INNOVATION is among the most powerful forces that continue to shape human society. The advances in the material standard of living enjoyed by most human beings are largely due to innovation. One of the principal arguments for free market capitalism is that it is the economic system that most encourages innovation because it allows innovators to capture a significant part of the remunerations of their work.

The financial services industry is no different. An accelerating rate of technological change, combined with shifting customer preferences and an evolving regulatory landscape, has dramatic implications for the ways in which financial services are designed, delivered and disbursed today.

Technology is overturning work-flows and processes in the financial services industry. Tasks once handled via paper money, bulky computers, and human interaction are now being completed seamlessly entirely on digital interfaces. Almost every type of financial activity – from banking to payments to wealth management and more – is being re-imagined by some tech-savvy banking incumbents as well as by startups. Meanwhile, the old guard is trying to solve a puzzle presented by the digital revolution: How can they benefit from the rise of the digital, and how can they stay relevant?

Money and finance, in some form, has been part of human history for at least the last 3,000 years. Before that time, it is assumed that a system of bartering was likely used. Coins were first discovered in the 7th century BC. Another 1700 years passed by before mankind invented paper currency when it was first experimented with in China in the 10th century AD. Paper currency as we know today is less than 500 years old. For a long time, it was private banks which issued currency notes; the history of banking is closely entangled with the history of money. Banking as an archaic activity (or quasi-banking) is thought to have begun at widely varying times, from a period as early as the latter part of the 4th millennia to within the 4th to 3rd millennia.¹

In ancient India there is evidence of loans advanced from the Vedic period. The earliest banks were exclusively used by rulers to fund large festivals or for meeting building expenses or even for funding wars. By the end of the 16th century and during the 17th, the traditional banking functions of accepting deposits, moneylending, money changing and transferring funds were combined with the issuance of bank debt that served as a substitute for gold and silver coins.

 

By the end of the 17th century, banking was also becoming important for meeting the fund requirements of the combative European states. This would lead on to government regulations and the first central banks. Many consider the origins of the central bank to lie with the passage of the Bank Charter Act of 1844, which authorized only the Bank of England to issue new notes.² For the most part of the history of money and finance, innovation remained slow paced. In a history spanning more than 5,000 years, perhaps the only major innovations have been introduction of coins and paper currency (backed by gold or otherwise), concept of interest rates and introduction of credit. But matters changed rapidly starting in the late 1980s. Backed by technological advances, banking and financial services have grown by leaps and bounds in terms of innovation and services offered from the 1990s.

The journey of the Indian banking industry too has been fairly exciting. The Reserve Bank of India (RBI) was established in 1935. Post-independence, despite the control and regulations of the RBI, banks in India except the State Bank of India (SBI), were owned and operated by private persons. The Government of India issued an ordinance, ‘The Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969’, and nationalized the 14 largest commercial banks. In the early 1990s, the government embarked on a policy of liberalization, licensing a small number of private banks, including the Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with the Oriental Bank of Commerce, UTI Bank (since renamed Axis Bank), ICICI Bank and HDFC Bank. The new tech-savvy private sector banks shook the banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (borrow at 4%; lend at 6%, go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to a retail boom in India. People demanded more from their banks and received more. New private sector banks adapted technology as a key differentiator of their services. In just about a couple of decades of their operation, these new private sector banks gained a disproportionate share of new age banking businesses.

 

The use of computers in the banking sector in India increased manifold after the economic liberalization of 1991, as the country’s banking sector was exposed to the world’s market. Private sector banks took the lead in technology adaption. Today, the internet banking and mobile banking services offered by Indian private sector banks are comparable to the best in the world. Technology has opened up many avenues for Indian private sector banks for improving their services and reducing costs.

Gone are the days when banking was a chore, demanding in many cases for one to take a day off to accomplish the task. Technology has enabled banks to be where the customer is; enabling her to connect to the bank at a time convenient to her from a place of her choice. Today, we are closer to year 2030 than to year 2000. Imagine if we were told in year 2000 that one would be able to bank from our phones 24X7 and accomplish most of our banking transaction in less than a minute? Not many would have believed it! But mobile banking is a reality today with more than 50 million transactions a month.³ By the year 2030, most of today’s technology will be redundant and replaced by other more evolved modes.

