Indian NeoBanks — What is behind the facade???

In this article, I try to cover the utility of NeoBanks in India. For more such articles click on the link

The last few years have seen an explosion of hundreds of fintech startups, trying to solve one problem or another. We have had NBFCs, P2P lending models, Payment Apps, Wealth Management Apps, and whatnot. Now there seems to be a new toast of the town, NeoBank. The traditional lending sector has been struggling for the past few years, with some high-flying white collars running away with a lot of money. At 7.1% Indian banks recorded the second slowest loan book growth in over a decade. The lowest coming in 2017. With their focus on cleaning their books, there was a need for the makeover. Voila, NeoBanks came to the fore to change the outlook.

Let us begin by understanding the business model and how it is trying to ensconce itself in the value chain. These are entities that do not have an offline presence and operate digitally. Though, they end up calling themselves ‘Banks’, they are not. As per the Banking regulation act, “no firm or individual or group of individuals shall, for the purpose of carrying on any business, use part of its or his name any of the words, ‘bank’, ‘banking’ or ‘banking company’.” These NeoBanks are not regulated by RBI and use other licensed Banks, they seek to replace, to render services of accepting deposits and lending.

Now, as I earlier pointed out that they do not have any banking license what that means is that they on their own cannot accept deposits. To solve that problem, they use traditional Banks like ICICI, RBL to accept their deposits and do the lending. Since your accounts are essentially opened in the Banks customers do have the option of going to the branches.

To put it in a nutshell, these are UIs which are pasted using APIs on the existing digital networks of the old banks. Just to contradict myself, I earlier pointed out that these are entities without any physical presence, but generally these NeoBanks let their customers visit the partner bank’s offline branch to deposit the money or for some other query.

So, in the value chain think of Traditional Banks as Products and these NeoBanks as Distributors with some jazz and additional features.

Why did they come into existence?

VCs have been pouring in millions into these models and there should be a well-founded reason. One reason can be that their counterparts in other countries have also attracted a lot of attention, and India can be a part of herd mentality. Even though the models might be different, for instance, digital banks in Singapore end up taking licensing permissions to run their operations.

However, the major reason seems to be the target segment they are going after right now. The SMEs, and low-income individuals.

First let’s understand the psyche of a normal branch business development team. One of the major KPIs is loan growth, which means that the person doing BD can either go after multiple small accounts or maybe a big account. Unless and until it is a low hanging fruit, the business development does not put in a lot of effort. Additionally, these customers do not have a lot of credit history, collateral or even guarantees to go by.

With the process of raising loans being tedious, we find that the already neglected get nudged to the informal sector for borrowing. We do have some new fintech NBFCs targeting the same base (CASHe, Zest money) but what sets these NeoBanks apart is the rate of lending and a couple of extra services like the feature of depositing money. In the case of SME targeting NeoBanks, they provide expense management, payroll management, and some other services.

The plan seems to be to integrate different accounts and collect data using multiple services.

Suppose there is a Small Enterprise, and like other SMEs it has multiple accounts. Once it gets onboarded with the SME, he or she can integrate its accounts in one place. Additionally, they can use one of the additional services like the expense management services provided by such NeoBanks. On top of that, the proprietor and his/her family of such SME who also may be having a separate bank account may also get onboarded, hence creating an additional trove of data.

All these data, using multiple account balances, expense management can be used to create novel financial products which will suit the customer hence pushing up the sales conversion rate and integration of accounts.

Taking my own example for individuals, I have 3 bank accounts (one of which I use for Salary and other two for personal purposes), then one account with Zerodha for share trading. If a NeoBank helps me integrate all these accounts it can get enough data to create and offer various financial products, one of which can be Share Hypothecation for a small personal loan.

We find that the use cases can be many for these NeoBanks. However, one question remains

Why do the big banks partner with them?

The simplest reason is Business Development. These NeoBanks will help the banks increase both their assets and liabilities. The data which gets created will most likely be shared with the partner banks to help identify the section of the population which is credible but underbanked.

