Fintech: The year of 2022 | A tumultuous 2023 awaits fintech startups

The operating environment is expected to get tougher for Indian fintech startups next year amid a worsening funding winter and regulatory changes in recent months, several founders and investors told ET

With the regulatory overhang on fintechs continuing and the Reserve Bank of India (RBI) taking steps to regulate various aspects of the sector, investors are expected to remain selective in their approach, leading to potential consolidation in the coming months, these people said . Furthermore, with the release of the new digital lending guidelines, banks and non-banking finance companies (NBFCs) have also moved away from First Loan Guarantee (FLDG) partnerships, dealing a blow to smaller fintechs by forcing them to lend to higher costs , at least five founders and executives told ET.

“Fintech companies that have learned to work within regulatory guidelines and achieved scale will win. In the short term, these larger fintech players will build on their leadership. In the long term, regulations may be the best medicine the industry was hoping for as they come in operational clarity for new players entering the market,” said Bala Srinivasa, CEO, Arkam Ventures.

Funding of winter bit fintechs

According to data sourced from research firm Tracxn, funding in the Indian fintech ecosystem almost halved to approximately $5.7 billion in 2022 from $10.3 billion in 2021. However, investment in Indian fintech this year is still significantly higher than in 2020 , when the sector only raised $2.02 billion in equity financing.

“During this downturn, investors’ expectations of unit economics have shifted from ARR (Average Recurring Revenue) to Profit After Tax (PAT), which has made many companies unlucrative because they cannot show profits,” said Akshay Mehrotra, Co-Founder and CEO, Fibe (formerly EarlySalary). “Also with PE funds writing big checks back-to-back in the digital lending space, this year the focus is more than ever on profitable growth.”

Private equity majors have continued to write growth checks this year as valuations have softened in the bearish market. According to Srinivasa, early valuations have also been affected and are down “almost 25% to 35% or more” from high-growth years.

Fibe and KreditBee are among the few digital lending startups this year to have raised growth rounds from private equity majors, including the likes of TPG, Norwest Venture Partners, Premji Invest and Motilal Oswal Alternates.

Yubi (formerly CredAvenue) also raised $137 million in March this year from the likes of Insight Partners, B Capital Group and Dragoneer.

Personal loan provider MoneyView is also in the final stages of closing its $150 million equity financing from Apis Partners at a unicorn valuation, ET reported on October 27.

“The key to investing now (in fintech) is whether the business model is good and sound today. Whoever can prove their business model will be able to raise. The second part is whether they are building a profitable business. Average business models will not be able to raise funds in 2022. The strong will get stronger and the weak will disappear, said a fintech entrepreneur who was looking to raise capital at the start of the year.

As the RBI delivered a final blow to card-based fintechs by barring prepaid payment instruments (PPIs) from being loaded with lines of credit, category leader Slice, which was set to raise $100 million in fresh funding, halted its fundraising plans, ET reported on 18. July. It had raised $50 million from existing investor Tiger Global in June. Instead, the firm has focused on digital payments, entering the Unified Payments Interface (UPI) space and seeking a PPI license.

RBI’s circular has also affected competitor Uni, which is trying to find an alternative business model.

Consolidation underway?

As global macroeconomic headwinds due to rising inflation and interest rates continue to drive a slide in public and private market valuations for global fintech giants like Stripe, Klarna, Zip and others, Indian fintechs have also found it harder to raise capital this year.

ET reported on November 25 that digital payments major PhonePe was close to acquiring buy-now-pay-later (BNPL) startup ZestMoney, signaling a potential consolidation wave in 2023.

“The regulatory landscape has made several practices such as FLDG unavailable to fintechs. This combined with the funding winter following globally means that the coming year is likely to see a dampening in terms of funding. Investors are expected to become more selective. There will be consolidation in the market, an increase in collaborative models with regulated entities and the exit of firms with weaker footholds, says Kunal Pande, partner, KPMG in India.

Pande added that with things still evolving on the ground following the recent regulatory changes, “investors are expected to continue to follow a wait-and-see approach over the next 6-12 months”.

Meanwhile, big fintechs like Cred and Razorpay, which raised big rounds through 2022, are looking to grow into their valuations. It’s no surprise that even as online credit continues to face regulatory scrutiny, several new banks and payments companies with wide distribution have scrambled to enter the lending space because of the margins the segment offers.

“We think in the more mature segments like alternative lending, you will see consolidation. Strong companies with strong balance sheets will have to strengthen their product portfolio and financial services are never a product game anyway… Whether you’re a new bank or a payments company, it’s not going to be easier to adopt a lending-first approach in 2023,” Srinivasa added.

Adding to the challenge, the Reserve Bank of India (RBI) has been strict in granting NBFC license to fintech firms, several entrepreneurs told ET.

As fintechs look for new business models, macroeconomic uncertainty has pushed the bigger ones into cash-conservation mode as new fundraisings take longer to close.