphones replacing physical cards," says Bipin Preet Singh, Founder CEO & Director, MobiKwik.

The company has around 25 million wallet users, adding around 2.5 million users per month. However there is a catch. Wallet companies offer big cashbacks, discounts and even 100 percent cashbacks in some cases to customers on every purchase made through their wallets, which seems to be driving wallets' adoption. But would customers still be using them if fintechs pull the plug on cashbacks and discounts? Singh disagrees.

"It is like e-commerce discounts because the market is huge and every e-tailer wants to capture customers and their loyalty. Wallet companies too want to capture users and build loyalty. People have used wallets to pay for recharges and bills but not for e-commerce. So, cashbacks and discounts also serve as incentives for creating sort of a user behavior, which is repetitive in nature," says Singh.

MobiKwik gets more than 90 per cent of its monthly business from repeat customers while around 8 percent comes from cashback. "This means that cashbacks and discounts are not driving the wallet adoption. Although it entices those who haven't discovered the convenience of wallet, once they try it they become loyal customers," claims Singh.

On the business side, companies like Mswipe have been enabling retail merchants with seamless payment acceptance from customers through its mobile point of- sale service, traditionally been offered by banks. However Manish Patel, Founder and CEO, Mswipe, doesn't seem to be disrupting banks.

"Traditionally, payment acceptance has been offered by banks not in true sense as there is a certain threshold for it. Also not more than 10 out of 300 odd banks in India provide this as a full-fledged service because of the cost involved. This has been used more as a tool to get SME customers and try to sell them more of the bank's services. This is where we see disruption as SME customers of any bank can accept card payments through mobile anywhere," says Patel.

Mswipe is currently tied up with 14 small banks to offer service to their SME customers. "Through this we are complementing the banking ecosystem instead of disrupting it. It is just that their pace doesn't match with us," says Patel.

Fighting Back

Banks too are in no mood to give up too early. Large lenders such as ICICI, HDFC, Axis and SBI launched their mobile apps for payments and money transfers. However, there is a lot of ground to cover for these banks. While ICICI bank's wallet app Pockets has seen around 3.5 million downloads since February 2015, HDFC bank's money transfer app Chillr and payment app Payzapp have seen combined downloads of around 2.5 million since February and June 2015 respectively.

On the other hand, Axis bank's money transfer app Ping Pay has just around 100k downloads since May 2015 while SBI's wallet app Buddy has only 350k users since August 2015. Clearly, it is an uphill battle against payment startups.

"Obviously, banks are losing market share as people are using wallets rather than using their cards and bank accounts directly," says Singh. MobiKwik and other wallet companies thrive on banks' weakness in technology and speed to market and ability to stay close to customers by innovating constantly which.

This is a pretty big disadvantage to banks as wallet market is scaling up in the pyramid structure rapidly. "People started using wallets at the base of the pyramid (for utility services). The usage moved up to using e-commerce and then offline commerce.

And now it is moving up towards lending micro credit and going forward it will be into proper lending or virtual credit, personal loans and also into investments. Banks haven't even started at the base of the pyramid so keeping pace with the fintech scaling up is a big challenge," explains Singh.

In addition, not many banks are embracing disruption to take advantage of the nimbleness of fintech start-ups. Apart from HDFC bank's integration with Chillr app in 2015, none of the big banks have tried to integrate their APIs with fintech start-ups.

"Integration is a must for banks if they need to survive because customers are willing to go to different service providers for services at better price, convenience or access point unlike previously where they were happy with getting all services from one bank," says Samir Bhatia, Founder & CEO, SMECorner. The platform allows SMEs to access loans from banks and NBFCs.

Losing Out on Digital

As on 1 January 2016, under PM Modi's Mudra Yojna to refinance collateral free loans of up to Rs 10 lakh, the government announced of disbursing loans by microfinance institutions and banks worth Rs 71,312 crore to 1.73 crore borrowers.

While banks are wellsuited to access credit or underwrite loans looking at a company's balance sheet, how do they learn to lend using another means which are instantaneous and essentially digital. Banks are still unable to do that and that's where they can lose out on their lending opportunity to small merchants, consumers, etc. to online lending and P2P lending platforms, such as SMEcorner (for SME loans) and Faircent (for P2P lending, personal loans).

"Banks have been used to earn large margins between disbursing and sourcing money. If they want to compete, they have to disrupt themselves. It is tough for them to replicate model like ours. Their customers are moving to marketplaces like us to get instant loan at cheaper rates.

This might force these banks to participate in lending through our platforms like us because we have a reverse auction model through which we are trying to commodify the whole lending space," says Rajat Gandhi, Founder & CEO, Faircent.

Compared to 18-20 interest rates by banks on unsecured personal loans, platforms like Faircent offers loans at competitive 15 percent. The start-up charges 2-4 percent in commission from the borrower and 1 percent from the lender.

Faircent has disbursed Rs 2.5 crore in the last 12-14 months and has 5,500 lenders around 22,000 borrowers registered. While banks are the biggest repository of customers' data but because of their complex structure, they lack the ability to create innovative solutions out of it. Also, all data is quite siloed, lying in different departments. This is a white space for fintech start-ups to capture.

"The whole digital revolution is all about data. Banks don't do well in analyzing enormous data they have and generally they are not able to attract the talent to do that. This is where fintech companies can come in through collaboration to mine and analyze that data," says Bhatia.

Banks have nonetheless realized that they have certain strengths on the capital structure, regulatory and compliance side; fintech companies have certain strengths on areas like technology, flexibility, talent and analytics. Eventually, a partnership can be expected to emerge if not complete disruption for banks.

However, fintech will still have an upper hand as to how money flows out in terms of payments, small ticket investments, etc.

(This article first appeared in the Indian edition of Entrepreneur magazine (March 2016 Issue).