State of Neobanking in India- A Reality Check!

The bloom of the Fintech Industry in our country has given rise to the concept of Neobanks.Neobanks are fintech companies that provide banking services via digital platforms by tying up with existing banks. They do not have any physical branches. While some neobanks provide full-stack banking services, others focus on one or a few services.

By plugging into the existing banks’ network, these neobanks cut back on costs and regulatory compliances required of a bank and can operate without a banking license. They are not responsible for the assets and liabilities as those are owned by the underlying bank.

NITI Ayog in 2021 had proposed setting up of full-stack digital banks report and the regulatory framework for it. While the RBI does not issue “digital banking licenses” or “lite banking licenses” for neobanks like elsewhere in the world, there was mention of “Digital Banking Units” in the 2022 Budget and RBI guidelines regarding the same allowing existing banks with digital past digital banking experience to open digital banking units as separate banking outlets. However, these regulations say nothing about neobanks and only provide existing traditional banks with this service.?

Banks, for their part, benefit from this agreement as they are able to onboard many more retail customers than they otherwise would have been able to and also onboard fintech companies as B2B clients. They also benefit from the marketing these neobanks do in the form of new customers.

Customers do not have to visit bank branches for opening their accounts and other things, since they can avail of those via their smartphones on their chosen neobank’s digital platform. Neobanks also generally have a better user experience and provide value-added services to customers. Another significant benefit for consumers is that they do not have to pay any annual charges or joining fees for using these services.

If the present trends continue, neobanks are set to disrupt the banking sector in a major way. The ease, convenience and user experience they are able to provide retail customers mean that they have a leg-up on traditional banks in these facets, and may become the preferred mode of banking for a lot of people since it would save them the hassle of visiting a branch and give them more choices, as otherwise people are forced to avail services from only the bank(s) that are in their geographical vicinity.

But neobanks in India, unlike in some other parts of the world are still wholly dependent upon their partner banks for services as they do not have a banking license, which is preventing them from realizing their full potential.

The government and RBI do seem to be waking up to the immense potential benefit that digital banking services can have for the Indian economy as evidenced by the NITI Ayog proposal of 2021 mentioned above.?

However, the focus seems to exclusively be on existing banks and the government seems reluctant to trust new companies with banking services- probably because there are very stringent regulatory requirements that these fintechs cannot meet.

These regulatory requirements are necessary to ensure banks have the underlying assets and resources to ring-fence the larger financial system and protect themselves from any shocks they may be subject to.

Other arrangements however can be looked at. Digital banking licenses can be provided to neobanks for limited services such as fund transfer and card transactions like those provided in Europe called an E-money license or EMI license, or a fintech license as in the USA which works along the same lines where the regulated entity is responsible for settlements, transfers, etc., while the fintech can work on providing customers with the best user interface and experience. An arrangement along these lines would let both entities concentrate on their strengths.