Banks starting to eat FinTech’s lunch?

I’ve long maintained that the “winner” in the “battle” for payments will be the conventional banking system, rather than one of the new “wallet” or “payment service providers”. This view is driven by the advances being made by the National Payments Corporation of India (NPCI) which is owned by a consortium of banks.

First there was the Immediate Payment System (IMPS) which allows you to make instant inter-bank transfers. While technology is great, evangelism and product management on the banks’ part has been lacking, thanks to which it has failed to take off. In the meantime NPCI has come up with an even superior protocol called Universal Payment Interface (UPI), which should launch commercially later this year.

There is hope that banks do a better job of managing this (there are positive signs of that), and if they do that, a lot of the payment systems providers might have to either partner with banks (the BookMyShow wallet is already powered by RBL (the artist formerly known as Ratnakar Bank Limited) ).

In the meantime, banks have started encroaching on FinTech territory elsewhere. One of the big promises of FinTech (and one I’ve participated in, consulting with two companies in the space) has been to ease the loans process, by cutting through the tedious procedures banks have to offer, and making it a much more hassle-free process for borrowers.

A risk in this business, of course, has been that if banks set their eye on this business, they can eat up the upstarts by doing the same thing cheaper – banks, after all, have access to far cheaper capital, and what is required is a procedural overhaul. The promise in the FinTech business is that banks are large slow-moving creatures, and it will take time for them to change their processes.

Two recent pieces of news, however, suggest that large banks may be coming at FinTech far sooner than we expected. And both these pieces of news have to do with India’s largest lender State Bank of India (SBI).

One popular method for FinTech to grow has been to finance sellers on e-commerce platforms, using non-traditional data such as rating on the platforms, sales through the platform, etc. And SBI entered this in January this year, forming a partnership with Snapdeal (one of India’s largest e-commerce stores).

Snapdeal, India’s largest online marketplace, today announced an exclusive partnership with State Bank of India to further strengthen its ecosystem for its sellers. With this association, Snapdeal sellers will be able to get approval on loans from financers solely on the basis of a unique credit scoring model. There will be no requirement of any financial statements and collaterals.

Sellers on the marketplace can apply for loans online and get immediate sanction, thereby enabling “loans at the click of a button”. This innovative product moves away from traditional lending based on financial statements like balance sheet and income tax returns. Instead, it uses proprietary platform data and surrogate information from public domain to assess the seller’s credit worthiness for sanctioning of loan.

Another popular method to expand FinTech has been to lend to customers of e-commerce stores. And in a newly announced partnership, SBI is there again, this time financing purchases on the Flipkart platform.

State Bank of India, the country’s largest bank, announced a series of digital initiatives on Friday, including a first of its kind partnership with e-commerce giant Flipkart, to offer bank customers a pre-approved EMI facility to purchase products on the retailer’s website.

The bank, which celebrates its 61st anniversary (State Bank Day) on July 1, said the objective was to provide finance to credit worthy individuals, and not just credit card holders. The EMI facility will be available in tenures of six, nine and 12 months.

Just last evening, I was telling someone that there’s no hurry to get into FinTech since it will take a decade for the industry to mature, so it’s not a problem if one enters late. However, looking at the above moves by SBI, it seems the banks are coming faster!


On the death of credit cards

An article that was recently recommended to me on Medium talks about the death of credit cards (among other things that are currently incumbent in the banking system). As someone who has worked a fair bit in “FinTech”, I broadly agree with what he says. As someone who has worked a fair bit in “FinTech”, I’m also not sure how easy it is to disrupt.

The article says:

The two primary use cases for a credit card today could be illustrated thus:

  1. I’m at the grocery store, swiped by debit card and the transaction was declined because my salary hasn’t yet hit my bank account. I need to buy these groceries for the family today, so I’ll use my credit card and worry about why my salary hasn’t hit the account later, or

  2. I really want this new iPad Pro, but I can’t afford it based on my current savings. If I use a credit card I can pay it off over the next few months

And proceeds to explain why each of the above situations can be unbundled to some kind of an instant credit scenario, rather than the bank having extended a lien to you through which you can borrow.

