Where will fintechs go? With India’s growth prospects, the fintech sector can grow if it follows regulations

The next decade could see the emergence of fintechs in a similar scale of impact. The best is yet to come.

Bill Gates’ famous quote, “Banking is necessary, banks are not,” warrants pondering upon. Consider 2021—the world is emerging out of the Covid-19 shock, digital technologies are changing the way customers interact with institutions, and data and AI are changing how the world operates. In this world, banks were the old, outdated, slow, unfriendly to customers and price-gorging entities, while fintechs promised to usher in the brave new world of lower prices, better convenience, lower risk, and universal coverage. VC funding into fintechs hit new records—$8.4 billion went into funding for these entities. India saw the emergence of 45 unicorns, and the year saw the emergence of many ‘soonicorns’—companies which seemed poised to reach the unicorn status in a short while. Skip to two years down, and fintech funding has seen significant reduction. In 2023, fintech funding fell 73% vis-a-vis 2021. Valuation of listed fintechs has fallen significantly and some trade below their IPO price. Some fly-by-night fintech operators have subsequently vanished. Fintechs in general are yet to break even, and many do not have a clear path to profitability.

So, this brings us to the central question—whither will fintech go? Which worldview holds true—that of the fintech as the new age disruptor, the cure to all ills, the technology-led enhancer of efficiency and customer satisfaction, or that of the fintech as the valuation focused, grow at any cost, regulations avoiding entity? The answer to this lies probably somewhere in between. Let’s consider where we are and what might outline the future for this fledgling sector. Five forces will shape the evolution of this dynamic segment.

First, the easy money environment that existed for the last 15 years now is likely behind us. This means that the need to build a sustainable business model with stable free cash flows becomes important for fintechs. The runway to move from grow at any cost, negative unit economics entities, to ones with sustainable unit economics and overall profitability is shrinking.

Second, the monetisation mechanism for a very large number of fintechs seems to be to get into lending, either directly as an NBFC or as a distributor. This made a lot of sense in a low-risk, low-penetration environment. However, in the rush for this opportunity, fintech has largely focused on unsecured, small-ticket loans. Further, the loan recipients tend to be folks who already are part of the credit ecosystem. The stated objective of bringing new-to-credit (NTC) customers into the credit ecosystem doesn’t seem to have transpired in reality. As an example, according to CIBIL data, about 6% of personal loans in the year 2023 was given to NTC customers. This share has fallen from 19% in 2019. Additionally, the digital lending guidelines and many of the erstwhile structures (e.g. FLDG) are now either not allowed or need to be done in a very different manner, which challenge the business model of fintechs. Further, the liquidity environment has been one of withdrawal of accommodation and is likely to continue in this fashion. A tight liquidity environment will increase costs for lending and will be further compounded by the increase in risk weights that the RBI has introduced. Both these will depress profitability of this activity. As risks grow, the unpenetrated customer segment shrinks and regulations become tighter. Thus, this notion of “I will acquire customers by offering X and make money by lending” will become more challenging.

Third, the regulatory posture has moved significantly to both regulating digital financial services differentially—take the example of digital lending guidelines, which are different from physical lending, and stricter supervision as articulated in multiple public statements. Any business model which derives from regulatory arbitrage is bound to face headwinds. We have seen such examples too.

All of these put together sound quite bleak from a fintech perspective. However, this may be the defining moment for fintechs. And driving that belief is the fourth and the most important force impacting this space. India’s macros look better than perhaps they have ever been. The demographic dividend of the country, which has long-promised compounding growth, is now finally looking set to deliver. India’s per capita income is now $2,450 and will likely get to $4,000 by the end of this decade, as per a report by Standard Chartered. This movement of a large number of people from a life focused on meeting daily expenses for essentials to having a surplus and spending on discretionary items will revolutionise financial services in India. The real addressable customer base will expand very dramatically. This set of customers need financial services, and entities who can deliver solutions will find takers.

We could see the emergence of a set of fintechs, each of which will be important players serving customers in a distinctive manner over the next decade. Winning companies will, however, need to do a few things differently. First, they will have to focus on genuine business model innovation and operate with a view of building enduring institutions that last generations, and not unicorns which can be IPO-ed in 5 years. Second, they will have to offer services that pay for themselves, lending and other cross sell can be a cherry on the cake, but the cake itself needs to exist independent of the cherry. Third, they will need to comply with regulations in letter and spirit. As a colleague put it, it must be remembered that regulations need to be treated as a feature and not a bug.

Every decade post liberalisation has seen the emergence of a few but very impactful financial services entities, private sector banks—HDFC Bank, ICICI and Axis in the 90s, Kotak in the 2000s, NBFCs such as Bajaj Finance in 2010s. The next decade could see the emergence of fintechs in a similar scale of impact. The best is yet to come.

Sameer Shetty, President and head, Digital Business & Transformation, Axis Bank penned this piece for Financial Express.

Views are personal and do not represent the stand of this publication.