A Big Step Forward in India’s Financial Inclusion Deliberations: Daniel Radcliffe and Rodger Voorhies

Posted on January 31, 2014 by Sumita Kale

This blog post has been reposted, with permission, from the IFMR Trust Blog

Guest post by Dan Radcliffe and Rodger Voorhies, Bill & Melinda Gates Foundation1

India faces a major financial exclusion challengeAccording 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 monthsThe 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’ depositsThe CCFS report marks a big step forward in India’s financial inclusion deliberationsWe evaluate the CCFS recommendations below, focusing our analysis on the most critical financial inclusion question confronting the RBI: how to regulate non-bank payment actorsWe 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 2016This is the right approachElectronic payments are the connective tissue of a financial systemThey enable people to buy goods and services, pay utility bills, and send money to friends and familyThey enable governments to disburse social payments and collect taxesAnd they enable suppliers to collect payments from buyersPayments are also the building blocks of financial servicesSavings is little more than a sequence of deposit payments and withdrawal paymentsCredit involves loan disbursements to the customer followed by repayments to the bankWhen 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 creditIt does this by recommending the creation of a class of narrow banks, or "Payments Banks, which can offer payments and deposits but not provide creditThe 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 riskOf 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 licensesWhile banks are well positioned to deliver credit services, they have struggled in every market to extend payments and deposit accounts into poor communitiesBy contrast, countries that have carved out regulatory space for non-banks to offer these services have seen dramatic expansions in electronic account accessIndeed, 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 servicesInspired 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 customersThe business case for serving poor customers with payments and deposits depends on particularly thin margins and is thus sensitive to changes in the cost structureWhile 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 CorrespondentWe worry that this could create an unnecessarily high entry barrier for providers wishing to test new business models in this nascent sectorAs mentioned, serving poor households with deposit and payments services hinges on thin marginsTherefore, non-bank payment actors may want to test the viability of this market before converting to a full-fledged Payments BankBut if entry costs are too high, providers may choose not to enter the space altogetherOne 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 BankThis 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 acrossIf the Committee recommendations translate into regulations, we believe it would trigger a significant expansion in financial inclusion in IndiaThe 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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Views on the Recommendations of the Mor Committee on Inclusion

Posted on January 30, 2014 by Sumita Kale

The Report of the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households made several recommendations to achieve the objectives set out by its six vision statementsReactions to the report range from hailing it as 'visionary' (Hindu Editorial) to one that 'impresses to decieve' (M S Sriram in the Mint)Whatever the reaction, the report has generated considerable debate on implementation and operational issues, which in itself is a good churning of views in the publicThis post puts together as many views as possible as a reference post for different aspects of the reportThe list is work in progress and arranged chronologically by date of publication( and does not include the articles from ICFI that can be found here and here).

Mythili Bhusnurmath (9/1/14, ET) gets to the core of the problem, which is not with the report but with the basic principle that RBI should  be the main driver of inclusionBanks are commercial entities and should not be made to deliver on social objectives, that is the business of the government.

M S Sriram (10/1/14, Mint) is not very impressed with the report, as it overlooks the challenges at the last mile, concentrating on the architecture instead.  If only this had been flipped and a large part of the report had focused on the last mile, the architecture could have been fixed in Basel.

Subir Gokarn (12/1/14, BS) applauds the Big Hairy Audacious Goal set by the committee, and raises questions on the best way to implement these objectives, calling for disruptive technolgies to reduce costs.Even now as a first step it is possible to exploit the low hanging fruit of allowing Aadhaar-linked e-wallets by PPIs to access the unbanked.

The views from NBFCs have been quoted in an article in the Hindu Business Line (13/1/2014), as quite positive, though some of their long standing and biggest demands have not been addressed.

Ila Patnaik (14/1/14, FE) calls the recommendations pushing the same approach of mandate driven inclusion, missing the need for increased competition, innovation and consumer protection.

M Rajshekhar & Vidhya Sivaramakrishnan (16/1/14, ET Bureau) give a detailed analysis of the feasibility of implementation of the main recommendations.

Haseeb Drabu (19/1/14, Mint) lauds the idea of leveraging Aadhaar to expand coverage of banking and calls for an Aadhaar Bank of India as one of the new banks which can revolutionise access.

N S Vageesh (21/1/14, Hindu Business Line) notes that while the recommendations on Priority Sector Lending are sensible and pragmatic, when it comes to specialised banks, there was a vast difference in the cost assumptions used in the architecture on the drawing board and the actual operations.

S S Tarapore (26/1/14, Hindu) calls the document too important to consign to the archives, and deserves serious indepth examination by policymakers and implementing institutionsHe makes the point that the Mor Committee recommendations need a major revamp of the financial legislative framework, and should be seen in tandem with the FSLRC recommendations.

