NEWSLETTER

Diwali festivities seem to have started a wee bit early within the fintech ecosystem. Spirits are high after the tough taskmaster and India’s banking regulator Reserve Bank of India gave a no-objection certificate to what is being touted as a rare merger.

Digital payments app company–Slice Pay–merging with the lesser-known Guwahati-based North East Small Finance Bank has certainly piqued the interest of stakeholders. This move effectively gives Slice the power to raise deposits, and lend and offer their own unique products to customers of NESFB.

Slice began operations in 2016 and was essentially a prepaid card with a credit line. According to data tracking platform Tracxn, the Bengaluru-based unicorn fintech company was valued at $1.8 billion as of March 2023. Meanwhile, NESFB’s valuation has been pegged at around $72.4 million.

For financial technology companies, this move comes as a lifeline as it opens up another avenue for scaling up operations.

In this article, we explore how fintech companies can lay the foundation and prepare for a probable merger-like scenario with a bank in the future.

License VS Merger
Points to Be Noted
Self-regulate Prudently
Play to Your Strengths
Customer is King
License VS Merger
Getting a banking license in India is a big deal. RBI scrutinizes applications under a microscope. Earlier this year in July, the RBI rejected three applications for small finance bank licenses, maintaining its reputation for being a taskmaster. In 2022, the regulator had rejected 6 licenses as it found it unsuitable.

One exception was the central bank’s green signal in 2021 to Resilient Innovations Pvt. Ltd (owned by fintech unicorn BharatPe) to buy a 49% stake in Unity Small Finance Bank. But, then this was a distress sale, where RBI was doing its job of safeguarding the deposit holders’ interest.

PwC’s 2021 report on neobanks in India delved into the ambiguity surrounding regulations for smaller digital financial institutions. Neobanks is a term used for financial institutions or fintech companies that operate digitally, without a physical presence. “Currently, unlike neobanks, the regulatory regime does not envisage a completely digital method of offering financial products. It is extremely critical that the current indirect regulations are relooked at in light of the digital offerings of neobanks and their relationship with financial entities.”

For a fintech company, opting to go through the due diligence of getting a bank license and following regulatory norms can prove to be a headache. At present, RBI rules state that a payments bank or an NBFC with a successful track record of 10 years is eligible to apply for a bank license. This may seem like a long wait for a fintech company as it may take years for some companies to even break even.

A fintech company usually has three options when it comes to the renewal of its license. One, it either applies for a non-banking finance company license with the RBI. Two, it can choose to join hands with another fintech company. And three, taking the heartbreaking decision of shutting shop in case they don’t rake in enough value. The option of merging with a small finance bank as a business objective was never really given much thought, until now.

Meanwhile, for a small finance bank, merging with a fintech company is a shortcut to upgrading its technology, staying relevant to the youth, and paring its losses to some extent. North East Small Finance Bank reported losses for the third straight year with losses widening to ₹288 crores in 2022-23. Its net worth dropped to ₹60 crore, much lower than RBI norms of maintaining a net worth of ₹200 crore. A section of the media has raised eyebrows over the shelf-life of this collaboration, given the losses on both sides and the contrasting cultures in both organizations.

However, the Slice-NESFB merger seems to be a well-planned strategy and not a spur-of-the-moment decision. In March, Slice acquired a 5% stake in NESFB, to get “comfort”. Media reports have also quoted an unnamed source from the company claiming that Slice had been following through with due diligence over the past 15 months to get the deal through.

True to their nature, startups, and fintech companies prefer to see this merger as a window of opportunity rather than view the deal with scepticism.

Points to Be Noted

Before celebrations begin within the fintech space, it is time for companies to ponder over making the most of this development. How can they be the next in line as far as envisioning their banking ambitions are concerned? Taking cues from this new-age merger, we enlist a few parameters on which fintech companies can buckle up and chart a similar route to growth:

Self-regulate Prudently
Fintech companies have long borne the ‘bad boy’ image in the eyes of the regulator.

In 2022, RBI barred non-banking entities from embedding credit lines in their loading PPIs (prepaid payment instruments) such as prepaid cards or mobile wallets. This decision had hit Slice itself which then applied for a PPI license and received it by the end of 2022.

Recently RBI Governor Shaktikanta Das asked fintech companies to form a self-regulatory organization. In RBI’s view, such an organization would help to evolve best practices, protect privacy and data norms, avoid mis-selling, and promote ethical business practices.

