Technology as the Enabler of Systemic Financial Revolution

For most of India’s existence as an independent country, access to formal financial services remained limited to the very top of the country’s income pyramid. Over the last decade however, the country has made rapid progress driving financial inclusion, with bank account penetration more than doubling, and digital payments now accounting for c.40% of all payments. This financial revolution was achieved through technology, in what is called the “India Stack”, a software infrastructure platform that has enabled digital finance.

However, while access to banking has been expanded rapidly in India, perhaps faster than anywhere in the world – among democracies or autocracies – with 465 million new bank accounts opened for those at the giant bottom of the pyramid. Following this monumental achievement, the next phase of the inclusion journey will need to focus on deepening the participation of the poor in financial services and prosperity more broadly. If successful, this will be the second financial revolution and one that holds promise for others across the world.

The challenge of deepening this financial inclusion is a tough one given that over 900 million adults (or nearly 90% of the adult population) do not access a diversified offering of banking, loan, equity, and insurance products, and that this penetration remains extremely low relative to other countries. Addressing these gaps is critical for India’s continued economic development. If India is to sustain high levels of economic growth, it will need its citizens to access financial products that allow them to save, access healthcare, be insured against the many risks that face them and be active consumers and investors.

Innovative digital solutions will be key to engaging these nearly one billion people and including them in India’s development and growth. The 'India Stack’ represent a core platform upon which new technologies and services can be rolled out to build a digital financial system that is fit for purpose in the 21^st Century, overcoming the infrastructure, financial and geographical constraints facing ‘traditional’ banking models in India. Both incumbent financial services players and new technology and FinTech companies are rushing to leverage and build on the ‘India Stack’ developing new products, new distribution channels and new business models that will transform India’s financial services landscape.

If India can successfully continue to develop its technology stack, it has the opportunity to not only accelerate and deepen financial inclusion, and unleash investment, growth, and innovation, it can also deliver a blueprint for a digital financial system to other countries around the world. This month’s Sign of the Times looks at the transformation currently underway and at the characteristics of the potential digital platform that can help India unlock its potential.

A Technology-Driven Paradigm Shift

India has driven significant financial inclusion in the past decade. Financial inclusion has expanded rapidly in India in the past decade, driven by underlying macroeconomic trends and ambitious government initiatives that have leveraged technology as well as the wide branch networks of the public sector banks. Rapid economic growth and urbanisation has led to a growing middle class, with India’s middle income (US$10-50 per day) population increasing three-fold between 2011 and 2019 to 107 millionⁱ . Mobile and internet access has also grown rapidly, with the total number of internet users growing 6x, to c.750m over a similar periodⁱⁱ . These trends have driven demand and enabled the use of new delivery models for formal financial services, including banking, loans, insurance, and asset management.

Simultaneously, the government provided a significant policy push to bring more and more people into the formal financial system, with government and regulatory initiatives including opening bank licenses, an ambitious initiative to open bank accounts for every Indian with debit cards, insurance cover and direct transfers of government benefits (the Pradhan Mantri Jan Dhan Yojana) which has resulted in 465 million new bank accounts opened since 2014, and an affordable housing loan subsidy program to build wealth and household assets (the Pradhan Mantri Awas Yojana).

The “India Stack” has been a critical enabler for this rapid increase in financial inclusion. The Indian government (together with various regulatory institutions) has leveraged the growth in mobile and internet connectivity, the universal unique identification program, and the bank account opening program to create a set of open APIs and digital public goods, known as the ‘India Stack’, a fully integrated and open software platform with four critical ‘layers’ that can address some of the fundamental challenges of financial inclusion:

1. Identification - The Presence-Less Layer - which provides open access to India’s Aadhaar digital ID database to allow financial institutions to instantly verify any Indian citizen as a customer, digitally and biometrically.
2. Verification - The Paperless Layer which creates a secure ‘digital locker’ of documentation for every individual which can be stored and easily retrieved to enable paperless know-your-customer (KYC) and signing.
3. Transactions - The Cashless Layer which creates a set of inter-operable electronic payments systems to enable instant payments between banks, individuals (via their mobile phones) and government agencies.
4. Security - The Consent Layerwhich provides a modern, digital, and secure way for individuals to share their personal data (or choose not to) with various stakeholders, to ensure privacy and prevent abuse.