Monika Halan (28/1/14, Mint) looks at the idea of the payments bank as a good innovation, one that may not see the light of the day due to fears of competition.

Smita Aggarwal (1/2/14, Business Standard) commends the idea of a Payments Bank as it would move more savings into the formal sector, provide better safety to customers and also de-risk the financial inclusion strategy of banks

Abhishek Sinha and Ignacio Mas (19/2/14, Mint) give a number of suggestions to new banks (payments banks) in achieving the inclusion objective e.gproduct miniaturisation, disruptive pricing, making people comfortable crossing the digital divide etcThere is a lot that can be done for banks to become truly mass market and embrace scale.

A roundup from the Mint (20/2/2014) giving the views from the Indian Bank Association, banks expressed their sceptisim about the timeline for UEBAs suggesting 2018 was more feasible a target than 2016, about the PSL targets, about the viability of Payments Banks etc.

Bill Gates (9/3/2014, Mint) talks of the value added by digital payments in the financial inclusion mission and lauds the payments banks concept introduced by the Mor Committee Report.

Indira Rajaraman (24/3/2014, Business Standard), makes the point that payments banks could take away deposits from other banks, and to allow unhindered credit flow, they should keep certain quantum of deposits in wholesale banks to complete the architecture in a meaningful wayMoreover, the report talks of credit needs only as a spatial issue, ignoring the problems in access to credit by certain urban segments like migrants.

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Financial inclusion - the Mor Committee Vision

Posted on January 29, 2014 by Sumita Kale

The Committee on Comprehensive Financial Services to Small Businesses and Low Income Households headed by Dr Nachiket Mor submitted its report by the deadline of end-December 2013. Two Committee Members  also gave in additional comments.

The six vision statements set out by the Committee are as follows:

1.Universal Electronic Bank Account (UEBA): By January 1, 2016 each Indian resident, above the age of eighteen years, would have an individual, full-service, safe, and secure electronic bank account.

2.Ubiquitous Access to Payment Services and Deposit Products at Reasonable Charges: By January 1, 2016, the number and distribution of electronic payment access points would be such that every single resident would be within a fifteen minute walking distance from such a point anywhere in the countryEach such point would allow residents to deposit and withdraw cash to and from their bank accounts and transfer balances from one bank account to another, in a secure environment, for both very small and very large amounts, and pay reasonable charges for all of these servicesAt least one of the deposit products accessible to every resident through the payment access points would offer a positive real rate of return over the consumer price index.

3.Sufficient Access to Affordable Formal Credit: By January 1, 2016, each low-income household and small-business would have convenient access to formally regulated lenders that have the ability to assess and meet their credit needs, and offer them a full-range of suitable credit products, at an affordable priceBy that date, each District and every significant sector (and sub-sector) of the economy would have a Credit to GDP ratio of at least 10 per centThis ratio would increase every year by 10 per cent with the goal that it reaches 50 per cent by January 1, 2020.

4.Universal Access to a Range of Deposit and Investment Products at Reasonable Charges: By January 1, 2016, each low-income household and small-business would have convenient access to providers that have the ability to offer them suitable investment and deposit products, and pay reasonable charges for their servicesBy that date, each District would have a Total Deposits and Investments to GDP ratio of at least 15 per centThis ratio would increase every year by 12.5 per cent with the goal that it reaches 65 per cent by January 1, 2020.

5.Universal Access to a Range of Insurance and Risk Management Products at Reasonable Charges: By January 1, 2016, each low-income household and small business would have convenient access to providers that have the ability to offer them suitable insurance and risk management products which, at a minimum allow them to manage risks related to: (a) commodity price movements; (b) longevity, disability, and death of human beings; (c) death of livestock; (d) rainfall; and (e) damage to property, and pay reasonable charges for their servicesBy that date, each District would have a Total Term Life Insurance Sum Assured to GDP ratio of at least 30 per centThis ratio would increase every year by 12.5 per cent with the goal that it reaches 80 per cent by January 1, 2020.

6.Right to Suitability: Each low-income household and small-business would have a legally protected right to be offered only suitable financial servicesWhile the customer will be required to give informed consent she will have the right to seek legal redress if she feels that due process to establish Suitability was not followed or that there was gross negligence.

The four design principles that would inform financial inclusion and deepening strategies discussed in the Report are: Systemic Stability, Balance-sheet Transparency, Institutional Neutrality, and Responsibility towards the Customer.

