Innovation in Financial Services for Maximum Social Impact

This week Bill Gates lauded the Indian payment ecosystem as a role model for the rest of the world, for speed, scale, and innovation.^[1] He said that India has built ambitious platforms for money transfers and reliable identification. These platforms have drastically reduced the cost and friction of money distribution to the poor in the country, especially during the pandemic.

This is indeed high praise for our ecosystem. It reflects the excitement that is evident in the fintech ecosystem in India. We are strong believers that these platforms are exciting for financial inclusion, and in this article, we look at these enablers and emerging use cases from a financial inclusion lens.

Over the last decade, we have seen the emergence of foundational platforms in India. Collectively called the India Stack, these have been transformative for the financial service ecosystem in India and promise to transform many others as well. The India Stack has been extensively written about, highlighting the nature of the stack as a Public Good^[2], and as an infrastructure for a digital India.^[3]

The platforms of India Stack have been built on the core principles that services can be ‘Presenceless’, Paperless, Cashless. User consent is an important aspect of the India stack thinking. These platforms have resulted in additional platforms, and layers that have enabled a whole host of services.

The Digital Infrastructure

Aadhaar: This provides a unique digital identity to all residents of India. The system is operated by the UIDAI (Unique Identification Authority of India), and provides authentication, and eKYC (online Know Your Customer) as APIs (Application Programming Interfaces). Aadhaar has been notified under the relevant rules, which enables it to be used for KYC for the financial ecosystem.

Aadhaar has been used to ensure that all Indians get access to banking easily. Driven by government backed programs, this has resulted in banking access to most households in the country. The Bank of International settlements has estimated that between 2011 and 2017, half a billion Indians opened bank accounts^[4] ! This journey would normally have taken 50 years, and yet, we were able to accomplish this in only 6 years.

The use of Aadhaar in financial services allows a user to set up an account without having to visit the financial service provider in person. This onboarding is completely compliant with all relevant regulations. For service providers, this brings down the cost of acquiring and servicing customers, thus allowing them to provide services to a larger market.

AEPS: The Aadhaar enabled Payment System creates interoperability across banks, and allows users to access their bank accounts through the closest business correspondent location. The Aadhaar Payment Bridge allows governments to send subsidies directly to the beneficiaries' Aadhaar linked bank accounts. This reduces the cost and time for delivering subsidies to individuals. During the pandemic, the government was able to make a decision on an emergency payment and disburse relief funds to individual bank accounts with no loss of time.

eSign: A digital signature protocol, which allows users to easily sign documents anywhere. These signatures are used for various purposes, including executing agreements, and creating instructions for banking. In particular, eSign has been used to authorize e-NACH (National Automated Clearing House) transactions for the purpose of recurring payments such as loan installments.

In addition, the National Payments Corporation of India (NPCI) launched a new digital payment platform - BHIM UPI. It separates the roles of account management, and payments initiation. A user can use any compliant application and make payment transactions from any of their bank accounts.

It is hard to imagine that 5 years ago, there were only about 1 million digital payment acceptance points in the country, and about 25 million credit cards issued. Today, every phone user can accept, and make payments. Reliable estimates of the number of users using digital payments are not available, but the number of transactions has crossed 2.2B a month. In the immediately preceding three years beginning 2017 and ending 2020, it witnessed a compound annual growth rate (CAGR) of 785% in volume and 570% in value.^[5]

The massive digitization of the financial services industry creates data trails for the users. India is moving towards a consent-based data sharing paradigm, which empowers users to share their own data for specific uses. A user can now obtain a complete picture of their assets with various regulated players, and share it for their benefit. An example of such purposes includes lending, and financial management / advice.

This has been operationalized through the NBFC-Account Aggregators, which have been licensed by the RBI. Given that the ecosystem is new, the NBFC Account Aggregators have formed an association - Sahamati. Sahamati is a self-regulatory organisation that comes up with common standards, APIs and governance mechanisms which helps the development of this market.

UPI, and the NBFC-Account aggregator allow a user to manage payments, and account data through third party applications - which forms the core of Open Banking access in other regulated markets. In India, though the structure is different, it allows the creation of newer services,and embedded finance offering for the market.

The following chart provides a timeline for some of these layers:
Development of India Stack - A collection of rails

Image courtesy: www.bis.org

The Broad Impact of the India Stack

The combined effects of these platforms has been to provide tremendous benefits and convenience to users. They can access financial services from anywhere, and go about their daily lives without the burden of having to visit the financial institutions. For the financial services industry, these platforms have reduced the cost of acquiring, onboarding and servicing customers while easing compliance with KYC regulations. The cost reductions have expanded the markets by making it feasible to service customers with lower ticket size, and those further away from physical locations.

