India's fintech needs to break free

For all its digital expertise and high-tech prowess, India is a neophyte when it comes to financial technology.

One Mumbai-based banker describes India as a “laggard for sure” in this field. 

“Our banks are good at digital, we have an outstanding IT sector, but in fintech we are playing catch-up, and coming from a long way back,” he adds.

It’s a commonly held view in the banking sector.

“Fintech is still in its early stage here,” says Pramod Kumar, head of banking at Barclays India. “There are fintechs specializing in consumer lending, in corporate lending to micro-sized firms and small and medium-sized enterprises, and payments companies and aggregators. It’s all still early stage, but there is massive potential in the industry.”

It’s both true and curiously anomalous. India’s lenders, particularly private-sector leaders such as HDFC Bank and Yes Bank, have taken the digital challenge to heart, while the southern technology hub of Bangalore is home to genuinely global IT powers including Infosys, Wipro and Tata Consultancy Services. 

Yet beyond India’s shores, you would struggle to find anyone who can reel off a single big name in the fintech space. There are a few shining lights, but even though they were founded and managed by local entrepreneurs, they are mostly funded and owned by some of the world’s top – non-Indian – technology firms and investors. 

Take Paytm, India’s leading digital payments company based in Delhi’s satellite city, Noida. The firm’s largest shareholder is China’s Alibaba Group, with a stake of just over 30%. Alibaba is also the largest shareholder in Paytm’s parent company, One97. 

SoftBank is another local power-player. The Japanese investment group owns 4% of Paytm and 26.1% of Ola, the largest ride-sharing service. It also paid $2.5 billion for a 21% stake in Flipkart, the Bangalore-based e-commerce platform, in August 2017; a year later, US retailer Walmart paid $16 billion for the online retailer.

Another of China’s technology firms, Tencent, owns 10.4% of Ola, and was one of three tech-heavy companies, along with Microsoft and eBay, to invest $1.4 billion in Flipkart a year before its sale to Walmart. 

Foreign private equity is also in on the act; New York’s Tiger Global Management was an early investor in both Flipkart and Ola.

This flood of activity goes to prove two things. First, that investors clearly believe in the future of Indian fintech – for good reason. In a report on financial inclusion published in March, the Brookings Institution stated that 80% of Indians have a bank account: but that still leaves at least 270 million people without one. Most of them are rural inhabitants who rely on manual labour or cultivation for their livelihood and who, more than likely, do not live close to either a bank or an ATM.

That presents a huge opportunity to mobile-money operators like Paytm and MobiKwik, an e-wallet provider whose shareholders include Japan’s GMO Venture Partners and Hong Kong-based Tree Line Investment Management. 

Nasscom, an Indian trade body representing the IT sector, expects fintech to generate $2.4 billion in annual revenues in 2020, up from $1.2 billion in 2017. In a report published in 2017, EY put the rate of adoption of any kind of fintech service in India at 52%, second only to China with 69%, and far above the average of 33% for the 20 markets it covers worldwide.

The second important thing to remember is that this is a sector in which foreign capital has been welcomed – and even encouraged – by government right from the start. Investors were more than happy to stroll in and put their money to work. “There’s no market in the world quite like India,” says a Mumbai-based private equity partner whose firm has made several profitable fintech-related investments. “In tech terms, China has already been carved up. The same is true for the US and Europe. But not India. There is a quiet but fierce battle under way for this market.”

But for all of its dollar potential and high adoption rate, not to mention the army of spiky start-ups bursting onto the scene in Bangalore, there is no doubt that fintech’s development in India has been handicapped.

The list of reasons is long, so let’s start with inconsistent regulation, focusing on the undulating fortunes of Paytm. Founded in 2010, the firm grew slowly as consumers caught on to the benefits of sending, storing and receiving cash digitally. Then in November 2016, prime minister Narendra Modi removed all high-denomination rupee notes from circulation. A population cut off from cash and desperate to continue to receive a salary, pay bills and remit money, turned to the only mobile-money provider they knew. Paytm was inundated with applications; the number of registered users doubled over the next three months to 200 million and continued rising.

But in India there is always a flipside to business, usually a law you didn’t see coming. So it was with the Aadhaar ruling, handed down in September 2018 by India’s Supreme Court. 

It is not hyperbole to describe Aadhaar as an astonishing accomplishment. Since 2009, India’s central identification authority has distributed a unique 12-digit identity number, or Aadhaar, to every single Indian – no mean feat in a country with a population of 1.36 billion. 

It was great news for old-fashioned lenders, but fantastic news for fintechs and payment banks, particularly those whose model was based on channelling loans to companies or individuals. Here was a single database containing the personal details of every Indian, from their age and place of work, to their credit history and salary.

The cost of carrying out a physical know-your-customer check is estimated to be around Rs100 ($1.42) in India. While that is no hardship, it is an additional financial burden, certainly if you carry out millions of checks a year. Suddenly, Aadhaar had all but eliminated that cost.

