Independent Research and Policy Advocacy

A Big Step Forward in India’s Financial Inclusion Deliberations

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India faces a major financial exclusion challenge. According to the 2011 World Bank Global Findex Survey, only 35% of Indian adults have access to a formal bank account and 8% borrowed formally in the last 12 months. The Reserve Bank of India (RBI) Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (or “CCFS”) was tasked with formulating policy recommendations to close this exclusion gap while protecting the stability of India’s financial system and the safety of customers’ deposits. The CCFS report marks a big step forward in India’s financial inclusion deliberations. We evaluate the CCFS recommendations below, focusing our analysis on the most critical financial inclusion question confronting the RBI: how to regulate non-bank payment actors. We highlight several promising elements in the CCFS report, while highlighting two risks that warrant further attention.

The CCFS report starts off on a strong foot, positioning electronic payments as a central plank in India’s financial inclusion strategy and calling for universal access to an electronic payment system by 2016. This is the right approach. Electronic payments are the connective tissue of a financial system. They enable people to buy goods and services, pay utility bills, and send money to friends and family. They enable governments to disburse social payments and collect taxes. And they enable suppliers to collect payments from buyers. Payments are also the building blocks of financial services. Savings is little more than a sequence of deposit payments and withdrawal payments. Credit involves loan disbursements to the customer followed by repayments to the bank. When poor households are entrenched in a cash economy with no access to electronic payment channels, it drives a wedge between them and the formal financial system by making it prohibitively costly for banks, insurance companies, governments, and other institutions to transact with them.

After establishing the importance of electronic payments in India’s financial inclusion strategy, the report then wisely separates the risks created by payment and deposit activities from those posed by credit. It does this by recommending the creation of a class of narrow banks, or “Payments Banks,” which can offer payments and deposits but not provide credit. The core principle is that a payments provider that accepts funds from the public and places 100% of those funds in secure assets (as designated by the central bank) is not exposed to credit risk. Of course, the RBI must still mitigate the technology, operational, and consumer protection risks associated with Payments Banks, but full-fledged banking regulations are not required given the lack of credit risk.

The report also acknowledges the critical role played by non-banks in extending electronic payment networks into poor communities, recommending that mobile operators, consumer goods companies, and other non-banks be allowed to apply for Payments Bank licenses. While banks are well positioned to deliver credit services, they have struggled in every market to extend payments and deposit accounts into poor communities. By contrast, countries that have carved out regulatory space for non-banks to offer these services have seen dramatic expansions in electronic account access. Indeed, just 4-5 years after the central banks of Kenya, Tanzania, and Uganda allowed non-banks to launch payments and deposit services, 77% of Kenyan adults and 47% of Ugandan adults have an electronic account, while 46% of Tanzanian households have at least one member of the household with an electronic account.

These electronic payment platforms are quickly integrating into national financial ecosystems and radically altering the cost of reaching poor people with financial, utility, and other services. Inspired by the dramatic gains in these countries, central banks in several key markets – including Brazil, Indonesia, Malaysia, Mexico, Peru, Rwanda, and Sri Lanka (among others) – have allowed non-banks to offer payments and deposits.

While these CCFS Committee recommendations promise to catalyze a big increase in financial inclusion in India, we flag two possible risks that could undermine the Committee’s objectives:

First, there is a risk that the Payments Bank licenses will have compliance costs that impair the business case for serving poor customers. The business case for serving poor customers with payments and deposits depends on particularly thin margins and is thus sensitive to changes in the cost structure. While the report wisely recommends that Payments Banks should have lower minimum capital requirements than credit issuing banks (Rs.50 crore versus Rs.500 crore), the report also recommends that Payments Banks should “comply with all RBI guidelines relevant for scheduled commercial banks (SCBs).” Given that traditional banking regulations are primarily designed to mitigate credits risks, we worry that this blanket requirement could saddle Payments Banks with compliance costs that are disproportionate to payments and deposit providers.

Second, the Committee recommends that all pre-paid instrument (PPI) providers be required to convert to a Payments Bank or become a Business Correspondent. We worry that this could create an unnecessarily high entry barrier for providers wishing to test new business models in this nascent sector. As mentioned, serving poor households with deposit and payments services hinges on thin margins. Therefore, non-bank payment actors may want to test the viability of this market before converting to a full-fledged Payments Bank. But if entry costs are too high, providers may choose not to enter the space altogether. One alternative may be to allow PPIs to operate (with cash-out functionality) until they reach a certain threshold deposit balance or customers base, at which point they must convert to a Payments Bank. This would create a more gradual path for payments and deposit providers to pilot different business models without establishing a full-fledged Payments Bank at inception.

