“Banking is necessary, banks are not.”
Bill Gates
INTRODUCTION
Traditionally, banks have offered a wide range of services from current and savings accounts, money transfer, debit and credit cards, loans, insurances etc. But, technological interventions have brought radical changes in the way these services are being offered to the customers. The technological advancements in the financial sphere resulted in emergence of ‘Fintechs’.
Fintechs are gradually transforming the face of banking by providing novel and customized products to meet the individual needs. Fintechs have overhauled the traditional system by making financial services more accessible, faster, cheaper and efficient.
Remember the 90’s when the only way of transferring money to someone’s bank account was visiting the recipient’s bank and depositing money using deposit slip or by sending money order. However, with changing times and technological advancement the scheme of things took a 180 degree turn. Physical money took shape of plastic money in the form of credit and debit cards, ATMs were introduced in 1987 and finally net banking became a reality in 1996. Though use of debit and credit card for online transaction is still stigmatized and many of our parents are still reluctant to use it. But, India is at the cusp of a transition with 65% population being below 35 years. A large portion of our demography is tech-friendly. The period of demonetization further pushed the use of digital banking by increasing the use of online transactions. And now with the outbreak of Covid-19, the preference for contactless payments via quick response (QR) code has risen, thereby minimizing the chances of contamination or spread of virus.
As per a recent report by Razorpay, digital payment transaction rose to 23% in a month during June 3, 2020 to July 2, 2020. Also, Unified Payments Interface (UPI) continued to be the preferred mode and grew to 43%, while use of cards was up by 40% and net-banking by 10%.
Now, the new era of neobanking is surfacing in the digital banking space. Neobanks refer to complete digitization of the banking structure with 100% virtual operation. The United States (US) is home to some of the oldest neo-banks including Simple, which was set up in 2009, and Moven, which founded in 2011. Neo-banking has also gained prominence in Europe since 2011 with the customer base growing to more than 15 million. However, it is a relatively new concept for India and has started gaining traction only in the past few years.
NEED FOR DIGITALISATION
With increased mobile and internet penetration along with availability of low cost data plans, customers are shifting from ‘paper only’ offline mode to fully automated online platforms for various services. Recently, Mastercard interviewed 17,000 people from 19 different nationalities. Majority of the respondents (82%) view contactless ‘tap and pay’ method as the cleaner way to pay, enabling the customers to get in and out of stores faster. It appears that the trend towards contactless payments is likely to outlive the virus, with 74% of respondents willing to continue contactless options even when pandemic is over.
The Indian banking sector could be changed dramatically with collaboration of all stakeholders, including regulators, market players and investors. Innovation is no more a luxury; rather it has become a necessity. More importantly there has been a rise in startups, which are gradually digitizing the retail financial services delivered to consumers. It is therefore important for banks to innovate in the retail financial services space in tune with the changing times in order to be relevant.
Customers nowadays enjoy a new world of multichannel banking, where they have access financial services while sitting at their home or offices through mobile based applications. Thus, banks need to have dedicated resources, to form an agile innovation unit, with a view to position themselves at the forefront of digital innovations amidst changing customer expectations and competitive landscape.
Traditional banking practices such as requirement of paper documentation and declaration for wire transfer by visiting the bank, emphasis on physically stamped bank statement for incorporation of company, requirement of tendering a cheque from an existing bank account for high value Real Time Gross Settlement (RTGS) transaction etc. is a tedious exercise. Further, considering lockdowns, quarantines, curfews and social distancing measures, customers are not able to reach banks while many other are reluctant to visit a bank due to the fear of contacting Covid-19. Additionally, many financial services including opening and making the bank accounts functional were affected. The accounts can be made functional only by servicing a ‘kit’ containing debit card, cheque book, banking passwords and account details, sent to the customers through courier services. Due to lockdown these kits could not reach the customers. All these factors, calls for revamping of the banking sector to enable the banking services being available with remote, nointeraction and contactless operations in order to cater to the evolving demands of the new age tech-savvy customers.
NEO WAY OF BANKING
Neo-banks are fully digital financial service providers offering a range of services including payment and money transfer, individual and business loan, overdraft facilities, savings account and tips for saving and budgeting thereby offering an immersive customer experience over a 100% virtual platform.
As per data by Zion Market Research, global neobank market which was valued at USD 18.6 billion (2018), shall be registering a compound annual growth rate (CAGR) of 46.5% during 2019-2026, generating USD 394.6 billion by 2026. As per PWC India, the substantial growth potential for neo-banks is driven by their low-cost model for end consumers with no or very low monthly fees.
It is no secret that traditional banking channels are on the fore-front of increased competition from many arcs of the digital environment. Neo-banks are expanding rapidly, using state-of-the-art technology to win over customers. In the recent years, neo-banks have become the next big thing in fintech.
