How to build a lending fintech in India?

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The current path to success for an Indian lending fintech company seems to be a) Build a business around an arbitrage in the short-term, b) build scale by complementing a Bank’s services, c) build a Brand, and then eventually d) build a Bank.

Exploit an arbitrage: The raw material (read funds) of a lending fintech is often 2-3 times more expensive as compared to their traditional counterparts. A typical up-start can raise debt from the markets at between 12-14% versus a Scheduled Commercial Bank deposit rate at between 4-6%. Most lending categories see a turf war or grabbing some share of an existing pie from the Banks instead of increasing the pie and thus it is crucial for an early player to identify an area of arbitrage which it can exploit to gain the initial momentum and sustain, especially given that it cannot get into pricing war on account of the higher cost of funds.

Complement Banking services to build scale: The other crucial point is to avoid a direct confrontation with the Banks in the early days and figure out ways to be complementing the Banks’ services rather than competing with them.

Build a Brand: “Whose customer it is?” This is the most important question to be answered when building a fintech. I have spoken to many Bank managements which are happy and comfortable in tying up with Fintech companies as distribution/delivery channels and believe that given the strong Brand pull and trust of the Bank, the customer ultimately belongs to the Bank. Fintech founders, on the other hand think that in most cases, they front the relationship with the customers and thus own the customers. In reality, the amount of value add as well as the extent of customer visibility will decide the customer’s as well as the Bank’s perception about whom does the customer belong to in a joint Bank/Fintech partnership for credit delivery. However, from a Fintech’s perspective, it is very important to build visible scale quickly in order to have any shot at building a well-known Brand and own the customer.

Build a Bank: Finally, the fourth step is to build a modern Bank in order to get access to the low cost of funds like the traditional Banks.

There are 5 types of arbitrages

  • Technology arbitrage
  • Regulatory arbitrage
  • HR arbitrage
  • Risk arbitrage
  • Bureaucratic arbitrage

Technology arbitrage comes from specific expertise such as data science, digital marketing or adoption of modern technologies (e.g. cloud core-banking vs legacy core-banking). Even though advantages arising from technology arbitrages are short-lived, they may be enough for a new player to establish early momentum. This arbitrage manifests in the form of innovative products such as Buy-Now Pay-Later (BNPL), digital distribution (early Bankbazaar), network effects (Payment companies) and amazing UX (Moneytap)

Regulatory arbitrage comes from loose/non-existent regulations in a particular space. Regulators are always behind the curve since they cannot always anticipate the ever-changing technology and societal landscapes. Thus, many new emerging areas often do not have any regulations to begin with. This manifests in the form of innovative products, innovative distribution (doorstep delivery model of Rupeek), efficiencies (better pricing power – EarlySalary, less regulatory burdens, Higher RoA NBFCs – Bajaj Finance)

HR arbitrage comes from the ability of the Fintech ecosystem to hire and fire skilled/unskilled workforce across geographies and lesser overheads and related liabilities. This often allows Fintech companies to build staff augmentation business models, especially in the broader geographies where the Banks may not be present (Most Micro finance institution and Business Correspondent models fall in this category – Vakrangee/Spandana)

Risk arbitrage comes from the ability of the Fintech companies to take on higher (sometimes undue) risk due to the high-risk nature of equity of Fintech companies as well as their growth focus. Banks on the other hand, are very risk averse given their fiduciary role to their depositors. This allows Fintech companies to take on higher risks (directly in terms of customer segments or through risk exposure – FLDGs or guarantees) and carry out risky experiments. This usually manifests in the form of newer categories (consumer durable loans – Bajaj Finance, Short-term loans – Early salary, etc.)

Bureaucratic arbitrage comes from smaller size, management incentives and results in a higher speed of decision making for Fintech companies as opposed to their larger Banking counterparts. It is fascinating how many times I have heard Bankers say that we had this or that fintech model proposed internally but nothing moved because of lack of management will, lack of clarity in regulation or some department stalling the progress. This arbitrage often manifests in the form of incremental product features such as pre-approved personal loans or specific end-use Bank accounts (Fampay, Happay)

Please note that the examples given above are just indicative and a Fintech may ride on more than one arbitrages to build its business model. Also, the technology and regulatory landscapes are ever changing and will continue to influence how the Fintech ecosystem evolves in the future.

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