Opportunities for Financial Services in a $10 Tr Economy

Based on article by EY-Parthenon

Indian FS sector GDP would be a top 20 country by 2034

• Current low penetration in financial services, combined with favorable growth conditions, is expected to drive increased penetration and business volumes.
• Financial services revenue pool projected to grow from ₹20 trillion ($0.25 trillion) in FY22 to ₹136 trillion ($1.2 trillion) by 2034.
• The growth in the revenue pool will be equivalent to the current GDP of Turkey.
• By 2034, if the Indian financial services sector were a country, it would rank among the top 20 global economies by GDP.

Opportunities for Financial Sector:

For India to become a $10 trillion economy, the financial services sector must play a crucial role, addressing significant growth opportunities ("white space") rapidly.

• Current conditions are favorable for innovators, supported by three main growth drivers:

- Demographic shifts

- Digital Public Infrastructure (DPI) 2.0

- Technology modernization by industry incumbents

• Seven key revenue pools expected to experience exponential growth due to strong demand and supply forces:

- Consumer lending / Nano/micro lending / SME lending / Distribution / Retail health insurance / Financial services technology ("TechFin") / Wealth management

DPI 2.0 Benefits for Financial Services:

• Enhanced Customer Insights:

- DPI 2.0 consolidates customer data from multiple sources, giving deeper insights into assets, liabilities, and cashflows.

- Enables creation of tailored products, such as customized repayment schedules and pre-approved offerings, reducing acquisition costs and improving conversion rates.

• Individual Loan Pricing Based on Risk Profile:

- Access to detailed customer data allows lenders to price loans according to individual risk, especially in nano/micro lending.

- Expected to lower interest rates for low-risk customers, increasing loan affordability.

• Dynamic Loan Pricing and Streamlined Collections:

- Better visibility of cashflows enables dynamic pricing based on borrower metrics.

- Improved focus on collections from difficult cases, reducing resources spent on lower-risk borrowers.

• Reduced Turnaround Time (TAT) for Secured Loans

- Digitized records (land, judicial, etc.) and NFIA data enable faster underwriting, reducing TAT from days to near-instant approvals.

Challenges: Distribution Challenges in Indian Fintech:

• Distribution costs are significant in the unit economics of financial services:

- 10% of revenue (Net Interest Margin) for secured loans.

- 20% for unsecured loans.

- 20-40% of the first-year premium for most insurance products.

- In direct-to-consumer small-ticket lending and insurance, distribution costs can exceed 50% of revenue.

• To manage high costs, distribution is often outsourced, converting it into a variable cost model:

- Agents for insurance.

- Direct Selling Agents (DSAs) for loans.

- Independent Financial Advisors (IFAs) for mutual funds.

Distribution Model of the Future:

• Technology-Led Distribution Models in Fintech:

- Digital Payments-Led Distribution: Platforms like PhonePe, GPay, and Paytm, leveraging consumer payment interactions despite low revenue margins.

- Online Product-Focused Distribution: Innovators like Policybazaar (insurance) and Paisabazaar (loans), offering tailored digital platforms.

- Offline Product-Focused Distribution: Companies like Andromeda (loans), Turtlemint, InsuranceDekho (insurance), NJ India Invest, and Prudent (mutual funds) focusing on offline models for specific financial products.

• Diverse Distribution Models:

- Due to India's vast and varied market, multiple models (offline, online, hybrid) will continue to coexist.

- Simple consumer products (e.g., personal loans, credit cards, basic insurance) are rapidly adopting fully digital models.

- Complex products (e.g., secured loans, SME/corporate products, advanced insurance, mutual funds) require a mix of digital and physical ("touch and tech") channels for guidance and risk assessment.

• Shift to Multiproduct Franchises:

- Competitive pressures will drive distribution businesses to move from single-product focus to multiproduct models.

- Cross-selling and repeat sales are essential, especially in micro-lending and insurance, to enhance lifetime customer value and offset high acquisition costs.

• Managed General Agent (MGA) Model in Insurance:

- MGAs could enable insurance intermediaries to capture more value by handling customer acquisition, underwriting, and risk-sharing.

- MGAs specialize in niche or nonstandard insurance areas (e.g., real estate, OPD) often overlooked by traditional insurers.

- In the US and UK, MGAs play a significant role, accounting for 6-10% of insurance premiums, with many P&C insurers partnering with MGAs to source new business.

Key Technology Investment Trends for Banks:

• Banks' technology spending is projected to increase significantly, rising from 6.9% to 11% of total spending.
• This increase will expand banking tech investment from approximately ₹58,000 Cr to around ₹3,60,000 Cr (~6x growth) over the decade.

• Networked Lending Architecture:

- Banks are embracing co-lending models, leveraging fintech and niche NBFC distribution and underwriting capabilities.

- Real-time, low-latency systems are crucial for cross-selling financial products through digital consumer platforms (e.g., payments, e-commerce).

• Regulatory Compliance and Growth in RegTech:

- Progressive regulators (RBI, SEBI, IRDA) require sophisticated systems to ensure consumer protection, manage systemic risks, and enable real-time monitoring, fueling RegTech growth.

• Modern Core Banking Applications:

- Some banks in India, alongside global counterparts, are starting to adopt modern applications for core systems (e.g., core banking, card management), with anticipated growth in adoption as these systems mature.