Honey, I shrunk the Bank

lobally, Open Banking was first initiated by The European Parliament which implemented a Revised Payment Services Directive (PSD2) in October 2015. This move enabled a new type of banking service that uses innovative online and mobile payments. By August 2016, the United Kingdom’s Competition and Markets Authority (CMA) advised nine of the biggest banks (Barclays, RBS, HSBC, Santander, Bank of Ireland, Allied Irish Bank, Danske Bank, Lloyds, and Nationwide) to allow licensed third-party direct access to their data.

EU, UK and Australia are leading the charge in terms of strong regulations, not only in open banking but also have seen massive innovation in a variety of models from full stack banking with a digital/regulatory license (Germany — N26, Solaris Bank; UK — Monzo, Tandem) to a plethora of companies who are operating at various levels within the banking infrastructure / Banking as a Service (BaaS) models (USA — Bond, Galileo, Marqeta; UK — ClearBank; Germany — Mambu, Solaris Bank).

 

 

Since, there is no equivalent of a PSD2 regulation in the USA, traditional regulated banks have started opening up their APIs to be utilised as a BaaS in order to protect themselves from competition and build a wider share through fintechs. This was initially started by CapitalOne and followed by BBVA, Goldman etc.

Over the last 10years, India has seen what can only be called a revolution in Fintech. It has seen ~$15B in funding in Fintech alone and today is perhaps the third largest fintech market in the world, only after USA and the UK. So far, Fintech in India has grown on a few fundamental rails:

• Digital identity framework / Aadhaar
• Pradhan Mantri Jan Dhan Yojna powering over 415M bank accounts holding over INR 135,000 cr in deposit balance in these accounts
• Platforms such as UPI, IMPS etc to move money/Payments
• Plethora of digital data across a variety of categories — Entity Information, Financial and Transaction Data, Individual Data, Credit Bureau and Social Data
• Adoption of mobile phones and some of the lowest data tariffs in the world

While a decade of proactive regulations has spurred innovation, vibrant venture capital and supply of money has created an ecosystem of high quality founders willing to give up lucrative corporate careers in order to build and scale.

As detailed here, C2B, C2C and to some extent B2B payments has seen influx of a lot of capital and currently has large incumbents. This has been driven not only by government regulation in enabling the payment stack, but also because banks understand payments and have been quite successful in building infrastructure on top of their own existing stack to partner with fintechs, specifically in payments.

Open Banking: The Account Aggregator Framework

Banks typically keep a record of every transaction we make — spending, lending, borrowing, travel bills, electricity bills, loan payments etc.— but they don’t make the best use of this rich information. A lot of time, this information is storied and buried away in different silos, never to see the light of day.

Open Banking is creating a data architecture, where a network of institutions can share the data through APIs. These APIs allow the financial companies and banks to share the data amongst them, in turn helping them to serve their customers better. This has opened the gates for fintech entities to work in collaboration with the banks to provide a seamless and personalised customer experience.

India is one of the first countries in the world to kick off Open APIs for consented financial data sharing. RBI also became the first central bank globally to publish a common technology framework — including detailed APIs — for consent driven data sharing across the entire financial sector (banking, insurance, securities, and investment).

The Account Aggregator (AA) framework will be powered by the Open Credit Enablement Network, which is a credit protocol that provides a common rail for interactions between lenders, fintechs and other loan service providers. Further, Data Empowerment and Protection Architecture(DEPA) framework enables users to securely share their data using a consent based model, and forms the base for the consent architecture for Account Aggregator.

So far, RBI has given out 4 licenses and 3 in-principle licenses for AA. As an early stage VC, we do not see opportunities in pure play AA’s since it is now regulated, licensed with minimal capital requirements and as of today, has an unknown business and revenue model.

India is just beginning its journey in Open Banking and has barely scratched the surface. The folks at The Digital Fifth have prepared this useful infographic on the Open Banking Ecosystem in India.

So far, most of the headlines have been stolen by Neo Banks in India and rightly so. Neo Banks in India, either on the Retail side (which has clearly more participants) or on the SME side, operating on a variety of interesting models, are today partnering typically directly with banks (Open with ICICI Bank, Niyo with IDFC First, Finin with SMB Bank, Yelo with ICICI and Federal Bank and so on) to provide seamless UI/UX for customers to open accounts, issue cards, payment services and other financial services.