While the idea of instant credit (on the lines of Affirm) makes intuitive sense, the problem is with transaction costs. Irrespective of algorithms significantly slashing the time required and marginal cost of underwriting loans, the fact remains that the marginal cost of underwriting and extending new credit can never be brought down to zero.

There are costs to updating the information the bank knows about you. There are costs to creating any kind of legal documentation, and insuring that. If you were to list down all such costs, you would find that even if the cost of actual underwriting itself were to be zero, the marginal cost of issuing a loan is significant.

It is for this reason that banks have traditionally settled down on a model of “approve once, borrow multiple times”. For retail borrowers, this translates to a credit card, where they can borrow up to a predetermined limit, with no questions asked for each borrowing. For corporate borrowers, this translates to something like a “working capital lien” or “overdraft”.

The article I’d linked above talks about one of the solutions being an “overdraft”. In that sense, what it says is that the physical credit card might disappear, but not the fundamental principle, which is “approve once, borrow multiple times”.

In fact, as companies come up with new and innovative ways of slashing marginal cost of underwriting to enable “on-demand approval” (I’ve been involved in such efforts with a couple of companies), the question is whether such costs can actually be brought to zero, and if not, whether the model can be sustainable.

As long as the marginal cost of underwriting remains even mildly positive, it is not profitable for lenders to lend out small amounts with “on-demand approval”. How this problem can be solved will determine how well “FinTech” lenders can disrupt banks (on the lending side).

No Chillr, Go Ahead

This is yet another “delayed post” – one that I thought up some two weeks back but am getting down to write only now. 

After some posts that I’ve done recently on the payments system, I decided to check out some of the payment apps, and installed Chillr. This was recommended to me by a friend who has a HDFC Bank account, who told me that the app is now widely used in his office to settle bills among people, etc. Since I too have an account with that bank, I was able to install it.

The thing with Chillr is that currently they are tied up with only HDFC Bank. You can still sign on if you have an account of another bank, but in that case you can only receive (and not send) money through the system. So your incentive for installing is limited.

Installation is not very straightforward since you have to enter some details from your netbanking which are not “usual” things. One is a password that allows you to receive money using the app, and the other is a password that allows you to send money. Both are generated by the bank and sent to your phone as an SMS which the app automatically reads. I understand this is part of the system itself and this part won’t go away irrespective of the app you use.

Once you have installed it, you will then be able to use the app to transfer money to your contacts who are also on the app without requiring to know their account number. The payment process is extremely smooth with an easy to use second factor of authentication (a PIN that you have set for the app, so it is instant), so if more people use it, it can ease a large number of payments, including small payments.

The problem, though, is that it is currently in a “walled garden” in that only customers of HDFC Bank can send money, and hence the uptake of the app is limited. The app allows you to see who on your contact list is there on the app (since that is the universe to which you can send money using the app). The last time I checked, there were four people on the list. One was the guy who recommended me the app, the second was another friend who works in the same organisation as this guy, the third a guy who works closely with banks and the fourth a Venture Capitalist. And my phonebook runs into the high hundreds at least.

In terms of technology, the app is based on the IMPS platform which means that in terms of technology there is nothing that prevents the app from transferring money across banks using its current level of authentication. This is very good news, since it means that once banks are signed on, it is a seamless integration and there are no technological barriers to payment.

The problem, however, is that the sector suffers from the “2ab problem” (read my  argument in favour of net neutrality using the 2ab framework). Different tech companies are signing on different banks (Chillr to HDFC; Ping Pay to Axis; etc.) and such banks will be loathe to sign on multiple tech companies (possibly due to integration issues; possibly due to no compete clauses).

Currently, if HDFC Bank has a users and Axis Bank has b users, and they use Chillr and Ping Pay respectively, the total value added to the system by both Chillr and Ping Pay is proportional to a^2 + b^2 (network effects, Metcalfe’s law and all that). But if these companies merge, or one of them gets the account of the other’s bank, then you have a single system with a+b users, and the value added to the system by the combined payments entity is (a+b)^2 which is a^2 + b^2 + 2 ab. Currently the sector is missing the 2ab. The good news, however, is that there are no tech barriers to inter-bank payments.

Postscript: The title is a direct translation of a popular and perhaps derogatory Kannada phrase.