 

Presently mobile banking and mobile wallets are the two fastest growing segments in the payments industry. The evolution of mobile banking on the back of a mobile phone revolution in India has helped clients make faster and secure banking transactions on the move. For banks, mobile banking is the most cost-efficient mode of offering services. It is a win-win situation for both banks and clients.

Digital business is an overarching trend covering how the blurring of the physical and virtual worlds is transforming business designs, industries, markets and organizations. Major business and technology advancements, such as the Internet of Things, 3D printing, and machine learning will combine to disrupt existing business models and create an opportunity for entirely new ones. Digital technologies build on each other with wave after wave of innovation.

Customer expectation for banking services (both offline and online) is being reset by the experience being provided by retailers and online providers elsewhere. Thanks to companies like Google, Amazon, Apple, Uber and our very own e-commerce firms, customers now expect every organization to deliver products and services swiftly, with a seamless user experience. New digital providers are definitely changing the rules and disrupting traditional value chains in many industries. The same could happen to the financial services industry as well. Fintech startups are already accelerating innovation in financial markets by leveraging technology. But it will be naïve to believe that technological advancement in banking will only be delivered by fintech firms.

Over the next couple of years, we should expect to see a lot of financial innovation spearheaded by incumbent banks – either independently or in partnership with new fintech firms. There is a growing trend where incumbents will be as good as fintech firms at innovation. Today a lot of banks are partnering with fintech firms for mutual benefit. Some of the traditional players in banking have been very agile in experimenting with new age technologies such as artificial intelligence and block chain. Banks and non-banks are innovating and the Indian ecosystem as a whole is gearing up for digital.

 

However, India is still dominated by cash; only 6-7% of transactions are conducted electronically, the rest being in cash or by cheque. It is a misconceived notion that cash is free. In May 2016, cumulatively, Indians made more than 730 million withdrawals from two lakh ATMs.⁴ Even if, on average, we take just five minutes per withdrawal it means that collectively we waste more than 60 million man-hours every month which otherwise could have been used for productive purposes.

As on 5 August 2016, currency with public was at Rs 16.6 trillion which is more than 95% of the total currency in circulation.⁵ This implies that almost the entire stock of printed currency notes is in daily circulation, which is reflected in the cost of Rs 34.2 billion just to print the paper notes for one year. The cost of printing notes accounts for more than 23% of the total yearly expenditure of the Reserve Bank of India.

 

Furthermore, banks have added close to 18,000 ATMs in FY ’16. The cost of maintaining these ATMs, along with the capex incurred in the new ATMs, is a whopping Rs 158 billion. On top of this, banks have a network of over 4,132 currency chests and incur costs on transporting cash along with the opportunity cost of idle cash. The high use of cash also gives rise to the menace of black money in the economy, resulting in a loss of tax revenue to the exchequer. Cash certainly has a few benefits, but these are far outweighed by its costs. Even by fairly liberal estimates, the direct cost of running a cash based economy is close to 0.25% of India’s GDP. Therefore, there is a massive direct benefit of moving towards cashless transactions.

Two very important developments have the potential to herald a new age of digital payments – rapidly growing smartphone penetration and proliferation of bank accounts. India has over a billion mobile connections with around 240 million smartphone users, which is expected to grow to 520 million by 2020.⁶ The National Optical Fiber Network initiative under Digital India will connect 250,000 gram panchayats across rural India and increase adoption of data services. The Pradhan Mantri Jan Dhan Yojana, through 226 million accounts and 183 million cards (as on 27 July 2016), has provided the infrastructure for universal access to banking.