But then the highest court in the land got involved. From October 12, it barred private firms – including banks, mobile money providers and loan-guaranteeing fintechs – from using the database to authenticate customers. For the likes of Paytm, it was a shock. They griped about the loss of a host of earned efficiencies – Aadhaar made it easy for millions to open accounts, get loans and insurance, and take out investment products – but to no avail.

“It was painful for fintechs whose models had been aligned to the Aadhaar setup,” says Surojit Shome, chief executive of DBS Bank India. 

The head of digital banking at a private-sector lender adds: “It was definitely a shock. And while it hurt fintechs, in a way it helped us. Aadhaar-based e-KYC crushed fintechs’ costs, but banks couldn’t switch overnight – we had to go on doing things the old way.” 

Curiously, the court later revised its ruling, to allow banks and telecoms firms – but not fintechs – to plunder Aadhaar for data. In India, the rule book is plastic, and always changing. 

It’s easy to forget that India is in reality a collection of regions, rather than a uniform state. Its 36 states and territories stretch from Tamil Nadu on the Indian Ocean to Jammu and Kashmir in the Himalayas. Uttar Pradesh has 200 million inhabitants, while the Lakshadweep Islands in the Laccadive Sea are home to just 65,000 people. No two states share the same set of languages or group of banks.

This poses a problem for fintechs, who tend to operate a hub-and-spoke model wherever they go. In a given market, they typically open a single office in the capital or largest city, and disseminate digital services from their local home. 

Most of the big US and Chinese technology firms adopt that low-friction model in new markets.

But in India that doesn’t really work, as Nithin Kamath found after setting up his pioneering online broking operation, Zerodha. The firm works by crushing costs at every opportunity. Its model is tailored to young, white-collar professionals seeking to ease themselves into the investment world. They benefit from Zerodha’s pricing model, which charges a flat fee of Rs20 per transaction for futures and options and intraday trades, and levies no fee on equity investments, which make up most of the daily business.

When Kamath found it difficult to get traction outside Bangalore, he tweaked the system, registering phone numbers in other cities, which automatically routed a caller to the firm’s HQ.

“But it didn’t work,” he says. “It was quickly spotted by customers, and instead we opened offices in Chennai and Hyderabad, and our leads and business in those cities rose. We rely on word of mouth to get new business, not marketing, and we saw how powerful it was to have all these offices. The costs aren’t as great as you’d think.” 

As Kumar of Barclays India explains: “India isn’t like China. It is a collection of states, each with its own characteristics, culture, regulations and growth dynamics. That creates a challenge for delivering credit to borrowers. It’s one of the reasons why India is different when it comes to financial and digital innovation – and the pace at which one can scale businesses.” 

The ongoing saga at Infrastructure Leasing & Financial Services has also been a hammer blow for many fintechs.

The infrastructure finance specialist defaulted several times on its loan obligations in 2018, forcing the government to take control in October. Delhi has since charged 14 former directors with money-laundering, and a state-appointed audit team found up to $2 billion in financial irregularities.

This matters because non-bank finance companies – and IL&FS is one of India’s largest – have for years been key providers of credit to fintechs. With IL&FS out of action, borrowers turned to other NBFCs for help. But they were suffering too, from falling share prices and a sharply higher cost of funding. Traditional lenders are also assessing which of their customers are creditworthy – innovative but illiquid young fintechs aren’t always at the front of the queue.

Another concern involves the size of the middle class and its willingness to consume.

McKinsey Global Institute once described a pent-up demand for consumer goods as India’s future ‘bird of gold’. In 2018, investment bank Jefferies put the number of active online shoppers at 50 million. That’s a lot, but compared with China (and Indians obsessively make the comparison with Asia’s largest economy) it is a drop in the ocean. The number of online shoppers in the People’s Republic passed that mark sometime in 2008; at the end of 2017, according to Statista, the number was 533 million. And while smartphone penetration is rising fast, it is coming from a low base. India had 340 million smartphone users in 2018, according to Statista, or one in four citizens. In China’s mature market, 775 million people or 56% of the population own a smartphone.

That is important for fintech companies, as the bigger and more digitally inclusive the market, the greater the opportunity.

“Everything here is still just a fraction of the China opportunity,” says a Mumbai-based banker. “It’s impossible to have a genuine fintech explosion with such a small middle class and low smartphone penetration.”

India is a highly entrepreneurial and ambitious country filled with people used to evading obstacles placed in their way. Fintechs will no doubt find willing new credit providers and solutions to the Aadhaar snafu. 

Online consumption will expand in line with the middle class, and a country of mini-states will, ineluctably, coalesce.

Many of the world’s best corporates and smartest investors continue to pile into leading fintechs. In April 2018, Paytm Mall, the mobile money group’s e-commerce platform, secured $453 million in funding from SoftBank and Alibaba. Warren Buffett’s Berkshire Hathaway also invested $300 million in the digital division, marking the US billionaire’s first direct investment in India, and valuing the platform at $12 billion. 

