Independent Research and Policy Advocacy

Missing links in financial inclusion

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Infrastructure facilities such as clearing houses, depositories, stock exchanges, and commodity exchanges are the backbone of any financial system. They allow the system to work efficiently, manage risks, maintain effective communication channels, enable predictability and transparency and, above all, allow the system to scale and serve every stakeholder.

In urban areas, Electronic Clearing Systems (ECS) have rendered redundant the use of cheques, making payments simple, cheaper and faster. Cheque truncation systems that use cheque images in place of its physical transfer to the place of clearing are slowly being adopted by banks. Real Time Gross Settlement (RTGS) systems have made real time interbank payments a reality.

Depositories dematerialising shares of companies and online stock exchanges have made it possible for the common man to participate in capital markets without having to ever see the insides of a stock exchange. Swiping a debit or credit card at the local shop has made purchases simpler and more frequent.

While fast-paced technological developments have made life simpler, they have not benefited everyone. The absence of some key infrastructure at the back-end inhibits the delivery of financial services to low-income households.

Easy Transactions

Savings (Transactions account): While a large number of households already have bank accounts, partly because of the push to “no frills accounts”, there are very few accounts that are operational and can be used to access comprehensive services. The Inter-Ministerial Group on Framework for Delivery of Basic Financial Services Using Mobile Phones (IMG) has suggested that the use of mobile phones in operating bank accounts could go a long way in promoting financial inclusion, ensuring the participation of the smaller banks.

Payments: Cashless payment can reduce cost considerably but it still remains a distant dream.

The existing International payment systems alliances such as VISA and Mastercard, though fast, are expensive.

The REMIT (Real Time Micro Transactions) system proposed by the IMG report and the India Money Line (IML) recently launched by the National Payments Corporation of India (NPCI) hold immense promise to facilitate large number of real-time transactions at low cost.

Given the extensive banking infrastructure, what is required is a means to use shared infrastructure and a national payment gateway for various transactions.

Currency Chests: Despite a fully functional transactional account and payment system, several transactions still involve cash.

In such a context, there is need for neutral geography-focused currency chests that are able to handle cash movements in the interim and, in the end act as depositories dematerialising and rematerialising cash as required. This will dramatically reduce the cost of moving cash.

Credit Information

Credit Information Bureaus: Most low-income households require credit either for investment, marriage, education or simply for consumption smoothening. Providers of such loans are apprehensive because repayment is a result of multiple factors such as viability of the activity, certainty of cash inflows, efficiency in expenditure, or simply willingness to pay (broadly categorised as adverse selection and moral hazard).

Such apprehensions can be addressed by making available to the lender, information from a neutral credible entity about the past antecedents and transaction patterns of households. While the RBI has made it mandatory for financial institutions to access the authorised credit bureaus entrusted with performing this function, they are besieged by the inability to accurately identify an individual customer simply because of the sheer population numbers.

One of the most significant contributions of the Unique Identification (UID) project for financial inclusion is in this direction. Once UID reaches some scale, it should be able to address the question of identity. UID will also make front-end authentication and complete de-duplication (having multiple identities or accounts in a system) possible. Permanent identity and credit histories are even more critical in a country like ours where migration is a frequent reality. With right information, credit bureaus are best placed to ride on their vast data and come up with advanced scoring techniques that help lenders in making credit decisions.

Land Repositories

Apart from addressing regulatory challenges, there is a need to find solutions to some nagging practical issues. For instance, a key issue restricting the growth of big ticket loans, especially in the rural context, is the uncertainty of enforcing collateral on default. Land, the most commonly used collateral in rural areas, is currently also the most complicated form of collateral. This can be significantly addressed by the introduction of land repositories that effectively digitise mortgages and land records, facilitating acceptance of land as collateral. Setting up public infrastructure such as these can make a huge difference to financial inclusion in India.

The article first appeared in the “Finance Matters” column of The Hindu Business Line.

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