Incredible India!

Emerging Market Perspective Series: Report 1

Executive Summary

A leading analyst group predicts that “India will climb…to be one of the world’s top five generators of non-cash payments by 2017.”1 In the emerging BRIC (Brazil, Russia, India and China) markets, cash remains king; but in India the tide is turning as consumers increasingly conduct electronic payment transactions with either plastic cards or, to a lesser degree, mobile phone-based applications. This market trend is being driven by a population of more than 1.2 billion, 350-400 million of which are part of the burgeoning middle class. This key demographic, growing annually at five percent, is developing a voracious appetite for consumer goods that can be supported through access to basic banking services provided by domestic and foreign financial institutions.

India represents a particularly bright spot in the global marketplace, especially compared to the anemic forecasted U.S. GDP growth rate of 1.5 percent. India’s GDP, as of first quarter 2011, was 7.8 percent. This chapter addresses conclusions from a recent TSYS and Evalueserve in-depth research report into the India electronic payment market. From 2004 until 2010, India’s average quarterly GDP growth was 8.4 percent,2 surpassing Brazil’s at 4.5 percent.3 Conducting business in India is not without its challenges, however. A greater proportion of India’s population falls below the poverty line compared to other BRIC countries. Plus, India’s payment infrastructure suffers from an acute lack of investment relative to other emerging markets. But India does represent the largest democracy in the world, boasting a young, upwardly mobile population both digitally and financially.4 In comparison to other emerging markets, India holds strong potential for financial institutions (FIs) to provide non-cash based payment mechanisms and basic banking services to two market segments — the middle class and, over the longer term, the rural unbanked. In rural markets, where the banking payments, technology and communications infrastructure is even weaker than that of metro markets, mobile payments could leapfrog over card-based payments as they meet the needs of a large percentage of unbanked customers. This topic will be explored in Part Two of the Incredible India chapter.

Part One: Four Imperatives to Accelerate Electronic Payment Adoption

Introduction

The sheer number of potential consumers is a key catalyst for significant growth of non-cash payments in India. However, the supply side — the availability of card acceptance points, point of sale (POS) devices, ATMs and kiosks — does not yet support the growing middle-class consumer’s appetite for such services. Part one of this chapter examines the crucial investments that must be prioritized by the electronic payments industry to gain momentum and reach its market promise.

The most critical issue is India’s need to fully develop and expand the existing technology infrastructure so that it will support banking and growth in electronic transaction acceptance points. The dearth of acceptance points is a critical bottleneck that must be overcome in order to meet consumers’ changing payment preferences and create a sustainable electronic payments system. Examining how the telecommunications industry leveraged the strategy of co-opetition, when competitors cooperate in order to create maximum value for all market participants, to spur the growth of mobile phone subscribers from approximately 100 million at the end of 2005 to more than 800 million today,5 this chapter discusses a model for how the retail banking market may evolve and overcome many of the infrastructure deficiencies that are currently limiting growth. With the loose framework of co-opetition laying the foundation for a scalable infrastructure, the other two critical factors are the role of government in easing the way for infrastructure development and the education of consumers on the tangible benefits of electronic transactions. It is imperative investments focus on four areas: developing the infrastructure with a co-opetition strategy, correcting the market’s structural imbalance, the Indian government’s role in banking services that are available and affordable to all, and educating the Indian consumer about the benefits of electronic payments. An effort in these areas will fuel the growth of electronic payments in India and ultimately generate the momentum needed for the market to reach its tipping point, the moment of time marked by generating critical mass.

The Promise of Electronic Payments in India: Banking Service Penetration & Growth Indicators

India’s growing middle class presents FIs a significant opportunity to link economically-desirable consequences and derive substantial revenue streams from new banking and payment products, channels and customer segments while rising to meet a developing market’s consumer needs. On the dawn of a new financial era defined by electronic payments, India’s penetration of electronic payment products is exceptionally low compared to other emerging markets, but it is increasing rapidly.

Figure 1 compares India to other emerging markets. These penetration figures, coupled with consumers’ eagerness to adopt non-cash based payment methods, amplify the opportunity for domestic or foreign FIs to increase their service offerings in India by taking the lead on electronic payments and by partnering with other consumer-facing industries and specialist service providers.6

The volume of India’s electronic transactions at POS is on the rise, growing at more than 40 percent annually.7 Payment card transactions — debit, credit and prepaid — are growing at double-digit rates with debit cards’ 45.5 percent CAGR driving the growth.7 Since 2003, debit card adoption rates have grown more than 40 percent annually8 and the volume of debit cards, at 216 million cards issued in 2010 and growing, is outpacing credit cards, which have settled at close to 18.1 million9 from a peak of 27 million. The TSYS/Evalueserve research found that the credit card spend, at $16 billion, is double the country’s debit card spend.8 The penetration of prepaid cards, estimated at 3.5-4 million cards, is appreciably lower than either credit or debit cards. Given that prepaid cards are experiencing an estimated CAGR of more than 50 percent and that the target prepaid customer segment is estimated to be 600 million, this type of payment card has the most significant room for growth.”8 Usage and adoption rates illustrate that consumer demand for electronic transactions is undeniably on the rise, which will be further cultivated with the investment in the outlined four imperatives.

Imperative #1: Developing the Infrastructure with Co-opetition

The most critical factor hindering the adoption of electronic payments in India is the lack of a technology and payments infrastructure that can support the emerging financial system. In China, the government’s protectionist role, often viewed as limiting, contributed to local FIs gaining the momentum to support increased competition. Today, many of the Indian government’s initiatives outline higher standards for India’s financial payment systems. Despite proactive endeavors by the National Payments Corporation of India (NPCI) and the Reserve Bank of India (RBI), India is less able to move in the same monolithic and oversized leaps as China, given the Chinese government’s role in mandating and implementing national change.

