Financial inclusion is as much about convenient channels of delivery as it is about appropriate products.
In designing channels for financial services delivery, three primary considerations are: how can financial services be delivered in such a high quality manner that they are optimally used by the clients; how can providers manage the risks; and how can both the above mentioned tasks be be done at affordable costs?
Quality needs to be defined from the clients’ perspective. When a client is putting money in a bank savings account or a pension product, she is taking risk on the institution’s ability to honour the financial contract, tomorrow or twenty years hence.
This continuity is important. She also expects the bank to be reliable, and not cheat her on the terms and conditions. In addition, she would also like to be able to access her account at a convenient location and time, and transact in flexible amounts and terms.
On the other hand, in services such as lending and insurance, the institution is taking the risk on the individual which then needs to be managed.
Lenders, for example, address this in many ways – taking collateral, developing credit scores based on past information, taking guarantees from others who know the clients. Typically, in the absence of hard collateral and titles, local information of the lender becomes an important substitute.
The main delivery channel for banking services in India has been the branch-based banking network. These include branches of commercial banks as well as cooperative and regional rural banks.
The outreach is still quite limited – more than 100 million households have no access to formal credit and only 39 per cent of rural population have a savings account. The insurance channel is primarily led by individual agents — almost 90 per cent of the population does not have any insurance cover.
Looking through the framework presented earlier, these bank branches are reasonably high on reliability and continuity, but have not been able to offer convenience and flexibility to smaller value customers.
Due to high transaction costs, it is difficult for traditional banks to ensure convenience and flexibility for lower value clients. The Rangarajan Committee estimates the transaction costs for a bank to make a small value loan (less than Rs 25,000) to be around 13 per cent.
There are also information problems in lending because most traditional mechanisms of risk management (eg. collateral, scoring) usually do not work for rural and low-income clients. Informal channels such as moneylenders and community-based insurance schemes, while typically scoring high on convenience fail the test of reliability and continuity.
The key challenge is therefore to have a financial inclusion architecture that combines the reliability and continuity of large financial institutions with the convenience of more local, proximate institutions. One example of this is the business correspondent model which involves banks appointing agents for delivering banking services on its behalf.
This channel has promise because it minimises the cost structure constraints that were preventing traditional banking services from reaching further. Presently, this channel is dominated by a few dedicated business correspondent companies, which have developed technologies and village-based channels for delivering banking services, including remittance.
The capability of this channel to deliver credit, though, remains to be understood and tested given the intensive nature of credit under-writing. In recent years, Micro Finance Institutions (MFI) have also emerged with financing partnerships with commercial banks and reached millions of people with microcredit.
These institutions have demonstrated good ability to deliver group-based credit to clients in remote areas, but because of a lack of continuous presence in villages, they are not suitable for savings-type services that require a local “touch point”, and therefore also cannot bring down costs below a certain level.
Against the 12-20 per cent transaction costs for banks in making small loans, MFIs are between 6-12%.
Other innovative models are now emerging to address this challenge. The Kshetriya Gramin Financial Services (KGFS) model is a case in point. KGFSs combine the local nature and branch-based service delivery of cooperative and regional rural banks at cost structures much lower than those of banks and MFIs – roughly, transaction costs of 3–5 per cent.
Each KGFS, which typically works in a restricted geography of about 3 million population, sets up village-level branches offering a wide range of locally relevant financial services. These branches are managed by locally recruited and trained wealth managers, who assess needs and give financial advice to clients.
The wide range of services helps build economies of scope, reducing costs for each unit service delivered, because relationships of the same clients are being deepened.
KGFSs are also appointing village-based individuals as sub-agents, responsible for pure cash-in, cash-out transactions. Aggressive usage of technology helps reduce the variable costs, making transactions of even Re. 1 viable. Models that combine the risk management capability of large well-capitalised entities with the outreach capability of flexible and convenient local channel partners may be the way forward.
The Pension Funds Regulatory and Development Authority (PFRDA) has taken a pioneering step in formalising this partnership approach by launching the concept of Accredited Intermediary (AI). In order to be an AI, the entity must satisfy certain capital and operational requirements. The AI takes responsibility for outreach while the “product” continues to be managed by Asset Management Companies. This way, the customer gets the “best of both worlds”. This is the future of channel design for financial inclusion.
This article first appeared in The Hindu Business Line.