MSMEs in the Age of Neobanks: Promise, Potential & Pitfalls

In the flowing river of human civilisation, banks emerged as the wheel that propelled civilisation to move forward. From the earliest temples of Mesopotamia, banks securing to get loans, to the great merchant banks of Renaissance Italy assisting global trade, banks have not merely stored wealth– they became the financial hearts that pump the lifeblood of economies. In today's fast-paced digital world, there is growing dissatisfaction towards traditional banking, which relies on slow brick-and-mortar infrastructure, hence, there is the rise of Neobanks, also known as digital-only banks. Now, India is a country that significantly depends on its MSME sector, which is often described as the backbone of the Indian economy. Are India's 5.70 crore MSMEs really ready to go fully digital?

Neobanks with AI

Neobanks are financial institutions that operate entirely online and do not have a physical presence. They foster the traditional banking experience with a seamless digital experience, leveraging cutting-edge technology to offer streamlined, app-based services such as user-friendly account management, budgeting tools, and hassle-free access without the need for physical branches and more. However, most neobanks do not have a standalone banking license, so they often collaborate with licensed banks to offer financial services. 

Integrating generative AI with Neobanks enhances operations and creates even more market opportunities. For instance, 'Neobank Bunq', a fintech licensed company in the Netherlands currently offering services across 30 European countries, launched 'Finn', a generative AI digital tools, into its platform in December 2023. It switched the search function on Bunq's app, which enables users to plan their finances, budget, find transactions, and navigate the platform. 

AI-powered neobanks are meticulous in monitoring performance, dedicating teams to analysing average daily customer, app usage time, and counting monthly active users. There, Neobanks are replacing traditional forms by employing chatbots, conversational designs, voice assistants, and live video consultations.

China is extensively using AI in their Webank for user interactions, claiming 98% of customer queries are adequately handled by AI-powered chatbots.

Market Overview

In 2024, the global Neobanking market size was valued at USD 143.29 billion. The market is projected to grow from USD 210.16 billion to USD 3,406.47 billion by 3032, showing a CAGR of 48.9% during the forecast period.

In India, as of 2023, about 26% population were using Neobanks, which is nearly 371.2 million account holders. The Indian Neobanking market is predicted to experience a CAGR of 42,16% during the forecast period FY2025-FY2032, expanding from 9.38 billion USD in FY2024 to 156.47 billion USD in FY2032.

Key Indian Neobanks typically operate in collaboration with traditional banks to provide regulated banking services. For example, Jupiter and Fi, partners with Federal Bank to provide instant savings accounts, Niyo and Open, have collaborated with multiple banks like SBM, ESFB, including ICICI Bank to deliver exhaustive business banking solutions.

Opportunities for MSMEs 

1. Simplified Orientation and KYC- Neobanks provide a fully digital account, which can be opened through e-KYC (Video KYC, Aadhaar-based, etc), which swiftly decreases paperwork and on-site visits.

2. Real-Time Payments, Automated Bookkeeping, and Compliance Tools- Neobanks often offer bundle services like instant IMPS/UPI/NEFT transfers, invoice creation, ledger management, and automated payment reminders. 

Few platforms even added GST filing and expense categorisation tools, helping MSMEs follow accounting knowledge. 

3. Easier Credit Access Via Alternative Data- Most small businesses lack collateral and credit history, but traditional banks mostly rely upon these things. Neobanks, however, leverage alternative data points like UPI flows, e-commerce records, sales transactions, and invoice history that help them to evaluate creditworthiness. This unlocks working capital loans for underserved MSMEs or microcredit.

Challenges Holding MSMEs Back

1. Trust Deficit & Digital Literacy- Still, many MSMEs in rural Tier 2, 3, struggle with digital interfaces, app navigation, and are fearful of cybercrime. There is a lack of trust for purely digital transformation, especially those that don't have a physical branch to approach in times of confusion or disputes. It is their common concern: " Who do we call if something goes wrong?"

2. Regulatory Ambiguity and Risk Concerns- At present, Neobanks in India don't hold banking licenses themselves; they just function in partnerships with RBI-licensed banks. This raises questions like, what happens if the partner bank faces bankruptcy, or if the neobank's services are suspended?

Conclusion

The emergence of Neobanks is the result of the digital renaissance in the Indian financial ecosystem. The Indian financial ecosystem has witnessed a digital renaissance recently-- Neobanks emerged as a result, which a allies for MSMEs, enhancing speed, simplicity, and smarter financial solutions. Their capability to ease compliance, streamline banking, and unlock credit using alternative data holds transformative potential for India's entrepreneurial backbone.

Yet, thinking about fully digitalising the MSME economy is still a fairy tale. Limited digital literacy, infrastructure gaps other regulatory ambiguities blur the promise of neobanks.

For India's MSMEs to boldly take this step, the next wave of neobanking must be secure, inclusive, and locally rooted.