In India, the best model for success in driving electronic payments is not necessarily understanding how another emerging market approaches payments. Rather it is looking to another industry that has achieved phenomenal success by deploying what may be a uniquely Indian strategy. For FIs, many lessons can be borrowed from the strategic playbook of India’s telecommunications industry. Its meteoric rise — growing 52 percent annually for the period 2005-2010 — has made it one of the world’s largest mobile markets.8 Understanding the growth of Indian telecom, achieved by leveraging a co-opetition approach, helps crystalize a development strategy for financial services to support the country’s banking and electronic payments services. “Co-opetition is a business strategy based on a combination of cooperation and competition, derived from an understanding that business competitors can benefit when they work together.”10 Telecom’s two pronged approach first entailed the players’ co-operation in joint shared investments in infrastructure and technology that enabled extended national reach and scalability for industry stakeholders, thereby avoiding duplication of capital and operating costs inhibiting the profitability of this nascent business. Furthermore, this approach led to telecom players outsourcing cost-intensive functions to third-party providers that offered core competency, specialist expertise and scale to further reduce costs. Second, the players competed by segmenting the market and distinguishing themselves through products, pricing and services attuned to the specific needs of niche customer segments.

Borrowing from the Mobile Telecommunication’s Playbook

Nationwide investment in the mobile telecommunications sector doubled to $40 billion from 2009 to 2010.8 A key driver of telecom’s growth was the industry’s recognition of the value of collaboration. Leveraging their strengths would produce industry-wide benefits, such as addressing geographic network fragmentation, averting significant capital investment by a single organization to establish a national presence, and enabling access for market segments across both rural and urban markets. A recent report, Mobile Network Sharing 2010-2015, states that “around 70 percent of operators [in emerging markets] have used sharing to their advantage in the form of site sharing, co-location and national roaming.”11

At the genesis of India’s mobile telecom industry, many providers were operating independently, each attempting to build its own infrastructure. As the market evolved, competitors recognized the synergies of shared infrastructure gained through outsourcing commodity-based elements such as cell towers. Bharti Airtel, India’s largest telecom carrier, outsourced the majority of its call-center operations to IBM and much of its core infrastructure, including cell towers, to Nokia and Ericsson.12 In order to boost its customer service expertise, Idea Cellular contracted with Firstsource to provide customer relationship management services including customer service, billing, new product information and plan details. Mobile carriers who utilized a shared infrastructure and outsourced operations achieved cost efficiencies and increased coverage, ensuring rapid, sustainable growth for all key industry stakeholders — mobile carriers, customers and business at large.

Some movement toward an outsourced shared banking infrastructure in India is evidenced by the creation of credit bureaus such as Credit Information Bureau India (CIBIL), and joint ventures with Experian and Equifax. A strong indicator of co-operation is Equifax’s market entrance with its credit information solutions garnered from six leading Indian banks and FIs — Bank of Baroda, Bank of India, Kotak Mahindra Prime Limited, Religare Finvest Limited, Sundaram Finance Limited and Union Bank of India — which reduces credit risk for the entire industry while encouraging the growth of consumer-based lending.13 But there is much work to be done to achieve the type of co-opetition mindset that would support the market for electronic payments reaching its tipping point in India. To do so would require a “divide and conquer” philosophy that benefits all key stakeholders. In the banking industry, outsourcing should be viewed as a solid strategic play allowing FIs to depend on a trusted provider to address capital, technology-intensive infrastructure provisioning and services, such as payment processing, which also require specialist expertise. This approach allows FIs to grow their core businesses without the need to focus on capital-, time- and cost-intensive infrastructure demands. In addition, the outsourced model can be leveraged by FIs to achieve distribution reach and deeper penetration in markets where the FI does not have a presence by establishing a Business Correspondents (BC) network in partnership with other industries. The FIs should instead prioritize market competition based on product differentiation and customer-focused initiatives related to customer acquisition and retention, account activation rates, usage, pricing, risk management and loyalty/reward programs; or on product innovation focused on the development of new products or programs targeting distinct market segments.

The concept of a shared infrastructure would allow banks to forge relationships for increased accessibility of banking services in a robust, scalable and cost efficient manner. In particular, translating this strategic approach to card payments, a shared infrastructure for ATMs, POS terminals, kiosks and mobile payments could be utilized by multiple FIs with a pay-per-use model. Already, Tata Communications Banking InfraSolutions Ltd. (TCBIL) and CMS Securities offer FIs a fully outsourced ATM model. As outsourced ATM providers, these companies select and set up the physical locations of the machines and, more importantly, incur and bear the capital costs and operating risk. As stated by Mr Rajiv Singh, President of TCBIL, “Our customers would not need to make upfront investments in channels like ATM, POS, etc., as we take end-to-end responsibility of asset ownership, deployment, and maintenance, backed up by our 24/7 operations capabilities.” We have assimilated strong capabilities in various banking infrastructure needs and are well positioned to service the growing needs of banks. Banks can focus on their core functions and investments and partner with us for the management of their infrastructure needs.”14 This co-opetition strategy could quickly and cost-effectively allow FIs to implement a payments infrastructure that supports electronic payments at the national level and enables deeper market penetration that supports the national objective of financial inclusion of currently excluded customers. Rural market dynamics appear extremely ripe for mobile payments, an opportunity that is explored in part two of this chapter.

