Solving India's trust deficit in Financial transactions | ft Castler & @HansiMehrotra-cfa

What is the Size of Financial Fraud in India?

Overview of Financial Fraud

• The estimated size of financial fraud in India ranges from 75 to 100 crores per day, with a potential to prevent up to 80% of it.

• Castler's mission focuses on eradicating fraud in business-to-consumer transactions, addressing the low trust environment prevalent in India.

Trust Deficit and Escrow Accounts

• In India, a significant trust deficit can reduce business by 50% to 100% annually for entrepreneurs. Trust accounts are equated with escrow accounts.

• An escrow account serves as a secure holding place for funds during transactions, ensuring that money is returned if contractual milestones are not met without litigation.

Introduction to the Guests

Background of Co-founders

• Vinit Singh and Kumar Ahmed, co-founders of Castler, share their experiences and insights into the fintech industry. Both have extensive backgrounds in startups and technology companies.

Vinit Singh's Journey

• Vinit began his startup journey at Infoedge in 2000 and later attempted an e-commerce venture before entering fintech with MobiKwik around late 2016 or early 2017. He transitioned into building solutions focused on escrow services.

Kumar Ahmed's Experience

• Kumar led business operations at MobiKwik before moving to Razorpay, where he significantly scaled operations from ₹500–600 crores monthly to ₹75,000 crores during his tenure. His experience highlights substantial growth within fintech sectors.

Identifying Pain Points in Transactions

Personal Experiences Leading to Innovation

• A personal incident involving delayed payment after selling a car highlighted systemic issues within consumer-to-business (C2B) transactions; it took ten days for him to receive payment despite having connections within the industry.

Escrow: Understanding Its Role in Transactions

Introduction to Escrow

• The speaker discovered escrow.com, a company founded in 1989, which inspired many other escrow-related companies globally over the past 30-35 years.

• The mission of Kesla is to eradicate fraud from business-to-consumer transactions, highlighting the ambitious nature of their goal.

What is Escrow?

• Escrow is defined as a special purpose bank account that differs from regular accounts; it does not belong to any party but is governed by an escrow agreement between involved parties.

• In most cases, a third-party actor (trustee or bank) manages the funds in an escrow account until specific conditions are met.

How Escrow Works

• A practical example illustrates how escrow functions: if someone buys a condo worth $1 million and pays a $200,000 advance through escrow, the seller must meet certain milestones before receiving the money.

• If these milestones are not achieved, the buyer automatically gets their money back without disputes or litigation.

Comparison with Other Account Types

• The discussion transitions to comparing escrow accounts with trust accounts and nodal accounts. An escrow account holds funds until goods/services are delivered.

• Nodal accounts were previously used by e-commerce platforms like Amazon for aggregating payments but have been largely replaced by stricter escrow accounts due to regulatory changes.

Regulatory Changes and Trust Accounts

• The Indian banking system has nudged users towards using more stringent escrow accounts instead of nodal accounts due to various issues encountered with them.

Understanding Capital Market Transactions and Escrow Accounts

Capital Market Transactions and SEBI Registration

• To engage in capital market transactions such as debenture trustees, IPOs, and M&As, registration with SEBI (Securities and Exchange Board of India) is mandatory.

• Non-capital market entities can establish a trust company without needing SEBI registration.

Technology Company Classification

• The speaker identifies their organization as a "techfin," which operates as an unlicensed technology company rather than a fully-fledged fintech.

Trust Accounts vs. Escrow Accounts

• In India, the term "trust account" does not exist; instead, escrow accounts are utilized for trust transactions.

• A TRA (Trust and Retention Account) is essentially an avatar of an escrow account created for specific legal purposes.

E-commerce Platforms: Responsibilities and Challenges

• Licensed e-commerce platforms like Amazon and Flipkart are responsible for delivery, returns, refunds, and seller payments.

• Matchmaking platforms like Instagram do not have the same responsibilities; they merely connect buyers to sellers without guaranteeing product delivery or service quality.

Consumer Protection Issues in D2C Transactions

• A significant percentage (18-20%) of transactions on matchmaking platforms encounter issues such as incorrect deliveries or poor return processes.

• Consumers face challenges when products do not meet expectations due to inadequate self-regulation among small sellers on these platforms.

Opportunities for Marketplace Escrow Models

• The lack of regulation allows many D2C marketplaces to operate without using escrow accounts, leading to potential consumer exploitation.

• There is no regulatory requirement for D2C marketplaces in India to collect buyer funds in escrow accounts; most use current accounts instead.

