Digital Banks – A New Era Rebooting Banks

The word Digital has become habitual in todays world as it is part of our everyday life. Technology has brought transition in such a massive way that from a generation where each and everything was done manually has changed to just clicks . This transformation has come in various stages and it has impacted human life in various ways. Digitial transformation is an clear example of this . With pandemic affecting health conditions all across Globe ,Digitalisation became the need of the hour to reduce human interventions for the purpose of safety . Seamless Flow, or hyperautomation, is transforming industries and societies across the world. Automated, digitalized processes reduce costs and free up time to spend on adding real customer value. This is now being extended to banking sector.

History Of Banking

The concept of banking may have begun in ancient timeswith merchants offering loans of grain as collateral within a barter.
Lenders in ancient Greece and during the Roman Empire added two important innovations: they accepted deposits and changed money
Archaeology from this period in ancient China and India also shows evidence of money lending.

Niti Aayog Initiative

A Proposal For Licensing & Regulatory Regime For India

India’s economy has also been a hotbed of financial services innovation over recent years. Numerous fintech startup businesses have formed, spanning the banking and financial markets industry. Plus, India’s banking sector has also witnessed industry convergence with businesses from other industries pursuing new banking opportunities.

The NITI Aayog (National Institution for Transforming India) is a public policy think tank (A think tank, or policy institute, is a research institute that performs research and advocacy concerning topics such as social policy, political strategy, economics, military, technology, and culture.) of the Government of India, established with the aim to achieve sustainable development goals with cooperative fedralism by fostering the involvement of State Government of India in the economic policy-making process using a bottom-up approach. It was established in 2015, by the NDA government, to replace the Planning Commision which followed a top-down model.

The NITI Aayog council comprises all the state Chief Ministers, along with the Chief Ministers of Delhi and Puducherry, Lieutenant Governors of all UTs, and a vice-chairman nominated by the Prime Minister. In addition, temporary members are selected from leading universities and research institutions. These members include a chief executive officer, four ex-official members, and two part-time members.

NITI AAYOG, under Prime Minister Narendra Modi led Central Government proposed setting up of full-stack ‘Digital banks’, which would principally rely on the Internet and other proximate channels to offer their services and not physical branches, to mitigate the financial deepening challenges being faced in the country. “In other words, these entities will issue deposits, make loans and offer the full suite of services that the Banking Regulation Act empowers them to. As the name suggests, however, DBs will principally rely on the Internet and other proximate channels to offer their services,” it said in a discussion paper. The Discussion Paper makes a case, and offers a template and roadmap for a Digital Bank licensing and regulatory regime for India. The Discussion Paper also recommends regulatory innovations such as Digital Bank license that hold the promise of solving for as well as mitigating the financial deepening challenges faced.

Digital Banks- The Concept

The variety of digital-banking business and operating models has led to some confusion over the distinction between digital channels, digitized traditional banks, and pure-play digital banks. A Digital Bank is defined as a deposit-taking financial institution that provides its products and services through a digital-first or digital-only business model. Digital banks have the following characteristics:

A Digital Frontend And Operations

Digital Banks acquire and onboard customers and meet most customer needs with little or no reliance on paper documents a physical footprint(For exaple , branches, ATMS, agent point of sale), or manula processing . They also aim to offer a high quality user interface and experience

A Digital-Native Back End Core

Digital Banks have configurable , modular , microservices-based cores with Application Programming Interface(APIs) that enable rapid IT delivery and innovation

A Structure And Culture Like Those Of A Technology Company

The characteristics of a digtal operating model include a horizontal structure , minimal bureaucracy , non hierarchial environment with high levels of staff empowernment and ownership and a test and learn culture enabling continuous development of systems , products and channels.

History Of Digital Banks

The earliest forms of digital banking trace back to the advent of ATMs and cards launched in the 1960s. As the internet emerged in the 1980s with early broadband, digital networks began to connect retailers with suppliers and consumers to develop needs for early online catalogues and inventory software systems. By the 1990s the Internet became widely available and online Banking started becoming the norm. The improvement of broadband and ecommerce systems in the early 2000s led to what resembled the modern digital banking world today. The proliferation of smartphones through the next decade opened the door for transactions on the go beyond ATM machines.