The issuing infrastructure is largely in place and with the launch of a Unified Payment Interface (UPI) will provide a significant fillip in the proliferation of low cost acquisition infrastructure by allowing smartphones to substitute costlier PoS devices. UPI will be a game changer in that it is a unique interface which works 24x7 across the banking system and is instant, safe, secure, cost effective and convenient to use. UPI allows payments to different merchants without the hassle of typing one’s card details, or net banking password. UPI is built on top of the IMPS, which we have used to instantly transfer money between accounts with different banks. All money transfers via UPI are secured with the two Factor Authentications (2FA) as mandated by the RBI – the first factor being your phone and the mobile pin as the second. UPI is likely to benefit the overall payments ecosystem as the payments service can be provided by banks to the merchant with an entry level smartphone and there is no need to install POS machine at the place of business.

 

Blockchain is another new technology that combines a number of mathematical, cryptographic and economic principles in order to maintain a database between multiple participants (lenders and borrowers) without need for any third party intermediary or reconciliation. In simple terms, it is a secure and distributed ledger/database, hardened against tampering, against which anyone can verify the validity of transactions. A block is the ‘current’ part of a blockchain which records some or all of the recent transactions and, once completed, goes into the blockchain as a permanent database. Blockchain represents the next evolutionary jump in business process optimization technology.

With the advance of smart watches, banking is already slated to experience a shift from ones pocket to ones wrist. Wearable banking will help banks roll out contextual notifications to clients, which means that actionable promotional content can be delivered at just the right time. The future ultimately lies in personalized, contextual engagement. However, smart watches are not the ultimate frontier of wearable technology. As technology extends beyond smart watches to include smart eyewear, gesture controlled devices and other connected products in the larger IoT (Internet of Things), we envisage an exciting world of ‘predictive banking’ to emerge. All the data one generates across ones daily life can be captured (with due permission of course), connected and analyzed – from sensors embedded in everything from wearables to cooking utensils to the car. The area is unbound for exploration and as we explore further, a billion possibilities will emerge.

 

You can expect your bank to create products that can connect with you on a deeper level but in a non-intrusive manner. Banks and financial institution will be a part of an invisible layer around your daily activities. For example, by linking to your fitness band, we would like to encourage your fitness goals by rewarding you on your achievements. We can track your health data (pulse rate, sleeping habits, daily physical exercise, calorie intake, etc.) and create customized insurance plans at the lowest possible annual premiums by partnering with various health providers.

Artificial intelligence (AI) and Machine learning is another important technology that combines natural language queries, predictive analytics, and self-evolving cyber security systems. Artificial intelligence is the future and has already started to become part of our everyday lives. Machine learning is an approach to achieve artificial intelligence where the machine is ‘trained’ using large amounts of data and algorithms that give it the ability to learn how to perform the task. Another emerging technological advancement is cloud computing – the practice of using a network of remote servers hosted on the Internet to store, manage and process data, rather than rely on a local server or a personal computer. The big benefits of the cloud are that it cuts costs, improves flexibility and scalability, increases efficiency, and serves clients faster.

 

Technology is making the world collapse into a smartphone. Regulators want better technology and more automation to encourage the development of next generation of compliance tools. Transforming reporting using technology would allow regulators to do their jobs more effectively by achieving a better view of systemic risks as well as individual firms’ exposures.

Regulators have increasingly aligned themselves with technology to encourage the development of the next generation of compliance tools, which they hope will wean financial institutions off the spread sheets still widely used to meet obligations. Fortunately, emerging technologies, such as big data, blockchain, and artificial intelligence have the potential to alleviate much of the regulatory burden and manage change better, faster, cheaper and safer. Of course, any firm can throw money at technology vendors to make problems go away, but when the industry works together in applying technology to regulation in a smart and safe manner, they become ‘regtech’: a new automated solution to compliance.⁷ It has been the regulators of late that have provided the push for collaborative solutions.

In India, regulation is moving at different speeds across the different financial sector regulators. All regulators want easier on-boarding, transactions and exit process, but have been unable to work with each other to give individuals a common interface. To enable individuals to see their entire financial life on one screen, the Reserve Bank of India recently announced the final regulations of ‘account aggregators’.⁸ The idea is to allow an individual to see all his accounts across financial institutions in a common format. The aggregator will be a non-banking financial company (NBFC) that will charge for this service. The data will belong to the customer and her consent will be needed before it can be shared with other businesses. Having said so, there are some challenges like security and compliance, reliability, interoperability, regulation compliance etc. which need to be looked after.

