INDIAN BANKING- IN A TIME OF CHANGE

Once in a while a major disruption or discontinuity happens which has huge consequences. According to Mr. Nandan Nilekani, founder of Aadhar, Indian Banking sector is going to witness similar disruption which will catapult banking in India to a different orbit in next 10 years. Mr. Nilekani, in his presentation, titled “Indian Banking – In a time of change” highlights 12 trends that will shape the future of banking.

Nilekani believes niche banks and financial technology providers mean banking is going to be much more personalized and structured. The huge untapped banking potential in the country will be harvested and usurious interest rates charged in the informal sector, would be brought at par with the rate structure in the formal sector. Payments, liabilities and assets will all undergo dramatic transformation as switching costs reduce and incumbents are threatened. Finally India is likely to transform from being data poor to data rich in the next 2-3 years.

Key trends that Mr. Nilekani talked are as follows

·  Transactions – Low Volume, High Value, High Cost to High Volume, Low Value, Low Cost: We are seeing strong pick up in Electronic clearing (ECS, NACH, IMPS, etc.) which is growing at 50% per year. In Q1 2015, it surpassed paper clearing (Cheques). Even IMPS volumes are higher than debit cards! The business models in banking are already moving from low volume, high value, high cost, and high fees, to high volume, low value, low cost. This will lead to a dramatic upsurge in accessibility and affordability, and the market force of customer acquisition and the social purpose of mass inclusion will consequently converge.

·  Credentials – From proprietary to open: Credentials are moving from ‘proprietary’ (card + PIN both managed by bank) to ‘public’ (Mobile phone + Aadhaar authentication). The phone will replace the card as the ‘What you Have’ authentication factor. Smartphones with integrated Aadhaar compliant Iris recognition which will be available for commercial use very soon!

·    Switching costs are going down!: 80% of telephones have a dual sim and there is no user cost for switching a sim. Similarly arrival of Aadhar and other technological improvement (such as UPI) should lower cost of onboarding of customer as well as transaction costs. It means deposits can be moved easily or switch loan with a click. It is expected to result in low/no switch costs to user which in turn will increase churn.

·    Lending – from uniform lending rates to individual pricing of risk: Data from social media, mobile, web, and other sources that have more data points than a thin credit report will be used for credit underwriting along with enhanced credit bureaus. This will change uniform lending rates to individual pricing of risk based on digital footprints. Further lending will move from secured lending against assets to lending against flows which lead to a better risk assessment, based on a complete picture of the business. This will also enable a transition from informal assets into the formal economy.

·    Business – From fee income to data: As data becomes the new currency, financial institutions will be willing to forego transaction fees to get rich digital information on their customers. The elimination of these fees will further accelerate the move to a cashless economy as merchant payments will also become digital.

·  PSU Banks – Shrinking Market Share: Government banks are already losing market share but the changing landscape could accelerate the decline. In 2000, PSBs commanded a market share of 80.2%, which came down to 73% in 2013. Nilekani expects the share to fall to 63% by 2025. The market capitalization of government banks, too, has already started reflecting what lies ahead.

· Merchant Models – Ready for Disruption: Current merchant model (Cards, POS, high interest on unpaid balance, MDR for merchants, limited outlets) will be completely disrupted. Smartphones on both sides will replace POS and card. Merchant on boarding will be self-service. New Customer / Merchant Bundles will be created and transaction fees will tend downwards to zero!

·  Cashless changes everything: The advent of the Unified Payment Interface will accelerate shift to cashless. Implications for cashless economy are many – Cash collection centers become less valuable; Merchant current account balances may be impacted; there will be formalization of economy; Tax collections etc. will go up and Customer ownership based on branches, ATMs, will be replaced by new assets - phone, platforms, data, algorithms, etc.

·  Interest Rates Will Converge: Today interest rates may vary from some 9% annually for some loans to 5% 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: Three systems i.e. Jan Dhan, Aadhar and Mobile (known as J.A.M.), which are getting integrated with each other, are expected to allow a range of innovative services to be implemented in a paperless, instantaneous and cost-effective manner.

o   Jan Dhan (Financial inclusion) – banking for all: 22.6 crore accounts are opened so far with Rs40,600 crore of deposits

o   Aadhaar (National Identity card): This now covers over 1bn people, provides online identification and KYC. It can authenticate 100mn transactions per day, in real time!

o   Mobile: Mobile phones penetration ~80%, ~100mn smart phones sold per year and rising broad-band connectivity (100% targeted by 2018)

·  The Emergence of the India Stack: A set of powerful open and programmable capabilities that are collectively referred to as the ‘India Stack’ by the think-tank iSPIRT has been created over the last seven years. Aadhaar provides on-line authentication using one’s fingerprint or iris, which can be done from anywhere. This can make transactions ‘presence less’. The eKYC feature of Aadhaar enables a bank account to be opened instantly, just by using the Aadhaar number and one’s biometric. The e-sign feature enables on-line documents to be digitally signed with Aadhaar. The ‘digital locker’ system enables the storage of such electronic documents safely and securely. All this can make the entire banking process ‘paperless’.

·  India Will Be Data Rich: Finally as India goes from being data poor to data rich in the next 2-3 years, the Electronic Consent layer of the India Stack will enable consumers and business to harness the power of their own data to get fast, convenient and affordable credit. Such a use of digital footprints will bring millions of consumers and small businesses (who are in the informal sector) to join the formal economy to avail of affordable and reliable credit. India will go from data poor to data rich nation in 5 Years!

Impact of these trends

· Smartphones will not only make brick-and-mortar banking redundant. All the ancillary technologies needed for banking will also go out of fashion.

·  UPI would ensure cards and point of sales machines (PoS) themselves would not be needed anymore. Account information would become virtual, eliminating the need for disclosure of accounts, and transactions through mobile phones in a secured and real-time manner would become the norm. Every transaction gives the platform more data about the customer, allowing him to be served better. This will increase stickiness, and avoid churn.

·    On the savings side, banks will not be able to rely on current and savings accounts for cheap capital, as competition will increase churn. Alternative low-risk savings products will emerge, providing higher interest rates and liquidity.

·    On the lending side, there will be emergence of alternate lenders (such as P2P lenders), which dramatically lowers costs. New entrants also bring pin point solutions. Lending is expected to grow 5x in next 10 years.