As the financial landscape is shifting towards customer experience and satisfaction, a gap is created between what the traditional banks offer and what the customers expect. Neo-banks are making an attempt to fill this gap. Since there is absence of physical structure with 100% virtual operation, the customer fee is significantly reduced. Further, neo-banks being customer-centric are capable of providing personalized services related to money transfer, money lending, and other related services.
Case Study: SBI Yono
Yono digital bank by State Bank of India (SBI) is an integrated digital banking platform offering a variety of services like Credit Cards, Loans, Insurance, Investments and other services such as taxi bookings, online shopping and medical bill payments. SBI Yono provides an appbased banking facility with instant account opening. It provides for digital on-boarding of customers through e-KYC and biometric authentication. However, one time branch visit is required to give biometric in case of digital savings account. While insta savings account can be opened within 4 minutes with no requirement of branch visit.
BANK-FINTECH COLLABORATION
Banks often see fintech as competitors but, a broader outlook reveal that banks and fintechs are not heterogeneous. Therefore, they shall act in consonance to attain larger economic goals. From the standpoint of fintech startups, partnering with banks shall enable them to attract a scalable customer base. Alternatively, legacy banking organizations struggling to keep up with consumer expectations shall be able to reach more customers by using technological support of fintechs. Additionally, fintechs can help the banks harness the power of blockchain, artificial intelligence (AI) and big data analysis and to come up with neo-banking structure with 100% virtual operation.
Recently, speaking at the Global Fintech Fest, SBI chairman, Shri Rajnish Kumar said that only 9 out of every 100 transactions happen in SBI branches, while the rest are done through alternative channels. Besides, transactions on ATMs, which used to comprise 55% of total transactions three years ago, have now declined to 30-32%. All this have been possible through bank-fintech partnership.
Case Study: Kotak 811
Kotak, a private sector banks in India, came up with an innovative product ‘Kotak 811’ addressing the concerns associated with physical branch visit and ‘paper-only’ services. Kotak 811 is a new age banking app with main focus on customer acquisition through digital platform with easy account opening services for customers from every strata of society. Kotak 811 provides for a zero contact, video –KYC facilitated banking solutions and is India’s first downloadable bank account that installs and starts in 5 minutes. It allows people to open a zero-balance digital bank account and comes with a virtual debit card with an option of physical debit card and free online fund transfer using National Electronic Funds Transfer (NEFT), Immediate Payment Service (IMPS) or RTGS. Kotak 811 and Kotak remit are blockchainbased financial products designed in collaboration with fintech platforms.
NEO-BANKS IN INDIA
SBI’s‘Yono’, Kotak’s ‘Kotak 811’ and Axis Bank’s ‘ASAP’ are the closest model to ‘Neo-Banks’ in India. Also, ICICI has launched a digital banking platform ‘ICICI Stack’ to provide banking services, including digital account opening, loan solutions, payment solutions, investments, insurance and care solutions. Though virtual banking licenses does not exist in India, foreign banks have managed to offer digital-only products through their Indian subsidiaries.
The Reserve Bank of India (RBI) remains stern in prioritising a bank’s physical presence in India. Further, RBI mandates the requirement of physical presence for banks to provide mobile payment services to residents of India.
In order to overcome regulatory hindrances, neo-banks in India are creating strategic partnerships with traditional banks to offer banking services, for example, Niyo solution tied up with Yes Bank. For the end customer, financial and banking services are offered by the neo-bank, but from a regulatory perspective, monetary transactions are managed by the partner banks.
RELOOKING THE REGULATORY FRAMEWORK
A robust neo-banking infrastructure cannot be created in vacuum. Thus, a specific regulatory framework is required overseeing the entire operations. In light of the same, the regulatory aspects associated with the traditional banking structure need to be relooked and modified. RBI provides for physical inspection of bank branches for different purposes. In terms of neo banking, necessary changes need to be made in RBI regulations to provide for virtual inspection wherein all the information required for the purposes of inspection shall be made available real time over a technological platform. As most of these accounts and data are stored over blockchain, it shall be more convenient for the regulator to trace any discrepancy. As transactions over blockchain are recorded in a chronological order with time stamps, any mutation of data is easily traceable without spending hours in screening through multiple files with bulks of information.
Recently, RBI has introduced amendment to Master Direction (MD) on Know Your Customer (KYC). Ideally, customer shall be able to send their details over a portal used by verifying entity. However, as per MD, the process of digital KYC shall be performed by officials of reporting entity which require more manpower than the earlier method, as now technicians and IT team is required to be on-boarded for the process. Further, the definition suggests that Digital KYC shall be used by banks only when physical KYC cannot be carried out. Thus, even after the MD on KYC being in effect the issue remains unaddressed. But to ensure the success of neo-banks, 100% digital KYC needs to be implemented.
Additionally, RBI circular on Storage of Payment System Data requires all data of payment systems to be stored only in India. International players usually store data on global servers and this requirement of data localization shall require additional investment. A foreign neo-bank willing to offer world-class facilities to the Indian customers may be inhibited by this pre-condition. The underlying procedural requirement insistent on physical form of banking needs to be revised. For example, physical stamping of bank statement for company incorporation, requirement of making payment via cheque for high value RTGS transaction from an existing bank account or making several branch visits to open business bank account. The mandatory physical presence by banks to provide mobile payment services to residents of India also need to be revised in alignment with the virtual infrastructure.
