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The financial industry’s efforts to serve lower-income customers has have gone through four distinct phases: from social banking to microfinance to financial inclusion and now to technology-driven financial services or “fintech.” Fintech has fundamentally changed people’s lives, and transformed the business landscape forever. In many markets, cash is fast becoming obsolete, and transactions are mostly via digital tools. Banking is also moving into a presence-less, paperless and real-time era: While there will always be bank branches, banks will become more “invisible” in how they deliver their services – many of which will be accessed primarily online.

This transformation is fully underway in emerging markets as well as developed ones. India is now the world’s second biggest fintech hub, trailing only the U.S. Today the global digital economy accounts for around 15% of the world’s GDP. In India, it is currently about 8% of the GDP – but it is growing 1.5 times faster than the global average, and at this rate it’s predicted to reach 30% of the country’s GDP by 2025. A Boston Consulting Group (BCG) survey estimated the size of India’s digital lending market at around $75 billion in 2018, up from $46 billion in 2016, projecting exponential growth in the sector in the coming years. Likewise, India’s digital payments market is set to grow to US $500 billion by 2020, and its overall digital economy could grow to US $1 trillion by 2025.

The Benefits of the Fintech Revolution

This revolution in fintech is led by a host of players, including commercial banks, telecommunication firms, payment banks, small finance banks and financial technology companies. It is harnessing technology to reinvent traditional business models, creating opportunities to connect India’s hitherto unbanked communities to affordable and reliable financial tools at an unprecedented speed and scale. It offers a preview of what the global banking model may look like a generation from now, delivering benefits that include:

• Financial flows that can be accurately tracked, resulting in safer and speedier transactions, and less corruption and theft;
• Useful insights from client transaction patterns and financial histories, which can help providers to design products that are better suited to customers’ needs, cash flows and risk profiles;
• The ability to instantly relay client account information, automatic reminders and helpful default options via mobile phone menus, making it easier for consumers to track and monitor their accounts, and to sign up for services quickly on their own;
• Direct deposits (including wages and social assistance), which allow money to “bypass” the client’s pocket, helping users to save rather than spend – and often giving women more financial authority within the family.

Fintech has freed bank staff from counters, and relieved customers of the inconvenience of transacting solely during banking hours. Most of their financial work can now be done via smartphone, improving payment systems, eliminating paper receipts, and reducing a number of frictions – not only saving customers time and money, but improving their quality of life. Meanwhile, the phenomenal data footprint provided by smartphones and data-connected mobile phones is providing an unprecedented opportunity to bring people with limited credit-history into the formal mainstream through alternate credit profiles. In conjunction with this digital data, artificial intelligence and machine learning algorithms can assess the creditworthiness of the user, making it possible to provide loans to them even in the absence of a traditional credit history.

As a result of this digital transformation, traditional financial institutions in India are losing their market share to technology-enabled entrants in many markets.To stave off this challenge and remain relevant, banks will have to reinvigorate their talent ecosystems and redefine their roles. But as the sector evolves in response to the digital age, it’s important to keep in mind that fintech is not free of risks or downsides.

The Disadvantages of Fintech

When it comes to lending, number-crunching with computers can help with decision-making, but it cannot replace it. Anecdotal evidence cannot be dispensed with, particularly in the case of families without any formal financial data. Proponents of algorithm-based lending argue that it eliminates the subjectivity factor in decision-making, replacing it with data-based decisions. But digitizing and automating the lending process may result in excessive standardization when assessing a customer’s repayment capacity. This can lead either to over-lending and customer over-indebtedness, or to the rejection of a loan based on opaque reasoning premised on arbitrary factors such as location.

For example, in microfinance, individual traits can best be captured by personal contact. And the best clients are often those who get a loan not on the strength of their credit scores, but on the basis of the transparent and unvarnished honesty about their financial dealings that comes through in these encounters. For these clients, computer modelling fails to convey these essential qualities.

Digital finance also offers major technological and infrastructure challenges. Sparse populations, inconsistent network coverage, insufficient capital for building new business models, and customers’ lack of trust and comfort with technology can stand in the way of success, particularly in remote or underserved communities. And the risks of implementing digital financial services are not just operational and technical: There are also concerns about the security, affordability and safety of these new financial channels.To take just one example, loss of customer privacy is all but inevitable, despite efforts to create safeguards. For India’s financial inclusion industry to capitalize fully on the benefits of digital finance, these accompanying risks must be understood and adequately addressed.