Market conditions for financial services mirror the explosive growth of the mobile telecommunications sector, which transformed its accessibility to a broad consumer base. First, rates will continue to fall. Mobile calling rates decreased more than 90 percent15 between 1998 and 2005, thus boosting subscriber levels. Seeking to spur similar cost reductions in electronic payments is RuPay, India’s domestic scheme recently launched by NPCI. Supported by RBI and owned by a consortium of nine public sector, private sector and foreign banks, RuPay is loosely modeled after China’s China UnionPay as a domestic alternative to the leading global providers, Visa and MasterCard, and supports the government’s vision of financial inclusion for the rural and unbanked. RuPay aims to lower payment processing costs, increase payment card acceptance points, and spur consumer adoption and usage.16 Second, demographic trends — the growing middle class and rising income levels — that contributed to robust mobile penetration has the potential to do the same for electronic payment transactions. Third, synchronizing the country’s mobile industry standards with global standards was critical. The RBI’s Payment Systems Vision Document outlines six key tasks required to support growth in electronic payment transactions.

Imperative #2 Developing the Infrastructure to Correct the Market’s Structural Imbalance

The typical “chicken and egg” situation in card issuance and payment acceptance is reflected in the imbalance between the number of payment cards in circulation and the number of acceptance points — merchants with POS terminals and ATMs — in India. This is a fundamental hurdle to growth in electronic payment usage and per-card transaction volume in the Indian market today. With approximately 10 bank branches per 100,000 adults, accessibility to banking services in India is extremely low in comparison to other emerging markets.7 Estimates suggest there are now 600,000 POS terminals, which is an enormous increase from the 40,000 terminals in 2002, but an extremely small number for the size of the population.18 In the near term, the country’s largest bank, State Bank of India (SBI), plans to install more than 500,000 POS terminals within the next few years, nearly doubling the country’s units.19 By comparison, China, a country with a similar sized population, has a 0.25 POS terminals penetration rate (per 1,000 capita), while India’s rate is 0.05. (See Payments Cards by the Numbers matrix.)

Indian merchants with POS units on average handle less than one debit card transaction and only 1.3 credit card transactions per POS terminal per day.18 From the merchant perspective, POS terminals are highly under-utilized; and from the consumer perspective, they are not easily accessible. Clearly, the lack of consumer access is a factor that works against motivating cardholders to activate cards and use them for purchases at retailers instead of using them to just withdraw cash from ATMs. Those FIs motivated solely by profits are removing unprofitable POS terminals. This is in sharp contrast to the SBI’s response to the Indian government mandate — outlined in the RBI’s Payment Systems Vision Document — to make banking services affordable and available to all. Currently, more than 70 percent of ATMs and POS terminals are located in major markets, while a mere five percent dot the rural landscape. Despite the relatively low usage and access levels, the existing POS terminals have registered double-digit growth — and are expected to register 24 percent growth in 2011 as banks increasing rely on this growing channel for incremental revenue streams.7

Despite more than 10 times as many POS terminals than ATMs, the vast majority of debit card transactions occur as ATM withdrawals as it is still easier to withdraw cash from ATMs than use cards at the myriad outlets operating without POS terminals. Even though today’s POS card usage is low, spending with payment cards — credit and debit — is expected to continue climbing. Prepaid cards alone are estimated to reach at least $9.9 billion by 2013 with Visa and MasterCard size estimates projected at $65-90 billion over the next 4-5 years.20 This is a true testament to the strength of the market size and an indicator of its growth trajectory. Modernizing the infrastructure will help spur a growth cycle for the entire ecosystem in which the supply side of card-accepting merchants develops in tandem with the demand side of consumers’ increased appetite for electronic banking transactions.

Imperative #3: Government’s Role in Creating Accessibility to Payment Services for All

Today, a significant discrepancy exists between customer demand and payments acceptance infrastructure in India, which entails distinguishing between usage and accessibility. The proactive role the Indian government is taking to help build the payments infrastructure is instrumental in bringing about change. Recognizing banking’s infrastructure challenges, the government approved the Payments and Settlement Systems Act (2007), which provided the RBI’s explicit regulatory control of all payments and settlement systems in India. The RBI’s Payment Systems Vision Document outlines six key tasks required to position the country for growth in payments, which will in turn spur economic growth. Its stated mission is “to ensure that all the payment and settlement systems operating in the country are safe, secure, sound, efficient, accessible and authorized.”17 Adhering to this lofty vision, RBI created the National Payment Corportion of India (NPCI). The NPCI’s mandate is to be the primary agency for retail payments development: “to build-state-of-the-art, world-class, customer-friendly electronic payments retail systems available and affordable to all around the clock.”21

Evidence of progress toward NPCI’s mission abounds, from government schemes, programs that encourage electronic payments and financial systems and products that reach beyond the metropolitan markets. The Indian government has evaluated cards as a payment instrument for government benefits and social schemes. One such example is the kisan card, which provides farmers with access to credit for their agricultural operation expenses, such as production and cultivation. The RuPay initiative,22 a key NPCI program, is based on creating a domestic scheme for authorizing and settling transactions at a lower cost than its global counterparts. This brings card accessibility to the masses as cost efficiencies afforded to banks are passed on to the end consumer. Providing enhanced security and simplifying the overall experience is an identity authentication pilot program utilizing biometrics data captured by India’s national Unique ID scheme (UID) for customers enrolled in UID, encouraging usage.25 Furthermore, biometric authentication, as a unique identifier, addresses RBI’s mandate of solutions supporting financial inclusion for all citizens.

India’s geographic landscape, with all its limitations in physical and technological infrastructure, creates challenges for electronic payment systems providers in reaching a range of customer segments. In order to expand banks’ traditional and alternative distribution channels beyond bank branches, ATM and POS terminals, the RBI supports the recruitment of Business Correspondents (BC) by banks. BC’s handle the delivery of cash and accept cash deposits, open new accounts and provide other services for rural populations where bank branch access is either limited or non-existent.

Imperative #4: Educating Indian Consumers About the Benefits of Electronic Payments

Cardholder numbers in India remain inflated as many cards remain inactive and a large percentage of cardholders never or rarely use them due to the debt-averse and traditionally cash-oriented nature of India’s culture. 

