A Fintech Opportunity Entrepreneurs Could Swiftly Respond to
This is how India's entrepreneurial ecosystem has largely ignored what could be a global opportunity worth several billions of dollars
The Indian fintech industry, which only last year raised funding in excess of $1.5 Billion, has focused almost singularly on the front-end or the consumer-facing side of banking, and we, therefore, see a proliferation of mobile wallets, apps and other technology products designed for the consumers. Only a handful of startups have focused on the banking back-end systems and processes.
The Alarming Situation
The US$2.1 Billion Nirav Modi scam convincingly showed us that even the highly-sophisticated banking systems, otherwise designed to keep our money safe, have loopholes that are open to exploitation. In this particular case, Modi exploited existing loopholes in all three core areas of a bank's operations: People, Processes and Technology.
This example shows us how India's entrepreneurial ecosystem has largely ignored what could be a global opportunity worth several billions of dollars – of improving and enhancing the back-end operations of the banking industry. Just fraud detection and risk management is a huge opportunity even in India – according to the Financial Stability Report (FSR) released by the Reserve Bank of India (RBI) on 26th June 2018, there were over 6,000 fraud cases registered last year, leading to a loss of more than INR 30,000 crore ($4.37 billion). This marked an alarming rise from the preceding year 2017, where banks had reported a loss of approximately INR18,170 crore, through 12,533 fraud cases, according to a report by Institutional Investor Advisory Services, a proxy advisory firm.
Soon after the Nirav Modi scam was made public, RBI released its circular that sought to plug the existing loopholes as well as create additional safeguards for unknown ones. Among the existing loopholes that Modi deftly exploited was the most crucial one: the Punjab National Bank's core banking system (CBS) was not integrated with their SWIFT system. As a result, SWIFT messages and transactions related to the scam were not reflected in the CBS and would go on undetected for years. Now, the RBI has mandated straight-through processing (STP) between the CBS and SWIFT, which once implemented, should be a major deterrent to a future scam of this nature.
Implementing the Proper Code
Implementation is the keyword here, as not all banks in India have the resources to upgrade their CBS just to integrate it with SWIFT. The CBS is a highly specialized software and while all modern banks use some form of CBS or the other, the global market is tightly controlled by just a handful of vendors. However, given that compliance with the RBI circular is not an option; 36 banks were only recently heavily fined for non-compliance; banks must find a way to achieve the STP and CBS-SWIFT integration. Indeed, many of them have found a middleware solution from independent providers to be a cost-efficient yet effective solution for CBS-SWIFT integration and compliance with the RBI mandates.
In India, there are over 100 major, mid and small-sized banks and co-operatives, and a majority of these banks fall in the mid to small-size category. We can classify a bank with 500-2000 branches as mid-sized, and one with less than 500 branches as small-sized. Only a handful of large PSU and private banks have the necessary resources and IT infrastructure to comply with various RBI guidelines, including the ones related to SWIFT transactions. On the other hand, many small or mid-sized banks neither have skilled manpower nor a strong enough balance sheet to radically overhaul their back-end systems and processes; leaving the space wide open for enterprising start-ups to enter with innovative yet cost-efficient solutions.
The opportunities available can be neatly mapped across the three core domains. On "people', training and reskilling of bank executives and staff is a significant opportunity. To take one example, banks are required to rotate their staff working on the SWIFT system every two to three years, which means that new staff needs to be trained and skilled. And following from above, the opportunity for reskilling is particularly significant in the case of small to mid-sized banks.
The second big opportunity lies in process reengineering and consulting. A majority of small or mid-sized banks have inherited grossly inefficient processes from large banks and have rarely invested in reengineering their processes.
We have in the past had scams like the Harshad Mehta scam which took advantage of the bank's processes and banks have responded by improving their systems. However, the challenge here is two-fold: Firstly, the type of terrorism has changed now, people sitting in other countries can now compromise our system and secondly, organisations and banks never challenge the status quo. For instance, if a system has worked for decades without any vulnerability, it doesn't mean it's not vulnerable. There has to be constant testing of the bank's processes and technology to make it more relevant for threats in current times.
Opportunity for Startups
Technology is the largest opportunity for the Indian tech startup ecosystem when it comes to back-end banking. In fact, cloud computing is a vastly underexplored and underutilized technology in the banking space. Cloud adoption also makes it easier for banks to use AI and Machine Learning technology to process their data. Cloud computing can readily help the small and mid-sized banks compete favourably with their larger peers while keeping technology costs low. For small banks, the biggest and the obvious advantage is zero need for significant upfront investment in tech infrastructure. Moreover, cloud-based applications can allow even mid or small-sized banks to use other cutting-edge technologies like computer vision for overhauling their documentation and risk assessment processes.
While there have been concerns about data security and privacy on the cloud, all large cloud platforms including Microsoft and Amazon have already set up local data centres to comply with the Indian government's data localization requirements. Further, given that there are several government projects that are running on the cloud, how far can the Indian banking industry really afford to ignore this technology? the answer will come soon in the form of cloud-based technology solutions from the Indian fintech start-ups.