India’s Digital Transformation Could Be a Game-Changer for Economic Development

Access to formal credit has long been a challenge for small businesses in India. Even before the onset of the COVID-19 pandemic, an alarming 92 percent of these businesses lacked such access. The micro, small, and medium enterprises (MSMEs) sector in India faces a significant credit gap estimated to be between $250 billion and $300 billion.

This disparity exists because credit opportunities predominantly favor larger firms and those with tangible assets, leaving MSMEs and individuals without collateral struggling to secure loans. Even when they manage to find a lender, the loan terms and conditions are often unfavorable or fail to cater to their specific needs.

However, India has introduced an innovative framework known as Account Aggregator (AA), which has the potential to revolutionize the country’s credit landscape. AA aims to make it easier for individuals and businesses with limited asset-backed collaterals or financial backgrounds to access formal financial institutions.

To fully grasp the significance of AA, it is crucial to understand the India stack. The India stack is a Digital Public Infrastructure (DPI) that has been established through a collaborative effort between the public and private sectors. DPIs are interoperable digital building blocks that adhere to open standards and specifications, enabling institutions and organizations to offer various services.

The India stack consists of three interconnected layers, which not only provide a digital identity to every Indian but also facilitate seamless, cost-free, mobile-first digital transactions. These layers serve as the foundation upon which the AA architecture is built. Leveraging the ecosystem created by each layer, the stack operates an architecture that is poised to empower and transform India’s credit environment.

First Layer: Identity

Until 2010, the majority of the Indian population faced a significant hurdle: the absence of reliable formal identification. This posed substantial challenges for the government and private sector in delivering essential services, particularly in rural areas. However, in 2010, the Indian government introduced Aadhaar, a unique 12-digit identification number issued by the Unique Identification Authority of India (UIDAI). This milestone marked a crucial turning point in India’s digital transformation journey.

Aadhaar, which translates to “foundation,” serves as an individual’s biometric identity. It incorporates biometric data (fingerprints and iris scans) along with demographic information such as name, age, gender, and residential address. Aadhaar serves as the foundational layer of the India stack and has empowered the government and private sector to enhance efficiency and develop innovative products and services.

Prior to Aadhaar’s introduction, only a small fraction of the population possessed any form of formal identification, with even fewer individuals having bank accounts. Aadhaar revolutionized the authentication ecosystem in India by replacing multiple government IDs, including PAN cards, passports, ration cards, and voter IDs, with a single unified form of authentication. Today, Aadhaar has become ubiquitous, offering quick and convenient authentication for millions of Indians and empowering citizens.

The Indian government, through the Pradhan Mantri Jan Dhan Yojana (PMJDY), has actively promoted zero-balance bank accounts and has successfully opened over 450 million accounts by 2022. Aadhaar has played a vital role in achieving this feat by streamlining the KYC process and significantly reducing the cost of conducting e-KYC from $12 to just 6 cents. This has facilitated banking access for millions of Indians, promoting financial inclusion and curbing corruption in accessing government services for the underprivileged.

Aadhaar has facilitated the transfer of more than $310 billion to over 6 billion beneficiaries through direct benefit transfers by the government. This achievement has been significant for India as it has allowed the government to directly deliver numerous social welfare schemes to beneficiaries’ bank accounts, minimizing leakages and ensuring that benefits reach the intended recipients.

Second Layer: Payments

The introduction of the Unified Payments Interface (UPI) in 2016 marked the creation of the second layer in the India stack, focusing on providing a digital infrastructure for payments in the country. The National Payments Corporation of India (NPCI), a not-for-profit organization operating under a public-private partnership, established UPI as a consortium comprising the Reserve Bank of India (RBI), public and private banks, and the Indian government. Prior to UPI, existing payment methods in India, such as Rupay, RTGS, NACH, NEFT, VISA, and Mastercard, were primarily accessible to the affluent, leaving less privileged citizens unable to embrace digital payment technologies.

UPI was developed to integrate the best features of previous payment systems and standardize payment methods. Leveraging the Immediate Payment Service (IMPS), UPI offered a 24/7 channel-independent payment system that could be accessed through mobile phones, the internet, ATMs, and Unstructured Supplementary Service Data (USSD) on basic phones with limited mobile internet access. The mobile-first implementation of UPI also introduced an open Application Programming Interface (API) for instant channel-independent service.

Unlike the closed payment system dominant in China, which is led by private fintech companies like Alipay and WeChat Pay, UPI was developed with regulatory oversight from the RBI, India’s central bank. UPI’s success was bolstered by the increasing adoption of smartphones in India, with a current user base of 750 million, and the disruption of the mobile internet market by Jio in 2016, resulting in a 96% reduction in the cost of mobile data. This led to a significant surge in mobile data consumption, from 140 MB per month in 2015 to 14.04 GB per month in 2021. The Indian government’s demonetization in November 2016, which rendered ₹500 and ₹1000 notes invalid as legal tender and caused a shortage of currency, further encouraged the shift towards digital payments over cash.

The open API architecture of UPI has fostered innovation and new service offerings by private entities. The ease of use, an improved enabling environment, innovation by FinTech companies, and other notable features of UPI have fueled tremendous growth in UPI transactions.

Even after the effects of demonetization and the COVID-19 lockdown subsided, the usage of UPI remained robust. Several key factors have contributed to the success of UPI:

1. Seamless Transfer

UPI enables swift and seamless money transfers between different banks, involving various stakeholders such as banks, merchants, and telecom service providers.

1. Instant Payments

Payments using UPI are executed instantly within the financial system, utilizing fiat currency.

1. Zero Transaction Costs

Users enjoy the benefit of zero transaction costs when conducting UPI transactions.

