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Can Neobanks Break the Rural Financial Barrier?

The UPI and JAM trinity (Jan Dhan Yojna, Aadhaar and mobile penetration) have played a crucial role in India's financial inclusion. The Reserve Bank of India (RBI) reports that the Financial Inclusion Index (FII) rose to 56.4 in 2022, up from 53.9 in 2021.

What Is Financial Inclusion Index?

It is a measure that looks at how well people in a country can access and use different financial services. It considers banking, investments, insurance, postal services and pensions. It uses three main factors to calculate the index: access, usage and quality.

  • Access looks at how easy it is for people to use financial services
  • Usage considers how much people use these services
  • Quality measures the effectiveness and reliability of these services

These factors are given different weights to determine the overall index score. The higher the index score, the better the level of financial inclusion in the country.

Though Government of India (GOI) initiatives have placed India as the frontrunner in fintech, there still has a lot of ground that remains to be covered. The Pandemic, JAM trinity and UPI were huge thrusters for Indians to go digital and adopt technology, but with their waning tailwinds, what push do we have left to include rural India financially?

This brings us to our main topic - Can Neobanks be the answer to rural India's financial inclusion? But before we look for the solution, let’s first understand neobanks.

Neobanks: Redefining Financial Services for All

"Neo" is a prefix derived from the Greek word “neos,” meaning "new" or "recent."

Neobanks offer digital, mobile-first financial solutions such as lending, payments and transfers. With no physical banking branches, neobanks provide 100% online solutions. This is a new way of banking for tech-savvy people.

Jupiter, Fi Money Freo, Fampay and Niyo are some of the neobanks among more.

Neobanks and Their Banking Partners

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The Legal Framework: Inside the Neobank Ecosystem

Even if it’s digital, banking is always under RBI’s purview

Under clause 6 of RBI’s Master Circular – Mobile Banking Transactions in India – Operative Guidelines for Banks [2014] [6.1] Banks that are licensed, supervised and have a physical presence in India are permitted to offer mobile banking services. Only banks that have implemented core banking solutions can provide mobile banking services.

Under [6.2]: The services shall be restricted only to customers of banks and/or holders of debit/credit cards issued per the extant Reserve Bank of India guidelines.

The clause explicitly mentions “having physical presence” as a criterion for engaging in mobile (online) banking services. Since the NeoBanks do not comply with this aspect, they are bound to partner up with banks and NBFCs to operate.

“Banks which choose to outsource financial services should however not outsource core management functions including Internal Audit, Compliance function and decision-making functions like determining compliance with KYC norms for opening deposit accounts, according to sanction for loans (including retail loans) and management of investment portfolio.”

This brings us to define what neobanks can exactly do and how they are different from digital and convenient banks.

The Scope of Activities For Neobanks

Neo banking generally offers the following features, among many others, to the customers: 

● electronic money transfers

● online bill payments

● direct deposit remotely

● mobile check deposits

Difference Between Neobanks, Digital and Conventional Banks

Though neobanks offer limited products, it has some pros over traditional banks like

✔️ Low operating cost

✔️ Easy to use

✔️ User-friendly interface

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As you now have a fair understanding of neobanks, let’s get back to our original question.

Can Neobanks be the Answer to Rural India's Financial Inclusion?

Neobanks have shown their prowess but for tech-savvy people. Also, they have huge potential to grow looking at the expected transaction size of $155.50 billion in 2027, growing at an annual growth rate (CAGR 2023-2027) of 19.21%

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But this growth doesn’t consider the actual problems of India's rural population. The neobanks' problem is exclusion by design, misalignment of products, high fees and limited reach. Let’s look at this in the next section.

Exclusion by Design

Many aspects of the methodology design of neobanks may deliberately or accidentally exclude the poorest. These include entry barriers like:

  • Tech-first approach: While being technology-driven can be a USP for neobanks, it poses a challenge in rural India. The rural population still lacks trust in online platforms compared to their urban counterparts, emphasizing the need for physical presence and face-to-face interactions
  • Lack of a supportive ecosystem: Rural areas often lack the necessary infrastructure, including reliable internet connectivity and access to smartphones or digital devices. This hampers the adoption of neobanking services and restricts the reach of financial inclusion efforts
  • Limited financial literacy: Many individuals in rural areas have limited knowledge and understanding of digital financial services. Neobanks need to bridge this gap by providing accessible and tailored financial education to ensure the effective use of their services

Misalignment of Products and Services

The products and services provided by neobanks are more suited to individuals who prioritize convenience and digital solutions.

