With the COVID-19 disruption taking a toll on the world, almost two billion people—close to a third of the world’s population being restricted to their homes, businesses being locked-down inside the houses and work-from-home becoming a need of the hour; 'contact-less' business is what the world is looking forward to. This new business jargon means that the entire transaction is done digitally, without requiring any of the parties to the transaction interact physically. While it is not possible to completely digitise all business sectors, however, complete digitisation of certain financial services is achievable.
With continuous innovations being brought up, the financial market has already witnessed a shift from transactions involving huge amount of paper-work to paperless transactions. The next steps are headed towards contactless transactions.
Digital business models have received whole-hearted acceptance from the financial market. Digitisation has also opened gates for different service-providers to aid the financial market entities. Technology companies are engaged in constantly developing better tools to support such businesses and, at the same time, the regulators are providing legal recognition to technology and making contactless transactions an all-round success. This is just the foundation and the financial market is yet to see oodles of innovation.
The following write-up intends to provide an introduction to how the financial market got digitised, what were the by-products of digitisation, impact of digitisation on financial markets, specifically FinTech lending segment and the way forward.
Journey of Digitisation
Financial entities and service-providers have already taken steps to facilitate the entire transaction without any physical intervention. Needless to say, the benefits of digitisation to the financial market are evident in the form of cost-efficiency, time-saving, expanded outreach and innovation, to name a few.
The process of digitisation of the financial market has seen various phases. The financial market, specifically, the non-banking financial companies (NBFCs) have gone through various phases before completely guzzling down digitization. The journey of NBFCs from over-the-table executions to providing completely contactless services has been shown in the figure below:
From Physical to Paperless to Contact-less: The Basic Difference
Before analysing the impact of digitisation on the financial market, it is important to understand the concept of ‘paperless’ and ‘contact-less’ transactions. In layman terms, paperless transactions are those which do not involve execution of any physical documents but physical interaction of the parties for purposes such as identity verification is required. The documents are executed online via electronic or digital signature or through click wrap agreements.
The shift of operations from physical to paperless and contactless modes, at various stages in a lending transaction is as follows:
1) Sourcing the Customer: In case of a physical process, the officer of the NBFC interacts with prospective applicants while in case of paperless and contact-less process, the website, app or platform (‘Platform’) reaches out to the public to attract customers or an artificial intelligence (AI) based system may target just the right prospective customers.
2) Understanding the needs of the customer: While in case of the physical process, the authorised representative speaks to the prospects to understand their financial needs, in case of paperless and contact-less process, the Platform provides the prospects with information relating to various products or the AI system may track and identify the needs.
3) Suggesting a Financial Product: Based on the needs of the customer, the officer suggests a suitable product in a physical process. On the other hand, the suggestions in paperless and contactless models are system generated based on the analysis of customer data.
4) Customer On-boarding: Customer on-boarding is said to be done upon the issue of a physical sanction letter to the customer in a physical model. In the rest of the two models, the basic details of the customer are obtained for on-boarding on the Platform.
5) Customer Identification:
a. In a physical process, customer details and documents are identified by the officer during initial meetings and physical know your customer (KYC) documents are obtained for verification.
b. In case of paperless process, customer identification is done by matching the details provided by the customer with the physical copy of the documents.
c. In case of contactless process digital processes such as video KYC are used to carry out customer identification.
6) Customer Due Diligence: In the physical process, background check of customer is done based on the available information and that obtained from the customer and credit information bureaus. On the other hand, in case of paperless and contactless process, information from credit information agencies, social profiles of customer, tracking of communications and other AI methods are used to carry out due diligence.
7) Customer Acceptance: In the physical model, customer acceptance is achieved on signing the formal agreement. A customer is accepted on the platform by clicking acceptance buttons such as ‘I agree’ on the platform or execution through a digital/electronic signature.
8) Extending the Loan: While in the physical process, the loan amount is deposited in the customer’s bank account, in case of paperless and contactless models, the loan amount may also be deposited in wallets, prepaid cards, EMI cards etc.
9) Servicing the Loan:
a. In case of physical process, the authorised representatives ensures that the loan is serviced.
b. In case of paperless process, recovery efforts are made through nudges on the Platform. Physical interaction is the last resort.
c. In case of contactless transactions, recovery modes are almost similar to those used in paperless transactions but physical interaction for recovery may not be desirable.
