Cost of financial intermediation poised to fall in India, says PCI report

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India has one of the highest cost of financial intermediation at around 3.2 percent compared with 2 percent in developed countries. The business of distribution of financial products has generally been profitable over the years as the cost of intermediation in India is high. But high costs also hurt the end consumer.

Now, there is hope that with the help of fintech, things might change. Cost of intermediations are expected to fall and directly help the consumer.

The convergence of financial services, exponential technologies and an evolving regulatory framework will play a key role in building a strong digital economy for India, says a report released by the Payments Council of India (PCI) and the Internet & Mobile Association of India (IAMAI) at the ‘Digital Money 2017’ conference.

The report says that banks have complex operations and are focussed on managing risk and compliance and lack the flexibility of startups. There is not a single business unit in a bank that is not being challenged in some form or fashion by a startup from outside. Online lenders, for example, are offering an alternative for small business owners who otherwise wait for weeks to get a bank loan. By looking at different data points and evaluating a business’ financials in a more systematic way, new lenders are able to lend to people within a few hours, whom banks would otherwise not deem creditworthy. The report notes the case of IFMR Capital, a company that brings institutional lenders closer to microfinance companies or other NBFCs who are in need of capital, for a broking fee.

In India, the average number of annual transactions per point of sale (PoS) machine is estimated to be around 1,700 in 2016. However, the average transaction size is Rs 3,100 (credit card) and Rs 1,300 (debit card), indicating that these transactions are higher than the typical retail transaction size. India has 2 million Point of Sale (PoS) terminals compared with 5.5 million in China and 6.9 million in Brazil. Total number of PoS transactions in India is around 10 percent of total ATM transactions, which leaves a significant untapped market. Some of the factors that slowed growth of PoS in India are low spreads for merchant acquirers and resistance to adoption of technology.

In this regard, a lot of change is expected in the point of sale (POS) transactions. Small customer acquisition is a low value proposition for banks and cost of PoS machines has always been a barrier for small merchants. But with changing technology, PoS machines can now work on smartphones. While companies like Square, Triangle created smaller devices to work on mobile phones. In India, companies like Paynear Solutions are making similar inroads so that smaller merchants can be enabled to have cheaper access to PoS machines.

One of the reasons frequently cited for India’s weak payment infrastructure is merchant discount rate (MDR) charges, which deters small merchants. Moreover, card acceptance acquirers see little financial merit with lowering of MDR. RBI has explored four options. The report wants differentiated Merchant Discount Rate (MDR) for scaling of POS infrastructure, based on nature of transactions and purpose and looking at regulating interchange. Further, the report wants to promote Aadhaar-based eKYC and eSIGN to move towards paperless authentication.

The other areas the report touches include cross-border e-commerce transactions, personal finance where robot advisors charge lower fees, online lending and crowd-funding.

India ranks 130th in the world in terms of ease of doing business. So it becomes important to remove regulatory red tape to unleash the entrepreneurial spirit of Indians. The report says that the more barriers there are to starting a company, the fewer innovative companies can start and create a virtuous cycle of growth. Any government must strive to reduce such barriers and adopting fintech is an important step in this direction.