“You need to think you are already a small finance bank and create those kinds of capabilities within the organization before the regulator would even consider something like this,” said Yogi Sadana, Founder and CEO of Zype Loan App. He added, “Unlike an NBFC, the amount of opportunities and liabilities that rests on a bank which a banking license allows taking customer deposits, to open bank accounts, that’s a completely different ball game altogether as compared with an NBFC which was not taking customer deposits, in terms of governance standards, in terms of operating stats, cheques, and balances, more importantly, the management. ”

It’s only a matter of time before RBI comes cracking the whip on those who fail to comply, which could in turn tarnish the company’s image.

“Eventually they (fintechs) should be ready to come under regulation…the framework for regulation may come. RBI does not leave any stone unturned to leave anybody out of their purview,” said Jaslene Bawa, from Flame University who has worked as a financial market researcher in the corporate sector.

Bawa also said that having rigid mechanisms, assessing credit profiles, regular audits, keeping an easy cash flow, and creating a robust board can help a fintech or an NBFC get bank-ready.

Play to Your Strengths
Setting up an intricate financial technology infrastructure for a mid-sized or a small bank is an exhaustive process. In such a scenario, merging with a fintech company is akin to adding a bit of zing to their portfolio. In addition, fintech apps are a popular choice among the youth, giving ready access to a younger customer base, albeit small to begin with.

“Strategic plan for a fintech should be how nimbly can they set this (technology) up. Can they set it up internally or do they need to acquire an existing company with skill sets and reputation which can marry their reputation, culture, and ethos so that integration of both is seamless and easier,” said Badrinarayan Vedanthan, a banker with 26 years experience across MNCs, SME and MSME/Rural Finance business sectors. Vedanthan, now an independent financial consultant, also previously served as the head of strategy at Suryoday Small Finance Bank.

Slice’s main target has been the Gen Z and millennial crowd. In a media interview in 2021, Rajan Bajaj, founder of Slice emphasized how they would continue to target the young segment, despite their high-risk profile. “The average age of slice’s customers is 23-24, which differentiates us from the rest. We understand the risk and demand profile of this young customer and know how to help them navigate through their finances. At present, there is no other solution at a slice’s scale in the market that can cater to the needs of this generation in a transparent and scalable manner.”

Fintech companies should play to their strengths as far as their technological reach is concerned. Digital payments have revolutionized the way Indian banks and organizations have managed to get millions of unbanked individuals into the purview. RBI’s Das acknowledged this feat in his speech at the G20 summit held in September.

Just a month before the Slice-North East Small Finance Bank merger was announced, RBI Deputy Governor Rabi Sankar took note of the upper hand that fintech companies possess. Sankar said, “An arrangement of financial institutions buying services of fintech companies was “functional” adding, …fintech entities can perform functions where they have a competitive advantage and banks focusing on areas of their expertise. While customers benefit from an improved experience with curated products and services at competitive prices…”.

Customer is King
A customer-service-oriented approach will help a financial technology company deepen its stronghold and make it an attractive proposition for merging.

“Banking is not just a business, it’s a responsible service, so if they wish to merge with any such entity, they have to make sure that the customer is well taken care of,” said former banker and head of department – finance at Lexicon MILE, Dr Manju Chopra. “Secondly, they (fintech companies) can go slow on the entire due diligence, the valuation study. Don’t hurry into valuing or finding these banks, ensure that synergies are very very high,” she added.

The segment and geographies where a fintech company operates could also end up being their USP (unique selling point). Deepening that stronghold could turn fintech into an attractive proposition.

RBI’s Das has himself stressed the three key aspects that will make fintech “future-ready”. “…key issues which are critical for the Fintech ecosystem to be stable and future ready. In this context, three critical issues, viz., customer centricity, governance, and self-regulation merit attention.”

Conclusion

On the surface, this merger seems like a foot in the door for financial technology companies’ growth, but it has raised many eyebrows for its “unusual marriage” of two contrasts.

It’s indeed an uphill task for both entities to find a middle ground as far as expanding their customer base, scaling up technology, and customer data sharing are concerned. Only time will tell if these opposites, who have attracted themselves to each other, will result in a honeymoon period for customers.

Unarguably, the merger has set the ball rolling for a number of possibilities for fintech companies and small finance banks to stay afloat. In the meantime, it only makes sense for these smaller players to clean up their image and books so that they are not caught by surprise when the RBI comes knocking at the door.

This article includes valuable insights by Prof. Jaslene Bawa, Faculty of Finance, FLAME University.