Financial services must enable households to manage the risk of uncertain incomes.
Well-targeted financial products can go a long way in meeting the varied needs of low-income households. The fact that financial inclusion remains an unfinished task points to the absence of such instruments to address the needs of the poor. Understanding the supply-side response of the Indian financial system will give us some hints as to why this crucial task remains incomplete.
In India, policy decisions related to nationalisation of banks, branch licensing norms and the big push to the co-operative and postal networks have been instrumental in establishing deep branch networks. On average, there is one bank branch for 20,000 individuals.
More recently, there have been significant contributions by non-bank entities, notably the micro finance institutions (MFI), organised chit funds and self-help groups (SHGs). While the adequacy of this network is debatable, it is nevertheless a deeply penetrated infrastructure. Why, then, has this network not translated into the kind of financial access that is meaningful?
WHY PRODUCTS FAIL
Jonathan Morduch, Professor of Public Policy and Economics at New York University, gives us a useful framework to score the quality of financial access. He lays out four critical ingredients: convenience, reliability, flexibility and continuity.
Let`s examine the performance of our financial system against each of these. The innocuous issue of the timings of a bank branch are a case in point. A typical bank branch is open from 10 am to 4 pm. This is precisely the time when people are busy at work on their farms.
This, combined with the distances from the village to the branch and the procedural barriers there, make frequent transactions challenging. So, even if bank accounts exist, there is very little transaction intensity. Contrast this with the informal provider, who comes to the doorstep of the customer and transactions with whom require minimal procedures.
Further, most formal institutions that do reach low-income households today, such as the post-office or the MFI, offer only a limited range of financial services. For a customer, this means visits to multiple providers (both formal and informal) to access the full range of financial services they need - including life insurance, general insurance, pension plans, short-term savings, investments, remittances and loan products. This greatly increases the cost and complexity of access to financial services by a household.
Many rural, urban and migrant low-income households lack documents that provide proof of identity, residence and income. Even the onus of proving identity has been transferred to the individual. (It is hoped the UID will transform this scenario). This becomes a fundamental barrier for them to interact with the formal financial system or, at the least, imposes a very high cost of access. In the absence of formal records, for instance, there is rent-seeking behaviour by local authorities to provide substitutes. As a system, we clearly fail the test of convenience.
The scorecard is not very different on flexibility and reliability either. Good product design is critical to flexibility. A key feature of low-income households is uncertainty in incomes caused by such factors as ill-health and accidents as also such regional factors as rainfall failure.
Financial services need to enable households to manage these risks better. An agricultural loan with fixed monthly repayments misses the basic point of the seasonality of the underlying income and imposes undue hardships on the household. Several categories of crucial financial services remain unaddressed because of poor product design.
Livestock is an important source of income for many rural households. However, they are unable to protect against the risk of death of livestock due to fairly trivial design challenges around livestock identity and fraud management. These are capabilities that surely exist in the financial system; however, these have rarely been brought to bear in the context of these markets.
RULES OF THE GAME
A reliable provider lays out the `rules of the game` in advance and stays true to it. This predictability is important for people to plan their financial lives over long periods of time. Often, government policy, on debt waivers for example, injects considerable uncertainty in the environment that erodes reliability.
Continuity is a parameter that speaks to the sustainability and governance of the provider. Improper risk management and controls have often resulted in the exit or bankruptcy of financial service providers. This creates a lack of trust in the provider, particularly for services where the individual is taking a risk.
Think of insurance and savings, where the contributions are made in the present, with expectation of payoffs in the future. Lack of trust in the continuity of the institution can result in a very low take-up of these categories of products.
The existing financial infrastructure, despite its significant size and span, has not been designed to meet even one, leave aside all four, of the characteristics desired by a low-income household.
It is clear to us that the architecture of our financial system needs to be revisited. We need several more entities that are able to deliver on the parameters of convenience, reliability, flexibility and continuity.
If a number of rural households are still not covered by banks, post-offices and MFIs, it is because their products do not pass the test of convenience, reliability, flexibility and continuity. We need more entities to deliver on these counts.
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