The Impact of Digital Payments and Fintech Innovations on Traditional Banking in India: A Post-COVID-19 Analysis
The Impact of Digital Payments and Fintech Innovations on Traditional Banking in India: A Post-COVID-19 Analysis
Introduction
Recent years have seen a gargantuan transformation in the world of financial services, driven by monumental technological advancements within digital payments as well as new-age fintech revolutions together prodding traditional banking players to quickly adapt towards digitisation while continuing their legacy. Since the arrival of Unified Payments Interface (UPI) in 2016, and rise of mobile wallets like Paytm/Phone Pe/Goggle Pay we have seen a fundamental change how consumers interact when paying to businesses until this year. The shift soared high up the hill during the COVID-19 pandemic as social distancing and contactless payments became a norm, fostering in increased usage of digital financial services. This has not only revolutionized consumer behaviours but also presented serious challenges to traditional banks, with competition from nimble fintech that are quicker off their feet and technology-savvy.
While traditional banks have been the primary providers of credit in India for many years, fintech platforms are now challenging them rapidly. Unlike traditional banking, where millions of Indians are either underserved or unbanked for several reasons-well now thanks to digital payment platforms- everyone can pay digitally with their apps instead, at significantly cheaper rates. It has therefore forced many traditional banks to be more innovative and digitally transform as they brace for competition from these fintech companies. The COVID-19 has rocked the world, no longer is there a need to turn back time: More and more transactions are online today than ever before.
Information technology, especially in the emerging markets, is restructuring the defined institutions of monetary systems with the use of innovations in India. Currently, the use of mobile-based payment systems, peer to peer lending and other digital wallet services have changed the flow of financial transactions. However, the Indian market is more complex due to its large population, a high level of communication, the governments drive for a cashless society and financial democracy. Most of the fintech platforms in India have its roots in the government sponsored schemes like Digital India, PMJDY, and the Aadhaar-based payment systems.
As illustrated above, digitization and related advancements are the promise and threats for traditional banks at the same time. On the one hand, the use of fintech technologies can give the banks the possibility to change the methods of offering the consumers and penetrating the markets that were not accessible before. However, these technological disruptions pose a great challenge to the established dominance of the banks especially in services such as payment processing, lending as well as financial advisory services.
As has been indicated, the players involved in the provision of financial services today are more closely related than in the past, and there is ever-closer collaboration between fintech companies and incumbent banks. However, the question remains: are traditional banks capable of doing enough, fast enough to keep up with the technological disruptions or is it going to remain a domain of the fintech companies?
This research will look at these dynamics through an analysis of how the digital payment systems and other fintech developments have transformed the financial structures in India especially in the wake of COVID-19 pandemic. Therefore, understanding the changes that happened before and after the emergence of the COVID-19 pandemic, this paper will discuss the results of the traditional banks adaptation to the new type of competition and possible future actions that could be required to operate in the analysed successfully.
Research Motivation
The genesis of which has been derived from the realization that it has now become clear that, fintech innovations, are now reinventing the wheel of the Indian financial sector, more so after the pandemic. The measures of Central Bank that emerged due to COVID-19 identified certain weaknesses associated with conventional banking sector; these are the restrictions of mobility during lockdowns, the slow pace of digitalization, and physical dependencies. Larger financial institutions were slow to adapt in the same way, while fintech firms were able to grow their service offerings to enable consumers and businesses to operate in a manner that was deemed essential during a totally unprecedented global health emergency.
The primary concern for selecting this topic is the changing dynamics of the traditional banking system in India due to the emerging fin-tech developments particularly, digital payments. Much focus has been placed on the advancement of fintech with little research on the nature of bank response to this technology innovation with regards to Covid-19 outbreak. This paper will address this gap by comparing the trends that have embraced the operational models, market shares, and profitability of these traditional banks in the light of emerging fintech solutions. Furthermore, this topic came as of great interest to policymakers and executives in the banking industry and banking technology pioneers as the advancements in banking trends advance year after year.
Therefore, this research aims at identifying the opportunities of innovation that fintech platforms has presented in the banking industry together with social disruption as the traditional banks struggles to grasp the future of the financial sector.