Strengthening the Fintech Ecosystem

The most important need is to strengthen the entire ecosystem within which last-mile agents, clients and financial service providers interact with technology. To facilitate a seamless transition in digital financial services, India will have to consider the following:

• The need to balance the regulatory framework to support innovation and competition, while ensuring the safety and soundness of the financial system;
• The need to maintain openness to new players and models, such as non-bank players like fintechs, telecom-supported financial services providers, crowdfunding and big data analytics;
• The role of regulatory sandboxes to test new digital ideas and initiatives;
• The importance of sufficient digital infrastructure;
• The role of national identification systems, biometrics, and tiered know-your-customer digital solutions that reach beyond the current banking system.

In addressing these areas, India will have to contend with a major geographical and cultural divide in terms of the uptake of fintech products. The aversion of underserved Indian customers to digital finance has much to do with their overall aversion to technology, which stems from their lack of trust in it. It is also partly due to the low technical literacy of consumers. Women in particular often face additional barriers, including less access to mobile phones, lower literacy and numeracy levels, less confidence in using technology, and restrictions on their travel or social interactions. Furthermore, villagers tend to value personal relationships – particularly when it comes to money. They will not trust technology that they do not understand for anything except very basic payments.

Migrating to a Cashless Society

These issues are further complicated by the fact that India culturally believes in cash. There are marked demographic and class issues built into India’s struggles to execute a cashless transition, and a paradigm shift in thinking will require time, resources and a migration to new social and cultural patterns and habits. But though it will be impossible for India to become a cashless economy in the immediate future, this is definitely something the country can look forward to. However, there are several challenges peculiar to India that may constrain a full-scale digital transition for the foreseeable future:

• To start with, India has 438 languages, with each having multiple dialects and different scripts. This greatly increases the difficulty in designing digital financial products that will be usable across India.
• Migrating from a cash economy to a digital economy will demand a recast of the entire consumer mindset, and the smooth functioning of last-mile touch points. Making gadgets available will not help unless India can bring about a change in the skills and digital literacy of users.
• The country’s financial services providers too often focus on short-term incentives at the expense of long-term customer trust and loyalty. Consumers will have to make an extra effort if they want to reap the harvest of these new financial tools. So providers will have to make these new technologies worthwhile by showing customers clear benefits, giving them confidence in the services, and making them convenient and affordable.

Maximizing the Likelihood of Success

As Nobel prize-winning economist Daniel Kahneman advises, when overcoming resistance to technology, it’s essential “not to persuade, but to assess the source of resistance and address that.” This will require thinking very hard about the motivators that will pull consumers into this new space. The issue is lot more nuanced than what we are seeing today, and these nuances change from culture to culture and consumer segment to consumer segment. But there are some motivators that almost everyone shares: For instance, in a digital world, safety and security are customers’ top priorities when considering financial services. Payment providers can develop the most fool-proof systems in the world, but the human element of payments – including the risk of digital theft and agent fraud – cannot be emphasized enough.

That’s why the government’s role will be critical, whether it involves reducing risk, improving uptake and usage, enhancing consumer protection or avoiding over-indebtedness. The tech revolution will have a better chance of success if it is driven less by the demands of an industry that believes it should be allowed unhindered freedom to innovate and introduce digital services, and more by empathetic governance.

India’s central bank has been espousing a cautious approach in addressing concerns around consumer protection and law enforcement. The key objectives of the regulator have been to create an environment for responsible fintech innovations, to expand the reach of financial services for the unbanked population, to regulate an efficient electronic payment system, and to provide suitable options to consumers.

There have been two highly significant developments in this space. The first is the Personal Data Protection Bill, expected to be introduced in Parliament this month, which specifies that a private entity must seek user consent before collecting personal data. A user can also choose to remove consent at any point while utilizing a service. The second is the Ombudsman Scheme for Digital Transactions, for the redress of complaints regarding digital transactions made through non-banking channels like mobile wallets.

As India’s government and fintech industry work to navigate the many challenges ahead, these efforts to maintain a balance between safety and innovation must continue. During this transition, it’s in everyone’s interest to pay heed to the words of UN Secretary General Kofi Annan in 2004, when the world was in the midst of an earlier phase of digital upheaval: “In managing, promoting and protecting the Internet’s presence in our lives, we need to be no less creative than those who invented it. Clearly, there is a need for governance, but that does not necessarily mean that it has to be done in the traditional way, for something that is so very different.”

Moin Qazi is an author, researcher and development professional.

Photo courtesy of Ashwini Chaudhary.

Homepage photo: Meena Kadri