Will every company be a fintech company?

A deep dive into banking infrastructure(BaaS) and it’s future. And a perspective on its evolution in India.

In India excluding a few sectors(Edtech, fintech and gaming mostly), a majority of Indian startups(mostly apps) have struggled with monetisation. Even Truecaller with a huge 150m MAU in India struggles to monetise using subscriptions and ads(low cpms). If we combine this with the fact that 39.5% of Nifty comprises of banking companies, here’s what we get. Every company wants to be a bank

This growth in fintechs has put the spotlight on the technology that powers these fintechs. As someone who’s spent the last 5 years in fintech, I thought it was a good time to explore the evolution of BaaS in India.

The journey for a fintech is a long one and typically starts with a partnership with a bank or NBFC. This is the hardest piece of the puzzle, especially if you’re someone from outside the banking sector.

The entire banking infrastructure consists of several components:

1. Capital – The partnership with a bank/NBFC(non-banking financial company) provides you with capital required to lend to customers(applicable for lending companies, rest have it easy). This is due to regulatory requirements. Typically this includes a ‘FLDG’ – first loss default guarantee which means the third party provides a guarantee that they will bear upto 5-7% of the losses in case of default.
2. Core systems – These are the basic systems which are responsible for a. Transaction processing and recording deposits of money and withdrawal of money b. Settlement systems c. Customer management systems
3. Payments – Systems for connecting to payment networks, settling transactions with the network and so on.
4. Data – systems responsible for managing your data, ensuring security and safety of the data.
5. Regulatory – A fintech has several regulatory requirements – reporting of credit bureau enquiries, loans and credit card issued, regular audits by concerned agencies etc
6. Fraud – Requirements for identity management, fraud detection in transactions/loans and other AML requirements
7. Front end and user interface – The user interface that most customers interact with. This includes the mobile app, the web app and any other interfaces.

As you can see, creating a new fintech product involves tons and tons of partnerships with different service providers to create the final product.

Services for banking 1.0

The first version of banking infrastructure is something I like to call – ‘services for banking’. Since each of the different components are complicated and require a great deal of effort to build yourself, the first set of companies offered specialised services for each category. For example, one service provider had all the services required for kyc and identity management including pan verification, photo id match, name match, Aadhaar kyc, physical kyc, mobile identity management and more. Thus different providers fulfilled different parts of the consumer lifecycle – underwriting, kyc, income processing, fraud management, location analytics and so on.

One would expect one vendor to complete fulfilment for each category, however in a country as diverse as India, something as simple as ‘name match’ is also a very difficult problem. And this is further complicated by incorrect data available in government databases. This has meant even under KYC, multiple vendors co-exist offering specialised solutions for each use-case.

Services for banking 2.0

In the evolution of ‘services for banking’, we’re seeing consolidation with the larger providers expanding to other areas to give you a full stack solution. This approach makes sense as a fintech has to interact with a small number of service providers, monitor fewer services, your data is shared with lesser service providers and you can quickly integrate their solution due to a uniform api documentation. Thus the kyc provider is expanding to provide bank statement processing capabilities or offering delivery services for physical kyc. In my opinion, this approach is only partially successful as it takes years for each service to mature to successfully handle all edge cases and segments.

AWS for banking – 3.0

If we take this approach a step further, we get an end-to-end solution provider that makes launching a new service as simple as plug-and-play. Along with kyc, identity management, the service provider also provides capital and regulatory support the smaller players are missing and don’t have the capability to deploy. Especially since partnering with a bank or NBFC is a time consuming process often taking as long as 6 months to a year.

We’re seeing Stripe in the US take big leaps in a 4.0 approach with the launch of Stripe Treasury. This involves lending to customers of Stripe’s customers(Example Shopify, Bigcommerce etc).

However for this approach to scale to more serious players like Uber, one needs to understand that internet companies are very careful about customer data, transaction data, credit policy and the end customer experience. And reliability, flexibility and scalability of the solution(top 3 principles for Amazon AWS) are very important for BaaS to work out. Thus the providers have to provide data localisation among other customisations.

To give you some perspective, if you’re a credit card issuer/fintech, a transaction goes through the below 12 hops to be complete!

To understand a transaction one needs a separate post. But to give you a brief over-view – there are acquiring bank, issuing bank, consumer, payment network and card processor/payment gateway as the different entities in this transaction. A transaction starts with the consumer swiping their card, then the details are sent from the card processing system to the bank that acquired the processor(yes, the terminals also are acquired by a host bank!), then the transaction goes to the network(Visa/Mastercard) and this link is also facilitated by a provider – in this case First Data. The first cycle described here is the capture and authorisation cycle. The next is the clearing and settlement cycle.

As one understood from the diagram above, there are different systems in a complete transaction cycle. A ton of systems like Vision plus from FirstData, Euronet, FSS, ACI are currently the connecting systems between the payment networks and financial service providers. However these systems are costly, difficult to integrate, legacy systems with less flexibility. The shortcomings are being capitalised by newer companies like M2P to provide a better customer experience and technology to companies.

Open Source as building blocks?

A few companies are experimenting with an open source approach to building the layers of banking infrastructure. While BaaS companies are great in providing a piece of the entire system layer, they are often not customisable enough to work for newer use-cases. For example if you wanted to create a push messaging system for your app, one of the options is to add a system like Urban Airship or MoEngage with reporting panels, delivery systems and campaign management and plug it in or choose a more customisable layer like AWS pinpoint and adapt it to your needs. (AWS pinpoint is still proprietary software, using a Github library would be a more apt example.)

A16Z recently invested in a company – Moov. That’s building these blocks for companies to build over.

Lending as a feature?

Kunal Shah(founder of Cred) famously said that lending is a feature. And the evolution of fintech is taking us towards a future where financial services can be added to your product as seamlessly as one integrates an api for google single sign-in.

This future is however some time away due to the inherent complexity of financial services. However there are several unsolved problems in credit underwriting, identity management, risk management, fraud detection, simplifying regulatory requirements in a country as large as India. And I’m excited to see it’s evolution across different services – core infra, support systems and end-to-end solutions.

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I’m a product builder currently re-defining credit in India. If you’re interested to work with us, please DM me here or on Twitter. I love all things consumer — fintech, social, video and music. You can follow me on Twitter or Linkedin.

Reference material:

1. First Data Sec Listing – https://www.sec.gov/Archives/edgar/data/883980/000119312515256975/d31022ds1.htm
2. Angela Strange’s epic post – https://a16z.com/2020/01/21/every-company-will-be-a-fintech-company/

Thanks to my friend Nitish Varma(who’s building a very interesting company Wealth42), my colleague & friend Abhishek Narkar(who’s a pro at all things banking) and Nameet Potnis for comments.