Red signals for fintech industry: The valuations game of the past is over

RBI Governor Shaktikanta Das' traffic light imagery for the fintech industry has several implications

Last week, Reserve Bank of India (RBI) Governor Shaktikanta Das did some plain-speaking, telling fintechs that it is imperative that they follow “traffic rules” for their own safety and that of others.
 

It was a wake-up call for an industry in which self-styled fintech evangelists believed that legacy RBI-regulated entities will soon be history because they are not nimble enough to rework their business models with the changes foisted by technology. The tone of the commentary at times even appeared to suggest that the management of some of these old-world players was dense.

All manner of data and observations -- from the bad-loan mountain, the huge unbanked hinterland, lack of understanding of new-age customers, and inability to leverage technology or data-mine – were bandied about to press the case that legacy entities would have to cede space to the new denizens.
 

But last November, when the central bank put out a Working Group’s (WG’s) report on ‘digital lending through online platforms and mobile apps’, its executive summary could not have been blunter.
 

The pandemic-led growth of digital lending had led to the unbridled extension of financial services to retail individuals, “susceptible to a host of conduct and governance issues,” it stated. On a larger canvas, digital innovations along with the possible entry of “BigTech” companies may alter the institutional role played by existing financial and regulated entities. And specifically, “A fallout of this may get reflected in blurring of regulated and unregulated financial institutions and activities. Such developments spurred by mere commercial considerations would pose regulatory challenges in ensuring monetary and financial stability and in protecting the interests of customers.”
 

The regulatory roadmap was made clear; it would play out at three levels -- regulated entities of the RBI; other regulated and authorised entities; and unregulated entities, including third-party service providers functioning in the digital financial realm.
 

The fintech industry’s mistake was that it did not read the WG’s point alongside the recent measures the RBI took to improve the financial sector’s health – such as cutting the regulatory arbitrage between banks and non-banking financial companies (NBFCs); the tightening of the governance code at private banks and urban co-operative banks; or, the fact that marquee names such as HDFC Bank, MasterCard International, American Express and Diners Club International had over the past two years been at the receiving end of the RBI’s displeasure (though it’s back to business now for the aforementioned players).
 

But a huge swathe of fintechs, venture capital and private equity (PE) firms that have pumped in billions of dollars into fintechs preferred to view many of the WG’s recommendations as symptomatic of lobbying by banks. Unrelated fault-lines were spoken of: That this lobby had earlier nixed the entry of NBFCs into the credit cards’ business despite the central banks’ enabling circular (of July 7, 2004), which had merely set the net-owned funds floor at Rs 100 crore. There is some truth to this, but it was not germane to the issues raised by the WG.  
 

This was on display again in April this year when the RBI said that pre-paid instruments (PPI) are not to be funded from NBFC credit lines. The narrative extended was: the bank lobby was again at work. This time the grapevine had it that the RBI itself was a divided house on digital lending. And the evidence presented?
 

The master direction of April 21, 2002 (‘Credit Card and Debit Card – Issuance and Conduct Directions’) – which reiterated the June 7, 2004 position on NBFCs’ foray into credit cards -- had been issued by the Department of Banking Regulation; but the one that barred funding PPIs through NBFC credit lines had come from the Department of Payment and Settlement Systems. Plus, the RBI’s Department of Fintech – set up early this year to mainstream fintechs – has yet to issue its first circular. The underlying messaging in all this: fintechs are being treated in a step-motherly way.

The reality is that the fintech valuations game of the past is over – from wallet companies to those mirroring instant noodles makers in their approach to credit and servicing their audience.

What nobody went into was why among the legacy entities, even the relatively better private banks took time to respond to the fintech challenge. One, they are tightly regulated; banks all the more so as they are part of the payments settlement system, and as deposit-takers are custodians of public trust. Two, they don’t have the privilege of playing off PE money; and their shareholders are “more real” when it comes to valuations. Can anything justify the valuation given to firms that have, at best, only stripped a particular segment of the banking business to make a play for it?
 

Finetchs have to realise that being privately held is widely different from being publicly listed; issues such as related-party transactions will soon be taken up by financial sector regulators.

The Articles of Association of several of these companies, which state that their promoters can continue to be on the board for eternity, is not going to hold for long. This may need a revisit given that governance for all manner of regulated entities of the RBI has to have uniformity. The exit route for fintechs and their backers is also going to be narrowed.

The Securities and Exchange Board of India will shortly look afresh at the capital float norms for start-ups, in general (and the grapevine has it that an insistence on a three-year dividend paying record -- ahead of listing -- could be back on the discussion table). In that sense, Das’ traffic light imagery for the fintech industry has several implications.

The fintech bonanza

• The next decade will record a ten-fold growth in the Indian fintechs to achieve $1 trillion in assets under management and $200 bn in revenue
• In 2021, fintech funding recorded 3X jump to $7.7 bn
• Payments, lending and insurtech were the preferred sectors in 2021
• Larger financial stakes will also call for better governance; room for regulatory arbitrage will be cut
• Venture capital and private equity firms may have to revisit some of their fintech exposures
• Sebi is revisiting the capital float norms for start-ups

Data source: EY