Global Practices Compared to Indian Regulations

• Globally recognized practices like those from eBay emphasize consumer protection through escrow services that ensure transaction safety.

Cash on Delivery in India: A Trust Indicator?

Understanding Cash on Delivery in the Indian Market

• The speaker discusses cash on delivery (COD) as a prevalent payment method in India, contrasting it with Western markets where it was introduced to build trust and brand equity.

• In Western markets, escrow accounts are often used for transactions; however, it's unclear if this is due to regulation or choice. An example is given of Shield Pay working with Gumtree in the UK.

• The speaker notes that while China has its own escrow mechanisms, there is no regulatory requirement for such systems in India, which contributes to a low-trust environment.

Trust Deficit and Its Impact on Business

• A significant trust deficit exists among Indian businesses, potentially reducing their annual business by 50% to 100%. COD reflects this lack of trust as customers prefer to see products before paying.

• The nature of COD means customers must pay upon accepting a package without prior inspection. This contrasts with typical return policies seen elsewhere.

Challenges with Returns and Logistics

• The speaker shares an anecdote about a glassware brand that saw improved sales after adopting COD, highlighting consumer mindset shifts towards this payment method.

• Return-to-Origin (RTO), where items are returned to the seller instead of being delivered successfully, poses significant challenges within India's logistics ecosystem.

Escrow Accounts as a Solution

• The discussion emphasizes that COD indicates a low-trust society; implementing escrow could enhance transaction security and trustworthiness.

• There’s recognition that societal nudges may be necessary for businesses to adopt better practices like using escrow accounts.

Regulatory Landscape Surrounding Escrow Accounts

• Current regulations mandate escrow accounts primarily for capital market transactions and mergers & acquisitions (M&A).

• Insurance purchases also require funds to be held in escrow during the free look period, although consumers may not be aware of this practice.

Government Mandates and Real Estate Transactions

• Various government transactions utilize escrows for transparency and security. For instance, health insurance policies hold funds until consumers decide whether to keep them.

• In real estate, new condo purchases require funds to go into an escrow account due to past issues with scams and corruption affecting buyer confidence.

Escrow in Real Estate Transactions: A Comparative Analysis

The Role of Escrow Accounts

• Escrow accounts are mandated for government subsidies and primary real estate transactions, ensuring trust between developers and consumers.

• In Western markets, secondary real estate transactions typically require escrow accounts, which protect all parties involved by ensuring service providers are paid before the seller receives funds.

• In India, secondary transactions lack mandatory escrow regulations, leading to potential fraud and consumer losses.

Historical Context and Future Outlook

• Real estate, liquor, education, and defense are among the last industries to modernize in developed economies; India is on a similar path toward modernization.

• There is a pressing need for regulation in secondary real estate transactions to prevent consumer fraud; stories of individuals being defrauded highlight this urgency.

Regulatory Evolution

• The Indian regulatory landscape has evolved slowly but is beginning to recognize the importance of consumer protection in financial transactions.

• Recent guidelines from regulators (e.g., PAPG for payment aggregators and SEBI for stock brokers) emphasize that funds must be handled through escrow accounts rather than nodal accounts.

Consumer Protection Focus

• Regulators are increasingly focused on consumer protection following significant financial crises (e.g., Chinese lending fiasco), indicating a shift towards stricter oversight of financial practices.

• The core principle driving these changes is safeguarding consumers from fraudulent activities within lending and real estate sectors.

Call for Action

• The speaker emphasizes that just as primary real estate regulations emerged after significant market failures (like the 2008 crisis), similar movements must occur for secondary markets to ensure consumer safety.

Understanding Escrow in India

Overview of Secondary Real Estate Transactions

• In India, approximately 3 million secondary real estate transactions occur annually, highlighting a significant market size.

• The discussion emphasizes the lack of public outcry regarding fraud and suicides related to these transactions, indicating deeper systemic issues.

Challenges in Establishing Escrow Services

• Building an escrow company is challenging due to it being a neglected banking product and a niche market that is hard to explain to investors.

• Unlike Western markets where digital escrow licenses exist, India currently lacks such licensing, which affects credibility and business operations.

Importance of Licensing

• Licenses are crucial as they provide credibility for businesses, enabling them to pitch for contracts and government RFPs effectively.

• The dependency on banks is highlighted; banks are currently the primary custodians of escrow services in India.

Evolution of Castler's Business Model

• Castler initially aimed to eliminate fraud but pivoted towards enterprise solutions due to pandemic-related lockdown challenges affecting B2C transactions.

