Hello everyone,

Welcome to the 107th edition of The Pattern, a weekly where we dissect the latest from the world of finance, economy and technology. Let’s get started.

The unbearable burden of being digital-first

There’s a scene in the latest Avengers movie where Thanos, after destroying half of the population, is confronted by the soul of his daughter who asks him what did it cost? And he says, “everything.”

The scene has become a popular feature in the contemporary meme-lore but it’s a poignant reminder of how certain choices can prove to be expensive – almost too expensive.

One could argue that the current digital rush in the Indian financial services industry is veering toward a dangerous curve where the glittery dreams of digital banking might morph into a horrifying nightmare. This isn’t an ominous prophecy but a probable outcome if banks, NBFCs and other financial players continue to look at digitization in a piecemeal fashion and forget to account for variable change.

The recent RBI action against a large private sector bank is only the latest in a series of regulatory curbs put in place to stem potential implosions in what appears to the outside world to be a hunky-dory digitization story. The RBI was scathing in its direction and called out the bank for being deficient in fulfilling compliance requirements as well as negligent in ensuring checks and balances to ensure transparent, fair and safe onboarding practices for customers.

While the bank’s stock price took a beating in the markets as investors punished it and it promised to make good to the regulator by correcting its failures, the bigger message is that digitization is no longer a passion project, but a centerpiece of the Indian financial system and any crack might open doors for large-scale malpractice leading to fraud and/or system-wide instability.

“While these [digital banking outages] are indeed annoying, the bigger risk is a UCO Bank-type scenario where the same money can be spent twice because it shows up in two accounts. If something like that starts happening at scale because of malfeasance or negligence, it could pose serious risks to financial stability. All benefits from digitization pale in front of such a threat,” wrote Bloomberg columnist Andy Mukherjee.

Mukherjee’s argument is straightforward – while digitization has led to rapid scaling of distribution and a non-linear expansion of both credit and deposit base for institutions, not enough attention is being paid to the finer details of this project. While the overall structure looks inviting and contemporary, it’s the structural strength of the myriads of integrations that determines the eventual stability, security and resilience of the edifice.

Penny wise, pound foolish?

If the chaos of digital banking and APIs wasn’t enough, there’s also the Core Banking Systems under attack. These central operating systems of banks are (usually) legacy mammoths which are built for stability but nowadays, they’re under a deluge of chaos caused by the surge of UPI transactions.

The darling of financial system and proponents of innovation, UPI transactions are causing a huge strain on the Core Banking Systems and burdening banking infrastructure under the weight of billions of micro transactions occuring every month.

“UPI switch is among the peripheral systems but every time you make a payment, it is recorded on the CBS, does not matter if it's an INR10,000 or INR10 transaction. CBS is a legacy architect which is burdened with UPI transactions,” said a former banker, who has implemented a digital-transformation project at a public-sector bank. “If my UPI transaction is stuck, it will unnecessarily put a load on CBS. If that happens, other peripheral systems could also get impacted. There is a ripple effect.”

This problem is so big that banks are actively considering changing their CBS from legacy vendors to new ones, but these projects are rarely executed without burning a large pile of cash and often end up breaking more than they fix.

There’s still no solution to the ongoing UPI-induced chaos yet, neither to the piecemeal digitization in progress at various stages of completion but it’s clear that banks will have to tackle this transformation a bit more seriously – lest the RBI forces them to.

That’s all from me this week. I’ll see you next week.

As always, leaving some reading recommendations below.

Reading list

1. Your preference for digital is leaving banks with a bigger bill  

2. Biz, trade caught between cyber cops & banks  

3. Lending and deposit rates rise across segments in FY'24  

4. C2FO's TReDS platform goes live with SBI, Dabur India as first participants  

5. Fin inclusion, digital growth to drive payments bank momentum in India: Airtel Payments Bank CEO  

Thank you for reading. If you liked this edition, forward it to your friends, peers, and colleagues. You can also connect with me on Twitter here and follow FinBox on LinkedIn to always get all updates.

Cheers,

Mayank