While each layer is ‘owned’ and managed by different regulatory agencies, all layers are fully-integrated with each other and are provided on an open access basis for companies to build tools and platforms to drive financial inclusion, by making it simple and efficient to open bank accounts (particularly in hard-to-reach rural areas), make real-time digital payments (with the UPI currently processing c.6.6 billion payments worth c.US$130 billion monthly^vi , and allowing for rapid credit checks on loans.

The current India Stack, its key building blocks, and the financial inclusion use cases it has enabled are a critical ad elusive driver of the success of the programme.

The next challenge is to deepen participation. Despite this rapid progress, over 900 million Indian adults are still not fully participating in the financial system. Despite the rapid growth in bank accounts and digital payments, the penetration of other financial products such as credit, insurance and financial investments remains very low compared to other major economies, thereby inhibiting economic participation, wealth creation and growth, in particular for the poorer population segments. Clearly, that could be a function of the low income and resulting priorities of the population (that is, basic sustenance needs) but the lack of participation also limits the ability of this population to break out of the poverty trap (for example, secure their first mortgage to buy their first property).

A more comprehensive view of the level of participation by the Indian population in the financial system reveals the scale of the challenge at hand:

• Starting from the bottom, 22% of the country’s population (c.235 million adults) are ‘non-participants’ who still do not have a bank account.
• A further 27% of the population (c.287 million adults) are ‘inactive participants’ who have bank accounts, but are not using them, for various reasons.
• And a further 37% of the population (c.389 million adults) are ‘semi-participants’ who are using their bank accounts and digital payments but little else, lacking access to formal sources of credit or other financial products, and typically reliant on informal credit from usurious local moneylenders.

Together, this adds up to over 900 million adults, or nearly 90% of the adult population that is still operating on the margins of, or completely outside, the country’s financial system and formal economy.

And it leaves only 13% of the country’s population (c.134 million adults) who are currently ‘full participants’ in the financial system, operating active accounts and access to formal credit and other sophisticated financial products. Full financial inclusion, where the individual participates in the economy by accessing credit, insurance and savings products is effectively accessed by this small subset of the population and is closely correlated with India’s wealth distribution; only c.8% of the population has more than US$10,000 of household wealth, a basic starting point to ensure economic stability, risk-taking and entrepreneurship.

For India to realise its famous “demographic dividend”, the accessibility and affordability of formal credit, insurance and modern savings and investment products needs to be expanded on a mass scale to bring their penetration in line with other large modern economies (while continuing to scale digital payments and bank account penetration).

The benefits are clear and compelling, and include:

• Access to formal credit is critical to lower the cost of capital and enable asset creation and investment in housing, small businesses, and consumption;
• Access to insurance against death, and also serious health issues, crop failure, floods and natural disasters is key to providing the poor with the risk-taking ability to participate economically, and
• Access to savings and investment investment products is critical to enabling both wealth accumulation, and the mobilisation of household savings towards productive financial investments, rather than investments in physical assets like land and gold which currently account for 95% of household savings^viii.

The success of the past few years suggests that the best, and perhaps only, way to do this rapidly, and at scale, is to augment the India Stack in a manner that enables private sector players – including both incumbent financial institutions and FinTech start-ups – to develop and scale use cases for these financial products for the bottom and middle of the pyramid. The experience of other large countries, China in particular, and analysis in earlier Sign of the Times^ix, suggests that this level of mass-scale full financial inclusion has the potential to unleash rapid and sustained economic growth and wealth creation, by allowing nearly a billion Indians to become full participants in the financial and economic system.

Of course, the participation of the poor in financial services can also be an effect, rather than a cause of economic growth, provided that it is sufficiently widespread and sustained over a long period, (as it was in China). However, given that India has already created mass inclusion for nearly half a billion people, the use of financial services to drive the domestic economy has become an an imperative for it.