Further, this research is important and relevant considering the present discourse regarding policy on the fintech industry in India. This is a challenge that the Reserve Bank of India (RBI) and other financial regulatory authorities have not been able to balance on how the six innovations can be supported in the fintech environment without compromising the stability of the conventional banking structures. That is why, studying the effects of fintech platforms on traditional banks is important for developing a fair regulation of financial innovations that would not jeopardize the stability of the systems.
Furthermore, data from the various banks and sources like the RBI, NPCI and reports from players in the fintech industry forms a strong ground on which an analysis can be conducted. These datasets make it possible to conduct an empirical analysis of such factors as the volume of transactions, profitability and with their help it will be easier to define the outcomes of the fintech innovations in the sphere of the traditional banking. Considering these considerations, this research will help to make a valuable contribution to the future of Banking and the predominance of digital environments.
In examining these questions, this dissertation will seek to offer policy prescription to both the conventional banks and policymakers. The incumbent commercial banks require measures to sustain competitiveness, still through partnering with the emerging fintech companies, embracing the digital platforms, and enhancing the clients satisfaction. To create a positive environment that encourages innovation, it is important for policy makers to mind the risks that accompany the disruption of the financial system. This topic is therefore of both theoretical and significance and it is an area of study that is relevant in the current complex and dynamism financial environment.
2. Literature Review
1. Digital Payments and Fintech Innovations
Digital payments and financial technology are evolving every day revolutionizing peoples global financial systems and revolutionizing traditional banking practices. The cashless society was seen in 2021, where the world made a 30% increase in digital transactions as compared to the banking transaction as per BIS (2022). This trend has been most evident in the developing economy like the Indian economy that has embraced digital payment modes such as the UPI for conducting its transactions (RBI, 2021).
Thus, a study by Zhao and Zhang (2021) analysed the impact of digital payments on traditional banking systems on Asian countries only and established that while the overall digital transactions increased by 45% annually between 2015 and 2020, the total profits of traditional banking declined about 20% during this period. This decline was attributed to the simplicity, and the relatively low cost of the electronic payment tools which continued to pull customers away from visiting Banks. Additionally, Zhao and Zhang observed that due to increased adoption of Fintech innovation in the countries including China Singapore and India it has caused a great disruption in retail banking in a way that institutions that offer banking services have no option than to embrace innovation or end up losing a good percentage of market share. According to the authors, the most important argument here is that the fintech cannot be introduced without regulation into the existing financial system without endangering conventional banking institutions.
Digital payment trend is not just restricted to developing economies such as India but has also been well accepted in other emerging economies of Africa and South East Asia where people are moving towards fintech solutions to bypass traditional banking constraints. Also, this kind of digital payment through mobile has recorded a high growth in developing countries such as Nigeria and Kenya through an M-Pesa. Likewise in Latin America; there is also an increase of mobile payment solutions such as Mercado Pago that enable mobile payment. This has therefore been vital in the expansion of the reach of digital payments especially in areas that have so far remained out of reach for traditional financial service providers. This trend is set to increase with advancement of smart phones and internet connection. As per BIS (2022), along with a rise of 30% in number of cross-border digital transactions, there are open banking models in developed countries such as United Kingdom and Australia, which has advanced the fintech development of systematic of financial ecosystems. However, the legal systems in these areas are more developed and are in a position to address the changing that is happening due to digitization.
Additionally, in India, the growth rate of UPI has triggered more traditional banks collaborations with fintech firms that the world realizes that digital payment systems are now the foundation of future banking services. This has been well illustrated by UPI working with Google Pay and Paytm which are both built on NPCI, which shows that the synergistic operation between technology firms, banks and the government are now central in promoting financial inclusion and efficiency in payment systems. Moreover, the RBI has not been backward in coming up with an appropriate regulatory framework on digital payments; coming up with guidelines over digital products, and putting in place sandboxes to facilitate experimenting on new technologies in fintech. This sets up the right structure for development that is not only encouraging of innovation but also has the consumer interest and soundness of the financial system in mind.
As the phenomenon of digitalisation of transactions gradually gains momentum globally, it is important to understand how these tendencies affect the Indian financial industry and to what extent the recent global crisis, including and especially COVID-19 pandemic, affects the development of digital payments.
