CHALLENGES IN DIGITAL
FINANCIAL SYSTEM IN INDIA

Slow infrastructure development

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Slow
and delayed infrastructure development is one of the greatest challenges for
digital evolution in India. India is a developing country and about 70% of
Indians live in rural areas. Even today, a major portion of the rural area
lacks access to internet. In India, the average Internet penetration is about
33% but it is only about 16% in the rural areas. Digitalization of India cannot
be achieved without internet access. Among 139 countries, India has been ranked
91st on the Networked Readiness Index 2016 (World Economic Forum). It
has been estimated that internet access is available only to 15 out of 100
households. According to the Cellular Operators’ Association of India
IMC-Deloitte report, India has been ranked 36th in Internet
inclusion based on affordability, availability, readiness and relevance.  India also lags behind many countries in
broadband penetration with only 23% as of August, 2017. Studies show that
broadband penetration is an important factor in the social-economic development
of a country. It has been estimated that if broadband penetration increases to
60%, there could be possible increase of 5-6% in the GDP.

Over
the past years, the usage of mobiles in rural areas has been rising steadily in
spite of poor network connectivity. Though India has achieved more 350 million
mobile Internet users in a short period of less than a decade, much of it is
concentrated in the urban areas. The benefits of digitalization are multitude.
But so as to achieve digitalization, proper measures need to be taken. The
government proposed the ‘National Optical Fibre Network’ as its flagship
program. This program will connect 2,44,729
Gram Panchayats in the country through optical fibre cable (OFC). The program has
been allotted a budget of Rs 70,000 crores. The program has been under operation
for the past few years yet several villages are yet to reap its benefits. While
the government claims to have reached 61,000 villages, reports say only 7,000
of them have a working network. And as most of these 7,000-odd panchayats,
there are almost no users or usage of the internet. India continues to trail
the world’s major economies in telecom infrastructure and penetration.

After
the demonetisation move made by the government, the people were encouraged to
use e-Wallets and make e-Payments. But e-Wallets can be used only if one has
access to internet, an internet-enabled phone, functional bank account and a
credit/debit card. Freecharge, Paytm and the newly launched Bhim app by the
government cannot be used if the consumer does not have internet connection. So,
a major challenge to ‘Digital India’ is lack of proper infrastructure.

Cultural differences

The
culture of a country also plays an important role in deciding the extent of
development. In India, there have been several cultural barriers for
digitalization. For instance, some panchayats or religious groups ban the use
of mobile phones or computer education for women. About 72% of Indian women do
not have access to mobile phones and only about 38% women have access to
internet in urban India (in 2015). Whereas in the rural areas, only about 12%
women have access to Internet.

India is
one of the most multilingual countries of the world in which more than a
thousand of mother-tongues were recorded by the census of India. In order to
tap rural areas, mobile manufacturers need to provide gadgets with multiple
language support as majority of people in India use local languages. Similarly,
all e-Transaction apps should have the option of multiple languages.

Moreover,
illiteracy is still a major issue in rural India. Therefore, e-content
needs to be delivered in not only in text mode but also in speech because that
is the only way to ensure that the illiterates can also make use of the digital
finance system.

IT literacy

The 2016 FII
survey found that 49 % of India population had less digital literacy.
Among the vulnerable groups, the situation was much worse.  The elderly are 18% more likely to be digitally
illiterate that youth. Women also had very low levels of digital literacy. Most
of the illiterate population was found to be digitally illiterate. Another
challenge was that people are not fully informed about digital services. As a
result of which, they lack trust in such services. When transactions fail due
to poor connectivity or confusing instructions, the initial trust placed in the
platform is lost and the customer returns to cash transactions.

Data security

Cyber security has become one of the most compelling
priorities for the government to ensure the safety of data. Over the past few
years, cyber
security in India has come a long way and has gained huge importance in recent
times with the thrust on Digital India, e-commerce, and mobile payments. Data
breaches have increased in number and intensity over the past few years. This
has made cyber security a top priority for governments today. The repeated
attacks against banks have shown that breach prevention and threat monitoring
alone will not protect the system.

With
digitalization, there has been a shift in the banking industry. The use of
digital channels such as mobile banking, digital wallets, Internet banking has
increased. This has made the financial system more susceptible to
cyber-attacks. The main sources of threat are hackers, malicious insiders, terrorists,
nations and unknown malicious outsider. Hackers are people who break into
computers for revenge, financial gain or other purposes. Malicious
insiders are employees or contractors who manipulate the system for personal
gains.