Dismantling the Past and Establishing the Future System

From the perspectives of a citizen, India’s Financial Revolution 1.0 was about inclusion, and 2.0 is about penetration. However, from the perspective of the finance industry, 1.0 has about creating new opportunities for both incumbent institutions and emerging specialists like fintech and digital payments players, while 2.0 is about establishing a new model for the industry that will dismantle the old guard that fails to adapt. and.

Augmenting the India Stack to Enable the Transition

Given the scale and diversity of India, it is difficult to achieve full financial inclusion using traditional business models. While the stack has already begun to undermine the old systems of physical banking, the planned augmentation of the stack will fully undermine traditional banking.

The emerging future financial services system of the country will need to be underpinned by technologies which makes service delivery far easier and far more cost-effective for a population that would be unprofitable to serve otherwise.

While the India Stack forms the centrepiece of this strategy, the government is augmenting its layers with new capabilities, and is in the process of rolling out three key additions to the stack:

1. An “Account Aggregator (AA)” framework for secure and seamless sharing of financial data between financial institutions (including banks, pension funds, insurance companies and asset management companies), in effect creating a single financial profile for an individual which can be used across different institutions.
2. An “Open Credit Enablement Network (OCEN)” which is a framework of open APIs to facilitate interaction between digital companies (e.g., FinTech and e-commerce start-ups) and regulated financial institutions to ‘unbundle’ lending and enable the creation of specialised businesses focused on one part of the value chain (e.g. distribution, underwriting, collection)
3. “National Health Stack (NHS)” which will include national health registries of healthcare providers, an open coverage and claims platform, and electronic health records for every Indian, thereby enabling the provision of health insurance by both private sector insurers and through the government’s flagship free health insurance scheme for the poorest 50% of the population.

As an early measure of success, it is noteworthy that there are already over a billion accounts on the Account Aggregator framework.

The government, together with various regulatory agencies, is already in the process of rolling out these new capabilities and understands the catalytic role that technology can play in rapidly expanding and deepening financial participation in the country, and the potential for digital lending, insurance, and investments in expanding modern financial services to the poorer population segments.

This will set the scene for further change that leads to a new system of finance that is at once inclusive and deep in penetrating the citizen base.

Creating the Conditions for New Opportunities for Inclusion and Growth

India is on the cusp of transitioning to a new-age financial system that has the potential to be fit-for-purpose for the 21^st century, and the country’s young and increasingly ambitious population. If executed successfully, it should be able to combine existing and emerging technologies to democratise access to both scale existing use cases, and to create use cases for lending, insurance, and investment products and services at scale. The potential step change this could create for these products and the country represents a financial revolution that is the beginning of a new wave of wealth creation.

The success of an inclusive deep financial revolution that engages the mass population further requires technology and the India Stack is the technology platform that India will need to migrate to its next version. 2.0 represents a major shift in its impact on the citizen and the industry.

Key Requirements for the Financial Revolution 2.0: India Stack 2.0

1. Digital Lending: Bridging the Formal Credit Gap

The Need: Formal Credit Limited by Data Constraints. While c.45% of Indian adults have borrowed money, over 70% of these borrow informally from friends or family, or high-cost local moneylenders, and only 16% of MSMEs have access to formal credit, largely due to a lack of credit information.

Technology to Leverage: Data Analytics, AI, and Machine Learning for Digital Lending. Digital lending volumes in India account for c.50% of all loans distributed by non-bank financial companies (NBFCs)^x today, and this could grow exponentially on the back of the new capabilities in the India Stack, including the AA Framework and the OCEN by reducing information asymmetries and facilitating the flow of formal credit through specialised digital lenders to underserved individuals and small businesses.

The Potential Future: Explosive Growth of Indian Credit Market. Domestic credit to the private sector in India today is less than 55% of GDP. Digital lending can help unlock additional opportunities to help India’s credit market expand to the level of international benchmarks, thereby injecting trillions into the economy

2. Digital Insurance: Data Driven Models Disrupting Insurance

The Need: Lack of Insurance Limiting Risk Management. India’s insurance market remains nascent with only c.3% of Indians having access to life insurance, and less than c.35% having access to health insurance, making it difficult for Indians to manage risk and leaving hundreds of millions of lower income households one financial shock away from having their savings wiped out.

