Fintech Fiasco: Operational Risk At The Core

McKinsey explainer in January 2024 defined “Fintechs—short for financial technology—are companies that rely primarily on technology to conduct fundamental functions provided by financial services, affecting how users store, save, borrow, invest, move, pay, and protect money. They make it not only possible but also easy to move money between accounts, people, countries, and organizations.”  

The Evolution of Fintech: A Decade of Disruption

There has been a chorus on digital banking since 2010 when the Fintechs came into being. Brick and mortar banking, rather branch banking in physical form, was considered archaic and would serve limited purpose for effective future banking. 

The ease of payment transactions through a smart phone gave the real push. I was not surprised to see a person seeking alms in front of a local Sainath Temple holding a QR Code of a Fintech for his daily activity. He confirms that his daily earnings improved twice after he opened account with the Paytm!! He does not know that with the present directive of the RBI, ere long, his deposits would do a vanishing trick. I told him what is in store for him and the need for him to quickly change the account and withdraw his deposit and move to his Jan Dhan Account with a public sector bank.

Regulatory Winds of Change: Key Milestones in Digital Banking

Reserve Bank of India stirred the hornet’s nest with its decision to ban fresh deposits and top ups in Paytm Payments Bank effective February 29, 2024. During the last few years five interesting things happened in the regulatory regime of digital banking: 1.Account Aggregator – NBFC with AA was set up for data exchange with customer consent, 2.Bharat Bill Payment System, 3. Prepaid instruments, 4.Offline UPI payments, and 5.Rupay Credit Card via UPI.  

All these interventions kindled hope and confidence in a large number of customers      of fintech operators. Bharat Pe, Phone Pe, YONO (SBI), Paytm, and many others are integrated with the UPI payments giving confidence to the users that everything would be fine with his phone wallet. Paytm ban shook it all. Is there a guarantee that this would not happen to the other wallets? 

Paytm Ban Fallout: Unpacking the Risks and Shareholding Dynamics

If we look at the happenings of the Paytm Bank, only 49 percent of the shares are held by multiple share holders while the rest is held by just one individual, Vijay Shekhar Sharma, a deft operator in digital banking and risk management. When we look at this pattern of shareholding, which would be known only to very few persons, the issue of licence to operate the fintech as a payment bank needs a deeper investigation. RBI, known as a deft regulator, levied a huge penalty of Rs.5.39crore in October 2023 for regulatory compliance deficiencies should have warned the users to move away from the Fastag and wallet payments within as short a time as possible. Of course, now there is time till 29th February for such move by its customers.

Mitigating Risks in Fintech: Insights from RBI and McKinsey

The larger question is the reliability of the fintech as a bankable entity. During the last two to three years, several customers lost billions of rupees in a jiffy in their transactions. Cyber thefts have been reaching their peak. Realizing lost money, even if the culprit is caught, has been found an uphill task. The McKinsey research team see three trends that could shape the next phase of fintech growth. First, they will continue to benefit from the radical digital transformation of the banking industry and e-commerce growth, particularly, in the developing economies.

“73 percent of the world's interactions with banks now take place through digital channels. Second, fintechs’ potential to grow is at roughly three times the present level between 2022 and 2028. Finally, some fintechs are proving more resilient during the current market correction than others.”

Asia-Pacific financial markets are more vulnerable to fintech failures than successes, for the reason that at least 80 percent of customers are not digitally educated. Operating a mobile transaction cannot be classified as digital knowledge. Of course, the concerns of the RBI on Paytm arose on account of money laundering and several questionable transactions between Paytm and the parent bank. There were reports of non-compliance of the KYC, single PAN for multiple customers’ accounts and these led to the drastic measures announced by the regulator. Operational risks somewhere missed the radar and tightening the belt in this area is required in regard to all the fintech companies. A special Risk Audit of all the fintechs and a transparent report of such audit would instill greater confidence in the retail customer. Sooner it is done, the better would it be.

A single bank failure or the failure of a technology-based financial institution should not unnerve the entire system. The responsibility of the regulator lies as much in creating confidence in the system as raising the right alarm in good time. It is the UPI that should make positive sounds now and resurrect confidence of millions of wallet users of different kinds. 

Companies in the growth stage (series C and beyond) showed the highest sensitivity to 2022’s downturn. Fintechs in the early and pre-seed stages were more resilient. Funding for B2B fintechs was more resilient than that for B2C ones. Banking as a service (BaaS) and embedded finance, and small and medium-size enterprises (SMEs) and corporate value-added services were the verticals least affected by the downturn.

By Dr Yerram Raju.

The Author is an economist and risk management specialist. He is presently the Founder Director of Telangana Industrial Health Clinic Ltd. The views are personal.

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