The framework to understand various types of banking system designs uses the functional building blocks of payments, deposits and credit and constructs two broad designsThese are the Horizontally Differentiated Banking System (HDBS) and the Vertically Differentiated Banking System (VDBS)Across these, ten existing and potential banking designs were identifiedThese are: National Bank with Branches, National Bank with Agents, Regional Bank, National Consumer Bank, National Wholesale Bank, National Infrastructure Bank, Payments Network Operator, Payments Bank, Wholesale Consumer Bank, and Wholesale Investment Bank


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Viability at the last mile of inclusion

Posted on January 24, 2014 by Sumita Kale

While all agree that the agent at the last mile is a crucial kingpin for the success of financial inclusion, data from the CGAP-CAB annual survey shows that the Customer Service Point still has severe stress pointsWhile the median income of an agent stayed at Rs2700 per month over 2012 and 2013, the estimated attrition rate of agents is high, ranging from 25-34% annually.The survey also showed the positive correlation between G2P services and the number of transactions, income for rural agents etcHowever, there is an urgent need to address the issues of attrition and commercial viability for the agents on the field.

Here, Puneet Chopra of MicroSave looks at these vexatious issues in depth in a report, Optimising Commissions and Payout Mechanism For G2P Payments Under Electronic and Direct Benefit Transfer , and makes the following recommendations:

  • The minimum compensation to the CSPs (at least equivalent to the minimum wage prescribed in the state) has to be mandated through policyThe model for determining CSP compensation cannot be based purely on the volume of cash disbursed, as it is influenced by many factors outside the control of CSPs.
  • CSPs should be paid electronically - directly into their accounts by the parent bank.
  • For BC institutions to continue to be viable (defined as a net profit in single digits or sub 10%), their compensation should be 0.6% to 0.7% of the cash disbursedThis excludes the compensation to CSPs, which, as recommended above (fixed minimum, with a variable payout in the range of 0.3%), needs to be paid to them directly by banks, instead of being routed through institutional BCs.
  • In order for banks to make a reasonable income, the payout to banks should be in the range of 3.0% to 3.3% (of this 1.9% should be passed on to the BCs and the CSPs; while 1.1% can be retained by banks to cover their costs and realise a small margin).
  • Governments should recognise the cost and efficiency gains from routing paymnets through the BC channel can be upto 4% of the welfare payments disbursed, such a payout would ensure a business case for banks and sustainability of BCs and CSPs At the very least 3% should be given out.
  • However, if the governments decide to limit the payout to 2.0%, due to budgetary constraints, the distribution across banks, BC institutions and CSPs should be as followsA relative comparison for the case of 3.0% is also given in the study.

This study outlines specific revenue sharing arrangments that will ensure the viability for each stakeholder in the payments chainUnless the issue of viability is addressed, merely raising the number of villages covered by CSPs will be of little value in achieving inclusion.

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Posted on January 02, 2014 by Sumita Kale

As the United Nations and other developmental bodies look towards setting the post-2015 agenda after taking stock of the progress (or the gap therein) on the eight Millennium Development Goals (MDGs), universal access to financial services is being considered as part of a potential new development goal on jobs,sustainable livelihoods and equitable growth.

A milestone report by the UN Secretary-General’s High-Level Panel of Eminent Persons on the Post-2015 Development Agenda mentions that "Financial services are critical to the growth of business, but also raise the income of individuals.

Annual report of the ‘United Nations Secretary General’s Special Advocate (UNSGSA) for Inclusive Finance For Development’ provides evidence of transformational impact of different types of inclusive financial services:

  • Financial wealth of Nepalese women grew up by 50% thanks to savings accounts; they invested more in education while also enhancing the livestock assets as well
  • Sri Lankan SMEs who got access to credit, saw an annual job growth rate of 12% p.abetween 2009-2012 – twice the rate of national growth rate
  • Universal health insurance decreased the number of families falling into poverty due to medical emergency to less than 3%; earlier it was 7%
  • Weather index-based agricultural insurance enabled small farm-holders in Ghana to invest 13% more – shifting to higher value, but more weather sensitive maize

While India is not listed as one of the 40 odd countries under the UNSGSA at the moment, it’d be useful to take heed of its five key areas of advocacy, viz.

1  Diverse financial services

Diverse set of financial services are needed for different segments and different needs.

2.    Bridging household and SME finance

Small and Medium Enterprises (SMEs) need business advisory support as well as access to financial services.

3.    Responsible finance and financial capability

Financial literacy can help people make informed choices and use appropriate and apt financial services while also avoiding crippling debt.

4.    Financial inclusion, integrity, and stability

Risks can be lowered and stability can be provided by a client-focused service provision under prudent supervision.

5.    Financial Inclusion Data

Policies and programs developed using data for benchmarking are more effective.Through its multitude of organs and initiatives and more specifically, under the post-2015 agenda,UN is indeed, trying to untie the knots around financial exclusion!


Deepak Maheshwari, a public policy professional, is currently associated with the ICFI as Advisor


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