In the first six months of 2017, one cyber-crime was
reported every 10 minutes. According to the Indian Computer Emergency Response
Team, 27,482 cases of cybercrime were reported from January to June, 2016. Financial
sector faced almost three times the cyber-attacks as compared to that of the
other industries. India has the highest average number of breaches recorded. In
India, 31,225 records were breached in 2015 whereas 29,611 records got breached
in the US. There was a 64 per cent increase in security incidents in India in
2015 compared to 2014, with incidents growing both in terms of volume and
sophistication,

As digital channels have become the
choice of many customers for banking services, banks will also need to leverage
advanced authentication and access control processes, without any compromise to
customer experience. The increased growth in digital payments platform in India
and the push towards a cashless economy has made cybersecurity the need of the
hour.

 

Few
of the major challenges faced by banks include

1.     Transaction frauds: The number of transaction and credit
card frauds have been increasing over the years. In order to protect against
them, fraud detection technologies should be in place with proper consideration
of risks based on the business factors.

2.     Difficulty in securing customer
data: Violation of
privacy can take place in banking sector like stolen or loss card data,
unauthorised sharing of data with third parties and loss of client’s personal
data due to improper security measures.

3.     Third party risk: Banks need to conduct due
diligence on third parties they are associated with. As per Payments card
industry data security standard, third parties need to report any critical
issues associated the card data environment to the bank.

4.     New cyber-threats: The cyber-threat landscape is
ever-evolving. The development in technologies is leading to the latest cyber
threats like next generation ransomwares, web attacks etc.

5.     Secure SDLC: Banks need to incorporate SDLC
security for banking products and applications.

 

Many Indians
hesitate using online payment platforms due to security risks. Estimates show
that there was little growth in the percentage of consumers likely to make
mobile payments between 2013 and 2014, increasing just 2 percentage points from
22% to 24%. Secure storage of financial account information is the most
important factor to consumers in a mobile payment application.

 

There have been
several instances of State Bank of India, India’s largest bank, on October 19th
2016, stated that it had blocked close to six lakh debit cards following a
malware-related security breach in a non-SBI ATM network. Several other banks, such
as Axis Bank, HDFC Bank and ICICI Bank also admitted to being victims of
similar cyber-attacks. Due to the massive data breach, Indian banks have
decided to either replace or request users to change the security codes of as
many as 3.2 million debit cards. However, in certain cases banks have decided
blocked the cards or issue fresh ones. Card data of 3.2 million customers was
stolen between May 25th and July 10th ,2016 from a
network of Yes Bank ATMs managed by Hitachi Payment Services.

 

Hence,
cyber-security and data security is a major challenge for digital finance. Though
cyber-security is considered to be a top priority today and measures are taken
to prevent breaches, India still has a long way to go in order to achieve a
secure digital financial system.

 

OPPORTUNITIES
IN DIGITAL FINANCIAL SYSTEM

 

Digital
finance can help achieve financial inclusion

 

Digital
payment systems play an important role in driving financial inclusion. Digital
payment systems help overcome barriers in access to financial services. All
over the world, about 2 billion people do not have any access to financial
services. The scenario is worse in the developing countries where only about
59% of women and 50% of men have bank accounts. It can be observed that women,
the poor, and small businesses depend mostly on informal financial services. In
India, in the year 2015, out of 600,000 villages only about 30,000 had a
commercial bank branch. This meant that a significant fraction of the rural population
did not have access to financial activities. More than 50% of the Indian population
did not have access to bank accounts.  Mobile
money schemes enable people who have a phone but not a bank account to make and
receive payments. In the right environment, these systems can take off and
reach massive size rapidly.

Mobile money can create significant improvements in
the lives of the poor. As most of rural India relies solely on cash, they are
excluded from the formal economy. Mobile money and payment systems is a convenient
alternative to informal financial services and cash-based assets. This way
mobile money helps in financial inclusion. It reduces dependency on cash and encourages
digital payments through mobile. It provides a way for people to take advantage
of a much broader range of financial services.

 

The business case for providing mobile money services
to the unbanked in the most remote rural areas of India is not appealing to
banks. Banks are interested in providing additive mobile banking services for their
existing client base, where mobile is simply an additional and more convenient
access channel. Until now, transformational mobile money services—the use of
information and communication technologies (ICTs) and non-bank retail channels
to extend financial services to clients who cannot be reached profitably with
traditional branch-based financial services—have not given banks the right
incentives to invest in these customers long term.

