With that kind of billing, venture capitalists believe fintech challengers like lending startup Capital Float, payments firm PhonePe, and mutual fund distributor Paytm Money can face off with traditional firms—banks like HDFC, or payments companies like Visa.
Nearly $10 billion has been invested in fintech in the last decade. That’s nearly as much funding as has gone into food tech, hyperlocal delivery companies, and ride-hailing put together in the same duration, according to venture capital data tracker Tracxn.
But very few viable business models have come out of this fintech hype machine.
“The hype sets in when investment dollars take over reality, and that leads to business running ahead of fundamentals,” says Kunal Walia, partner at Khetal advisors, a boutique investment bank. Over the last 15 months, the real picture behind fintechs’ hyped growth has been emerging.
Fintech apps—like payments apps, wealth tech apps—spend Rs 150-300 ($2-$4) to get one app install in India, but 59% of those apps are uninstalled in a day, says AppsFlyer, an app analytics firm. Fintechs aren’t any closer to cracking their core businesses. For example, payments companies like Paytm*, PhonePe, Google Pay, BharatPe bank on the richness of transaction data to then monetise that data through ads or credit. But ironically, fintechs solely focused on credit—like Capital Float—are struggling.
Still, hype has its uses. “It is only when there is enough hype in a sector does it get a lot of dollars and only then those dollars reach those few worthy companies that otherwise may not have got the money,” says Walia.
Besides, it also brings the focus on who’s bringing value to users. And who isn’t.
Should, say, a Paytm, which grew to 140 million users by offering cashbacks to get people to choose its app, really be more valuable than traditional credit card payments company SBI Cards? SBI Cards has an 18% market share with 9.4 million cards but profits worth Rs 863 crore ($121 million). Paytm, on the other hand, saw losses double to Rs 3,960 crore ($555 million) in the year ended March 2019. And yet, Paytm has a $15-billion valuation while SBI Cards, at best, hopes to record a $8.4 billion valuation in its upcoming IPO in the year ended March 2020.
So, while the hype draws attention to the sector, lift the veil and the imminent future of (and threats to) fintechs becomes clearer.
Bajaj’s offline gameplay
The financial sector is reeling from a $200-billion bad loan nightmare. It began with infrastructure lender IL&FS running out of money to pay its dues in 2018. That along with bad loans that Yes Bank and public sector banks made to corporates has choked the supply of capital to fintech lenders, sparking a liquidity crisis.
“No one expected to have a down cycle this quickly [after the financial crisis of 2008]. So a lot of investment went chasing lending companies and that’s why lending till now was loan book led. We are in a down cycle and it will go down further in 2020,” said the founder of a lending fintech.
While the public sector banks mostly face the heat for the extent of bad loans, fintechs’ bad loan skeletons are not fully out of the closet. Yet. A prime example of bubbling bad loans among fintech lenders is Capital Float. The company, which personified fintech lending, saw its gross NPAs (non-performing assets) double to 6.8% in the year ended March 2019 from the previous year. (Gross NPA as a % of AUM was 4.8), according to ratings firm ICRA. It also wrote off 1.8% of its assets under management, as of September 2019. This, while its loan book grew 2.5X in just two years to Rs 1,403 crore ($196.5 million).
The liquidity crisis should have sent fintech lenders into conservation mode. But fintechs that relied on external capital didn’t want to sacrifice growth. So those like Capital Float wrote loans to users of edtech companies like Byju’s, but suffered defaults thanks to the sales tactics of the company (we wrote about it here. Capital Float itself wrote about what went wrong here). This has left Capital Float with far-from-desirable asset quality.
There are more fintech-led bad loans in the making. Credit rating company Cibil, in a private event, said that the Indian fintechs’ NPAs for six months was at 7.2%—even among prime customers who borrowed less than Rs 50,000 ($697). Compare this to 3.3% for non-banking financial companies (NBFCs) and 1.1% for private banks.
Ironically, the hoopla around fintech lenders was that their algorithms and machine learning could accurately identify the creditworthy, resulting in lower NPAs. Similarly, tech would reduce operational costs.
If tech and underwriting prowess were the markings of a true fintech, the one successful lending fintech to emerge out of 2019 has been the 10-year old Bajaj Finance Ltd.
Bajaj benchmarks itself against Amazon, Netflix, say former employees. It studied Netflix to see how the streaming company uses algorithms to serve different content to different users. Similarly, Bajaj starts all users with consumer finance loans and then puts its algorithm to work to see which would be the best loan to cross-sell to its borrowers.