• The company has developed an "enterprise escrow" model over the past few years, focusing on high-value transactions for enterprises rather than individual consumers.

Features and Future Vision of Castler

• Castler aims to integrate multiple bank accounts into a single dashboard for large corporations, enhancing transaction management through advanced technology.

• The platform offers comprehensive tools including access control engines and risk management systems tailored for corporate treasury needs.

Simplifying Escrow Accounts

• Castler's product simplifies the traditional complexities associated with opening escrow accounts by reducing costs significantly from previous standards.

Escrow Agreements and Automation in Financial Transactions

Standardization of Escrow Agreements

• The speaker discusses the democratization of escrow agreements, highlighting that they have standardized documents for various use cases over four years and now provide escrow agreements for free.

• Setup fees for their services range from ₹50,000 to ₹2.5 lakhs, depending on the customer's needs; however, they offer solutions as low as ₹10,000 for smaller transactions.

• The first customer was a large Indian conglomerate seeking automation in lending processes; this led to the development of their initial workflow automation model.

Customer-Centric Approach

• As they acquired customers, feedback helped identify problems that needed solving through automation and productization.

• The complexity of escrow arrangements involves multiple stakeholders: banks, trustees, customers, and service providers like the speaker's company.

Integration of Services

• They have integrated features from banks and trustees into their platform to streamline processes using APIs.

• By managing all aspects of escrow on their platform, they've significantly reduced turnaround times (TAT).

Role Consolidation in Escrow Transactions

• The speaker confirms that their platform combines roles traditionally held by lawyers and trustees while maintaining a bank layer for financial transactions.

• Lawyers are effectively eliminated from the process as approvals are managed through their automated platform used by licensed trustee companies.

Innovations in Source Code Escrow Services

• They describe "escrow done right," which includes a licensed bank account, standardized agreements, licensed trustees, and automated workflows tailored for financial transactions.

• The discussion shifts to source code escrows mandated by financial regulators post-WWII due to global interdependencies affecting IT service providers.

Regulatory Mandates on Source Code Control

• Financial regulators require entities to maintain control over source codes from IT vendors; this is crucial during crises such as geopolitical conflicts.

• Recent mandates from RBI (November 2023), SEBI (December 2023), and IRDAI (late 2024) enforce that regulated entities must utilize source code escrow services.

Market Potential for Source Code Escrow Services

• This emerging market represents a $10 billion opportunity globally with few major operators currently involved.

Cloud-Native Source Code Escrow Solutions

Introduction to Cloud-Native Escrow Services

• The discussion begins with the existence of secure storage facilities for source code, emphasizing that billion-dollar companies provide disaster-proof vaults.

• A new cloud-native escrow solution allows users to store their source code without physical hard disks, directly integrating with repositories like GitHub or GitLab.

Features and Benefits of the Service

• The service ensures continuous updates and verifications on whether the code is deployable or has been copied, enhancing security and compliance.

• There are approximately 30,000 regulated entities that may be required to use this service due to regulatory compliance needs.

Regulatory Landscape and Global Adoption

• India’s regulatory mandates for software escrow have emerged later than those in North America and Europe, which are more mature markets.

• The launch of Castler's service in October 2024 includes significant banking software from major Indian IT firms stored in escrow.

Use Cases Beyond Compliance

• Besides regulatory requirements, the service supports business continuity planning and disaster recovery strategies as part of global cyber resilience efforts.

• Large corporations involved in this sector generate substantial revenues (upwards of half a billion dollars), indicating a competitive market landscape.

Cybersecurity Considerations

• In case of a cybersecurity attack, the escrow service provides an additional layer of protection by storing backups securely away from direct organizational control.

• Access to the stored code is tightly controlled through an escrow agreement that outlines specific conditions under which it can be retrieved.

Security Measures and Certifications

• The design of Castler's services minimizes risks associated with simultaneous attacks on both client systems and the escrow provider.

• Various certifications (ISO, SOC2, GDPR compliance in Europe, etc.) ensure robust security measures are in place for protecting source code against threats.

Conclusion: Future Outlook

Understanding Escrow Services and AI in Agreement Management

Overview of Security Compliance and Escrow Services

• The speaker discusses the importance of SOC 2 compliance, which is a security standard aimed at minimizing malicious attacks, including ransomware.

• Castler provides financial transaction escrow services and source code escrow, emphasizing the reliance on agreements and contracts by their customers.

• There are challenges in contract lifecycle management, particularly in reading agreements for escrow purposes where terms must be verified before payments are released.