In the same way, Rao et al. (2020) looked at the competition between fintech and traditional banks in Europe and the U.S They also observed that due to the slow rate of innovation, the American traditional banks are losing their customers. By 2025 digital wallets and Payment based on the proximity of phones would be popular as a means of electronic transfer of funds.Overall, electronic payment systems have received much reception in these areas following the effectiveness, convenience, and low charges behind it (Rao et al., 2020). This discovery is important as it points to the difficulties faced by the conventional banking institutions worldwide and how the only key to their sustainability is as a result of innovation in response to consumers shifting preferences and technology. The findings also result in discourses concerning regulation that will be taken forward in the following section.
2. Fintech Start-ups and Its Impact on the Indian Banking Industry
Currently, India is in the leading positions in the fintech market due to such trends as Digital India and the use of the Aadhaar identification system. In 2016 UPI (Unified Payments Interface) was launched which brought major changes in the digital payments by allowing real time interbank transfers at almost negligible charges. Mehta and Sinha (2022) noted that digital payments in India increased at a year-on-year 55% rate between 2016 and 2021 with UPI handling over 40 billion transactions in 2021. Such an increase in digital payment services has not only added value to the financial systems but it also change the parameter of conventional banking.
Similarly, the study conducted by Mehta and Sinha focused on the issues affecting traditional banks that are experiencing pressure to compete with the fintech solutions level of efficiency and cost advantage and availability of services. Based on their findings, they opine that among the fintech solutions, the mobile-payment based services have helped financial inclusion to the overwhelmingly un-banked population of India. They also have pointed out that this rapid evolution has had the effect that it challenged traditional banks to shift their business models and put increased emphasis on the digitalization process in order to survive.
The fintech market has benefited from a range of socio-demographic and policy developments in India such as the expansion of a youthful population, mobile devices ownership and financial liberalisation. These elements are well-aligned to foster a high growth of the fintech start-ups as evident from figure 4 below. As stated by NASSCOM, the fintech industry in India is estimated to be valued at $150- $ 160 billion by the year, 2025. Moreover, Indias social structure where the financial consumer segment is highly diverse and tiered make it easy for fintech start-ups to target a variety of classes from the upper segment of society to the rural community. This wide market focus accompanied by the favourable regulatory changes such as the obligatory KYC or the Know Your Customer policy has made India an ideal environment for the revolutionary fintech developments.
The introduction of Aadhaar biometric identification system has go far ahead in simplifying the way people are able to access banking services, basic hurdles like long documentation procedures are now limited, especially for a people in the rural regions. Todays start-ups like Paytm, PhonePe, and Razorpay have made payments, lending and wealth management products and services accessible to everyone who was earlier locked out of the banking system. There are new entrants into the banking industry, which comes in the form of neo-banks that are digital-only banks and thus pose a threat to the conventional banks such as Jupiter and Fi Money. Further, this dynamic scenario has changed the existing economic and market situations that compel legacy physical banks to reinvent and engage with these fintech start-ups through the co-lending structures, digital wallets integration and, the launching of new digital financial platforms like ICICIs iMobile or SBIs YONO.
What this signifies for India and its financial structure is the incremental transformation that implies the global nature of how conventional banking institutions are threatened or challenged by the adoption of fintech.
3. COVID-19 and Its Effect on Digital Payments and Conventional Handler
COVID-19 pandemic influenced the development of the digitalization process as a new direction in industries development, and the banking and financial services industry was one of those most affected by these changes. Research shows that when Covid-19 was at its worst, Global digital payments skyrocketed a whooping 200% the World Bank (2021) Adding to this, it has been perceived how economies such as the India banned the use of cash due to social distancing hence boosting digital payments. More telling is that even when restrictions were lifted, a significant percent of consumers still chose electronic means of transactions because of the comfort and safety that they afford.
Over the years, due to the growth of fintech, many countries regulators worldwide have been struggling to balance protectionism in the financial sector and innovation. India is a good example of how governments have been very receptive to the digital revolution having put in place several programs and incentives to support fintech businesses. Digital India and many of its sub-projects, for example, PMJDY and BBPS are responsible for this giant leap forward for millions of the population getting previously excluded from digital financial payment systems.