Figure 2 indicates that from 2005 to 2010 the CAGR for cards issued was 75 percent higher than the CAGR for transaction value over the same time period. This divergence shows low activation and usage of the cards that are in existence.26 Estimates indicate that 50 percent of credit card accounts are dormant and 80 percent of debit cards are not used at the point-of-sale. Further compounding this lack of consumer use is the limited number of merchants with point-of-sale terminals, and these numbers will continue to remain low until the payments acceptance infrastructure is developed.27

Consumers’ existing cultural values and beliefs toward cash and debt could present challenges to the development of a mature electronic payments industry. Deriving from these traditional values is a persistent belief that non-cash based transactions bear a high-level of risk. However, there’s evidence of changing consumer behavior toward increasing adoption of prepaid and electronic payment mechanisms among Indian consumers, with consumers growing increasingly comfortable with the benefits of electronic payments. In fact, India’s e-commerce market is growing by leaps and bounds — about 30 percent annually — with online auction company eBay alone experiencing 60 percent year-over-year growth.28 In order for consumers to participate, online purchases must be made with either a prepaid, debit or credit card; or through PayPal which is linked to either a payment card or a bank account.

The findings from Visa’s 2010 prepaid card survey suggest that 80 percent of those surveyed, “ … enjoy the benefits of cashless transactions and the convenience of carrying [prepaid] cards.”20 According to Edgar, Dunn & Co. Director Samee Zafar, “banks can issue prepaid products across consumer segments and across product sets — from a “bank on a card” for the un/underbanked to per diem corporate expenditure cards to government or state benefit cards to mobile wallets for contactless and remote mobile payment. Prepaid cards are now being used to facilitate remittances as well. India is the world’s largest recipient of foreign remittances. The direction of a bank’s initial foray will very much depend on a bank’s strategic priorities and plans.”31 Consumer education focused on the value of electronic payment mechanisms could facilitate the adoption of card-based transactions. Education would promote and increase awareness about the benefits of card usage, including security, convenience and loyalty and reward programs. Ultimately, these efforts could encourage adoption of payment instruments, drive card activation rates and increase usage volume — all critical for realizing electronic payment transactions’ potential.

SUMMARY

India’s population is one of the world’s largest, but its sheer volume of consumers alone cannot create a market without the proper infrastructure. From the outlined evidence and studies, it should be clear that electronic payments will experience exponential growth as India’s technological and communications infrastructure begins to achieve higher standards. The co-opetition strategy borrowed from the mobile telecommunications industry’s rapid rise is one avenue for addressing the challenging market conditions. And the value derived from outsourcing operational elements to trusted third-party partners will allow FIs to focus on creating differentiation through customer-oriented marketing, leveraging the distribution reach of other consumer-facing industries through core payments infrastructure and capabilities built by specialist providers. In and of itself however, an enlightened industry model is not enough to ensure that the electronic payments sector reaches its tipping point in India. It is critical for the government to play a proactive role in advancing infrastructure and regulatory improvements in order to open up the market. Efforts by FIs to educate consumers about the benefits — safety, convenience, and security — of electronic transactions are also crucial. Modernizing India’s payment infrastructure would ease access, promote card usage and trigger a much needed transformation of banking and payment services, enhancing the country’s competitiveness as a global player and elevating the living standards of its citizens. With a clear outline of what it will take for India’s electronic transactions ecosystem to reach its potential, a remaining question left to discuss is, “What is the role of mobile payments in improving access to India’s rural and unbanked customers?” This is discussed in part two of the chapter.

The following table demonstrates how India has yet to reach its tipping point in many key indicators.

Payment Cards By the Numbers

Part Two: M-Payments and Prepaid Poised to Define Financial Institutions’ Delivery of Banking & Payment Services to Rural India

Introduction

Today it’s fairly common to see a passenger board an international flight in New York by presenting a smart phone loaded with an e-boarding pass or a train in Italy by displaying a quick response code-enabled e-ticket on an iPad. Mobile transactions are catching on in developed markets as consumers increasingly move away from computers and on to a new generation of mobile devices. The next wave of electronic transactions—mobile payments, or m-payments—is on the verge of surging. This is especially true in emerging markets like India where frugal innovations could fill enormous market voids that leave large populations at the bottom of the pyramid (BOP) underserved. In particular, the symbiotic relationship between prepaid and mobile phones defines a natural entry point for inclusion of the rural unbanked into the formal financial system and would support adoption on a mass scale. Innovation at the intersection of these two already widely adopted services by India’s BOP consumers is a market opportunity ripe for development by financial institutions.

Earlier in 2011, Yankee Group forecasted “unprecedented growth in mobile transactions worldwide, with the total value of global mobile transactions increasing from $162 billion to $984 billion in 2014.”33 This represents a compound annual growth rate (CAGR) of more than 90 percent. Industry analysts predict India’s share of global transactions will exceed $1 billion by 2014. India’s electronic payment transactions at the point of sale (POS) are experiencing 40 percent growth annually.34

A recent report from The Economist on the state of international banking noted that “banks in emerging markets are leapfrogging their rich-world rivals in efficiency, technology and innovation” and as a result are growing annually at 20 to 25 percent—often more.35 At the same time, financial institutions (FIs) — domestic or multi-national — may largely be missing the boat on tapping the significant potential of the BOP market. According to C.K. Prahalad, “Multi-National Corporations (MNCs) often assume that the default rate among the poor is likely to be higher than that of their rich customers. The opposite is often true. The poor pay on time, and default rates are very low.”4 This misperception is just one reason why FIs have not made inroads with BOP customers. Other challenges include the BOP market’s lack of credit history, the country’s nascent credit bureau infrastructure and national ID system, and limited penetration of the formal banking and payment systems across rural India. Several compelling factors, however, should prompt FIs to rethink their conventional wisdom on such potential customers, particularly in India where opportunity abounds and partnership across consumer-facing industries could prove fruitful.