Development of AI-Powered Agreement Reading Tool

• Castler is developing an AI-powered product called "Castler Docs" to assist with agreement reading, currently being tested by banks and trustees in India.

• This tool aims to simplify understanding contractual obligations for users, such as home loan borrowers needing clarity on liabilities from lengthy agreements.

• The product will help users quickly identify their rights within complex documents without needing extensive legal expertise.

Future Enhancements: Agreement Builder

• Phase two of the product development includes creating an agreement builder to automate complex escrow agreements for various business transactions.

• The goal is to standardize agreements through AI technology while ensuring ease of use for both internal teams and customers.

Regulatory Challenges in Escrow Licensing

• The speaker expresses ongoing concerns about fraud elimination while discussing regulatory hurdles faced when seeking a B2C service license.

• Obtaining a Payment Aggregator License (PAPG) poses significant challenges due to high compliance costs relative to the small market share of escrow services.

• The speaker advocates for a tailored licensing approach similar to other economies that allows specific licenses for escrow rather than full payment gateway licenses.

Market Insights on Consumer Transactions Requiring Escrow

Business Growth and Future Prospects

Overview of the Company’s Journey

• The speaker discusses the importance of identifying the end beneficiaries in their business model, emphasizing that while goals are still being pursued, adjustments are necessary to align with initial visions.

• The company was conceptualized in early 2020, with commercial operations starting in April 2021. They are now completing their fourth year as a small startup focused on revenue generation.

Financial Performance and Projections

• Current revenue is projected at around $2 million (16 crores), with controlled burn rates allowing for a runway of approximately 10 years.

• The company aims for a growth rate of 125% next year, targeting revenues between 35 to 40 crores.

Regulatory Environment and Business Opportunities

• The speaker notes that new regulations will take time to fully impact the business landscape, predicting significant opportunities within two financial years.

• In their code escrow business, they have seen an increase in annual contract value (ACV), indicating growth potential as they acquire more bank customers over time.

Market Position and Competitive Landscape

• The company anticipates becoming a ₹500 crore entity within five years due to high gross margins (80-85%), positioning them favorably against competitors who may have lower margins despite higher revenues.

• Plans include global expansion; however, current resources limit ambitious product development.

Funding Strategy and Market Dynamics

• Despite having a long runway, funding was raised to accelerate growth. Current account acquisition rates highlight market limitations—100 new accounts monthly versus only 20 from banks.

• The company has become one of the largest escrow banks in India by processing significant volumes compared to traditional banks.

Global Competitors and Product Comparison

• Discussion includes insights into global players like NCC Software and Iron Mountain, noting their established presence but suggesting potential advantages in product offerings from the speaker's company.

• While acknowledging that global competitors have mature products due to extensive customer bases, the speaker believes their core product features could surpass those available internationally.

Unique Selling Proposition: L2 Verification

Global Market Strategy and Product Development

Capacity Constraints and Market Expansion

• The discussion begins with the challenge of capacity constraints in India due to banking issues, raising questions about targeting global markets.

• The speaker mentions plans to raise additional funds from Rainmatter to support expansion into English-speaking markets such as Canada, North America, the UK, and Australia.

Regulatory Certifications for Launch

• To launch in Europe and North America, certifications like DARPA and GDPR are required. This highlights the importance of compliance in international markets.

Transitioning from Physical to Cloud Storage

• The company aims to be a pure cloud service provider overseas, moving away from physical storage solutions. They plan to utilize major cloud platforms like AWS, GCP, and Azure.

• A key advantage of cloud storage is real-time updates compared to quarterly updates in physical storage systems.

Financial Growth Projections

• The company has raised approximately $7 million with current revenues at $2 million. There is significant potential for growth.

• Without further funding, they project becoming a 300 crore company within three years based on existing capital.

Addressable Market Insights

• The total addressable market (TAM) for escrow services is estimated at around 5,000 crores. They aim for a 10% market share over five years.

• Even if the market remains static at 5,000 crores, it is still large enough for sustainable profitability.

Challenges in B2C Market Entry

Initial Loss Leader Strategy

• Entering the B2C space may require operating as a loss leader initially due to consumer price sensitivity observed during negotiations on transaction fees.

Fraud Prevention Potential

• In India, fraud amounts to approximately 75 to 100 crores per day. The company's services could significantly mitigate this issue if they penetrate the consumer market effectively.

