Digital Financial Inclusion in India – Taking Off in 2015

> Posted by Rishabh Khosla, Senior Investment Analyst, Accion Venture Lab

The following post was originally published on SocialStory.

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The Indian financial services landscape is undergoing a tectonic shift. The last few years have seen a renewed public focus on expanding financial inclusion. Building off prior programs, the government has invested in regulatory reform, improvements to the banking system, payments, and ID infrastructure. They have also announced a series of programs targeting the bottom of the pyramid (BoP) and micro, small, and medium enterprises (MSMEs). Simultaneously, we are beginning to see real shifts in the adoption of digital technologies and banking services (such as basic savings accounts and smartphones), driven by compelling use-cases, such as government subsidies, delivered directly into bank accounts, and rickshaw-hailing apps that use mobile wallets. Together these trends are unleashing tremendous innovation with the potential to speed financial inclusion for millions.

As investors in early and growth stage “social” enterprises that are speeding financial inclusion around the world, we believe startups are uniquely positioned to navigate this shifting technological, regulatory, and competitive environment. Indeed, financial sector reform in India has had many false starts, and there are still many regulatory and structural hurdles to be overcome. However, we believe India is nearing an inflection point with changes playing out in three areas that are giving birth to exciting startup financial services models: MSME finance, digital payments, and consumer services.

MSME Finance

As mainstream microfinance (targeting the poorest) has matured, focus has turned to the country’s chronically underserved MSMEs, where, according to an IFC estimate, there is a debt gap of over $60 billion. Already, innovative companies like Aye Finance, Varthana, Vistaar, and Kinara Capital have been serving this sector by partnering and building specialized acquisition and underwriting approaches. These changes are being accelerated by the government: last year, the RBI announced a new category of “small” bank that focuses on poorer customers. This year the government proposed the creation of a MSME bank (MUDRA) with a $3 billion capital allocation for the sector. Supported by these initiatives, over time, we expect to see more players and capital flow into the space, resulting in a greater volume of lending to the underserved.

In the past, we have highlighted the wholesale debt gap as a major pain point for these kinds of innovative startup lenders. Without demonstrating break-even and several years of track record, it’s very difficult to access affordable funding critical to scale. Players like IFMR and Intellegrow are supporting these lenders along with other entrants, though we think that plenty more can be done here.

On a more positive note, as e-commerce, internet, and smartphone penetration have grown, new data sources and channels are opening up, allowing companies to better reach and serve new customer segments. Companies like Capital Float partner with e-commerce marketplaces to access and assess small merchant vendors. SMECorner, IndiaLends, and Namaste Credit have gone completely digital: they acquire potential borrowers online, help them complete an application, and provide them with a range of credit options from different banks.

Digital Payments

For a long time, India’s digital payments infrastructure languished, until efforts led by the National Payments Corporation, an entity blessed by RBI and owned by leading financial institutions in India, began to knit together the plumbing that connected banks, points of sale, mobile wallets, and other financial accounts. These efforts have eased barriers to adoption and interoperability issues: volumes through IMPS, a system used to send smaller payments instantly between bank accounts and other digital wallets, reached $1.3 billion per month in February (up 13 times since September 2013).

The government has also encouraged a burst of private innovation by promoting “payments” banks, a new category of Indian banks. The new structure is designed to attract fresh players (that is, non-bank and non-NBFC actors), to hold and transfer money on the consumer’s behalf. Mobile operators, for example, have millions of distribution points for pre-paid credit around the country; they can now be used to load cash onto mobile wallets and sent across the country. Perhaps, the most recent visible successes in this space are third-party mobile wallet operators like Hermes, Oxigen, and Paytm (which recently received an investment from Alibaba). Paytm has made its platform interoperable with IMPS (enabling instant transfers to bank accounts); and offers peer-to-peer transfers through mobile apps, and will soon launch a network of physical “cash-in and cash-out” locations.

These signs are encouraging, though the market is still nascent and fragmented. Most volume is from early adopters and wealthier users. To achieve real scale, players must look to ensure greater interoperability, and provide more relevant use-cases and value-added services that make digital payments convenient to mass markets, BoP, and micro businesses.

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Rishabh Khosla is a senior investment analyst with Accion Venture Lab, supporting the team’s investment activity in India and the U.S. Rishabh also provides extensive support to Venture Lab’s portfolio engagement activities and fund operations. This article was written with input and support from Ganesh Rengaswamy, Managing Director at Accion’s Frontier Investments Group, and Vikas Raj, Director of Investments at Accion Venture Lab.

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