The rural population may have specific needs related to agriculture, livestock, or small-scale businesses, which require specialized financial products and tailored solutions. Neobanks, focusing on streamlined digital services, may not have the flexibility or expertise to cater to these unique requirements.

High Fees

According to a 2021 report by the World Bank, the average disposable income of rural households in India is just $1,200 or Rs. 88,986 annually. This is significantly lower than the average disposable income of urban households, which is $2,500 or Rs.185,575 per year.

Now that is a huge problem you see…

Neobanks often charge higher fees than traditional banks. This can be a barrier for rural customers who have limited financial resources.

Limited Reach

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After learning about the misalignment between neobanks and rural India's financial needs, one can argue that neobanks cannot be the answer to breaking the rural financial barriers.

Exploring Neobanks as Catalysts for Rural Financial Inclusion in India

Neobanks have the potential to play an important role in rural financial inclusion by partnering with fintech companies specializing in rural financing and remodeling their structure to address the unique requirements of rural customers.

Partnering With Specialised Fintechs

Neobanks can develop and provide tailored products and services to the rural population by collaborating with fintech firms holding expertise in rural financing. These offerings could include agricultural loans, livestock insurance, microfinance options and digital platforms to facilitate rural transactions.

Startups like Kaleidofin Finance and Sarvagram have mastered customized financing for people and businesses in rural areas. Partnering with them can help neobanks in customer acquisition and expand product offerings resulting in revenue growth.

UK's Fintech Farm: Weaving Success Through Partnerships

Started in 2020, Fintech Farm adopts a credit-led neobank approach, providing loans to customers with limited credit histories through cards and a mobile app. The company follows a partnership model, collaborating with local banks in each market.

Fintech Farm handles app and credit decisions, while the partner bank provides local expertise, licensing, and funding. By collaborating with experienced fintech firms in rural areas, Fintech Farm targets the unique financial requirements of emerging markets, delivering customized products and services.

Launched as Monobank in Ukraine, Fintech Farm achieved remarkable success in Eastern Europe. Boasting over 4.5 million customers and generating operating income exceeding $100 million, the company has become a prominent regional player.

Since its launch as Leobank in Azerbaijan, Fintech Farm has issued over 100,000 cards in just three months, with a target of reaching one million by the year-end. The company plans to expand into eight emerging markets across Africa and Asia, with Nigeria as its next target.

Strategic Product Alignment: Maximizing Impact in Rural India

Neobanks can use the existing products and reach of specialised lenders to provide the customised products to MSEs (Medium and Small enterprises) in rural areas.

SIDBI (Small Industries Development Bank of India), a wholly-owned subsidiary of the RBI (Reserve Bank of India), specializes in products to promote and finance the growth of small-scale industries in India.

  • SIDBI has launched the Digital Prayaas lending platform, which provides small loans typically ranging from Rs 1 lakh to Rs 3 lakh to low-income entrepreneurs in rural areas. This platform enables neobanks to reach out to underserved individuals and provide them with much-needed credit for their businesses
  • SIDBI's GST Sahay platform facilitates lending to GST-filing micro, small, and medium enterprises (MSMEs). Neobanks can leverage this platform to provide invoice-based financing to startups and non-banking financial companies (NBFCs) based on unpaid invoices
  • SIDBI launched the e-Udyam registration program to support non-GST-filing MSMEs in accessing credit. Neobanks can collaborate with banks and MFIs to connect their data to SIDBI's system, allowing them to assess the creditworthiness of non-GST businesses and provide them with the necessary financial support

Increasing Financial Literacy in Rural Areas

Neobanks can contribute to rural financial literacy programs and initiatives, empowering individuals with the necessary knowledge to make informed financial decisions.

Lending a Helping Hand to the Government

Neobanks can collaborate with government agencies and financial institutions to facilitate the delivery of government schemes and subsidies to rural beneficiaries. Partnerships with entities like IndiaPost, rural banks, CSCs (Common Service Centers), Anganwadi centers and Self-Help Groups (SHGs) could create a seamless ecosystem where rural individuals and businesses can easily access government schemes and subsidies through the digital platforms provided by neo banks.

By identifying and capitalizing on these opportunities, neobanks can significantly contribute to rural India's financial inclusion, addressing the unique challenges and requirements of the underserved rural population.

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Can Neobanks Break the Rural Financial Barrier?

Ankit Abhishek
,
Yatharth Chaudhary
,
  • January 23, 2024
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