 

Digital finance can increase women’s economic
participation. In part, this is because digital payments can more easily be
concealed by the recipient than cash, at least temporarily, which helps shift
economic decision making in favour of women. This helps in increasing female
empowerment as women start feeling more independent and they learn to make choices
of their own. There is a significantly positive relationship between female
labour force participation and female bank account ownership.

 

Digital
finance can increase efficiency

 

The internet reduces the cost of many financial
transactions by allowing their unbundling into separate components that can be
automated or provided by specialized entities. Digital payments help reduce
costs to recipients. Digital payments allow better control. A retail payment
consists of pre-transaction, authorization, clearing, settlement, and
post-transaction, each one again involving several steps. Specialized providers
can execute individual steps, yielding economies of scale that translate into
savings. Such service providers are becoming more widespread in developing and
emerging markets. Governments can also lower the cost of financial
transactions. Digital finance also increases the incentive to save, through
automatic deposits, text reminders, or default options. Digital payments speed
up delivery, which is especially important in case of emergencies such as
natural disasters. And they increase security as it is often not safe to travel
with large sums of cash.

Moreover, a report by McKinsey had estimated that
Indians lose more than $2 billion a year in income simply because of the time
it takes travelling to and from a bank. With digital finance, vital baking services
can be brought to 1.6 billion people. For all individuals, convenience, cost,
and the range of financial products would dramatically improve. (McKinsey Global Institute (MGI) report
‘Digital finance for all: Powering inclusive growth in emerging economies’)

Financial services providers would also benefit
from the shift from cash to digital payments, expanding their balance sheets by
as much as $799 billion in India. For financial service providers, the cost of
offering customers digital accounts can be 80 to 90 per cent lower than using
physical branches. (McKinsey Global
Institute (MGI) report ‘Digital finance for all: Powering inclusive growth in
emerging economies’)

Digital
finance reduces frauds

 

Digital payments create a clear digital record and
can be traced back to the source. Thus, the likelihood of funds not reaching
the beneficiary or of duplicate payments or payments to “ghost” recipients who
do not exist will be lower. Evidence from India also shows that using smart
cards rather than cash for social security payments halved the incidence of
demands for bribes. (World Development
Report, 2016)

 

Digital
finance enables financial innovation

 

The financial sector is transaction-intensive and
has always adopted cutting-edge new technology. Automation has helped reduce financial
transaction costs. This has encouraged innovations, such as automated credit
scoring using advanced analytics and massive amounts of data. Automating processes
enable emerging fin-tech firms to offer services costs much lower than traditional
providers.

 

Another important innovation has been the emergence
of digital currencies. The most well-known digital currency called Bitcoin was
introduced in the year 2009. Over the past years, its value in terms of
national currency has been wavering. It has not been widely accepted as a means
of exchange. There have also instances of frauds. But a study conducted by the

Bank of England states that the main innovation of
such currencies is the distributed ledger which does away with accounting and
settlement by banks. This model could also work for other financial assets such
as loans, stocks, or bonds.

Digital
finance can boost the economy

A report by McKinsey has estimated that the widespread
adoption of digital finance can boost the GDP of emerging economies by as much
as $3.7 trillion by 2025, a 6 per cent increase versus a business-as-usual
scenario. For India, digital finance is a $700 billion opportunity which can offer
a 11.8 per cent boost to GDP by 2025, benefitting millions of people. This
additional GDP could create up to 95 million new jobs across all sectors, 21
million of them in India (McKinsey Global
Institute (MGI) report ‘Digital finance for all: Powering inclusive growth in
emerging economies’)

Digital finance could be a boon to individuals, businesses,
and governments across the developing world in boosting GDP. In India, digital
finance can unleash over $689 billion in loans to individuals and small
business. This will have a good impact on the economy in the long run. With
increased loans, more capital investments can be made. This will improve productivity
and improve the economy in the long run.

REFERENCES:

1.     McKinsey Global Institute (MGI) report ‘Digital
finance for all: Powering inclusive growth in emerging economies’

2.     World Development Report, 2016

3.    
‘Digital
Financial Services: Challenges and Opportunities for Market Banks’ – https://www.ifc.org/wps/wcm/connect/4e45d83f-e049-41d3-8378-2e388ffc1594/EMCompass+Note+42+DFS+Challenges+updated.pdf?MOD=AJPERES