10) Customer Data Maintenance: In case of physical process, the lender maintains physical data files of customer relationship. In case of paperless and contactless models, cloud-based information systems that store more than customer relationship information (such as KYC details, social profile, transaction records etc.) are the common practice.
The Manifold Repercussions of Digitisation
Payments Coming to Online Platforms
With mobile phone density in India reaching 88.90% in 2019
, the adoption of digital payments have accelerated, showing a rapid growth at a CAGR of 42% in value of digital payments. The value of digital payments to GDP rose to 862% in FY18-19. Simultaneously, of the total payments made up to November 2018, in India, the value of cash payments stood at a mere 19%.
Need for Service-providers
With everything coming online, and the demand for digital money rising, the need for service providers has also risen. Services for transitioning to digital business models and then for operating them are a basic need for FinTech entities and thus, there is a need for various kinds of service providers at different stages.
Deliberate and Automatic Generation of Demand
When payments system came online, financial service-providers looked for newer ways of expanding their business but the market was already operating in its own comfortable state. To disrupt this market, the FinTech service-providers introduced the 'idea' of easy credit to the market. When the market got attracted to this idea, digital lending products were introduced. With time, add-ons such as backing by guarantee, indemnity, and first loan default guarantee (FLDG) cover were also introduced to these products.
Consequent to digital commercialisation, the need for payment service-providers also generated automatically and thus, leading to the demand for digital payment products.
Opportunities for Service-providers
With the digitisation of non-banking financial activities, many players have found a place for themselves in financial markets and around. While the NBFCs went digital, the advent of digitisation also became the entry gate to other service-providers such as:
In order to enable NBFCs to provide financial services digitally, platform service providers floated digital platforms wherein all the functions relating to a financial transaction, ranging from sourcing of the customer, obtaining KYC information, collating credit information to servicing of the customer, etc.
Software as a Service-providers (SaaS):
Such service-providers operate on a business model that offers software solutions over the internet, charging their customers based on the usage of the software. Many of the FinTech based NBFCs have turned to such software providers for operating their business on digital platforms. Such service-providers also provide specific software for credit score analysis, loan process automation and fraud detection etc.
For facilitating transactions in digital mode, it is important that the flow of money is also digitised. Due to this, the demand for payment services such as payments through cards, Unified Payment Interface (UPI), e-cash, wallets, digital cash etc. has risen.
NBFCs usually enter into partnerships with platform service-providers or purchase software from software as a service (SaaS) providers to digitise their business.
Heads-up from the Regulator
Recent years have witnessed unimaginable developments in the FinTech sector. The ability to undertake paperless and contactless transactions has urged NBFCs to achieve pan India presence. The government has been keen on bringing about a digital revolution in the country and has been coming up with incentives in the form of various schemes for those who shift their business to digital platforms. Regulators have constantly been involved in recognising digital terminology and concepts legally.
In the Indian context, innovation has moved forward hand-in-hand with regulation
. The Reserve Bank of India (RBI), being the regulator of financial market, has been a key enabler of the digital revolution. The RBI, in its endeavor to support digital transactions has introduced many reforms, the key pillars among which are - e-KYC (know your customer), e-Signature, unified payment interface (UPI), electronic national automated clearing house (NACH) facility and central KYC registry.
The regulators have also introduced the concept of 'Regulatory Sandbox' to provide innovative business models an opportunity to operate in real market situations without complying with the regulatory norms in order to establish the viability of their innovation.
While these initiatives and providing legal recognition to electronic documents did bring in an era of paperless financial transactions, the banking and non-banking segment of the market still involved physical interaction of the parties to a transaction for the purpose of identity verification. Even the digital KYC process specified by the regulator was a physical process in disguise.
In January 2020, the RBI gave recognition to video KYC, transforming the paperless transactions to complete contactless space.
Further, the RBI is also considering a separate regime for regulation of FinTech entities, which would be based on risk-based regulation, ranging from 'Disclosure' to 'Light-Touch Regulation & Supervision' to a 'Tight Regulation and Full-Fledged Supervision'.
(The writer is an executive with Vinod Kothari Consultants P. Ltd.)