Technology to Leverage: National Health Stack to Democratise Health Insurance, Reduce Fraud, and Improve Penetration of Other Non-Life Insurance. FinTech companies already account for a third of insurance purchases in the country, with superior distribution, customer service and data analytics capabilities for better underwriting. The National Health Stack can be leveraged to rapidly expand health insurance coverage (both public and private) while the unified customer profiles in the emerging India Stack could be used to develop and underwrite new non-life insurance products for the poor (such and property, crop, and natural disaster insurance).

The Potential Future: India Becomes a Top Five Global Insurance Market. India’s insurance market today is only 3.8% of GDP^xii, c.50% lower than the global average and more than 60% lower than that of advanced economies^xiii. The use of digital distribution channels can both widen and deepen India’s insurance market to unlock significant domestic capital for investments and risk taking to drive growth.

3. Digital Investments: Digital-First Models Catering to Underserved Investors

The Need: Indian Savings Remain Locked in Non-Financial Wealth. The average Indian household holds 95% of its wealth in physical assets (84% in real estate, 11% in gold), and only 5% in liquid financial assets^xiv, significantly limiting the domestic investment capacity of the country’s wealth.

Technology to Leverage: Data from Across Financial Institutions to Create Customised (and Low Risk) Investment Products for the Poor. Increasing household participation in equity markets requires technology-driven wealth management platforms that leverage data to create innovative and easy-to-access investment products, such as social trading platforms where investors can seek real-time expert advice and automated micro-investing products, which invest spare change into mutual funds or other asset classes.

The Potential Future: Domestic Investment Boom. Equities today only comprise 14% of household financial savings, vs. nearly 50% in the US, and nearly 30% in China^xv. Substantially increasing this will trigger a domestic investment boom that will reset India’s equity capital markets relative to its GDP, driving massive and broad-based domestic wealth creation.

4. Blockchain: Linking the India Stack to the World

The Need. India Stack Currently Limited to Domestic Transactions. The India Stack allows point to point transactions with anyone in India but to date does not allow users to access the wider global economy or international capital, limiting India’s links to the world.

Emerging Technology to Leverage: Blockchain and Cryptocurrencies. The Reserve Bank of India’s plan to roll out a digital rupee in 2023 could not only further democratise domestic access to financial services but also be combined with wider cryptocurrency support of the stack to create an international payments capability that isn’t controlled by any other country at either the currency or platform levels.

The Potential Future: Decentralised, Democratised and Globalised Finance. Adding the digital rupee and crypto functionality to the India Stack can link India and its people to the world, unlocking international capital for all of India’s economic participants and also opening global markets to its millions of entrepreneurs.

Realising the Financial Revolution 2.0: Execution Considerations

The next financial revolution requires developing the India Stack 2.0 and implementing the technologies, products and business models on it that that will shape India’s future financial system. This project needs to be multi-stakeholder one, bringing together not just the finance industry and the technology (and FinTech) sectors, but also involving government and regulators as well as India’s 1.4 billion potential savers, investors, and consumers, each of whom has an important role to play the future framework’s success:

1. Government - A Forward-Looking Regulatory Framework to Enable New Business Models. The government and central bank have an important role to play in creating an environment that enables innovation and protects the privacy and interests of consumers. In this context, the Reserve Bank of India’s current regulatory sandbox regime, which allows for the live testing of new products and services by FinTech and incumbent players in a controlled regulatory environment with fewer restrictions is a progressive initiative, and one that will need to be continuously scaled and augmented to keep up with emerging financial technologies and business models.
2. Consumer - Financial Literacy to Increase Trust and Usage of Financial Products. Simply creating the new technological frameworks and launching a slew of new financial products for the poor is not enough. There is a significant trust deficit and lack of financial literacy in general which prevents the poor from using modern financial products even when they have access, best reflected in the large number of inactive bank accounts, with nearly 50% of people with an inactive account and 30% of people without an account citing a lack of trust, and c.30% of accounts inactive because the account holder does not feeling comfortable in using the account (see charts below^xviii). Clearly, a comprehensive financial literacy campaign is required for the poor, supported by adequate consumer protection to ensure that this trust is not breached.

