As regulations bite, VCs cautious on fintechs in short-term

Bengaluru: In the midst of stricter oversight on financial technology companies (fintechs) by federal regulators, venture capital firms (VCs) are cautious in investing in the short-term. However their overall sentiment is that of a positive outlook on the ecosystem.

This calendar year so far, VC investments in Indian fintech startups has reached $637 million (as of July 31), according to data by Venture Intelligence. In the whole of 2021 the number stood at $8.1 billion, $5.7 billion in 2022, and $1.4 billion in 2023.

While VC funding to startups overall hit $8.3 billion in April-June 2024, investment in fintechs has only been at $329 million. Stricter regulations by the Reserve Bank of India (RBI) and Securities and Exchange Board of India (Sebi) have played a part in what can be considered a lukewarm interest in the sector.

“The problem with regulators has been that they are happy to absolutely kill an innovation instead of giving a viable solution that allows the innovators to survive. VCs are moving away from innovation that happens in areas where regulation is silent – because future regulations most likely will be negative,” said Anand Lunia, Founding Partner, India Quotient.

“Regulators have not adopted tech driven compliance and this gives an advantage to incumbents who have feet on the street. The penetration of fintech to serve the underserved will become slow. Incumbents are happy to milk the top customers,” Lunia explained.

On August 16, the RBI tightened norms for Non Banking Financial Company-Peer to Peer Lending Platforms (NBFC-P2P Lending Platform) to improve transparency and compliance. As per the revised master direction issued by the RBI, a P2P platform should not promote peer-to-peer lending as an investment product with features like tenure-linked assured minimum returns, liquidity options, etc.

On August 23, the RBI imposed fines totalling Rs 4 crore on two fintechs operating in the P2P space – LiquiLoans and LenDen Club.

“RBI is the king, emperor and god of fintechs. With one circular, it can wipe out a whole category. P2P lending is over,” Rajesh Sawhney, Founder and CEO of GSF Accelerator, commented on X.

Many investors believe that before regulations got tighter, there have been compromises on deliveries and lack of corporate governance has hit some fintechs.

“By nature, startups try to do something which is non-existent, so there are no existing policies around it and it may not have been factored in by regulators. A classic case is P2P lending. If it becomes a platform where there could be an issue of unknown parties transacting, then there is a risk of people losing money. Without compliance challenges addressed, then I don’t think any regulator will allow those companies to function in the first place,” said Anil Joshi, Founder and Managing Partner at Unicorn India Ventures.

“We believe that the current lending is largely predatory taking advantage of the consumer and eventually the regulatory body will clamp down on such practices. As a result, we have not invested in startups in the consumer lending space,” said Rajiv Mehta, General Partner, Athera Venture Partners.

“Unchecked growth is always bad in the longer term. Hence, having a watchdog from the government’s side looking at how to avoid malpractice and breaking the consumer’s trust in the country’s central bank, while helping the overall ecosystem, is what RBI and Sebi are doing. In the short term people might find it tough, but eventually it will boost the sector,” Mehta said.

Neetu Chitkara, Partner at the Boston Consulting Group (BCG) said that VCs are increasingly careful about grey areas. “Many times, people go around saying that technically, this is what’s written in the regulations. But if you go into the spirit of the regulations, you’re actually not following that,” Chitkara said.

According to data from BCG’s upcoming Global Fintech Report, Indian fintech revenue has grown from $16 billion in 2022 to $25 billion in 2023. BCG continues to maintain a positive long-term outlook on fintechs and sees revenue hitting $190 billion by 2030.