First, unencumbered by the need for consumers to transition from old to new technologies, emerging markets like India are poised to outpace other more established markets in the adoption of m-payment transactions, especially among the rural unbanked. India’s vast and established mobile networks have the ability to supplement the traditional branch-based approach to banking. This would allow mobile to provide the technology platform and the distribution channel for extending banking services to rural populations. In other words, mobile operators already have in place extensive rails covering a significant portion of the country on which the payments industry can ride in order to deliver m-payment services.

The financial sector in India is well positioned to develop two distinct and complementary types of electronic payment transactions, which may materialize simultaneously.34 The first is the more traditional card-based payment model, which is discussed in report one of the “Incredible India: Emerging Market Perspective” series, titled, Four Imperatives to Accelerate Electronic Payment Adoption. The second type of transaction includes mobile-based payments, (referred to throughout this report as m-payments) which have the potential to transform the banking landscape for India’s underserved rural populations.

This report will explore how the untapped market opportunity of m-payments can act as both a significant market opportunity for FIs and a great equalizer for BOP consumers in rural India. It will then discuss the key market indicators that highlight the sea change underway in electronic payment transactions, specifically m-payments, in India: 1) the promise of frugal innovation as an alternative to expensive infrastructure improvements needed to expand limited access to retail banking outlets; and 2) high and rapidly rising mobile tele-density, combined with increasing familiarity with and receptivity to prepaid payment instruments. This includes ‘no frills’ accounts, which are changing the traditional “cash is king” attitude among rural consumers. Next, the report identifies some challenges that exist for m-payment adoption and calls out the key lessons learned from the successful penetration of rural markets by fast moving consumer goods (FMCG) partners, known in the U.S. and Europe as consumer packaged goods companies. Finally, this report explores elements fundamental for m-payment adoption, including prepaid payment cards, partnerships between FIs and mobile providers and the proactive and supportive role of the Indian government, all of which can help fulfill the goal of bringing consumers into formal and organized financial markets that are accessible, secure, convenient and rewarding. Improving connections between these complementary industries and the government could provide great rewards for all constituents.

Mobile as the Bank Branch: A Promising Alternative to the Informal Financial Markets

Financial reports claim economic growth in rural markets has surged nearly 40 percent beyond that of urban markets, which have been increasing at 20 percent, and rural growth now accounts for half of India’s GDP.37 Just as FMCG companies have tapped into India’s rural market opportunity, a distinct opportunity exists for financial services in serving the rural unbanked. McKinsey & Company estimates that “informal lending in rural areas amounts to $85 billion, roughly one-third the amount of credit from the formal financial systems.”38 Many of India’s unbanked are engaged in agrarian activities. At the end of a harvest season, without a financial mechanism such as a savings account to carry them over until the spring season, kitchen utensils have sometimes acted as a stored-value system. Bought at the end of the harvest, the utensils are stored until cash is needed to invest in the next cycle of farming operations. Janmejaya Sinha of the Boston Consulting Group in Mumbai speaks to the creativity of the rural poor who devised these unusual and primitive financial products: “In the past they would buy kitchen utensils and keep them unused, then sell them back to the merchant for a 10 percent discount when they needed money for food. Now technology is supplanting kitchen utensils.”35 In the formal markets, it is hard to imagine a customer promotion designed with the expectation of a 10 percent loss at withdrawal as an attractive customer acquisition strategy, but in the agrarian society of rural India it is treated in a way similar to insurance.

Mobile as a consumer servicing channel is a global phenomenon, but nowhere more so than in emerging markets like India. For FIs in India, a platform that provides the ability to package payments and alerts and deliver key customer payment transaction services is one begging for expansion. For India to meet the market’s expectation of its emergence as a powerful global player and ensure sustainable market growth — a stated objective of the Reserve Bank of India (RBI) — developing a financial ecosystem inclusive of the rural unbanked will be critical. Partnerships between the leading mobile operators and FIs are already being formed to meet this objective. Joint ventures, such as that between Airtel and State Bank of India (SBI), highlight the potential for global or domestic FIs to partner or strengthen existing relationships with mobile carriers operating in India. These partnerships can help provide m-payment transactions that support basic banking services for India’s rural population, an extremely large and underserved population of more than 800 million, 600 million of whom are estimated to be unbanked.39

The Economist’s World in 2011 predicts the Indian m-telephony revolution will not just be about phones, but also about networks that will enable mobile phones to be a great equalizer connecting the underserved to the rest of India and the world. These networks will allow India’s rural populations to access current crop prices, enabling price discovery, transparency and other benefits from a host of services and information previously unavailable. However, “millions of ordinary Indians will get online, cheaply, for the first time in 2011.”40

Limited Access to Retail Banking: Frugal Innovation as an Alternative to Expensive Infrastructure Improvements

For banking services to reach the rural unbanked, FIs will need to either focus on expensive investments to build out the network of POS devices and automated-teller-machines (ATMs), or design innovative solutions or alternative distribution channels to provide banking services that are affordable and accessible by all. More than 70 percent of India’s population lives in rural villages with limited or no access to the most basic banking and credit services, including deposits, withdrawals, balance inquiries, small loans and basic payment services. Urban markets are attractive to FIs, but even with a variety of institutions serving portions of the rural markets — regional rural banks, cooperative banks, micro finance institutions and financial inclusion providers — an opportunity exists for FIs to provide additional services or supplement current ones. To date, the banking industry has focused on providing electronic payment mechanisms primarily to the burgeoning middle-class in the urban or semi-urban markets. As a result, Indian consumers’ accelerating shift from cash to electronic transactions has been largely limited to the country’s urban pockets. For banks extending into rural markets, it’s not just the weak infrastructure that presents a challenge, but also the small average transaction size — commonly referred to as a micropayment — made by the rural poor that presents challenges for service delivery. For these reasons, the cost to conduct business in these markets has often outweighed the returns.