    

   

    

3. Financial Institutions - Transforming Legacy Systems to Leverage Core Assets. Incumbents will split into those that fall under the weight of change, unable to adapt, for which the government will have to make provision for restructuring and the social impact on employees, and those that will flourish by acquiring the business of the fallen and embracing the new opportunities. Successful players are already complementing their robust balance sheets, brands, and on-the-ground capabilities with meaningful investments in technology and data. Indian banks and insurers currently invest only c.1.5–2% of their annual revenue on technology, well below the global average of c.10%^xix, so there is likely far further to go. Further, their investments to date have largely focused on customer facing technologies rather than on infrastructure and data processing, leaving them unable to fully leverage the benefits of digital finance. Building the technology capabilities to address these gaps is critical for current industry leaders to remain relevant.
4. Fintech Challengers - Building Scale and Differentiation. While multiple FinTech companies have achieved significant growth by catering to underserved segments, many of these companies remain unprofitable and rely on external sources of capital to fund their losses. This is unsustainable, particularly as venture funding has slowed down and competitive intensity has increased significantly. Many of these businesses are already flawed and will also fall under the pressures of the market. Successful businesses will build viable business models that can scale in the face of a cadre of older incumbents that are transforming and ready to compete with the fintech industry.

It is already clear that emerging technologies and business models are set to drive significant change across every segment within India’s financial services landscape. Many incumbent financial institutions, who have hitherto relied on the advantage of their licenses or legacy brands, are likely to be displaced by their peers who have adapted as well as new-age, technology-enabled challengers, a development that has already been observed in several developed markets and China. However, in a country as large and diverse as India, financial services are not a zero-sum game.

The new India Stack 2.0 will enable greater specialisation and also collaboration between incumbent financial institutions and FinTech challengers, hence there will be room for both to grow and thrive, particularly if they can successfully adapt to address the needs of the bottom of India’s financial inclusion pyramid.

Conclusion: Creating a Financial System that Makes India a Model for the World

For a long time, India has been heralded for its democracy and demographics and its potential to deliver high economic growth, and this has held out the opportunity to be a strategic ally to others in a rapidly changing world order. For India to achieve this potential it needs to be a prosperous nation, ideally also a peaceful, and free one, and that requires a series of revolutions on how this giant operates.

The last decade has demonstrated that rapid progress is indeed possible. The government has leveraged growing digital connectivity to drive banking access and develop a sophisticated and open technology stack to simultaneously drive both innovation and inclusion. Private sector financial services players – new and old – have invested heavily to create products and systems that leverage the stack and democratised financial services access across the country. As such, a new digital financial system is rapidly emerging, which, if rolled out effectively, could fundamentally re-shape the way India transacts, borrows, invests, and secures long-term financial stability.

Successfully doing so will require creating and augmenting the India Stack, investing in the new building blocks for the new stack to succeed, and continued private sector innovation, by both challengers and incumbents, across the financial services landscape. Government regulations will also have an important role to play and will need to strike a balance between encouraging innovation and protecting the interests of customers. Governments will need to have resolved the roles of crypto, blockchain and mobility in finance.

Ultimately, the financial system of the future will be decentralised, democratised, and disintermediated, enabling low-cost peer-to-peer transactions, entrepreneurship, and wealth creation.

Having financially included a population greater than all of Europe’s in the past decade, India needs to build on the progress made to date to create a truly world-class digital financial services system, one that makes all Indians deep participants in the financial system and helps unlock new opportunities and prosperity for them. The prize for getting this right is lifting a billion people into prosperity, a step-change in economic growth, and a sustainable growth blueprint that can be emulated by both developing economies looking to rapidly expand financial inclusion and developed economies looking to adapt their legacy financial systems for the digital age.