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The coronavirus pandemic will accelerate growth of digital financial services, benefiting State Bank of India (SBI) and large private sector banks, according to Moody’s Investors Service.

The coronavirus outbreak and restrictions on physical contact will further boost demand for online financial services, making it more imperative for banks to accelerate digitalisation, the global credit rating agency said in a report.

“Yet only SBI and a small number of large private sector banks have the resources to effectively capitalise on the growing preferences for digital services among consumers and businesses.

Also read: RBI proposes 24×7 helpline for digital payment services

“Except for SBI, public sector banks generally have limited financial capacity to invest in technology because of weak asset quality and profitability. Small private sector banks lack resources to invest heavily in digitalisation,” Moody’s said in the report.

This means that digitalisation will help SBI maintain its leadership and large private sector banks gain market share on the other state-owned peers, which will increasingly face challenges in acquiring and retaining customers, particularly individuals and MSMEs, as they become accustomed to digital services, said the agency.

“While public sector banks have larger shares in loans and deposits than private sector lenders, HDFC Bank, ICICI and Axis along with SBI, dominate digital payments.

“This segment is at the core of banks’ retail banking strategies because digital payments not only help banks retain brand recognition but also increase customer engagement and create cross-selling opportunities, which can lead to growth in revenue per customer,” the report said.

Digital financial services: Rapid growth

Moody’s said digital financial services are rapidly growing in India. It observed that the Government’s efforts to boost financial inclusion and make the economy less dependent on cash have driven growth in the use of digital financial services, particularly electronic payments.

The Reserve Bank of India’s (RBI) Digital Payments Index (DPI), which was constructed with March 2018 as the base period — DPI score for March 2018 is set at 100 — DPI for March 2019 and March 2020 stood at 153.47 and 207.84 respectively, indicating appreciable growth.

Also read: RBI sets up working group to identify risks posed by unregulated digital lending

“Further, the regulator estimates that the number of digital transactions will jump to 87 billion in 2021 from about 40 billion in 2020. Already, the number of digital payments increased by more than seven times from 2015 to 2020, according to data from the RBI,” the report said.

India has a number of factors favourable for the further development of digital financial services, including a large and growing middle class population and a well-established digital identification system, via the Aadhaar, an increasing penetration of smartphones and high-speed internet.

MSME lending

The agency underscored that one segment with abundant growth potential is digital lending to small businesses, many of which have difficulty borrowing from banks because they have limited financial records and lack proper documentation.

Given that micro, small and medium enterprises (MSMEs) have relied on informal lenders at interest rates as high as 30 per cent-35 per cent, almost twice as high as rates charged by banks, Moody’s said this has created an opportunity for digital lenders to target the unmet demand for financing among MSMEs.

Alternative lending is the second-most funded and one of the fastest-growing segments of fintechs in India. The country now has more than 300 lending start-ups, it added.

Moody’s observed that for MSMEs, digital lenders can be attractive because they can process loan applications faster than banks. Digital lenders can use identification information gathered via Aadhar and bank accounts.

Also, they use artificial intelligence, machine learning and big data to assess MSMEs’ earnings and cash flow, and build models for credit scoring that do not solely depend on formal records.

However, a focus on riskier customer segments, nascent underwriting models and a lack of customer histories can lead to larger loan losses for digital lenders than incumbent banks in the initial stages.

At the same time, fintech firms are increasingly collaborating with traditional non-banking financial companies (NBFCs) in lending to MSMEs to benefit from the latter’s loan collection channels.

Fintech sector: attracting foreign interest

Reflecting the growth potential of India’s fintech sector, it is attracting capital from global venture capital companies. In the past six years, fintech start-ups have raised about $10 billion in capital funding, the report said.

In 2019 alone, more than 200 companies raised about $3.2 billion. In addition to venture capital firms, Amazon.com Inc. and Facebook have invested in the sector, while Singapore’s DBS Bank Ltd has created a digital bank in India, says the report.

In addition, global incubators and accelerators, Startupbootcamp, Barclays Rise and Swiss Re InsurTech, have rolled out programs in India.