The Secret Sauce To Profitability:

Starling bank Case Study27 While “front-end focused” neo-banks have found achieving balance between growth and profitability a challenge, their full-stack (Digital bank) counterparts appear to have found the secret sauce to profitability. An important case-study in this regard is Starling bank (UK). It offers insights into the question of what is the most viable business model for Fintechs offering digital banking services in India.

Starling Bank: Starling bank acquired a restricted license from the PRA Prudential Regulatory Authority in 2016. In the past 5 years, it has come of age with offerings both on the small business side and retail side. While in the initial years, interchange revenue dominated other sub-heads, the latest annual Report reveals NIM to outrank fee income from their interchange, B-A-A-S and marketplace offerings.28 Most importantly and supported by NIM growth, Starling turned monthly profitable from October 2020. On the other side of the balance sheet, acquiring the restricted banking license early on the curve enabled Starling to issue low-cost deposits (protected by UK’s deposit insurance scheme- FSCS).

Starling’s case study highlights the importance of NIM and on-balance sheet lending on profitability. The ability to do balance sheet lending is especially important for a fintech offering digital banking in India given RBI’s prescriptive regulation capping interchange. So, regulatory innovation in terms of engineering a DB license they can leverage is the key.

Digital Banks – Growth Opportunity For India

In India, to move on from physical verification for KYC, video-based verification may be introduced by the market regulator for a better process. Digital savings accounts are also being offered by several banks. These accounts are similar to the basic savings account, offering full banking facilities to users without having to maintain a minimum balance, with a virtual debit card convertible to a physical debit card. It will take some time before physical branch banking can be replaced fully with digital banking. Customers prefer human interaction for important decisions like taking a loan or negotiating the terms for it. However, digital banking is proving to be handy for recurring banking essential functions. With time being a crucial factor for customers, as well as services, the digitally savvy customer will always look for personalized and seamless digital services provided at their time.
Niti Aayog’s move to set up full-stack ‘Digital Banks’ is a great enabler. Allowing Digital Bank as a new category will help set up a fresh thought process that is end-to-end digital, and where operational efficiencies will help deliver better value to the consumers as per the experts opinion.
India is becoming a digital-first country where the power of technology is constantly being leveraged to foster financial inclusion.
The report has laid out a detailed plan and framework around how these full-stack digital banks should come into being. It proposes a ‘Digital Bank Regulatory Index’ that includes four parameters – entry barriers, competition, business restrictions, and technological neutrality. These are then mapped against the five benchmark jurisdictions of Singapore, Hong Kong, the United Kingdom, Malaysia, Australia, and South Korea. It also recommends a stage-wise approach to licensing – a digital business bank license within a regulatory sandbox, and a universal full-stack digital bank license issued based on performance in the former. A full-stack license will need capital worth INR 200 Cr, the same amount required to set up a small finance bank.
This phased, well-thought-out approach to the setting up of digital banks reinforces that the Niti Aayog is advocating a confident yet cautious road ahead. If this proposal is adopted, it could possibly set the stage to make banking and especially, FinTech, profitable again.
As is recognised by the paper, MSMEs are growth and employment generators that remain under-represented in the formal financial system, having to rely on informal, and often exploitative, sources of credit.
Given the proposed full-stack digital banks will not rely on physical branches, they will be able to address the credit gap without facing any of the cost of infrastructural issues that are common with traditional banks. The proposal has the potential to disrupt the still largely traditional banking system and bring in innovations that serve the specific needs of MSMEs and SMEs.
Niti Aayog’s move to set up full-stack ‘Digital Banks’ is a great enabler. Allowing Digital Bank as a new category will help set up a fresh thought process that is end-to-end digital, and where operational efficiencies will help deliver better value to the consumers as per the experts opinion.
The establishment of digital banks will help in bringing this large part of India’s underserved population to the formal banking sector. This will further help in driving financial inclusion for Bharat that will lead to the growth of our overall economy. India is at the forefront of the digital revolution with increased efforts from our government and FinTech firms who are providing customised solutions to create a better customer experience.
Beyond digital-savvy youth, this initiative can help tech-shy Bharat leapfrog to the next level of connectivity and commerce. Leveraging technology, this low-cost, efficient model will help accomplish a lot more in consonance with the existing banking infrastructure.