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Financial technology: Opportunities dwarf threats

N Sawaikar, Nov 21, 2016 14:44 IST
Over the last 50 years, the expansion of financial services to excluded groups like farmers and small enterprises has been a major priority for the Indian government. To achieve this goal, the government has greatly increased its control over the banking system through nationalisation and regulation, with mixed results.

In the last 10 years however, a new technology-based path to financial inclusion has emerged, made possible by the plummeting costs of information technology and the spread of mobile phones. This path uses information technology to process, analyse and transmit financial information more efficiently, reducing the costs of providing financial services.

Over the last decade, three key enablers for technology-led financial inclusion have emerged. First, there has been a rapid expansion of mobile telephony. Secondly, the government has developed ‘Aadhaar’: a biometrically linked unique identity number. Finally, there has been increase in the number of basic bank accounts, for example through the government’s ‘Jan Dhan Yojana’, under which 25 crore bank accounts have been opened since 2014.

These enablers come together to form the JAM Trinity: ‘Jan Dhan Yojana’, ‘Aadhaar’ and Mobile, which allow the government to better target subsidies to the poor and transfer money to bank accounts directly, cutting out the middle man and reducing leakages.

Some major hurdles still remain. Many of the new bank accounts have tiny balances and little activity. Another issue is the ‘last mile’ problem; rural recipients may struggle to collect money, which has been electronically deposited in their accounts. One solution is through the existing business correspondent network of third-party agents who carry out transactions in rural areas, perhaps using micro-ATM devices. Another possibility is a cashless money transfer system like M-Pesa, which was launched by Vodafone in Kenya and allows users to transfer money through their mobile phones.

Financial technology can also be used for more complicated services like insurance and lending. For lending, banks have traditionally used loan officers and a deep paper trail to assess the creditworthiness of the borrower. The challenge is to replicate this at a lower cost using information technology. For example, First Access, a data analytics company, works with mobile network operators in East Africa and uses phone histories to provide credit scores to low-income borrowers who lack a formal credit history.

A related approach is peer-to-peer (P2P) lending, where an online platform acts as an intermediary between borrowers and lenders and charges a fee for the service without holding the loans on its books like a conventional bank. This model seeks to lower the costs of intermediation between borrowers and lenders and could potentially increase lending to farmers, small enterprises and other underfinanced sectors.

Technology can also improve the operational efficiency of sectors like microfinance, which lend to the poor but often use paper-intensive processes that require loan officers to visit far-flung rural areas. Companies like Artoo work with microfinance institutions and improve their processes through biometric verification, paperless processing and analytics.

Another promising area is micro insurance where, for example, small farmers may purchase crop insurance to protect them from deficient rainfall. Traditional insurance models, which require expensive farm visits don’t work in developing countries, where the farmers can only afford a premium of a few dollars.

Syngenta Foundation, an NGO, pioneered an alternative approach by teaming with microfinance lenders and seed companies in Kenya to bundle low-cost insurance plans with their products. Instead of farm visits, they used satellite data and automated weather stations to determine payouts.

Startups and NGO’s are good at experimenting with new technologies and business models but scaling up these ideas is often best done by large commercial organisations. Beyond banks and other financial companies, there is an important role for telecom and retail companies.

Telecom companies are well-suited to provide financial services directly because of their large distribution networks and expertise in data analysis. Vodafone is a pioneer in this area and its M-Pesa service launched in 2007, has moved beyond money-transfer into services like international remittances, saving and borrowing.

Ecommerce companies also have valuable expertise in payments and data analysis. Alibaba, the Chinese ecommerce giant, has successfully expanded into financial services through its online payment platform Alipay, and AliFinance, which provides loans to vendors on its platforms. India Post, with its massive network of 1,50,000 offices, 90% of which are in rural areas, is also well placed to solve the “last mile” problem in rural India.

To encourage such non-financial organisations, the RBI has developed the concept of payment banks which are allowed to accept deposits up to Rs 1 lakh and can distribute mutual funds and insurance products. Airtel, Vodafone, Paytm and the Department of Posts have obtained licenses to start a payment bank

These new technologies and business models are both an opportunity and a threat for existing banks. In the short run, they allow banks to expand their customer base and offer more services at a lower cost. However, in the long run, as new models like peer-to-peer lending mature, and consumers become comfortable using financial services online, banks may slowly get eclipsed. The key for banks is to closely follow new trends, exploring avenues for cooperation while also staying alert to competitive threats. A good example is SBI, which has started a Rs 200 crore fund for financial technology startups.

Financial technology also creates new concerns for regulators. One concern is privacy since financial technology is driven by the collection and analysis of massive amounts of customer data. Another concern is that a small group of companies will dominate data collection blocking newer companies and restricting competition. The challenge for the government is to design a regulatory architecture for data which allows many competing companies to use rich data sets to deliver financial services while minimising the loss of consumer privacy.

Ultimately however, the threats are dwarfed by the opportunities. Practically every sector of the economy can benefit from technology-led financial inclusion.

Low income savers will have a wider range of savings products and will be less likely to buy gold or just stuff cash under a mattress. Small enterprises in the unorganised sector, perpetually starved of funds, will develop a digital trail allowing them to access loans and other financial services. Farmers will gain better access to loans and insurance allowing them to increase returns by taking calculated risks and investing in agricultural technology.

Finance is the lifeblood of the economy and the more channels it flows into, the more it will enrich every corner of the Indian economy.

(The author is core faculty in Economics at the Welingkar Institute of Management Development & Research, Mumbai)

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