Watch out the sea change in the way banking is done in India

Entrepreneur, bureaucrat and politician—the man who brought Aadhar in the life of billions of Indians making things simpler for them, Nandan Nilekani in this exclusive article for DSIJ shares his thoughts on the Indian banking sector in the days to come.

Indian banking is at the cusp of a paradigm shift when it comes to the future. There are as many as 12 trends which will shape the future of banking in the country. First would be the way we transact on a daily basis. Currently there are high value transactions which are really low in volume but high in cost. Transaction in today’s times take place through various modes namely, cheque, ECS, IMPS, card payments and also mobile wallets. If we see the average transaction sizes payment made through cheque is Rs. 75000, ECS Rs 7500, IMPS Rs 8000, card payment ranging from Rs 3000 to 1200, whereas transaction made through wallet platform is at Rs 300 and 500. In the recent years, we have seen a trend emerging where electronic clearing has surpassed paper clearing by a big amount. Electronic clearing (ECS, NACH, IMPS, etc.) is growing at 50 per cent per year.

There has also been a trend noticed where IMPS volumes are recorded higher than debit cards in the last 12 quarters. In the times ahead, the move will certainly be from High Value Low Volume transactions to Low Value High Volume transactions and this will be accompanied by lower transactions costs, and will align market forces (customer acquisition) with social purposes (inclusion).

Credentials when it comes to customer authentication will move from ‘proprietary’ (card+ pin both managed by bank) to ‘public’ (mobile phone+ Aadhaar authentication) as phones will replace the card as an authentication factor.

Just like mobile number portability where a customer can change his/her telecom service provider without changing the number, we will see bank account portability, which gives customer more flexibility as there is no switching cost involved. Deposits can be moved easily, and it will be possible to switch one’s loan with a click. As and when customers are easily able to switch loans there would be more churn seen in the books of existing lenders.

Lending rates would see a transformational change as lending would gradually move from uniform lending rates to individual pricing of risk. This would be made possible by use of technology in the financial inclusion system. Lending changing from uniform lending rates to individual pricing of risk will be based on digital footprints. As every individual transaction of a person is conducted through banking channels it would leave behind footprints or records with the lenders. With data from credit bureau being enhanced with data from social media, mobile, web, and other sources that have more data points than a thin credit report, it will give lenders a whole lot of consented data regarding every individual customer which would help banks and financial institution in making better credit offers. Credit will move from secured lending against assets to lending against flows which leads to a better risk assessment of customers, based on a complete picture of the business.

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Business would change from fee income to data based income. Today banks to a large amount rely on fee income. New financial players will go to transactions for free, using the data generated to add value to their operations.

In recent years, the PSU banks have seen declining market share. PSU banks are losing share on the lines of which we saw in both the government owned telecom and airline business where government companies lost their dominance. PSU Banks market share has declined in the last 15 years from 80.2% in 2000 to 63.2 % currently. On the other hand market share of private banks has seen a healthy rate of growth over the years as they make up combined 32.1% up from mere 12.3%, 15 years back. Private lenders have a healthy CAGR of 23% compared to that of 17% of PSU banks. Market capitalisation is also reflective of this, as top four private banks market cap is twice that of all the public-sector banks including country’s largest bank SBI. Shrinking public sector market share is de-facto privatisation, government is losing opportunity to make billions of dollars of market capitalisation.

The biggest disruption caused would be in merchant transaction models. Current merchant model (including cards, POS, high interest on unpaid balance, MDR for merchants, limited outlets) will be completely disrupted. Cards will go as with mobile payments, smartphones  will replace POS and card. Universal Payment  Interface (UPI)will be the tipping point. New customers/merchant bundles will be created and customised service will be provided.

Transaction fees will tend downwards to zero. Informal supply of credit will decline rapidly in the days ahead. Demonetisation will only accelerate the trend.

The thrust to move towards a cashless economy has the potential to bring sea change in the way banking is done currently. Cashless implications on the economy would be enormous. Bank branches which are cash collection centres, become less valuable as current account balances of merchants will decline. Cash withdrawal would be thing of the past as the smartphone becomes the bank. Self-service would be the norm. Going cashless would also mean formalisation of the economy as benefit and convenience of being in the formal system will outweigh the alternative.