The CCFS report is the most comprehensive and forward thinking central bank policy assessment we’ve come across. If the Committee recommendations translate into regulations, we believe it would trigger a significant expansion in financial inclusion in India. The task now is to ensure that non-bank payments regulations are proportionate to the risks involved.

1 – Dan Radcliffe is a Senior Program Officer and Rodger Voorhies a Director in the Bill & Melinda Gates Foundation’s Financial Services for the Poor team.

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7 Responses

  1. Thanks for the thoughtful commentary Rodger and Dan. I want to respond to the concern on “compliance costs”. Since the assets on the balance sheet of a Payments Bank are all envisaged to be investments in Government securities, all the compliance related to the lending business will automatically fall off. In our view, the real issue to be tackled was the entry capital and beyond that, proportionate regulatory treatment follows from the nature of activities & balance sheet. We also make an overall recommendation to move rapidly towards Risk Based Supervision so that scarce supervisory resources can be directed where the risks are the largest – this will also build capability to deal with large numbers of banks – specialised and full-service.

    1. Thanks Bindu for the comment. Our biggest concern is that Payments Banks are forced to meet compliance requirements that are geared towards credit-issuing institutions. If these credit-related compliance requirements indeed fall off once Payments Banks invest funds in government securities, then that would address our core concern.

  2. Thank you for your encouraging post, Dan and Rodger. I just wanted to touch on your other concern around PPIs. Cash-out functionality, as the report points out, actually exists for current PPIs but is restricted to banking outlets alone owing to their relaxed KYC norms that do not provide adequate protection against AML/CFT risks. In addition, existing PPIs are limited in their ability to pay interest on balances and are fraught with contagion risk associated with escrow arrangements with partner banks. While you are right to point out that Payments Banks have higher barriers to entry, the other route
    proposed by the Committee is that of the Business Correspondent which represents
    a lower entry cost channel to test new business models. In terms of viability,
    the report highlights several revenue enhancing adjacencies that BCs could
    exploit or build.

    1. Hi Rachit-
      Very good comments. Two quick responses:
      1) A key question is whether PPIs can offer accounts with cash-out functionality on their own. If PPI customers must first transfer funds to a bank account before they can cash-out, then it is unlikely that PPIs will be able to scale account on their own. The process for a customer is just too cumbersome.
      2) I agree that there could be contagion risk if the escrow accounts reach a size where they become systematically important. That is why we recommend that PPIs be transitioned to Payments Banks once they accumulate a certain level of deposits. That will ensure that no PPIs can grow to a level where they become systemically important and pose contagion risk.

      Thanks again for your comments!

  3. Dear Radcliffe and Rodger Voorhies
    While I have no comments precisely on the two risks associated input in the supply side , I share my concern from demand side perspectives on the final outcome in terms of closure of “ exclusion gap” out of risk free non- bank payment actors in general and universal access to electronic services as recommended in the report contextually in India .
    Arguably closure of exclusion gap calls for appropriate financial inputs and suitable delivery means tailoring to the needs and capability of the given socio economic profile of the excluded. This factor also ensures more safety to the prospective customers from the targeted excluded cohort.. Taking cognizance of the above premise, it is debatable on the compliance of electronic payments system by the target group , albeit such payments are the connective tissue of a financial system in the supply front.
    To wit further, who are the target group for the so called financial inclusion mission?. As referred by you , WB Global findex survey , only 35% of Indian adults have access to formal bank otherwise indicating 65% of them remain excluded . Towards closure of’ ‘exclusion gap’ it is prudential to appreciate “Who are these excluded adults ? so that inclusion strategies could be wisely designed suitable for their adoption . These excluded cohort need not confine to small business and low income categories.
    The above hypothesis is made on the two rationale pertaining to the adult excluded in the demand side
    First, India has currently has the largest population of illiterate adults in the world with 287 millions ( Global Monitoring Report- UNESCO) accounting 37% of the global total. This social profile of adult expose their poor capability in challenging the various complexities in the process of accessing financial services and application of digital languages through electronic based devices in the last mile without seeking external assistance.
    Second the earlier financial inclusion committee report ( 2008 by Dr C.Rangarajan) has indicated that in India “51.4% of farmers households remain excluded from both formal/informal sources. This economic profile of these excluded reflects the livelihood status and their season based demand but limited financial services unlike business and trading communities requiring electronic payment modes .
    Both these socio economic profile of Indian excluded cohort questions the suitability and safety to them in the process of electronic mode of inclusion from demand side perspectives. Even if there is an inclusion intentionally or incidentally or accidentally , sustainability is not guaranteed since it is unavoidable of nascent included account becoming in-operative and defunct there by getting excluded again ( lesson from the inclusion through Nofrill a/c in the manifestation of ‘defunct a/c’ ‘drop outs’ & group mortality’ in SHG-MF system). Perhaps these kind of risks defeating the very purposes of inclusion also merit the attention of the inclusion experts along with supply side risks as referred by you
    In fine this observation is not necessarily meant against the use of electronic system and good theoretical construct on inclusion in Mor’s report. Contextually the anguish expressed here is that there is an imperative need to perceive the complexities of digitalized inclusion compliance and its extent of adequacy in both supply and demand sides in the real world and design suitable products and services contextually given the profile of target group instead of preaching solely on electronic services be all and end all for closing the exclusion gap.
    Thank you for sharing my views
    Dr Rengarajan

