NITI Aayog flags problems with neobanking model, says credibility on line

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The government’s think-tank Niti Aayog had flagged several concerns about neobanks including challenges with respect to revenue as well as viability and the existing “partnership-based” model.

In its Digital Banks- A Proposal for Licensing & Regulatory Regime for India report published on July 20, Niti Aayog talks about lack of revenue resources, obsolete tech infrastructure of partner banks and low-entry barriers hampering innovation and also allowing non-serious player in the space.

With no physical branches or paperwork, a neobank is a digital bank offering a range of services through online platforms. It does not hold a licence but provides services through licensed partner banks.

Neobanks can be seen as a layer over traditional banks but with limited offerings as they don’t offer large corporate, car or home loans.

Here are the 5 major challenges as identified in the report:

1 Lack of revenue resources

The report suggests that fintechs have a monetisation and viability problem and thus fail to generate adequate revenue to sustain the model.

“They earn fee-based revenue wherever they act as channel partners (account opening and onboarding, investment opportunities credit), and potentially earn a fraction of interchange on payments processed through cards; but other than these two buckets, lack any other revenue sources,” the report says.

2 No proper regulation for interchange

There is no direct regulation in India for interchange, unlike in developed markets. In countries like the US, fintechs can earn revenue on interchange by partnering with small and medium banks but there are no such options in India. Interchange is indirectly regulated in India through merchant discount rate regulation. Thus, unlike advanced economies, Indian fintechs can’t generate profit through interchange.

The report terms interchange as the fee that merchants are charged for accepting payments made through credit cards, debit cards, net banking and digital wallets.

3 Obsolete tech infrastructure of partner banks

There are various loopholes in the business and technological infrastructure of the partner banks, especially the traditional banks. In many cases, partner banks often fail to properly cater to the demand and needs of an emerging class of “digital-native” businesses, which poses a challenge to the business model of these digital-only banks.

According to the report, “Without the ability to leverage their balance sheet and their own technological stack to create ‘ground-up’ credit products and user experiences, their potential will never be fully unlocked.”

4 High cost of capital

In the absence of a licensing framework, neobanks fail to issue low-cost deposits. Thus, by default they have to rely on expensive equity capital to fund innovation and operations, leading to increased cost of capital.

5 Lack of regulator framework

There is hardly any framework that can serve as an entry barrier for fintechs entering the neo-banking space. Thus, companies are intruding into the neo-banking space, leading to a drop in the credibility of the system. Any company can now replicate business models and products already existing in the markets. Thus, there is a lack of concrete drive for genuine innovation.

“As with any ecosystem with low barriers to entry, this context offers opportunities for actors that are not fit-and- proper to enter the market creating a consumer protection risk especially on the retail side,” the report says.