From an inclusion perspective, these are very important developments. By making bank accounts easy to open and operate, they enable universal access to banking. Bank account opening, and access to these accounts is a significant barrier to financial inclusion which has been overcome. Through direct subsidy transfers, users get regular payments in a digital form, initiating them on their digital journey. The widespread, inter-operable business correspondent network makes it easy to operate bank accounts anywhere, and UPI makes it easier for small merchants to start accepting digital payments.

With payments moving to the phone, funds in these accounts can be used digitally, which removes another barrier. Finally, by empowering a user to consent to data-sharing, a service provider can make better decisions about the financial needs of the user. This allows a service provider to create, and sell more appropriate products for the user, improving inclusion.

The following table shows indicative use cases for the various APIs and platforms within the India Stack:

Innovation for Financial Inclusion

The steady roll out of these platforms over the last 10 years has created a dynamic fintech industry that is looking at how best they can serve customers in a new way! The list of use cases that I am presenting here is not complete - it is but a sample from the ones that we have seen and work with. For the impact focused investment community, this is a very exciting time, as we are now seeing products being created to serve the users that we care about and impact them in a positive manner.

Credit

Credit is the fuel for businesses to be created, and to grow. Many of the users have been denied credit due to the fact that they had limited collateral to offer, and very little history to make help with risk assessment. The formalization of their financial lives helps to generate data that starts to make these credit "invisibles" become viable borrowers. The pandemic has created significant uncertainty in the business environment, and the moratorium has reduced some signals. However, we expect that this market will recover, and the more agile fintechs will find ways to make good lending decisions based on data. iSpirt conducted a pilot on digital lending in 2016^[6] , and showed that it was possible to complete the loan process in 5 minutes, while complying with all existing regulations. Since then, the digital lending industry has grown significantly, and newer startups are beginning to solve for different aspects of the problem:

• 1. Using alternate data to assess credit risk better. By using transaction information, and other data with the consent of the user, it is possible to get a better estimate of income, and ability / willingness to repay a loan thus allowing businesses / business people to get the credit that they need. CreditVidya, for instance, uses a Neuro-Linguistic Programming (NLP) and Artificial Intelligence (AI) based unstructured data processing framework to assess new to credit customers, and enables them to access credit.
• 2. Using alternate data from MSME clusters to build better models for the business.
• 3. Sachet loans with flexible repayment - once users have been on-boarded onto a lending platform, they can avail multiple smaller loans, and make payments (as required) for working capital - as opposed to a larger term loan.
• 4. Using technology to discount future cash flows through invoice financing.
• 5. Controlling end-use of borrowed funds - for instance, by making payments directly to vendors.
• 6. Getting control on incoming cash-flows, so that a loan against a receivable is paid directly, thus reducing risk.
• 7. The large gap between the cost of formal and informal credit has offered an opportunity to P2P lenders, to create a marketplace, which offers lower lending rates to the borrowers (compared to the alternatives), and higher returns for the lenders (with some risk).

A new emerging API in this space is the Open Credit Enablement Network (OCEN)^[7]. This allows an entity which has customer relationships to create a marketplace, where lenders can compete to provide a loan. All else being equal, this reduces the operational cost of acquiring customers, giving credit, and collections - and should hence enable more credit at a reasonable cost to newer customers.

Image Courtesy: iSpirt

Savings

The pandemic has highlighted the need for households, and for businesses to have some savings to build resilience. In conversations, we have often heard people say that they wish they had saved more earlier. Fintech startups have looked to serve this need through a variety of products:

• 1. Digital Gold - the consumer demand for gold as savings has always existed, but it required larger amounts of capital. Digital gold allows users to save in smaller quantities.
• 2. Goal based savings - low-income users have high volatility in their income and expense streams, making it hard for them to commit to any particular savings plan. Yet, they have savings, and given sufficient support with flexible plans can make, and execute on plans to save to accomplish certain lifegoals, or business goals. Kaleidofin has created such products, and is distributing them to users, who otherwise did not have access to appropriate products.
• 3. Digital Group Savings and Borrowings (ROSCAs) - Many low-income customers have come to rely on chit-funds for both savings and borrowing within their community. Regulated digital chit funds provide these features conveniently and safely while providing more transparency to the users. We have been working with Chitmonks, and Kyepot as a part of our Inclusion initiative.
• 4. Sachet-sized mutual fund investments - many fintechs provide a bouquet of liquid funds to provide short term savings for customers (with a low chance of capital loss).

While ROSCAs require fixed and timely payments to the group, the other products provide for sachet sized payments on a flexible time scale - with the option of liquidating these when required.

