Though India has deep financial infrastructure comprising a large number of bank and post-office branches; agricultural cooperative societies; and, now, micro finance institutions; there still remain gaps that have prevented us from leveraging the full potential of this financial infrastructure.
Delivering financial services
Financial service delivery requires channels to play three very important roles, namely, provide a point for transactions; under-writing (in the case of credit and insurance); and act as a specialised customer services point on an ongoing basis.
Of the three, the current infrastructure has been able to provide transaction points, but has not been able to connect with all households. Even among those that are connected, it is not always at a convenient distance from the household.
Out of the 600,000 habitations in the country, only 30,000 have access to a commercial bank branch. Even the micro finance institutions that have a presence in some of the habitations, they have their field staff visiting them only once a week, that too largely for credit transactions.
While in urban geographies, transaction points have become ubiquitous for the banked population because of mobile banking, Internet banking, phone banking, and ATM, also allowing them to shift away from cash transactions; rural areas and most slum populations in the urban areas do not have access to such transaction points.
A key factor for this lack of access in rural areas is the absence of adequate infrastructure, particularly Internet connectivity. Currently, the tele-density (Internet, broadband and mobile) in rural India is 26 per cent.
Setting up transaction points alone is not enough. For, if we were to account for all the opportunity costs of time spent in transacting at these points, they are not only expensive to access, but are also not equipped to handle a broad range of financial services.
In the case of MFIs, these costs are recovered directly from the clients, while in the case of the SHG model, it is borne by clients who have to travel to banks.
While clients may be able and willing to bear such cost for credit products, even a 4 per cent transaction cost on savings, can turn return on saving products negative.
This means that it is indeed better for the household to keep surpluses at home rather than saving in the bank as not only is the return not negative in this case, it also saves the effort of going to a transactions point, apart from money being available for use at any time.
The second major challenge is the inability of the current channels to effectively underwrite. In the absence of standardised proof of income, it becomes difficult for financial institutions to assess repayment capacity of individuals. While microfinance models, both SHGs and JLGs, have shown that group models can address this challenge effectively, the models limit them to small amounts with first loans sometimes as small as Rs. 4,000, while the industry average size is close to Rs. 8,000. This too, however, has a cost.
In the case of MFIs, this translates into higher operations costs, and in the case of banks this has shown up in the form of default rates which may be upwards of 10 per cent of the total SHG portfolio. Further, under-writing is a specialised skill that demands trained individuals.
Understanding the needs of household and suggesting appropriate financial products is a highly specialised skill and requires intensive training.
Kirana stores and other existing channels can become transaction points, but for complete financial inclusion, such transaction points would need to be supplemented by other channels that have adequately trained personnel who are capable of assessing households and advising them.
Lastly, aspects such as costs of specialised services, such as claims, administration for insurance and withdrawal of small denominations of savings, are also significant. More importantly, these services are not available at all.
For instance, an insured person, even on the happening of a catastrophe against which he is insured, does not easily get the sum assured in the absence of proximate expert delivery channels
While these three costs put together are high for credit, there is also a significant cost attached to cash movement. Given that most rural and low income households primarily operate in cash-based economies, movement and stocking of cash can add several percentage points to costs and increase the risks associated with business.
Transaction costs therefore become one of the single largest reasons inhibiting financial institutions from delivering financial services to rural households.
KYC and Unique Identification
The Reserve Bank of India and other key players in the sector have realised that some of these transaction costs can be reduced by making available standardised documents to establish identity and proof of residence. Currently, clients who lack identity and address proof can get a letter from a local authority, such as the Panchayat head. But, even this is not universally accepted.
For instance, mutual funds and insurance companies do not treat these as adequate proof of identity and address. The ongoing UID project is a significant step towards establishing and authenticating identity of clients, which would lower transaction costs for both financial institutions and clients.
The Reserve Bank of India implemented the National Financial Switch (NFS), an interbank network that allows clients to withdraw funds or check their balances through a network of 50,000 ATMs of 37 banks, which are a part of the network.
Providing a similar facility to clients of low-income households through local level touch points, such as a Business Correspondent (a range of entities and individuals allowed by the RBI to provide financial services on behalf of a bank), that can be integrated with the NFS or its equivalent, could greatly reduce transaction costs for clients and facilitate ease of access.
Technology could also be used in ensuring ubiquity of financial institutions’ touch points, even in the absence of formal branches.
The number of mobile subscribers in India crossed the 617-million mark in May 2010 and continues to grow. This can be used significantly by the financial sector in extending financial inclusion by leveraging the mobile services retail network as well as using the mobile phone as a transaction platform for a few services.
In Kenya, for instance, the M-Pesa service linked to Vodafone has been successful in reaching over 9 million customers within a short span of its launching. In India, companies such as FINO (Financial Information Network and Operations Ltd.) and Eko, in partnership with banks have been catalysing access to savings accounts and remittances through technology-led channels.
The emergence of non-bank transaction points and other trends discussed here offers great potential in reaching low-income households across the country.
The above article first appeared in the “Finance Matters” column in The Hindu Business Line.