GLOBAL SCENARIO
After the global financial crisis of 2008, a widespread distrust surfaced for conventional banking system. Traditional banking failed to keep up with financial innovations and the everincreasing complexity of the financial industry. This presented fintechs and neobanks as possible alternative to the archaic banking regime and lead to popularity and adaptability of neobanks worldwide.
Europe has been a bright spot for neo-banks in the world owing to the relaxed regulatory regime. Payment Services Directive (PSD) Law has helped in the emergence and development of neo-banks in Europe. The PSD regulated payment services provided for rights and obligations of payment service providers and its users. However, soon PSD was realized to be inadequate on some counts, such as not including entities from other countries outside of the EU region within its ambit and loopholes in guaranteeing user safety. Thereafter, the revised PSD2 was passed in 2016 which came into force in 2018. PSD2 made online banking easier and safer, with new provisions for payments and transactions made outside or received from outside the EU economic area. PSD2 has been a revolutionary move in standardizing the digital market and making it more customer-centric. PSD2 has a significant impact on the establishment of open banking in Europe, allowing users to perform variety of financial transactions and processes with greater ease and security. The sense of security and control over data has played key role in increasing acceptance of neo-banks in Europe.
Case Study: Revolut
Revolut is UK-based neobank established in 2015 with over 10 million users. Revolut has been granted a specialized banking license by European Central Bank via the Bank of Lithuania in 2018, allowing it to accept deposits and offer consumer credits. The main difference between a specialized and a full-range bank is that the former is not authorized to provide investment services. It has an internet-only or digital-only interface. Revolut uses cloud computing services of Amazon Web Services (AWS) and Microsoft Azure and offers all core functions expected out of a traditional bank including current and savings account facilities, wire transfers, insurance, trading, loans and overdraft and business accounts other than handling cash or cheques or offering phone-based assistance. Customers can make transactions as small as USD 5 using Revolut. Further, Revolut automates bulk payments, regardless of business size or payment amount and allows customers to obtain the entire transaction data using ‘search’ option. It is an ‘end to end’ application for banking and financial services. The business model of Revolut is based on vertical integration where there is no intermediary either for core service or for adjacent services. For example, Revolut has built a card fraud detection system ‘Sherlock’.
All of its services are run, built, deployed, and managed internally allowing changing or pivoting the products quickly and affordably.
In Asia, Hong Kong and Taiwan are some of the first regions to issue neo-bank licenses to banks operating solely as digital banks. The Hong Kong Monetary Authority (HKMA) issued guidelines for authorization of virtual banks primarily delivering banking services via internet or other electronic delivery channels. These guidelines can act as a blueprint for other jurisdictions planning to grant digital banking license. As an autonomous license, distinct from the physical bank shall help in better regulation and management of neo-banks.
WAY FORWARD
RBI may have problems regulating these virtual banks that will operate mainly with point-of-sales devices and through business correspondents. But, there is a need for RBI to be more sophisticated and have novel regulatory approach in so far as digital banking is concerned. The financial experts in Hong Kong and Taiwan are of the view that granting licenses to neo-banks shall be a boon for specialized sectors such as micro, small and medium enterprise (MSME) that are continuously seeking expedited credit approval. Hence, with India’s ‘Atmanirbhar Bharat’ mission, we need to consider the specialized banking needs of MSMEs. Creating regulatory sandboxes is a big step towards enabling the growth of digital financial system. Other leading financial regulators including, Monetary Authority of Singapore, HKMA, and Israeli regulators are already taking progressive steps towards neobanking. It is time that RBI follows the trend and chalks out a scheme for rolling out virtual banking licenses in India.
CONCLUSION
Covid-19 pandemic has left no option but to usher a renaissance in the global banking industry with almost every aspect of life transformed by digital enablers. With the rise in online activities and demand for technology enabled financial services skyrocketing, banks have the responsibility to offer frictionless services to their customers. This is the right time for banks to use technological expansion and transform their traditional structure to discover new opportunities of collaboration with fintechs for transitioning to neo-banking structure.
Neo-banking structure not only hold significance in the current situation of Covid-19 by enabling zero-contact, but shall also prove to be of importance in simplifying and increasing ease of doing business in India. It shall improve the image of India as an investment destination since most jurisdictions are now transitioning to tech enabled banking without the incessant requirement for branch visits. Also, this when backed by specific regulatory norms with adequate measures for data protection shall increase customer confidence and adaptability.
Kritika Krishnamurthy (Founding Partner, AK & Partners), Anupam Alok (Senior Legal Counsel, Sberbank), Akanksha Rathore (Associate, AK & Partners).
Assisted by Aashrit Varma (Consultant, Bridge Policy Think Tank).