Real Estate Transaction Insights

Fraud Prevention and Blockchain Opportunities in India

Overview of Fraud Control Potential

• The speaker estimates that they could potentially control 80% of fraud in the Indian market, acknowledging a significant black market presence that remains untraceable.

• They identify three key areas for fraud prevention: the entire metaverse ecosystem (including platforms like WhatsApp, Facebook, and Instagram), used vehicle markets, and two-wheeler/four-wheeler transactions.

Blockchain's Role in Financial Services

• While blockchain has intellectual potential for self-executing contracts, the speaker questions its current business viability and revenue opportunities within India.

• There is optimism about blockchain's role in escrow services, which are central to cryptocurrency operations.

Regulatory Landscape and Business Impact

• The speaker expresses skepticism about cryptocurrency adoption in India but sees potential for collaboration with Central Bank Digital Currency (CBDC).

• They clarify that CBDC could disrupt their B2C product plans but would not affect their B2B operations.

Company Structure and Growth

• The company currently employs around 85 people, with a majority focused on product development and technology.

• Recent hires include an engineering lead from Info Edge to support growth initiatives.

Challenges Faced by Fintech Startups

• The sales process encounters resistance as many view fraud prevention as a non-essential service rather than a necessity.

• Indian regulators have been proactive in preventing fraud compared to Western markets; however, some fraudulent activities still occur occasionally.

Market Dynamics and Strategic Positioning

• Larger fintech players have provided negative feedback regarding the Total Addressable Market (TAM), impacting funding opportunities.

• Competition exists among fintech companies; however, niche markets can be profitable despite challenges faced by startups entering established sectors.

Innovation vs. Market Reality

• Innovators often face skepticism when introducing new concepts; success requires persistence against prevailing doubts about market viability.

Fintech Growth and Investment Strategies

Current Financial Position and Valuation

• The company processes transactions worth one lakh crore, but operates on thin margins of 1% to 1.5%. Gross margin is reported at 90%, with net margins around 80%-87% .

• Discussions are ongoing for a new funding round, with expectations of decent valuations, potentially achieving revenue multiples of 20 times .

Rationale Behind Raising Funds

• The CEO emphasizes that raising funds when not in immediate need strengthens negotiation positions and prepares the company for uncertain future events, including geopolitical risks like potential wars or economic downturns .

• Planning for long-term stability is crucial; having additional cash reserves can provide peace of mind and support inorganic growth opportunities .

Market Conditions and Strategic Growth

• The fintech market has faced significant challenges over the past two years, yet it presents good opportunities for companies with available capital to invest wisely .

• There’s a focus on global expansion and acquiring necessary licenses, which requires substantial investment to scale operations effectively .

Business Model Insights

• The business model involves a strong emphasis on revenue generation through escrow banking while also needing significant investments in core operations to ensure sustainable growth .

• Success in this sector often hinges not just on product quality but also on endurance—being the last man standing can lead to eventual success .

Investor Relations and Company Structure

• All investors are corporate venture capitalists (CVC), including notable names like Info Edge, Zerodha, Flipkart, and Stride. This unique investor composition influences company strategy towards conservative growth practices .

Building a Business: Insights on Bootstrapping and Team Dynamics

The Journey of Bootstrapping

• The speaker shares the initial idea for their business, highlighting the importance of bootstrapping as advised by Sanjie, who emphasizes that true bootstrapping involves risking everything on a single idea.

• After raising funds and running the business for a year, Zerodha's Rainmatter provided a term sheet. Sanjie encouraged further learning before investing in the seed round.

• Upon discussing the time since earning revenue (44 months), Sanjie deemed the speaker ready for investment in their pre-series A round.

Building an Effective Management Team

• The speaker reflects on assembling a management team based on age dynamics to ensure longevity in leadership; DH is five years younger, Amit six years younger than DH, and Ret eight years younger than Amit.

• This strategic approach aims to sustain business operations over the next 25 to 30 years.

Lessons Learned in Fintech

• The speaker discusses how working in fintech has instilled patience due to dependencies on external factors like banks and regulatory scrutiny affecting operational timelines.

• Unlike previous ventures driven by speed and passion, fintech requires balancing internal capabilities with external ecosystem developments.

Evolving Perspectives on Execution

• There’s an acknowledgment of maturity in execution strategies; rather than focusing solely on speed, effectiveness and impact have become priorities.

• Learning to say no has been crucial; avoiding bad business opportunities helps maintain credibility and long-term viability.

Conclusion of Insights

• The discussion wraps up with reflections on eliminating fraud from India as an ongoing challenge but acknowledges progress made so far.