FinTech returns ‘inside the box’

I’d like to start with this line from George Santayana’s?The Life of Reason -

“Those who cannot remember the past are condemned to repeat it”

I know it’s been quoted to death, but it pretty much sums up what I want to talk about today - the specialisation of financial services seems to have already had its day in the sun. Now we’re witnessing a return to generalisation.

The biggest disruptors in FinTech have given the clarion call to fall back into business structures that, in hindsight, may appear all too familiar.?

The fallacy of over-specialisation

Cred, which has burnt through?hundreds of crores?on building a specialised brand centred around a premium offering, now plans to expand in a decidedly different direction. If?reports?are to be believed, the company is gearing up to disburse loans to non-prime customers.

Players like Cred invested heavily in finding a niche and developing a well-marketed product catering to it. They are the result of onerous repetitions of an experimentation cycle necessary to find the right product-market fit.?

Founders helming these FinTechs once aspired to the niches thus formed. Of course, they have business benefits like word-of-mouth brand awareness (since the communities served tend to be small and tightly knit), and the ease of verticalisation in smaller total addressable markets.

But the catch is, in the present funding environment, this cash burn strategy to gain a competitive advantage in terms of establishing market brands doesn’t work when the revenue can’t keep up with burn , specialisation can’t do much for you. I?wrote?a few weeks ago in this newsletter -

“The underlying product largely remains the same across these subcategories, it’s just the use cases overlaid and marketed on top of these financial services that tell them apart.”

There is plenty of evidence to corroborate that this is, in fact, the prevailing sentiment. Daylight, the LGBTQ+ banking platform I referenced in that piece, also recently?announced?that it will be shutting shop.

This also explains why Cred would deign to diversify beyond its niche. Although the company already offers personal loans to its captive user base made up of premium customers, “there's only so much you can do with the top-of-the-credit-layer customers in the country (the top 30 million),”?The Economic Times?quoted its sources as saying.

There isn’t as much demand for credit among this customer base, which means it is also slower to grow. In contrast, India’s new-to-credit population stands at 66 million, making for a ripe opportunity for digital lenders.?

Why must FinTechs rebundle?

While Cred is still readying to tap into the potential of diversifying by lending to new-to-credit customers, another FinTech heavyweight has already reaped the benefits of rebundling.

Paytm, the payments-focused FinTech giant, saw its revenue projections slashed by Macquarie Research in January 2022 due to the limited potential of merchant loan distribution to scale.?

However, the company seems to be on the brink of a turnaround. And there are two strategic moves to thank for it:

• Paytm introduced a?collection-performance bonus structuring. It encouraged its partner-lenders to account for fewer losses than expected with the promise of recovering the difference and earning a share of it. If it failed to recover the promised share of defaults, it would not only lose out on the revenue but also give the lenders a discount on the sourcing fee.
• It gathers merchant transaction data through its 6 million low-MDR soundbox PoS devices, which has given its merchant lending a substantial push.

The company grew its total loan amount disbursed exponentially in FY23, revenues from which helped it achieve operating profitability of Rs 234 crore. Commentators attribute?its success largely to the fact that it has built a critical and lucrative in-house collections arm, in addition to its origination benefits.

Cred seems to be on a similar trajectory. It has acquired the non-banking financial company (NBFC) Newtap, which in turn has acquired the NBFC Parfait Finance and Investment to source capital for its lending activities. It also acquired analytics company?CreditVidya to power its own data intelligence.?

Both companies did not start out as digital lenders, but are expanding to this segment to survive. Paytm’s in-house collections and Cred’s in-house capital and data intelligence signal a return to subsuming a comprehensive set of capabilities that fuel a variety of financial services within a single organisation.

Doesn’t this ring a bell?

FinTechs seem to be abandoning their niche in favour of more diverse, yet general, offerings. Does this mean that competition for banks will stiffen?

Replicating the bank model?

The new playbook that seems like an innocuous expansion strategy is in fact reminiscent of what banks have been doing for decades now - bundled financial services, all under the same umbrella. The question then is, now lacking a clear differentiator (in terms of the product offering and/or the target audience), can FinTechs compete with the bank model?

• Customer experience is a close race

Banks are getting serious about the customer experience on their own mobile apps. In fact, banks are driving the development of a superapp for financial services. Examples can be seen everywhere - SBI’s YONO clubs all its services like mutual funds, credit cards, insurance and investments under a single app.?

As FinTechs expand the suite of services on offer, they will mimic banking apps and compete not just with other FinTechs, but also banking apps.

• Regulation

FinTechs may replicate the banking app model, but will they ever be accorded the same legitimacy as legacy banks that enjoy regulatory backing? Given that the regulatory environment is already wary of new entrants and still defining their roles, banks will continue to have a leg up.

Even for those FinTechs that may have acquired NBFCs to gain a regulatory advantage, the competition with banks will remain a stiff one simply because of higher cost of capital and the ensuing lack of parity in interest rates. Which brings me to my next point…

• The ultimate differentiator

FinTechs may dress their credit products as they like, but the truth is that the borrowers’ choice of loan products boils down to one critical factor — interest rates.?

Short-term credit products like BNPL have so far been digital lenders’ playground. However, it has been long established that BNPL and other forms of short-term point-of-purchase financing are?convenience?products?as opposed to being?credit?products. They are used as gateway products that help capture customers to offer them large-ticket loans that actually make money.

The natural next course for FinTechs in search of improved revenues is to offer large-ticket loans, where, unlike small-ticket short-term credit, interest rates become a key determinant of uptake. With their high cost of capital, most NBFC-backed digital lenders cannot stand to compete with banks.

Moreover, for FinTechs that have thus far focused on non-prime segments, it becomes harder to break into the band of 650-750 credit score customers, which may be an untapped, yet promising market.?

Conclusion

In their fight for survival, FinTechs are opening themselves up to diversification of offerings. But the surety of their success still remains in question. Because this implies a return to banking turf, which banks are already better positioned to defend – through regulatory backing, and their own exploits in digitisation.

But do these ever-resilient FinTechs have an ace up their sleeve? Will they be able to find a differentiator, even while thinking inside the box, and secure their positions? Time will tell.?

I’m excited to see what’s next.?