Although consumer finance loans account for only 12% of its income, Bajaj is able to leverage and sell other consumer loans, which make up 22% of its income. Almost 60% of the total loans it has sold are from cross-selling, according to its latest quarter of earnings in September 2019.
Fintechs, emboldened by tech-based lending, have also underestimated physical distribution. Bajaj, which isn’t online-only, doubled its presence to 100,000 touchpoints in two years. Combine this with its cost of borrowing. NBFCs’ cost of borrowing is about 10% while fintech NBFCs go as high as 22%, said the founder of a fintech lending company, who didn’t want to comment publicly. Because of this advantage, any operational efficiency tech can generate can’t compete with NBFCs’ cost structures.
That is why even in the toughest of environments for all lenders in 2019, the gross NPAs for Bajaj stood only at 1.54% in the year ended March 2019, with public sector banks at 9.3%. With such a business, Bajaj Finance is valued at $32.4 billion.
Fintech lenders are now playing catch up. LendingKart, for instance, relies on agents to source loans. Consumer finance companies like ZestMoney are going offline to lend. Fintech lenders are searching for niches missed by Bajaj Finance and banks. But the catch here is that once a niche is identified, and a segment has been verified as risk-fee, Bajaj Finance could swoop in to snatch the best borrowers.
It is a vicious cycle that can only be broken with a highly differentiated product. Some startups have their hopes pinned on tech.
Razor-sharp tech focus
Any feature that any tech company launches gets democratised in a matter of months. But payments aggregator Razorpay and discount broking startup Zerodha want to take those fleeting advantages.
Total digital payments volumes in 2019 grew to 31.3 billion transactions, 51% over last year. This momentum has been the wind beneath Razorpay’s wings. Razorpay helps businesses accept all modes of digital payments—from credit card to Unified Payments Interface (a real-time mobile-based payments system).
Up until 2014, two companies held the digital payments volume pie. Billdesk, which earns Rs 1,000 crore ($140 million) by processing utility payments, and Naspers-funded PayU, which accepts payments from the internet economy. In the five years that Razorpay has been around, it has made 8-year-old PayU uncomfortable.
Indians make $60 billion worth payments in a year, half of which happen online. Razorpay claims it processed $10 billion worth of payments in 2019. A 500% growth over last year. This growth was driven in part by digital adopters spending more online. That alone made for 30% of the growth, said Harshil Mathur, co-founder and CEO of Razorpay.
It is on the back of this that Razorpay doubled revenues to Rs 193 crore ($27 million). A feat few Series C funded startups can claim in the year ended March 2019. Razorpay’s growth stands out because it comes at a time when there is large consolidation among online players, leaving few opportunities. That makes retention of those merchants that much harder.
To hold on to merchants, Razorpay is banking on new products—loans, current accounts, corporate credit cards, payment pages for offline stores accept payments, etc. According to Mathur, one of the most valuable metrics for the company is the number of products per customer. Mathur says this has grown from 1.5 last year to 1.8, with the ideal number being 2.5. At that level, Razorpay can better retain customers and close the gap with PayU.
It is this feature-focused approach that also led to one of the biggest fintech successes in 2019, where a startup grew bigger than the traditional incumbents.
The legend of Zerodha
If there is a fintech that is both profitable and fast-growing, it’s Zerodha. It took 10 years for Zerodha to become the largest discount broking company in 2019. A company, which, by charging only Rs 20 ($0.28) for trading, outgrew other broking behemoths like ICICI Direct and HDFC Securities in the last financial year. Zerodha, as of 2019, had 1.8 million active clients racing ahead of market leader ICICI Securities with 924,585 clients.
It has grown to account for 10% of all the trading that happens on the stock exchange.
Two things got it this kind of revenue and growth. First, a simple flat fee helped it see a 90% increase in revenues to Rs 950 crore ($133 million) in the year ended March 2019, with a profit of Rs 350 crore ($49 million). This, while banks charged a commission of about 0.5%.
Second, Zerodha’s tech and features. Traders who sell and buy stocks are a finicky lot. Downtimes result in losses. So they need a nifty trading platform. “This is a bit like car racing, the team that builds the best car wins,” says Kamath.
But Zerodha’s problem is this. Its pool of active traders makes for 90% of the revenue. Its growth is constrained by the number of traders who take part in the market. There are only about 300,000 to 400,000 active traders in a day.