1. Regulatory Compliance

All parties involved in UPI transactions must adhere strictly to financial regulations, ensuring comprehensive oversight by regulators right from the inception of the ecosystem.

1. QR Code Payments

Making payments at physical stores is made easy by scanning QR codes, thereby promoting UPI adoption even among individuals who may face challenges with reading and writing.

1. USSD Service

UPI offers usability on mobile devices even without internet access through the USSD service, expanding accessibility.

In 2021, the UPI platform facilitated an impressive volume of over 38 billion transactions, valued at approximately $900 billion, through popular mobile apps such as PhonePe, Google Pay, and WhatsApp. This number skyrocketed in 2022 to an astonishing 74 billion transactions, totaling $1.5 trillion.

Such transactions were handled through a shared and interoperable digital public payment infrastructure. UPI not only enhanced transaction efficiency but also contributed to improved financial inclusion and reduced informality within the economy.

Third Layer: Data Governance

In the modern digital landscape, every online activity and digital payment generates a digital footprint, raising concerns about data protection. Governments worldwide are prioritizing the implementation of regulations to safeguard this sensitive data. However, the approaches taken by different countries vary significantly.

The United States has embraced a market-oriented approach, allowing large corporations to retain control over their customers’ data. In contrast, the European Union places a strong emphasis on preventing harm, as exemplified by the General Data Protection Regulation (GDPR). The United Kingdom has adopted an open banking framework to regulate data protection.

India has taken a distinct approach, focusing on empowering individuals by granting them control over the data collected from multiple sources. This is where the third layer of the India stack, known as the Data Empowerment and Protection Architecture (DEPA), comes into play. DEPA is built upon three key pillars:

1. Personal Data Protection Bill

India is in the process of discussing a personal data protection bill in parliament, which will establish comprehensive regulations for safeguarding personal data.

1. Electronic Consent Artifact

DEPA incorporates an electronic consent artifact capturing user consent for sharing personal data with third parties. This artifact ensures that individuals have control over the data they share and enables them to make informed decisions about its usage.

1. Consent Managers (Account Aggregators)

In the financial sector, DEPA introduces a newly regulated entity called Consent Managers, referred to as Account Aggregators (AAs). These AAs are non-bank financial companies (NBFCs) regulated by the Reserve Bank of India (RBI). They serve as intermediaries, facilitating secure and authorized sharing of financial data based on user consent.

By establishing DEPA and its associated pillars, India is striving to create a data governance framework that empowers individuals, protects their privacy, and ensures responsible data-sharing practices. This approach reflects the country’s commitment to fostering a secure and transparent digital ecosystem.

What are Account Aggregators?

Account Aggregators (AAs) are consent managers introduced under India’s data protection bill to facilitate data-sharing across institutions using the DEPA electronic artifact. AAs were launched in September 2021 by the RBI.

Previously, individuals and small businesses had to approach each institution separately to access their data, hindering their financial empowerment. The current method of storing financial data is inefficient, relying on notarized hard copies, screen scraping, PDFs, and password sharing, posing privacy risks. The AA architecture revolutionizes data sharing by providing individuals control over their data through standardized formats and APIs, simplifying information transfer between institutions. AAs act as intermediaries, allowing users to regulate the flow of information, similar to how UPI transformed money transfers.

The AA ecosystem is customer-centric, promoting secure consent-based sharing of private and sensitive data. This democratizes data usage, enabling Financial Information Users (FIUs) to request users’ financial information. As the system evolves, it has the potential to transform various industries, including health, insurance, personal financial management, and advisory services. Access to data extends beyond financial information to social media, credit card points, ride-share data, health data, and other digital data, opening up limitless opportunities. Private participation encourages innovation.

AAs have the potential to transform lending for MSMEs:

• AA enables data as collateral, leveraging digital transaction records generated by millions of individuals and MSMEs. This data history builds trust with financial institutions, enabling innovative lending practices.
• Data sharing becomes standardized, secure, and instantaneous, allowing lenders to assess repayment capacity based on past cash flow and revenue generation.
• AA reduces the cost of accessing and analyzing data, enabling financial institutions to design tailored loan packages for different segments of society.

Users can register with any of the seven functional AAs and connect their financial information, such as bank accounts and mutual fund details. When applying for a loan, users grant consent to share specific data requested by the FIU. The AA securely transfers the consented data to the FIP, which then provides the encrypted data to the FIU. Financial institutions benefit from sharing data through official channels, gaining access to new customers while maintaining the privacy and security of their own customer data.

Since its launch, the AA ecosystem has grown significantly, with around 200 active financial institutions, including major public and private banks and insurance companies. In FY2023, approximately $750 million was disbursed using the AA framework, with 50% of lending directed toward the MSME sector. The number of linked accounts has surged, reaching 9.43 million as of June 2023, showcasing explosive growth and the growing adoption of AAs.

Fueling the digital revolution

The MSME sector plays a vital role in India’s economy, contributing around 30 percent to the GDP and over 40 percent to exports. It serves as a catalyst for job creation, with approximately 110 million employment opportunities according to National Sample Surveys conducted in 2015-16. MSMEs empower individuals with limited capital to start businesses, both in rural and urban areas. The growth of this sector is intricately connected to India’s overall economic development.

India’s ongoing digital transformation has the potential to accelerate this process further. Initiatives like Aadhar, e-KYC, and UPI have already played a significant role in advancing financial inclusion in the country. Now, Account Aggregator (AA) has the potential to be the game-changer India needs. If it fulfills its promise, AA could bring a multitude of small businesses and individuals into the formal economy. This would be a boon for MSMEs struggling to access credit from formal sources. By creating a more equitable system, AA would enable them to obtain credit from financial institutions on par with larger corporations and higher-income individuals.

Final Thoughts

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