These Banks operate in multiple languages, even if one goes on the play store one can see that in case of NiYo even the customer service responds in Hindi. Their customer-first approach might help them get some of those customers.

Someone reading closely might realise would there not be a risk on the books of account when Banks on behalf of NeoBanks do the lending? The answer is there might be. If the banks remain as stringent then these banks would not be able to grow and if they don’t then the asset quality can see a dip. Traditional Banks for now seem to be willing to take the risk. Additionally, increased data will help the banks take better decisions. NeoBanks can also do the underwriting by having an FLDG agreement wherein they can take some risks on their books. However, most of the risk will still be borne by the banks as the NeoBanks are mainly the interface.

Another reason banks choose to partner is the DNA of the banks and the NeoBanks. These NeoBanks are startups, with the license to experiment. They can experiment with the interfaces and the approach towards attracting the customers at the expense of Limited Partners’ money. Traditional banks have a lot of other regulations and operations to look after they are not Technology Companies, at least not yet.

Can the Traditional Banks become NeoBanks themselves?

Yes and No. Yes, because theoretically it is possible and there have been attempts. Kotak 811 and SBI Yono are attempts by both a major private bank and a major public sector bank. Both have failed to gain a lot of traction. No, because the time and their DNA does not help them. Banks have traditionally not adopted the customer-first approach. With the economy nosediving, taking bets for experiments might not be in the best interest of the banks. Even the NeoBanks are trying to figure out what works and what does not work. Being the first mover may not be the most advantageous, they just should not be very late to the party.

How will they earn money?

By providing new customers to the banks, the NeoBanks charge commissions. If one goes on Open’s website one realises that they are only charging Payment gateway fees from the customers. However, it is reasonable to assume that in the future there would be commissions they would claim for doing the cross-selling. The revenue items in the P&L should carry all the items as in the P&L of a bank barring the Interest Earned. All the more, the specialised services will be charged for. Commission for referrals, subscription fees, selling insurance, or mutual funds.

A major chunk of the expense would be the Tech cost, marketing cost followed by Salaries. On a large customer base it is reasonable to assume that they should be able to cover the costs rather easily, because of the lack of physical presence.

In conclusion

India is a highly underbanked country, and NeoBanks along with a host of NBFCs are trying to address the problem. With no intention of missing out on the wagon, traditional banks have partnered with the NeoBanks, what is left to be seen is that can the NeoBanks back the noise they have created, and end up transforming the banking landscape. I hope they do but the verdict is still out.

Some of the NeoBanks operating in India are:

NiYo : Founded by Vinay Bagri, a finance industry veteran. This start-up is targeting people with salaries less than INR 15000- 20000. It approaches corporates that hire Blue-Collar workers for their salary accounts. Hence, a B2B2C model.

Offerings: Their main offerings are Salary Accounts, Smart Banking for SMEs (Account management, credit loans, Overdraft facilities), forex cards, etc.

It claims to be having ~1 Mn odd subscribers. It has about 6000 odd subscribers. However, one thing I liked about the application was in the Play Store reviews the responses by the company were in Hindi. It partnered with Yes Bank initially now works with DCB Bank.

Open: It has marquee written all over it. A Tiger-Global backed start-up founded by Citrus Pay staff, targeting SMEs. One other investor is Citrus Pay founder Jitendra Gupta, who also happens to be starting his own NeoBank, Digifin.

Offerings: Credit card facilities, Book-keeping, payroll management, and accounting tools.

Valued at about $150Mn. It has about 100000 customers (Tech Crunch). This happens to be one of the most famous startups. Open’s app store currently has 10 apps, including ones for marketplace listings, tax filing, and bookkeeping. It has partnered with ICICI Bank

RazorPayX : Again funded by Tiger Global, launched by RazorPay to take advantage of its existing base of 800000 online merchants. ICICI Bank is its partner bank.

Offerings: In addition to account management, payroll management, and credit cards they also offer CRM facilities.

We have DigiFin and Yelo which are yet to start their operations, again targeting Salaried Employees earning up to 35K or individuals part of the gig-economy

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