All roads lead to Credit (#66)
Fintech industry's gold rush towards credit and how it may change the landscape
Welcome to the 66th issue of Unit Economics. In this article, I opine on the brewing gold rush towards credit in Indian fintech, and what may define the winners for the next decade. Dive in!
Indian fintech is a behemoth. With a $600Bn+ market size and 1/6th of India’s startup funding, the fintech festival has been running for over a decade. Seven more years and the market size is expected to grow 3X and breach $2Tn.
But peel a layer and we notice different levels of maturity and contributions from the many fintech verticals. For instance, Investments and Insurance continue to be push-based, relatively nascent and struggle with large CACs. Payments has the largest distribution and customer mind share but finds it tough to justify unit economics. And Neobanks, despite the superior banking experience, need more from the regulators to level with the traditional banks.
Which leaves us with the vertical of Credit. Not surprisingly, credit cards and lending have had to share a large portion of the industry burden. For instance, in 2023, lending tech contributes to >50% of the domestic Fintech market size. Why? I briefly capture that below.
Favourable margins: The 1-3% distribution fee for loans, and a high share of transaction interchange and revolving revenues for credit cards are all sizeable revenue streams that most verticals struggle to match
Stronger customer pull: The growing portion of affluent Indians, and compounding needs for discretionary spending on consumer durables, weddings, vacations, along with 1% or more in credit card rewards – all create a strong pull for credit. The growing average spends and the ~100Mn outstanding credit cards are indicators of the same.
Low private credit penetration: Private domestic credit as a proportion of GDP in India is abysmally low at 50%, roughly 1/3rd of what would be considered healthy, a metric that signals the large white space that continues to exist in private credit. You will see this metric quoted often by most strategy operators in lending.
Low operational costs: The digital-first nature of issuance and disbursals has reduced the operational costs (excl. collections) for Credit by >60%, which allows the PnL to support an even healthier RoA.
Regulated enablers: Tens of fintech-first NBFCs and the ready API stacks from the TSPs have enabled a large number of fintech companies to go to market quicker, allowing an entry point to the vertical with little regulatory hassle.
The nature of credit, and the above tailwinds are all overwhelmingly positive. Additionally, in an investment climate where the path to a sustainable business model is a pre-requisite and not a side conversation, it is not wishful thinking when reports suggest that lending tech would make up >60% of India’s Fintech market size by 2030.
This is significant and bound to change the Indian credit industry for Fintech companies in multiple ways. I have tried to articulate my views on how it may go down below.
Clutter and Distribution Wars
Most of the leading fintech players, as we speak, are working on a credit card, personal loan, credit line, or credit card on UPI product.
Unfortunately, the second-order effect of the pressures of expanding fast in a market expected to clutter makes the GTM strategy distribution-first, rather than product-first. Implying that there would be little differentiation or innovation in the product offerings from how it appears from afar, and the SEO and rate of interest price-wars may take up most of the mind-share in closed-room conversations.
With the festive season to follow next few months, we should expect heavy performance marketing costs – and potentially low CTRs due to the clutter.
Stricter regulations, with a bank-first approach from the RBI
With the extent of new entrants in the lending ecosystem, the central bank notices large systematic risks and appears to be taking a strong stance towards keeping control within the traditional banks.
The growing volumes of personal loans from NBFCs may become particularly concerning, and I expect that this would,
Make underwriting and KYC regulations for NBFCs, and consequently digital fintech journeys, more strictly audited, and
Raise barriers to an NBFC license further for those without existing lending expertise or experience, a likely hurdle for Fintech companies
Slow, deep banking integrations will sustain
The pressures of growing fast in a venture-led ecosystem can push many to take short-cuts or half-measures. But what has become increasingly clear with the BNPL, PPI, and digital lending regulations is that unless you are operating in the green, and integrating deeply with the banks – there is little that saves you from being pushed over in a blink.
For the new-age lending service providers, it would be absolutely critical to operate issuance and collection businesses more traditionally, and to keep a long-term vision for creating value for both sides of the platform: banks and customers. The deeper the banking integrations and networks, the broader the revenue lines and regulatory support.
Innovating for New to Credit (NTC) Distribution
The clutter for distribution has started to overwhelm the existing to credit (ETC) customers already, with the supply of loans and credit cards appearing almost endless for good customers. But if everyone fights for the same customers, while the average number of personal loans and credit cards may increase per customer – there is likely to be a fall in the average adoption rate of credit products on individual platforms.
For instance, as a rule of thumb, cross-selling personal loans or cards on a platform usually has a 2-3% adoption rate. However, we should expect the averages to go down with the excess of options that customers will now have across digital platforms.
As a result, to solve for higher adoption, capturing a larger share of the NTC users in the funnel would become increasingly critical to improve conversions. With the existing underwriting capabilities of banks, we should expect the change to be slow. This presents an opportunity for fintech companies to expand distribution by enriching underwriting with stronger signals of alternate data.
Outlining the winners
With the expected fintech tussle for cards and loans, I imagine the primary winners to undoubtedly be the Banks with strong digital distribution focus, including Axis, IDFC, and ICICI. Higher regulations on digital KYC journeys and added overwatch on NBFCs further strengthen arguments for bank partnerships, despite their traditional, conservative stances.
The slew of mid-layer enablers, including TSPs such as Hyperface and Upswing are also well-positioned to benefit by connecting banks with fintech companies, a role that would immediately provide value with the goal of faster GTM.
On the consumer end, I imagine that those best positioned to ride the wave would be the ones that either:
build an engaging in-app ecosystem play (eg: Swiggy offers rewards in the form of Swiggy Money),
focus vertically toward the needs of a particular target group (eg: Scapia for travellers),
utilise their large existing customer distribution of ETC, CIBIL 700+ customers (eg: CRED likely has >10Mn customers with 700+ score), or
improve underwriting to bring NTC customers more religiously towards lines of credit
Further, with the expected per-user exposure to credit on the up, there would be merit in exploring aggregator or marketplace plays, assuming clear definitions for revenue lines can be developed on top of them. Until next time!
On a bit of a personal note, happy to share that I have taken the plunge to start-up. My co-founder and I would be happy to chat and bounce off ideas with operators, investors in the industry (reach out here). And if you are coming to Global Fintech Fest next week or are in and around Bangalore, happy to chat over a coffee as well.
If you have any views or feedback to share on the topic, feel free to add a response below or to share your thoughts with me over Linkedin. In case you feel your friends or family would be interested in reading about payments and lending, feel free to share the blog with them as well. Back again in a few weeks!
Interesting read, hard facts and to the point. Thanks.