Thus, the COVID-19 pandemic contributed to the deployment of digital payment solutions because of the social distancing and lockdown policies that changed traditional consumers transactions. Bhattacharya and Roy (2021) looked at the impact of COVID-19 on the country and concluded that the level of financial technology or fintech solutions have significantly increased as a result of the pandemic through a revealing analysis of the rise in the use of financial technology in the country primarily through the use of digital payments, which rose by 65% in the one year of the pandemic. They believe that the pandemic accelerated the transition, making even the most sceptical consumers and businesses make digital transactions, thereby reducing their use of banking services.
The study also drew attention to the challenges faced by conventional banks which were they were already reeling under pressure to go digital. Bhattacharya and Roy proved that though, digital transactions climbed up, the conventional banking services like branch visit, and cash operations declined by 30% in the respective period. This reduction in the role of conventional banking services raised the need for enhancing the digital capabilities of the banking institutions in order to contain with the arrival of nimble fintech channels.
Thus, the necessary step in India is to understand whether shifts in consumer behaviour are permanent and traditional banking will be able to win back the market or not after the exit from the pandemic.
4. Fintechs Latest Trends, Challenges & Innovations, and Government Regime and Support
The policies framed by the Indian government have accelerated the advancement of Fintech and Digital payments in India. Popular government programs like the Digital India campaign, use of Aadhar cards for making payments, and the RBI objectives of financial inclusion are favourable environment for the growth of digital payments and financial technologies. Patel, and Verma (2020) explored the regulations that have supported the growth of Indias fintech sector, In the government-supported drive, customers such as Pradhan Mantri Jan Dhan Yojana (PMJDY) and Bharat Bill Payment System (BBPS) have made millions of the unbanked population financially included.
However, the legal framework is fairly favourable for the development of such business models, but certain features make the work in this domain more complicated, primarily, in the matters of personal data protection and their security. A far-reaching change that has happened in the financial sector is the fast embrace of digitization which has created new opportunities in cyber-attacks and fraud. As a result, the increasing digitalization of the financial sector has prompted the RBI to set up a set of stringent policies concerning the localization of data, compliance with norms for Know Your Customer (KYC), and measures for redressing customer complaints with an aim of maintaining the integrity of the financial regime. On the same note, the fintech firms are extending the common cybersecurity techniques, adopting blockchain for secure financial transactions and embracing artificial intelligence for real-time fraud detection.
Furthermore, new emerging forms of fintech include, BNPL services, embedded or open finance, and decentralized finance (DeFi) are emerging in India. On the one hand these trends create new sources of revenues, on the other, they bring perturbing regulatory issues as the very nature of these relationships is quite complex and rather undefined. For instance, Although BNPL provides the convenient credit solution, questions about consumers indebtedness and repayments clarity led the regulators to contemplate better control. In the future, the question will arise as to how the Government of India and the RBI would be able to support more and more fintech firms and at the same time, regulate them so as not to disrupt the financial market.
However, it is not restricted to just the digital payments as a result, the fintech sectors like lending, wealth management, and insurance have also seen tremendous growth with delivering a contactless experience compared to that of traditional banking systems. Pandemic period revealed that the digital loans given by the fintech companies surged to a level of 40% in India while the loans given by the old age banks reduced to 15% as per the NPCI (2022). This change was made possible due to the fintechs risk assessment underwriting through the use of Artificial Intelligence where they offered better rates than traditional banks, who further lost market share.
According to Patel and Verma, these policies along with the regulatory support extended by the Reserve Bank of India (RBI) have made it possible to develop digital payments and such innovations as UPI. It also revealed that there should be an optimal level of regulation that should be welcomed by the Fintech companies without causing a disruption to the regular financial institutions. In the years to come, the planning of the regulatory framework will determine the presence of the two structural units of the financial market: traditional banking and fintech.
