Accelerating Digitalization in Financial Services

The financial services sector has changed beyond recognition in the past few years, with traditional licensed players increasingly leveraging technology to stay relevant and up their game. They are building APIs either inhouse or by partnering with third-party providers to offer seamless online financial and digital financial services to customers, expand their addressable market and enhance their operating efficiency.

APIs, which essentially facilitate easier sharing of information between two or more parties, have been around for over a decade now, but their importance in the financial services landscape has never been greater. To leverage their strength, APIs are now managed like a product one built on top of a potentially complex technical footprint that includes legacy and third-party systems, which can be shared, reused and monetised to extend the reach of service providers and open up new revenue streams.

The figure below captures the main trends that has led to this accelerated disruption in the financial services ecosystem. These changes have resulted in financial service providers increasingly relying on open architecture and integration of their systems with third parties (both licensed and non-licensed) through APIs.

Rise in internet penetration, data usage and smartphone penetration

• Initiatives such as India Stack, which provides a set of public APIs on one platform, continue to push digitalisation

• The introduction of open-source and interoperable payment system – UPI – was a pivotal moment in accelerating the digital push

• The launch of Aadhaar-enabled Payment System (AePS) – a bank-led model that facilitates interoperable transactions at PoS (microATM) – has aided last-mile smallticket-size payments

• Launch of account aggregator ecosystem to enable consent-based sharing of data across financial service providers to further push for open banking architectures

• Include AA here

• Digital onboarding enabled through permission for OTP-based eKYC, video-based customer identification process (V-CIP)

• In May 2019, the RBI permitted use of Aadhaar card for OTP-based eKYC for limited KYC accounts

• In December 2019, the government announced zero MDR on all transactions on UPI and RuPay network

• India has one of the largest Gen Z1 and millennial2 populations; this segment has significantly higher receptiveness and preference for digital channels

• As of 2020, millennials constituted 24% (333 million) of the population, and Gen Z constituted 9% (123 million)

• India has 35% of its population in the 15-34 age bracket, compared with 27.5% and 27.3% for China and the US, respectively

in retail digital payments

Pressure on yields leading to enhanced focus on efficiency

• The continuous pressure on yields has forced players to reduce disintermediation costs through investments in technology, digital channels and partnerships

• The interest rate for large banks (public and private) on fresh home loans dropped ~160 bps to ~7.5% during the 4-year periods ended March 2022. The pressure on yields has been especially high for secured loans extended to customers with a healthy credit profile.

Note: *Basis volume of different retail payment modes; other includes AePS (Aadhar Enabled Payment System), NEFT (National Electronic Fund Transfer), NACH (National Automated Clearing House)

Retail digital payments include all digital payments except RTGS and paper clearing

1Gen Z is defined as the population aged between 20-24 years (as of 2020) and 2millennial is the population aged between 25-39 years

Source: TRAI, NPCI, CRISIL Research

Account aggregators (AA–NBFC), a new class of NBFCs approved by the RBI created to manage consent-based data sharing of users between financial entities, started operations in September 2021. All entities regulated by the RBI, the Securities and Exchange Board of India (SEBI), the Insurance Regulatory and Development Authority of India (IRDAI) and the Pension Fund Regulatory and Development Authority (PFRDA) can act as financial information users (FIUs)/financial information providers (FIPs) in the AA ecosystem. CRISIL Research finds that the AA ecosystem would lead to the following:

1. Reduction in the turnaround time for loan processing and optimisation of acquisition costs, as the entire digital footprint of the user will be available through a single window

2. Further streamlining and possibly automation of the underwriting process; data received through AA would be in a standardised and machine-friendly/readable format, thereby providing a push to cash-flow-based lending

3. Enhanced ability of even legacy players to adopt cash-flow-based lending, due to the availability of digitally signed documents, lending comfort on data authenticity

The launch of the AA ecosystem provides a further shot in the arm for the API ecosystem, as financial institutions would have to merely integrate themselves with the licensed AA-NBFC. Also, to ensure stability and interoperability of the system, all stakeholders will have to adhere to the common set of technical standards as prescribed by Reserve Bank Information Technology Pvt Ltd (ReBIT).