In addition to short / medium term goals, the informal workers do not have sufficient savings for their retirement and long-term goals. The lack of these savings leads to greater dependence on family support, and reduced resilience through their life. Financial service providers can collect sachet sized payments for depositing into approved pension schemes, thus improving the long-term savings, and resilience of this community.

Payments

There has been a tremendous growth in the payments industry in the past few years, and a few large players have emerged. However, payments have still not penetrated throughout the country, and in particular to the lower income / feature phone segment. Fintechs have been working in this space to:

• 1. Bring digital payments to feature phone users
• 2. Bring more service providers onto bill payment platforms.
• 3. Enable more merchants to accept payments.

Insurance

Insurance has been sold in India as a mix of downside protection and savings! The impact segment has been underpenetrated by insurance, leading to a significant protection gap. There are estimates which indicate that a large number of people who have risen above the poverty line fall back due to an unexpected health emergency. The pandemic has made this risk even more visible to consumers. Fintechs are solving various problems in this space:

• 1. Co-creation and distribution of small ticket insurance in rural areas. Startups, such as Gramcover, have been working to create appropriate low-cost insurance products and distribute them to their user base.
• 2. Claims preparation and support - During a health emergency, users have no support to help them make choices, and no knowledge about the processes to get the benefits from their insurance providers. Digitizing the process, providing support at the time of need, and helping customers navigate the claims process can solve these problems for the users. A good experience with this can help increase insurance penetration as well.
• 3. Micro-Insurance - Just like other financial products, users need to be able to cover for smaller events as well. A pure digital only micro-insurance cover can be bought by users to cover for specific risks.

Technology Platforms and Embedded Finance

In addition to financial service providers, the growth in digital technologies has led to the creation of technology intermediaries who can situate the financial product at the right point in a business cycle. For instance, a treasury management product can be embedded within the payments workflow. This is enabled by a new set of fintech players, who provide APIs to other players. These take different forms:

• 1. API based product studio - Companies such as Setu, are creating a collection of APIs, which allow developers to pick and choose the right financial tools to be a part of a user experience - thus allowing every tech company to become a fintech!
• 2. Financial products for Gig platforms - traditionally benefits (such as insurance, pensions) have been distributed through employers, and have not been available for the informal workforce, or contract workforce. Technology players can now allow custom financial products to be offered to the contract / Gig workforce in a sachetized manner, so that it meets their needs better.
• 3. Improved user interfaces, and local language interfaces for new to digital users. This includes better UX, but also technologies such as voice that can provide sufficient confidence to these users to get onto the technology platform.
• 4. API based insurance distribution - Startups such as Riskcovry have created platforms which enable easy distribution of insurance, particularly for embedded use cases, such as bundled with other products.
• 5. Embedding finance into associated activities of the business (such as book-keeping, inventory, etc.)

Crossing SILOs

In addition to these use cases, we have been working with entrepreneurs who are creating products that serve user needs, but don't fall into neat categories. The ideas include

• 1. Creating a guarantee pool based on philanthropic capital, which can unlock credit to small neighborhood businesses.
• 2. Providing capital to businesses, which is more in the nature of equity as opposed to credit.
• 3. Enabling a group to pool premiums and insure each other against health risks.

Financial tools and products, when designed well, can save us time, reduce stress and help us in fulfilling our goals. So far, due to low-ticket sizes and high acquisition/retention costs, the financial system has been catering mostly to the needs of the top of the pyramid. The bottom of the pyramid has a more pressing need for financial expertise, but currently only get basic access products. These platforms change the calculus of that equation.

The development of these large-scale country wide platforms has allowed service providers to expand markets. In the process, there are many problems to be solved, and many unmet needs, which are being discovered. In addition, the pandemic has highlighted the need for resilience. As a result, the product mix that is now available to the previously underserved customer is vastly different than before. Low-ticket sizes are mitigated by the large volumes of such customers, and the inherent zero-marginal costs of software products. These should have a positive impact on the lives of the poor making it a very exciting time to be an impact investor.

References:

^1. Bill Gates calls India’s digital finance approach a global model
^2. India Stack - Digital Infrastructure as Public Good. By Vivek Raghavan, Sanjay Jain, Pramod Varma, Communications of the ACM, November 2019, Vol. 62 No. 11, Pages 76-81
^3. Aadhaar 2.0: Creating India’s digital infrastructure. By N S Ramnath
^4. The design of digital financial infrastructure: lessons from India. Dec 2019 By Derryl D’Silva, Zuzana Filková, Frank Packer and Siddharth Tiwari
^5. www.livemint.com
^6. Making 5 minutes loans a reality with the India Stack
^7. OCEN - A conversation