Mobile payments present an excellent, ready-made alternative channel for harnessing Indians’ mobile phone usage. According to Gartner, by 2013 Indian texting could reach 192 billion messages.41 Mobile technology has the potential to bridge many of the current market gaps, close the urban-rural divide, cultivate financial inclusion, and bring the Internet-based information age to millions — all for the benefit of consumers, the financial sector and the country’s economy. The rural market in India represents an extremely large and underserved population, many of whom engage in the $85 billion informal credit market.39 For this market segment, mobile phones present an attractive and near-term solution to leverage mobile operators’ established and extensive networks that reach into these underserved markets. In fact, due to the ubiquitous nature of mobile phones in India’s rural environment, mobile payments could advance and gain deeper market penetration than traditional card-based payments in India’s 600,000 villages, of which approximately 550,000 have no access to banking, credit or Internet services.

Figure 3 demonstrates the growing opportunity for m-banking at current trends. Global or domestic FIs in partnership with mobile operators hold the potential to develop payment channels utilizing a technology platform that is operationally scalable across geography, culture, education level and language barriers, while equalizing the imbalance of access between urban and rural segments. Mobile payments are a quicker, more efficient and more economically viable solution for FIs to provide banking services for consumers and merchants in these rural underserved markets.

The ubiquity of mobile phones in rural India provides FIs with an attractive alternative to expensive infrastructure improvements. This strategy leverages the disruptive-innovation theory, which advocates “…driving growth through new offerings that are simpler, more convenient, easier to access or more affordable…”44 In India this is commonly referred to as a frugal-innovation, taking into account the needs of poor consumers by stripping the product down to its bare essentials. An article from The Economist underscores that while cutting costs is at the core of these innovations, frugal does not mean second-rate, as the products must be user-friendly, durable and relevant for local market conditions. As an example, Nokia’s mobile handsets include a flashlight function in case of power outages, which occur frequently in India.45 Indeed, the simplest and cheapest mobile handsets in India also allow users to engage in video games, access the Web and conduct basic financial transactions.

Rising Mobile Tele-Density and Prepaid Card Propensity: Changing Attitudes About Cash Among Rural Consumers

Today, the high mobile tele-density level in India’s rural environment provides FIs the ability to offer Internet and mobile banking services without a bank branch.46 For India’s population of more than 1 billion, the promise of electronic payments is fueled by the sheer volume of micro transactions given the size of the market and the number of mobile subscribers. As referenced in an earlier sidebar, the total mobile banking (m-banking) subscriber base in India is projected to reach 65 million by 2012 as compared to 23.5 million in 2009.33 This is a mere fraction of the total mobile subscriber base of more than 800 million in 2011.47 Currently, the majority of m-banking transactions support payments for utility bills, mobile recharge, movie tickets and airline tickets. As urban mobile penetration levels peak, most of the growth is driven by rural and semi-urban areas. Deloitte reports that subscriber levels increased 35 percent between March 2009 and 2010, with tele-density levels of approximately 30 percent.48 This translates to approximately 8.76 million new mobile phone subscribers per month in rural areas between December 2009 and March 2010.37

Particularly compelling is a report on The India Prepaid Card Market that states the number of mobile phones in rural India reached 236 million as of July 2010.37 This figure exceeds the estimated number of rural bank account holders — 187 million adults — and far outpaces the total population’s access to broadband Internet at 8.8 million connections as of March 2011.41 In India’s rural communities, mobile phones are significantly more common than financial outlets. The majority of mobile phones operate on a prepaid model, and consumers are both comfortable and reliant on credit or stored value. These market indicators suggest a high probability that the rural unbanked mobile subscriber could advance directly to m-banking services, bypassing traditional banking channels, products and payment solutions.37 In an interview with The Economist, the former Chairman of the State Bank of India (SBI) pulled his mobile phone out of his pocket and stated, “This is the [bank] branch.”35

Prepaid cards already fill a distinct market niche for many Indian consumers—as evidenced by skyrocketing growth projections of more than 50 percent for a customer segment estimated to be approximately 600 million.37 Furthermore, the fact that mobile carriers’ recharge plans are based on the prepaid model suggests that many consumers in this market segment are already comfortable with the idea of mobile electronic transactions. According to Edgar, Dunn & Co. Director Samee Zafar, “The link between a prepaid product and the mobile device is crucial. A prepaid wallet on the mobile helps consumers send money to others, pay for goods and services, and also pay their bills. A linked branded prepaid card allows mobile wallet users to make in-store purchases and withdraw cash. If the card is scheme branded, Visa, MasterCard, or RuPay consumers will have the ability to make payments or withdraw cash wherever these brands are accepted.”49 This familiarity with prepaid cards for mobile applications indicates a high likelihood that rural Indian consumers will accept mobile phones as their e-wallet for money transfers or other types of electronic payment transactions.

FMCGs’ Evolving Roadmap for Penetrating Rural Underserved Markets

FIs expanding their reach to rural populations could adapt frugal innovations and cross-industry collaborations deployed by India’s leading FMCG companies. Poised to become a $100 billion category by 2025,50 India’s FMCGs have adopted strategies and developed products, customer value propositions and distribution channels to address the host of challenges inherent in penetrating and serving the rural market segments. Led by industry giants such as Unilever, Proctor & Gamble (P&G), Imperial Tobacco Company (ITC), Reliance and the Tata Group, these global companies have successfully addressed India’s market conditions that pose challenges in accessing remote rural villages. The success of FMCGs is attributed to growth driven by designing simpler products often offered in smaller formats, increased accessibility enabled through unique distribution channels, and the ability to offer products at lower price points and value — the key tenets of successful disruptive or frugal innovations.