    1. Dear Dr. Rengarajan-
      Thank you for your comment. I agree there needs to be more demand-side thinking to better understand the products, pricing, and delivery channelsthat meet the financial needs of different population segments. We are encouraged by the fact that digital financial systems in East Africa are quickly propagating into low-income population segments. Just six years after the launch of M-PESA, 45% of sub-$2/day Kenyan adults are actively using a digital financial service (FinAccess Survey 2013). According to the Intermedia survey in Tanzania, 29% of sub-$2/day households and 25% of rural households have a mobile money user. This is encouraging and makes me cautiously optimstic that we would see similar down-market penetration in India if non-banks were allowed to scale these systems on their own. However, there is no guarantee that low-income Indian adults will adopt digital financial services at the same rates as in East Africa. To better understand the demand-side situation in India, we have launched a 50,000 household national financial inclusion survey in India. This survey will be managed by Intermedia and IMRB and will be repeated every year. This should give us a good understanding of the financial needs of low-income households and how digital financial services are propagating among different population segments.

  4. Dear Dan RadCliffe
    Thank you for your positive response reiterating the values of demand side insights in the process of financial inclusion.
    Regarding past experience on mobile money in African countries, there are also equally discouraging studies on mobile magic highlighting the unintentional outcomes such exclusion of bottom , rich and poor divide, inequity gap, victims of cyber crime, etc To quote some.
    A paper published in March by the Consultative Group to Assist the Poor, a nonprofit group, ( Sarah Rotman & Claude Robert 2013) looked at text and call data in three African countries to figure out what drives adoption of mobile money. Growth, the paper noted, “has not been as fast as anticipated” and the authors discovered a gap between rich and poor. According to the World Bank’s CGAP blog post (Sara Rotman) the past experience in M-Pesa and Jipang ku sav admittedly is that bottom poor are hardly reached and only small trading/business community is benefitted. Further related articles are in!Small farms, Big funding Gap: Local bank financing for smallholders farmer meets 3 percent of overall demand( Dan Zook and Sara Wallace. “Is India looking at financial inclusion backwards?” By Rgavendra Badskar. “Why mobile wallet will not work in India : yet the need is there but obstacles remain”. By Retesh Dhawan
    Therefore the rate of inclusion does not matter where ever in the globe, but the fact on what happens in the access process and after inclusion in the demand side assumes more significance from client protection perpsectives. . Further in the context of multiple playesr in supply chain including network /mobile service providers, the question begs who is the principal stake holder for ensuring client protection or safety in the last mile inclusion?
    Another point meriting attention , both Asian and African regions have more poor living with varying degrees of social vulnerabilities and economic deprivations beyond in terms of $ 2 , on one hand and myriad ethnic groups /sub groups following diverse values and belief on the other and these social and anthropological factors also cause more social exclusion than financial inclusion. Unlike in western world, in these regions responsible financial inclusion with mere digital services, therefore is difficult in vacuum without social inclusion sequentially.
    I do appreciate the conduct of survey for better understanding the needs of the excluded . But at the same time my submission is such study or research should have more socio anthropological approach for capturing the demographic realities at household level rather than using mere economic oriented linear functioning calculus. Further in the context of existence of patriarchal society for longer period in India and women SHG system, looking the facts through gender lens would be more useful to perceive the extent of exclusion among the adult female in the target population segments.
    In fine in the process of closing the exclusion gap through the digital means, it is imperative need that it should not eventually result in widening the inequality gap between the rich and poor which is worse than poverty.
    Thank you for sharing my views
    Dr Rengarajan

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