As the sector finds its feet, it is discovering its identity. Amit Shah, group president of Yes Bank, tips India to become a pioneer in deep-tech fintech, finding solutions to social and environmental problems. 

One thing is for sure: Bangalore, rather than Mumbai or the capital Delhi, will be Indian fintech’s spiritual home. Firms such as Flipkart, Ola and Zerodha are already based in southern India’s largest city, as are point-of-sale technology specialist Ezetap, and Tracxn, an analytics firm that tracks global startups. Founded in 2013, Tracxn is part of a new wave of fintechs to secure early-stage funding from local entrepreneurs, including Flipkart co-founders Sachin and Binny Bansal. 

So, yes, India is a laggard in financial technology, but rest assured, it has a bright future. 

The online broker has transformed stock trading in India. Within a decade, the Bangalore firm has become the country’s largest broker, expanding into bond, currency and commodity trading. And it did it all without a cent of private equity capital.

Zerodha's founder and chief executive Nithin Kamath

When Zerodha opened for business in 2010, its founder and chief executive Nithin Kamath was already a stock-broking veteran. 

He started trading Indian securities in 1997 when he was still at school, and spent the next 13 years working with his brother as a sub-broker under the umbrella of Reliance Securities, trading for clients and distributing products on his own books. When the day was done, he worked nights at a call centre.

It was an exhausting life, and with the worst of the global financial crisis ebbing, he looked around for a new challenge. A heady mix of rising smartphone use, better WiFi, rising financial inclusion and the advent of fintech would, he saw, transform broking in India. 

“I could see disintermediation would happen here,” he says. “So I opened my own online brokerage. If I hadn’t done it, someone else would.”

Less than a decade later, Zerodha has surprised everyone by becoming not just the biggest domestic online stock trader but also India’s largest brokerage. In January 2019, according to data from the National Stock Exchange, Zerodha had around 850,000 active clients, ahead of long-time leaders ICICI Securities and HDFC Securities, having seen its customer base grow 56% in the nine months to the end of 2018.

It is also the biggest broker by trading volumes on India’s twin bourses, the NSE and the Bombay Stock Exchange. Trades are completed online or via its app. Its model is simple, in that it charges no fee at all on equity investments – which constitute the majority of business – and a flat Rs20 ($0.11) levy on futures and options and intraday trades.

To say the firm never sits still is an understatement. Zerodha’s platform offers retail and institutional broking, and trades bonds, currencies and commodities. 

It began offering direct-to-customer mutual funds online in 2017, and within a year it was the market leader. In January 2019, the firm disbursed its first loan-backed securities, courtesy of its fully licensed non-bank financial company. 

Kamath and his team run free classes that aim to empower and educate would-be traders, and run an in-house fintech fund and incubator called Rainmatter.

Zerodha is different in so many ways. Its founder is probably the most important voice in Indian fintech. Kamath in effect built an industry from scratch, learning to cross the river by feeling for stones.

“When we set out, the number of active retail traders in India was under 600,000,” he says. “It was imperative to grow the industry, so we came up with the idea of waiving commission if a trader kept their position overnight, and it caught on. No one believed a brokerage could survive by charging a low, flat, per-trade fee. But we did, and that got us great word of mouth.”

The firm is profitable: it reported a profit of $35 million in the Indian financial year to the end of March 2018, and Kamath expects that number to jump 40% in 2018/19. It employs 1,200 staff in Bangalore and in physical offices located in Mumbai, Delhi, Hyderabad and Chennai. 

The majority of its customers are young, white-collar professionals under the age of 40, many venturing into the world of personal investment for the first time. They may well be clients for life.

But what impresses most about Zerodha – and makes seasoned investment bankers get all misty eyed and retrospectively wishful (“I wish I’d had the courage to do what Kamath did,” says a Mumbai-based veteran) – is the way it was and is financed. There is no venture capital or private equity at work here, no capital flown in from Mumbai or Singapore or New York. Kamath financed the whole thing himself, and continues to do so.

“Being bootstrapped has been our biggest blessing,” he says. “I met a few [venture capital funds] in 2010, which was the worst time for broking as volumes dried up around the world. The few people I met thought we were uninvestable. We were in a highly regulated industry, and the technology that drives us now wasn’t in place for another two or three years. 

“But in hindsight it worked out well,” he adds. “We don’t have any investors, so we built at our own pace. There was no expectation of returns, no pressure to grow or to pursue a listing. 

“I’ve met every [private equity] firm out there now, and they all talk about big secondary investments, but we’re happy as we are. Many of our original analysts are still with us, and clients see we are more than just a business – they can see that we care.”

It sounds fun, passionate and, in its own way, very human. The rest of the fintech world could learn a few lessons from Nithin Kamath.