Financial inclusion is a key determinant for the development of an economy. However, increasing financial services penetration by setting up Tier II & III cities branches leads to high customer acquisition costs for banks and NBFCs. Additionally, the high cost of delivery, small transaction sizes, lack of credit history, and documentation among rural individuals & MSMEs lead to financial institutions favoring crème customers. This leaves a large untapped opportunity for Fintechs that operate on asset-light tech-centric models to solve the problems faced by traditional banks and make it easier for them to serve lower-income groups.
The MSME Landscape
At the heart of India’s dynamic business landscape, ~63 million MSMEs contribute 27% to GDP, generating one-fifth of India’s employment. The Indian economy continues to modernize at a healthy clip, thus pushing the formalization of businesses. Events such as the introduction of GST in India have further accelerated this process. Thus far, MSMEs have been operating in an informal setup; however, there is a multi-decadal trend where these MSMEs need to formalize and digitize to remain relevant and continue to grow. The introduction of GST has seen rapid growth in the number of GST taxpayers from 5.7 million in 2018 to 7.0 million in 2020. Further, India’s 70 million retailers want to increase their product offerings and augment their income on the rural front. These numbers are expected to increase manifold in the forthcoming years as they come into the financial inclusion fold.
The formalization of this customer group creates multiple opportunities across various technology SaaS products, income augmentation products, and financial services. One of the challenges for traditional delivery models has been how to reach these MSMEs across India given geographical dispersion, slow technology adoption, and low ticket/ transaction size. This will be solved through the technology-led ecosystem and efficient distribution. This is creating an attractive product market gap for Fintechs and is a structural opportunity.
How is Fintech helping MSMEs?
Fintech, in its endeavor to provide hassle-free financial services, is working towards becoming a one-stop solution for small enterprises to meet their financial needs. The need for businesses to formalize is creating multiple product opportunities. The product stack of Fintech is more wide-ranging than traditional banks. The fintech product stack could be dispersed and range from procurement, SaaS-ERP systems, commerce and payments, income augmentation, wealth, and lending. This allows Fintech to drive greater business visibility, exercise better control, and generate transaction data.
We have seen the single-product (lending only) and multi-product Fintech models beginning to scale in India. Our view is that a multi-product allows firms to generate transaction data to solve the lending in a rather difficult segment. The payments have been at the forefront of adoption as B2C-centric MSMEs digitized their customer-facing payment systems. The adoption of UPI is a prime example of the payment revolution in India. In the UPI ecosystem, the growing disintermediation of payments has created intense competition for banks. While the bank retains control of the payment source and destination (along with any related costs), Fintechs (with a 98 percent value market share in UPI payments) dominates client and merchant acquisition and the user experience. On the B2B side, the payment systems adoption rates have significantly increased, driven by internet adoption and the need to move businesses online. Fintech again continues to dominate this segment with payment gateways and aggregator platforms. Fintechs powered with alternative credit evaluation models and transaction data can offer low-cost loans with a technology-enabled asset-light model on the lending side.
Rural India landscape
India is home to over 1.3 billion people, out of which 900 million reside in rural areas. A major chunk of this population is underserved in terms of basic banking services. Therefore, to promote financial inclusion, the Government introduced various initiatives, most important among them was developing a digital pipeline that involved linking Jan Dhan accounts (currently standing at ~420 million) with Aadhaar cards and mobile numbers (i.e., the JAM trinity). This digital infrastructure acted as an essential backbone for facilitating DBT (Direct Benefit Transfer) flows, adopting social security schemes, and promoting a cashless society by enabling digital payments through RuPay cards. Thus, accelerating the pace of developing an insured, digitalized, secured, and financially empowered society. The current average balance in these accounts stood at around D 3,000/- as of March 2021.
However, for the rural population to shift from cash to digital modes of transaction, the need for robust interoperable cash in cash out (CICO) network emerged. Hence, in conjunction with the Government, the RBI launched the banking correspondent (BC) model and set up new brick-and-mortar branches and ATMs in every location to increase penetration in Rural India and expand the banking network. But, given India’s vast geographical base and large population, it becomes excessively difficult for FIs to reach out to every individual. Setting up branches to increase touchpoints involves huge infrastructure costs. On the other hand, the BC model attracted various regulatory requirements like settling withdrawals and completing accounting with bank branches within 24 hours of completing the transaction, which is difficult due to the distance, lack of human resources, and technology. Therefore, access to banking services among the rural population is a problem that persists.
Financial Institutions like iServeU specifically target these challenges and the audience associated with them. Their objective is to promote financial inclusion by catering to the said underserved audience.
Fintechs leveraging on the BC model
Fintechs today, with their innovative business models, provide last-mile links to banks to connect the rural population to modern technology and offer services through local retail stores. They empower BCs through their technology-enabled platforms and are riding on the various initiatives taken by the Government over the past decade like JAM trinity, RuPay cards, and the continuously advancing digital infrastructure – the IndiaStack.
On the other hand, banks benefit through this model as the entire setup cost is taken care of by Fintech. Since Fintechs operate on a fully digital asset-light model, it becomes easier for them to serve lower-income groups in deeply penetrated areas. Partnering with banks enables Fintechs to embed offerings like loans, insurance, and investment in their product stack. As for banks, tie-ups with Fintechs help them in increasing customer servicing channels that result in enhanced user engagement, increased market reach for their products, and drive cross-selling through the network.