 

A combination of higher spending power and a freer adaption of technological adoption means that banks and other financial institutions have an entire market of willing and able customers to offer better financial products/services at lower costs. The fact that the unbanked population in India halved from 577 million to 233 million speaks volumes about the advancement of financial inclusion efforts. Technology is the biggest enabler and equalizer today. As we connect one-on-one in real time, it has created massive new flows of trade for markets that were underserved or overlooked. Cellphone subscription in India has crossed one billion. So the first massive change in the network effect of financial inclusion is that millions of people who previously had zero access to digital services are now on the network and connected for good.

 

It is also very encouraging that we have a central bank that is equally enthusiastic about promoting innovation and technology. The Reserve Bank, in its continued efforts towards building robust and secure payment and settlement systems for achieving a less-cash society, published Vision 2018 which highlights the need for making regulations more responsive to technological development and innovation in the payments space.⁹ India now has the best digital infrastructure for financial universalization and with the Jan Dhan, Aadhaar and mobile (JAM) layer, there is an indigenous Indian stack that is propelling us from being a data poor nation to a data rich nation. Add to this the data available through GST Network, under which companies will upload nearly three billion invoices every month and the government will have real-time economic data 24X7.

Digital adaption and moving away from cash would not be without complications. Some objections can be easily addressed, such as a claim expressed by a fifth of the respondents, who in a recent survey said that they like the feel of carrying cash. But other problems will be harder to ignore. The most intractable is the risk that sections of society will be left out of the financial system in a world where smartphones and plastic become the only ways to pay. In a near cashless world, vulnerable groups such as the poor, the elderly and migrants, could become further marginalized, and those who are especially cash dependent for income such as street vendors, small traders, charities and the homeless, would fear a drop in their incomes.

Banking is a complex business delivered through multiple channels. The challenge is to offer consistent experience with each channel promoting others and be seamlessly integrated. For example, when interacting with a branch employee, the customer may be assisted in the use of mobile banking, and get help with online banking when calling a call centre. Today, far too many banks create silos for each channel – including separate reporting lines and separate sales goals. This has to change quickly because in the customer’s mind, all channels merge together to form an aggregate customer experience. When customers are given choices on how to do business, and those choices are relevant and the experience is consistent, there is much more satisfaction.

 

Finally, it is customer preference which will drive business models. Customers with new expectations and the need to build trusted relationships are forcing incumbents to seek value propositions where experience, transaction efficiency and transparency are key elements. As self-directed solutions emerge among competitors, the ability to differentiate will be a challenge. In addition to social changes, the driving force behind innovation in financial services can largely be attributed to technological advances outside the financial services sector that will bring new opportunities to understand and manage risk. While it may be fairly easy to replicate technology, the critical aspect will be building a culture of innovation and the ability to leverage insights to build solutions that will determine who will be able to maximize the opportunities and emerge as a winner.

 

Footnotes:

1. R. Davies and G. Davies, A History of Money From Ancient Times to the Present Day. University of Wales Press, Cardiff, 1996.

2. The Development of Central Banking, The Tercentenary Symposium of The Bank of England.

3. Bank Wise Volumes in Mobile Transactions, Reserve Bank of India, March 2016.

4. Bank Wise ATM Statistics, Reserve Bank of India, May 2016.

5. RBI Annual Report, 2015-16, August 2016.

6. BCG – Google, Digital Payments 2020, July 2016.

7. ‘Regtech’ in Financial Services: Technology Solutions for Compliance & Reporting. International Institute of Finance, March 2016.

8. Master Direction – Non Banking Finance Company – Account Aggregators (Reserve Bank) Directions, September 2016.

9. Payments and Settlement Systems in India – Vision 2018, Reserve Bank of India, June 2016.