Not to be left behind, traditional banks have also launched their own neo-banks with the largest being SBI Yono. Others too have joined the bandwagon — Kotak 811, Digibank by DBS, Axis ASAP, Mine from ICICI Bank.

Despite several countries across the globe issuing digital banking licenses, RBI is yet to come out with a definitive timeline on this in India. However, it has taken steps in the right direction by starting to give out Small Finance Bank licenses on tap (Shivalik co-operative bank has received an in-principle SFB license from RBI).

Without a clear guideline from RBI, it is hard to imagine it giving out digital banking licenses in a 3–5 year time frame. This is important as it now opens the question on whether the current model of Neo banks as a layer between the user and the bank is sufficient to build deep moats and get access to low cost capital, without a full banking license. We are keen to hear from companies who are building a NeoBank, either on the Retail side or on the SMEs side and have a differentiated answer to the question on long term moats.

Banking as a Service (BaaS) — Building banking infrastructure

I think the true first movers in India in terms opening up their banking infrastructure via APIs for fintechs to build on top are the traditional regulated banks. They realise that instead of competing with fintechs head on, their biggest strength is that they hold a banking license and are sitting on infrastructure that could be utilised to partner with fintechs and get access to customer segments that they directly cannot access.

What is interesting is that despite no regulatory push, over the last 3–4 years, Indian banks like RBL Bank, ICICI, Yes Bank, IDFC First have been on the forefront by opening up their banking infrastructure via APIs, allowing fintechs to operate within a sandbox and creating an API hub/market place. For instance, Yes Bank claims that it has over 350 APIs developed that are being utilised by 1,700 businesses live on its API banking platform with API volumes being 25% of total volume!

This is very similar to what BBVA built through its Open Banking Platform. It unbundled and opened several of its core banking products and services in easy to use modern API infrastructure for 3rd party fintech such as Digit, Azlo to use and build their own products and specialised use cases.

Before we progress further, here is a recap:

Playbook 1: Neo banks such as Yelo, Niyo etc work with 1, at best 2 banks to unbundle various banking services and offer it to their users with superior UI/UX, better technology and enhanced customer relationship.

Playbook 2: Banks not wanting to be left behind, are launching digital versions of themselves — SBI Yono, Axis ASAP, ICICI Mine etc.

Playbook 3: Banks also are opening up their API’s and allowing third parties, fintechs and businesses to build products and run experiments within a sandbox. Example: IDFC First, Yes Bank, RBL Bank etc. Global case study: BVBA

Playbook 4: Pureplay fintechs/API Stack players operating as BaaS players. Their job is to work with multiple banks and help them build easy to use APIs which can then be consumed by fintechs. While, this is a rather simplistic explanation, it should suffice at this stage. However, in more advanced regions such as the UK/EU and the US, there are multiple billion dollar models within the broader BaaS ecosystem.

Key here is that BaaS players themselves do not have a banking license. They sit on top of the Sponsor/Regulated Banks, utilise their license and banking stack to unbundle various services which can then be used by fintechs to innovate and create their own products.

India’s fledgling BaaS ecosystem

Why should these Baas companies even exist?

• Building banking integrations and working with banks is painstaking and time consuming; Fintechs rather work with a few BaaS players who have already done the hard work of building these banking integrations
• Banks too would rather work with a few BaaS companies rather than a plethora of fintechs whose core competency is not banking tech
• While the newer banks might have more modern Core Banking Systems, the older ones probably have legacy systems with extremely complex systems which would require specialised BaaS players to build on
• India has 22 Private Sector Banks, 12 Public Sector Banks, 56 Regional Rural Banks, 1,482 & 58 multi state co-operative banks, 10 Small Finance Banks, 6 Payments Banks and 44 Foreign Banks with a branch presence in India. Imagine the systems and complexities each one of them would entail and unleash!
• Outside of the big banks, several smaller and PSU banks too are keen to partner with fintechs and most of them not only need help in modernising their systems and but also hand holding in opening up their banking services through APIs
• Banks are keen to work with fintechs to open up new markets and increase their lines of revenue while utilising the trust they have built and expertise in back end banking ops they have mastered over the years

We are keen to talk to BaaS players who are working to build API’s and Banking Infrastructure, especially around powering B2B payments, cards and core banking services.

In the next part of this series, I will dwell deeper and attempt to peel the onion on further nuances in the models of Neo Banks and BaaS players in the Indian ecosystem.