5. Opportunities and Threats of Conventional Banking Institutions in Todays Fintech Era
With fintech companies rising as challengers in different segments of financial services, it is still unclear what role more traditional banks will play in the future. In Sharma and Gupta (2022) it was established that despite the rapid market penetration on the side of fintech in areas like payments and lending, traditional banks still have an edge when it comes to issues to do with trust, customer relations as well as regulatory requirement among others. While discussing the future of traditional banking, Sharma and Gupta pointed out that it will largely depend upon the banking sectors efficiency to embrace new digital technologies and phase them into their existing setups.
From their study, it emerges that the relationships between conventional banks and innovative fintech firms provide a possible approach to the solution of this problem, with experience of traditional banks that use fintech platforms to bring value-added services to their clients but do not give up the benefits arising from being an experienced financial institution. However, should traditional banking institutions not adapt to the shift taking part within the monetary sector, they could find themselves being outcompeted by the newer, more acceptable and genuinely progressive fintech opponents.
While fintech firms have made deep incursions into consumer financial lives, incumbent banks, however, enjoy several sources of competitive advantage including customer loyalty, strong legal compliance and brand recognition. Conventional banks also have established the unlikely capacity to carry out large scale operations financially in a way that fintech companies may lack the capacity to emulate. Still, the real competitive advantage will belong to traditional banks, which will need to transform and incorporate fintech solutions into their technological structure. This will call for a shift in this conservative approach to credit crunch, which used to be the hallmark of banks.
In addition, saw that traditional banks are gradually starting to appreciate the potential of fintech solutions in aspects such as blockchain, AI, and machine learning, as a means of optimising processes and cutting expenses. In fact some of the banks have even partnered with these new players in the market, commonly known as fintech start-ups, due to the technological advancement that they bring to the table. For instance, HDFC Bank has collaborated with many other fintech companies to offer, personal loan services and products, automatic customer service, and immediate fraud checking systems. Over time, such partnerships can chart the place of banking sphere in the future and it seems that this is a kind of a combination of a traditional banking sector with the elements of innovation provided by fintech companies.
However, as earlier mentioned one of the biggest risks that traditional banks continue to face is the speed of technological advancement. As we see fintech firms continue to develop their products and services, incumbent banks are in danger of getting left behind if they do not take as radical a new perspective. Old fashioned banks risk writing their obituary if they do not take the right steps towards the right direction since the new entrant fintech firms are more flexible and are capable of servicing the new digital customer. However, todays fintech companies are not limiting themselves to basic services, however, they are venturing into other related higher-level services in robo-advisory platforms, AI financial planning, and digital wealth management areas that were dominated by traditional banks for years, reducing the competitive advantage that traditional banks used to enjoy.
Such a shift from the competitive approach towards the cooperation between banks and fintech firms reveals the presence of a mutually beneficial symbiosis because both sectors are able to complement one another in the best interest of the overall financial industry.
References
Bhatia, R., 2020. The Impact of Fintech on Traditional Banks: A Case Study of India. Journal of Financial Services Research, 45(2), pp. 301-318.
Chakrabarti, A., 2022. The Future of Banking: Digital Transformation in Indias Financial Sector. Indian Journal of Finance, 34(4), pp. 25-42.
Mishra, S. and Ahuja, P., 2021. Post-COVID Challenges for Traditional Banking: A Comparative Study of Fintech vs Banks in India. International Journal of Banking Studies, 28(3), pp. 210-225.
Patil, K. and Kale, S., 2022. Government Initiatives in Digital Payments and the Rise of Fintech in India. Economic and Political Weekly, 57(12), pp. 30-39.
Rao, V., Desai, A., and Pillai, R., 2020. Digital Wallets and P2P Platforms: How Fintech is Changing Retail Banking in the West. Journal of Financial Innovation, 39(3), pp. 145-164.
Sharma, P. and Kapoor, M., 2021. How COVID-19 Accelerated the Adoption of Digital Payments in India. South Asian Economic Review, 48(1), pp. 74-85.
Singh, R., 2021. A Comparative Analysis of Fintech Adoption in Developing Economies: The Case of India and Brazil. Journal of Emerging Markets Finance, 19(2), pp. 115-134.
Zhao, X. and Zhang, Y., 2021. The Digital Payment Revolution and its Impact on Traditional Banks in Asia. Asian Financial Review, 17(4), pp. 40-56.