Based on this premise, P&G recently launched the Gillette Guard Razor, a cheaper but effective alternative for men in rural India who lack indoor plumping and don’t shave with regularity.44 Unilever’s Indian subsidiary, Hindustan Unilever Ltd. (HUL), devised an innovative rural distribution channel called Project Shakti.51 HUL describes Project Shakti as a direct-to-consumer sales model relying on female micro-entrepreneurs. This rural sales model and distribution channel has infiltrated India’s rural markets, driving positive social change, opening new markets and generating business from what HUL refers to as a “fast-growing global market of low-spending consumers.”52 Multi-sector partnerships could strengthen the distribution model. HUL, together with SBI, is piloting a program in which the HUL micro-entrepreneurs also serve as customer service providers (CSPs). “HUL’s Shakti Ammas, women who sell HUL’s consumer products in rural India, have doubled up as CSPs and opened around 1,000 [bank] accounts for rural folk.”53 The two key takeaways from FMCGs success include: (1) how to cost-effectively and successfully penetrate the rural customer segments with frugal innovations and (2) how FIs could leverage existing distribution channels — whether those of the FMCG or mobile operators — to extend the reach of electronic payment transactions and the acceptance of m-payments.

One potential approach would entail leveraging cross-industry collaboration. Specifically, this would be a unique opportunity for banks to integrate the rural supply chain with mobile payments — in essence, automating the distribution value chain with the potential to reduce administrative costs, control revenue leakage, speed data capture, and provide data for analyzing customer behavior and rural market trends. FIs, mobile operators and FMCGs hold a common interest in serving India’s rural customer segments in a viable manner while also creating a positive social impact. As FMCG’s customer segments become more comfortable operating within the formal banking sector, consumers’ increased lines of credit will allow for the purchase of larger product formats for family use or in micro-entrepreneurial pursuits. Further establishing partnerships among FIs, mobile carriers and FMCGs would allow FIs to leverage FMCGs’ consumer mind share, as well as their proven and unique rural distribution model, to create awareness and educate these customer segments on the benefits of m-payments. Rural markets are ripe for electronic transactions, but a key factor for gaining momentum entails making a concerted and significant effort to increase customer awareness, incentivizing them to activate accounts and adopt new payment behaviors.

While FMCG products achieve penetration through innovative package formats, attractive price and value propositions or distribution channels, FIs and mobile operators must seek industry innovations relevant to their own market challenges and objectives. The margins and growth projections will vary across industries, but the micro-transactions defining the rural banking market will be driven by the sheer volume of customers and their usage frequency. Even so, the overarching concept of extending electronic payment transactions into rural markets by way of a viable, cost-effective and scalable model may be most effectively achieved through cross-industry collaboration.

New Connections Signal Promise of M-Payments

Unlike the U.S. market where mobile payment transactions threaten FIs’ traditional revenue models, the potential to create a financial ecosystem that leverages mobile phones in India offers scale beyond any other distribution channel and new revenue streams. Competition among handset manufacturers has spurred falling prices for mobile handsets, calling rates, data plans and launch of faster 3G services. All are advantageous for Indian consumers, but place immense downward pressure on mobile operators’ operating and profit margins as shown in Figure 4. Tethering to FI’s payments initiatives offers Indian mobile operators potential relief through incremental revenue streams derived from enabling m-payment transactions while offering FIs a cost-effective approach to reaching rural markets.

Partnerships between mobile operators and FIs are forming with more likely to follow. The most notable joint venture is between the country’s largest commercial bank, State Bank of India (SBI), and its largest telecom provider, Bharti Airtel, which is perceived as a world-class operator. This partnership represents one of the boldest efforts to bring the unbanked into the formal financial sector. In lieu of bank branches, the venture designates Bharti Airtel’s retail outlets as Customer Service Points, physical locations where customers can open SBI bank accounts and handle basic banking needs. This would be a model most similar to reloading prepaid cards or mobile minutes at a convenience store or other outlet. As stated by Airtel’s Chairman, “This historic collaboration between SBI and Airtel will create a scalable operation that will address the banking requirements of millions of Indians through the mobile platform.”54 According to Noel Gordon of Accenture, “They [SBI] are using the unbanked as a big laboratory to pilot new ways of banking. The phone really is the branch, extraordinary though it may seem, and it is taking SBI into 100,000 villages that have no other banks.”35 While the public sector banks are connecting with mobile operators, the private sector banks are also pursuing similar partnerships. One such venture is between Vodafone Essar, the second largest mobile operator, and ICICI, the country’s largest private bank. According to ICICI, the partnership “offers a range of services in a simple, consolidated menu. Now you can carry out banking transactions like funds transfer, bill payment, balance enquiry, locate a branch, view last five transactions and much more through your mobile phone.”55

As India’s public sector, and, to a lesser degree, private sector domestic banks set the foundation for m-banking and m-payment services in rural markets, their efforts are developing this market’s category and spurring competition. This presents an opportunity for other private sector and foreign banks to complement or directly compete in the rural markets. Already, international banks are piloting programs — in 2009, for example, Citibank launched Citi Mobile. According to N. Rajashekaran, Country Business Manager, Global Consumer Group, Citi India, said, “Given the recent growth trends in mobile phone usage in India, we expect this to grow into a significant channel for customer service and contact.”56

These banks are competing for the business of rural customers, offering consumers choices while opening previously inaccessible markets. This is a win-win for all—FIs, mobile operators, customers, merchants and the government. For FIs, offering these value-added services grows the revenue pie for the entire industry and their organizations, while mobile carriers benefit from a new revenue stream. For mobile operators incremental revenue streams improve their ability to generate a positive return on costly investments in building a network. Currently, as Figure 4 shows, “only one of the big four firms was close to recouping its cost of capital last year as the price war hit margins and an expensive 3G spectrum auction in 2010 bloated balance-sheets.”57 The win for the government is the fruition of its financial inclusion vision and the additional tax revenue created by drawing people out of the gray and informal markets and into the formal banking sector. The win for consumers, particularly the underserved BOP, is the convenience of mobile payments and the expanded access to basic banking services, such as checking and savings, money transfers and credit-based services that integrate them into the formal economy. With more consumers participating in the formal markets, merchants can grow transaction volumes and revenues.

