Does retail neobanking stand a chance in India?

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Neobanks have been at the receiving end of a fair amount of venture capital attention in India recently, with companies in this category raising nearly $116 million in 2019. Neobanks are essentially digital-only banks that are aiming to change the way retail banking happens; they have been at the forefront of fintech start-up activity in the EU and the US for the past few years. Poor customer service, legacy tech and rising bank fees at traditional banks are some key factors leading to their rise, in addition to their being more customer friendly and millennial facing.

On the retail side, neobanks have started by providing customers a mobile bank account and a linked debit card in the first instance, and then expanding to other financial services. While eschewing fees, these banks make money by earning interest on deposits, charging subscription fees and via interchange revenue earned on debit card transactions.

Neobanks are still quite a nascent idea in the Indian context, with many still waiting to launch publicly. But there are already a few players attempting to capture a share of the retail banking market by trying to target a slightly different segment and solve a slightly different problem. Thanks in part to the Pradhan Mantri Jan Dhan Yojana, nearly 80 percent of Indians now have a bank account. India’s primary financial problem is no longer one of an unbanked population, but rather of an underbanked one. Creating products to cater to the very diverse financial needs of the many different Indians does create distinct business opportunities for neobanks.

That said, there are real challenges to the retail neobanking model. Recent moves to cut UPI interchange fees to zero, spells bad news for any fintech player in the country, and neobanks are no different. Payments and interchange are not going to be a source of revenue for these players.

After its experimentation with payments and small finance banks, the RBI is unlikely at this point to grant new bank licenses for a few years, instead focusing on integrating the new players into the banking sector and giving them time to stabilise. This means Indian neobanks have to partner with existing banks to provide their services, which puts them in a weaker negotiating position when it comes to revenue sharing. It also imposes limitations on the range of things they can do (though the flipside of the argument is that it also ensures their immediate focus is on finding the right niche to play in).

Partnerships with banks are one part of the equation; neobanks are also likely to partner with providers of other financial products to offer access to investments, insurance, even loans. Given the extremely fragmented nature of India's financial landscape—with Non-Banking Finance Corporations (NBFCs), insurance companies, and capital market intermediaries making up other components of the financial services sector—neobanks could potentially provide customers value in being a single point of access to a variety of financial instruments. Here an easy-to-use interface and great customer experience could make an offering truly sticky and allow for genuine brand creation.

At the same time, incumbent banks have not been sitting still. Many of the big banking players were slow to get on to the UPI bandwagon, much to their detriment. They have since course corrected. Ironically, the State Bank of India, the country's largest public sector bank, might be the original neobank mover in the country. It launched a fully digital offering, Yono, in November 2017, and by the end of 2019, had ~17M registered users and ~6M digital savings accounts (63 percent of all SBI savings accounts are now opened through Yono). SBI's scale and size helps it here and it already offers 34+ financial products including mutual funds, credit cards, and insurance on Yono. Neobanks will have to reconcile both competing and collaborating with their bank partners, especially when it comes to becoming the primary bank account of their customer (which is what will give them the kind of data they need to do the interesting things like smarter underwriting, etc).

As is always the case in India, there are also things happening on the sidelines. Financial regulators last year started to work on an account aggregator framework with the aim of building data rails that allow the sharing of financial information between regulated financial institutions. Like UPI, this framework has the possibility of being a massive game changer. Having learnt from their UPI experience, the big banks are already in the process of adopting the framework. How the account aggregators shape up and how quickly they are adopted will be incredibly important in determining if India's population can go from unbanked to underbanked to being better served. But it also puts neobanks, which operate in a regulatory grey zone, at a disadvantage.

Finally, while I am all for more financial inclusion, the prospect that neobanks, if they take off, will make a complex and opaque industry becoming even more intermediated is very real. India is still at a point where public trust in private financial institutions—or indeed private corporates of any kind—can erode very quickly. The Yes Bank saga, for example, has probably done a lot of damage on this front. People depend on being able to withdraw and move the money in their bank accounts. Even a short outage—not unthinkable if you look at neobank experiences globally—will not bode well.

That said, there is clearly a lot happening in consumer retail banking in India and some of the neobanks have very seasoned founders and operators at the helm. As an observer it will be interesting to see how this space evolves once these banks fully launch their products.

The writer has worked in consultant and growth equity investing. She is a graduate of the Wharton School of Business

The thoughts and opinions shared here are of the author.