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Bank assets in terms of branches and ATMs, will be replaced by new assets - phone, platforms, data, algorithms etc. which would become an important metric in studying a bank. In terms of revenue, with more coming under the formal economy, tax collection would witness a huge surge.

Convergence of interest rates would happen. Currently interest rates are different in both formal and informal sector of our economy. Today, interest rate may wary from some 9 per cent annually for some loans to 5 per cent a day from a money lender. Easier access to formal credit will eliminate the informal' systems leading to massive economic efficiencies.

Jan Dhan- Aadhaar- Mobile (JAM) has all the ingredients to be a game changer for the country’s economy activities and financial inclusion goals. Pradhan Mantri Jan Dhan Yojana i.e banking for all opened 22.6 crore bank accounts in record time bringing people under the banking umbrella for the first time. Aadhaar platform with over a billion people under its ambit aims to be a one stop destination for various authentication need for financial inclusion. Aadhaar will create a ubiquitous Digital Identity Infrastructure for a digital desh. Aadhaar system can authenticate 100 million transactions per day on a real-time basis. Complementing the bank account and Aadhaar authentication is smartphones whose adoption has witnessed a phenomenal rise in the country. The banking regulator, RBI  has played a  pivotal role in accelerating the process of granting banking licenses to the new players in the fray. In 49 years, only 14 new bank license had been granted compared to RBI granted 21 new banking licenses in last 2 years. As recent as August 2016, RBI came up with On Tap Banking licenses which means continuous process of granting approvals for banking license therefore ushering in a new era of differentiated banking.

The Indian stack- built on JAM has expanded over last 7 years. We clearly see the progress from Aadhaar authentication, Aadhar eKYC in 2010 and 2012 to eSign, Digilocker, UPI in the year 2015 & 2016 respectively. Adoption of JAM has also seen a great amount of shift in past years. Indian stack appears to be a disruptive force as it allows innovation, no more physical presence required, cuts on boarding and transaction costs etc.

India will be data rich country in the upcoming future. Adoption of smartphones in the country has led to ever increasing internet penetration with more than 331 million users. Now both are taking the country towards the goal of Digital India. India will go from data poor to data rich nation in 5 years. Data would flow in from varied platforms and sources like social-media, commerce, payment, paperless and digital identity. All the generated data can be used in lending decisions. Hence stronger underwriting, will be this with less likelihood for loan default. Data can also be used to track flows digitally thus providing traceability which will help in quickly identifying fraud and taking early action.

Banks in future would act as a new age digital platform which would provide financial transactions like customer profile, ledger, personal finance, wealth management etc. In terms of financial products, it would primarily be owned or via partners. Transactions leave digital footprint which can be of immense information to financial institutions. Every transaction gives the platform more data about the customer, allowing him to be served better. This will increase stickiness, and avoid churn.

Banks would compete among themselves therefore leading to bank account churn. Banks would offer alternate savings products which would be analysed based on individuals’ digital footprints. Alternate savings product are gamified products, goal oriented savings and hybrid products. Alternate lending models would also come into the fray as to fill the massive credit gap currently in the financial system.

In today’s time a small borrower face a lot of hardships as customers with the lowest default rates must pay the highest interest on borrowed capital. Alternate lending will grow as it would be backed by surge in alternate FinTech lenders. Alternate lenders are playing on dramatically lower costs like lower cost on loan servicing, collections, origination and underwriting etc. New entrants in the lending space are both consumer and business facing. These startup lenders are bridging the gap between the lender and borrower by a click of a button. New age lenders will help in the growth of lending in the next 10 years which is estimated to see 5x growth.

UPI (Unified Payment Interface) is a step close towards achieving a less cash and more digital society with many banks on the platform to provide uninterrupted round the clock 24*7 and 365 days services to the customers. Services like Payments can be initiated by payer or payee, with no need to disclose account information, and with real-time validation of the account and balance. Every one with a bank account can send money to any bank account in the country with real time posting, funds not bring locked, and immediate notification of payments made.

Disruption is waiting to happen which gives immense opportunity for all the incumbent players plus at the same time can also be profitable for new age companies operating in financial sector space. As the Credit Sussie report on banking technology has said, there is a 600 billion dollar market capitalisation opportunity waiting to be harnessed!