The Challenges Ahead for M-Payments: Syncing Capabilities with the Market Need

Even though market indicators for the adoption of m-payments are both strong and promising, obstacles do exist. From the consumer perspective, adoption of electronic transactions could face similar hurdles as card payments in rural India—low awareness, lack of merchant acceptance capability and overall security concerns. From a technology perspective, the current m-payment capabilities present limitations requiring increased collaboration between FIs and mobile carriers. The simplicity of mobile phones—like those offered by MicroMax or Karbon—has allowed for a reasonable price point as low as $20. These stripped down smart phones still enable basic features and access to applications like Facebook or Twitter. However, in order to handle electronic payment transactions safely and securely, the handsets will require more robust security and fraud detection, data storage and processing capability. From a merchant perspective, further engineering would bring down the cost of using mobile handsets to accept in-store payments. Another problem is the lack of interoperability standards for mobile wallet payments across banks and mobile operators. A street vendor selling fruits and vegetables via mobile terminals would need to be compliant with PCI standards to allow for printing or electronically transmitting customer transaction receipts. Currently, the cost of payment acceptance via mobile devices could more than double the cost of a fixed point-of-sale terminal. Even with current limitations, electronic transactions are an exciting reality for providing hundreds of millions of consumers with banking and payment services in a low-cost and convenient manner as a realistic and compelling alternative compared to cash or kitchen utensil transactions.

SUMMARY

As summarized by The Economist, “India’s mobile-phone industry inspires great hopes. Many see it as vital to the nation’s development: a way of bypassing obstructive bureaucrats and bringing services to the masses, from mobile banking and payments to accurate crop prices. Already a third of subscribers are in rural areas. Mobiles bring the whole world to villages.”57 Global and domestic FIs can better leverage prepaid and no-frills bank accounts to fulfill RBI’s vision for financial inclusion for all. Furthermore, FIs in partnership with mobile operators have the capability to develop a payment channel utilizing a more defined mobile network, a technological platform that is operationally scalable across the geography, culture and language, while at the same time addressing the imbalance of access between urban and rural markets. FIs that develop expertise and services for the rural unbanked market will influence positive social consequences and benefit economically. FIs that create and guide the growth of mobile payments are best positioned to reap the rewards, in this case the potential of ushering millions from the informal banking system into the formal one.

While this report does not predict when exactly mobile payments in India will meet their potential, it clearly outlines the key imperatives that will enable m-payments to fulfill their domestic promise and global role:

1. The financial industry’s limited penetration in provisioning technology, banking and payments infrastructure in rural markets suggests it is imperative to leverage mobile telecom’s existing distribution channel and networks’ ability to scale and transcend boundaries.

2. Prepaid already fills a distinct market need for many Indian consumers. This familiarity with prepaid cards for mobile applications indicates a high likelihood that rural Indian consumers will accept mobile phones as their e-wallet for money transfers or other types of electronic payment transactions.

3. The government’s vision for financial inclusion for all and its fundamental and proactive measures — supporting infrastructure expansion, deploying business correspondents and rolling out a national identity number — are imperative for facilitating the extension of formal financial systems to the rural markets.

4. Cross-industry collaboration among FIs, mobile operators and FMCGs is imperative to generate consumer awareness and pull consumers into organized banking and credit markets that are accessible, secure, convenient and rewarding to all market participants.

CONCLUSION

India’s society and economy are both so vast that they defy categorization. As the world’s largest democracy and one of the fastest growing major economies in the world, India’s market potential is enormous. A burgeoning middle class built on an entrepreneurial, service-oriented business sector has led the way and engendered a new sense of optimism among many Indians. Yet while most major indicators point to a continued robust growth trajectory, India does have immediate opportunities to grow and modernize its payments industry, the lifeblood of any economy.

Cash is still king in most parts of India, particularly in the rural areas where the majority of the population lives. There is a marked need to accelerate the adoption of electronic payments in order to facilitate continued growth and to encourage a more equal distribution of credit and, ultimately, wealth. Remedies for the infrastructural challenges in the payments ecosystem include an active role for both the private sector and government to foster innovation, encourage co-opetition in the private sector and provide a strong regulatory foundation for managed growth. Further, the rural market is primed for mobile payment (M-payment) adoption built on a prepaid model.

Playing a pivotal role in this environment are issuers and acquirers. Their payment strategies have several drivers, such as significantly ramping acceptance, lowering issuance and acquiring costs, addressing rising technology costs, developing increased regulatory oversight, handling bank consolidation, and solving rising fraud and security challenges. These demands are met by financial institutions through a number of options, such as developing a new payments platform in house, licensing an existing platform or outsourcing the work. With India being a leading market for contracted solutions, many financial institutions are partnering with global third-party processors such as TSYS. Other financial institutions are opting to license payment platforms from large software and service providers like TSYS, differentiating themselves in the market through customized platforms for their unique needs and payment products. Concentrating on customer needs, service and core competencies will allow issuers and acquirers to accelerate the pace of electronic payments adoption. That in turn will help keep the Indian economy running smoothly.

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