For 2020, Zerodha is eyeing a bunch of businesses to diversify from just broking. It wants to lend to people to buy more stocks and also give loans against securities (LAS)—like mutual funds. “No one has tried selling LAS to mass retail. It is mostly a High Networth Individuals (HNI) product,” says Kamath. It also wants to build a platform for people to invest in US stocks. With this, Kamath hopes the broking business will eventually account for just 50% of revenue.
Other startups are following suit. A company called Small Case, for instance, which lets customers invest in stocks based on themes or objectives, has grown to 250,000 investors who have traded close to Rs 2,000 crore ($280 million) over the platform. Companies like Smallcase are the true beneficiaries of the fintech hype.
But all innovation doesn’t come from just venture-capital-funded, private limited companies.
When you examine the reason for a company’s success and why it is lauded, the answers lie under the hood of their flashy apps.
Take mutual funds, for instance. It saw its highest ever growth in 2019, despite very volatile market conditions. The asset under management rose by 18% to an all-time high of Rs 27,00,000 crore ($378 billion) in November 2019, according to the latest data available with the Association of Mutual Funds in India (Amfi).
Wealth tech companies are sprouting to get a piece of this mutual funds pie. The sector saw $141 million in funding in 2019, according to Tracxn. Zerodha ramped up its mutual fund distribution to 200,000 investors from 70,000 last year and managed Rs 2,700 crore ($378 million) worth of assets. With just four people in operations. Behind this efficiency lies a product from a stodgy 144-year-old stock exchange. Bombay Stock Exchange or BSE.
BSE is fast losing currency to the younger National Stock Exchange (NSE). BSE is fighting back to stay relevant, and its weapon of choice is the mutual funds platform—BSE StAR. It allows distributors to connect to StAR instead of the numerous asset management companies that make the mutual fund plans. For BSE, StAR is its only shot at competing with NSE. StAR earned BSE, Rs 29 crore ($4 million) or 6% of revenue in 2019.
A decade-old platform itself, StAR got a new lease of life last year. It went from under 10% market share of all inflows to 35% market share of all inflows into the mutual fund industry. This was due to the bump in interest from online mutual fund distributors.
Online platforms account for only about 3% of all mutual fund investments in the country, but all the newly-funded ones are plugging into BSE StAR. The transactions through StAR nearly doubled to 36 million transactions in 2019. Companies like Scripbox, Zerodha and new entrants into the wealth management space like payments company PhonePe—which also lets users buy mutual funds—have been able to scale easily using StAR.
“It is like the UPI of Mutual Funds,” says Kamath.
UPI, a payment system made for mobiles, allowed companies like Google to turn payments into a market leader overnight. It was not something that came out of the stables of the tech company but from National Payments Corporation of India (NPCI)—a quasi-regulator in the business of payments. We have written in the past about the complex payments beast that is NPCI.
Ganesh Ram, business head of BSE StAR said the platform eventually wants to become a marketplace for selling all financial products. From corporate fixed deposits to gold and bonds to other financial service providers. This would mean any fintech can easily scale riding on StAR – much like how UPI is driving payments.
UPI is largely responsible for the hype around payments in India. Payments alone has attracted close to $4.2 billion in funding. And as much as tech companies rode with UPI, it was the underlying infrastructure built by NPCI that made it trivial for any new payments company (with capital) to scale. In a way, making NPCI a fintech too.
But NPCI itself faces great risk.
India’s finance minister confirmed that from January 2020 onwards, Indian merchants will pay no fees to financial institutions that help merchants accept digital payments (via Rupay cards and UPI)—a fee called Merchant Discount Rate. While this means no revenue opportunity for payments companies, it hits NPCI. “The entire payments value chain is at stake,” says a payments executive.
The government, meanwhile, wants NPCI to take UPI international. “If the government cuts NPCI’s source of funding, how will it invest in infrastructure and expand?” says the payments executive quoted above.
Payments companies may eventually make more money than NPCI through ads or disbursing credit. But the companies will have to turn to innovation on core products or to entities like NPCI to power their growth—and now NPCI isn’t so well-placed itself.
The bar for what makes a fintech is rising. But regulation is a great equaliser for all fintechs. The real test for a fintech today is to see how much retail investors will pitch in if they were to go in for an IPO.
*Disclosure: Paytm founder Vijay Shekhar Sharma is an investor in The Ken