A Visionary Approach to Financial Inclusion

By James Militzer, Next Billon

A Visionary Approach to Financial Inclusion

The words “banking committee report” and “excitement” aren’t often found in the same sentence. But there’s no other way to describe the reception the Nachiket Mor committee report on financial inclusion has received – both in India and globally.

Commissioned by the Reserve Bank of India and released earlier this year, the report garnered headlines by setting a lofty goal – bank accounts for all Indian adults by 2016 – and laying out an innovative, detailed vision of how to reach it.

Some high points of its approach include:

  • Utilizing India’s massive “Aadhaar” national ID card enrollment drive to help locate and verify the identity of new account holders;
  • Establishing “payments banks” to provide payment and deposit products (but no loans) to small businesses and low-income households;
  • Calling for new banking licenses for non-bank entities to widen access and target the unbanked;
  • Giving low-income households and small businesses a legally protected right to be offered only suitable financial services.

If they’re implemented, the Mor committee’s recommendations could prove to be a historic experiment in how public policy and financial institutions can interact to drive financial inclusion. If they’re successful, they could provide a valuable model for other developing countries. So we were excited when Mor agreed to discuss the report on NextBillion Financial Innovation. Part one of our two-part Q&A follows. You can read part two here.

James Militzer: A number of bankers in India have characterized your report as impractical or overly ambitious. Is this a fair critique? And do you anticipate much resistance to the proposals, if they’re acted upon – and if so, do you have a plan to bring banks more fully on board?

Nachiket Mor: The committee was asked to review existing strategies for financial inclusion and to come up with new ones if required, while being guided by a set of overarching principles. We have submitted the report and a final decision on the recommendations is for the RBI to take.

The committee in its preparation of the report has had extensive deliberations with a variety of stakeholders and the report has arrived at a framework taking into consideration these multiple views. Banks have also been part of this exercise and will continue to be. For instance, with regard to the recommendation on Universal Electronic Bank Accounts (UEBA) enabled through Aadhaar, the ideas were run past banks and in fact three banks have already expressed interest in providing such accounts. However, the framework is not bank-centric per se and it envisages a whole host of entities playing a simultaneous role in creating access to finance. While some of the recommendations are extensions of existing regulations, some others need more changes.

JM: Some have pointed out that the report seeks to achieve in the next two years something that India (and the RBI) have been working toward for decades. What is radically different about your plan (or about the current state of India’s economy, government or new technologies) that will make these goals attainable so quickly, where prior efforts have failed?

NM: The recommendations of the report are anchored to the underlying momentum generated by several dramatic developments in India, especially the ones in supply side infrastructure seen in recent years. For instance, the Unique Identification (UID) project has already covered 500 million Indians and expects to complete the task of issuing a UID to the rest of the country by 2016. By linking UID numbers to Know Your Customer (KYC) norms, RBI has already paved the way for universalising bank accounts, thus removing one of the most important barriers to financial access.

Telecommunications companies now have over 870 million mobile phone subscribers of whom over 350 million are based in rural areas, and the rural number continues to grow at an annualised rate of 10 percent. Therefore, India already has all the elements for success in place – a wide range of institutional types, well-developed financial markets, a good regulatory framework, and large scale and high quality authentication and transaction platforms. If these elements are used well, paradoxically, it is even possible that poor historic progress on financial inclusion may actually present India with an opportunity to leap-frog over the rest of the world and may prove to be an advantage.

JM: By offering automatic electronic bank accounts with Aadhaar registration, is it likely that millions of low-income people will end up with accounts that they didn’t really want, don’t intend to use and perhaps can’t afford, since banks would be free to charge for all transactions? If so, what should be the next step in drawing them into the formal financial system?

NM: The Unique Identification Authority of India has indicated that 240 million individuals who have an Aadhaar number have expressed a wish to have a bank account. The request for bank account is to be initiated by the customer, and once initiated, be activated by the customer, thus indicating her acceptance of the account. Although the recommendation regarding the universal bank account has received a lot of attention, the bigger challenge would be to make these accounts contextually useful for the account holder.

The report therefore has many recommendations with regard to financial services that entail putting to use these universal bank accounts, such as the recommendations regarding the functionalities possible at a payments access point within 15 minutes of walking distance, or the recommendations regarding RBI-regulated agents providing multiple financial services such as investment and risk management products through a single KYC process, using the universal bank account as the starting point. All business correspondent transactions rely on the availability of a functioning bank account, and credit can be disbursed through them as well as repayments collected through them. Mutual fund investments and redemptions as well as insurance claims payouts, all need a functioning bank account as a safe and secure backbone to transact on, using biometric authentication. There is therefore tremendous scope for making these accounts meaningful for their owners.

JM: Are you concerned that by restricting payments banks’ ability to lend/invest and offer other products, you’ll not only limit their usefulness to low-income customers, but also reduce their financial incentive to serve these customers? If so, would you be open to permitting these banks to offer more services in time?

NM: Broadly, recommendations of the committee seek to encourage specialised institutions and the development of partnerships between specialists. In this spirit, payments banks could partner with banks, insurance companies and mutual funds to offer a suite of credit, investment and risk management products.

However, it should be noted that the financial viability of the payments bank does not hinge on this. Broadly, there are two revenue sources that a payments bank would have. One, the payments bank would benefit from the shared infrastructure of its existing business (such as the sale of mobile airtime or postal products) and the enhancement of revenues on that front on account of the additional loyalty induced by the payments business. Two, it would charge a transaction fee for all transactions including balance enquiry and would benefit from the interest income on its investment in government securities.

It is expected that a high volume of transactions and strong non-financial revenues will ensure financial sustainability while keeping the transactions charges very low even if the balances in the new bank accounts are low. For instance, Diconsa, an operator of 22,000 grocery stores in rural Mexico, began a program to deliver cash payments from government benefit programs to people in its stores. Since they began doing this, they have seen customer visits and foot traffic increase by 20 percent. This model of “adjacent” non-financial revenue possibilities seems highly scalable without creating additional risks to the financial system while delivering very low costs to the end customer.

JM: About the proposal to hold banks legally responsible for offering only “suitable” financial products, and giving customers the right to seek legal recourse against the bank if they feel due process to establish suitability was not followed: Is there a risk that this could expose banks to potentially frivolous lawsuits from people who voluntarily consent to a loan and regret it later, for instance, but would prefer to hold the bank responsible?

NM: The report has clearly laid out suitability as a process of the provider rather than as an outcome for a customer. Outcomes can be driven by many factors outside the control of the provider and in most cases it will be near impossible to specifically assess the extent to which unsuitable provider actions were responsible for it. Suitability as a process would require every financial services provider to have a board-approved suitability policy that the company must follow in all interactions with customers – the policy must lay down the processes for customer data collection, analysis, communication of recommendations (both advice and product sale) and follow-up. It is the implementation of the suitability process that should determine if a financial services provider has indeed acted in the best interests of the customer.

The power of the suitability approach is that it will be necessary for the financial services provider to repeat this process on an ongoing basis – in every interaction with every customer. Financial institutions, therefore, are responsible for following the process, not ensuring outcomes. Moreover, suitability is not a new concept in India and regulators like RBI, SEBI and IRDA have begun to follow the global trend (Australia, UK and the USA have shifted to a provider-liability regime) of mandating a process for ensuring suitability.

Editor’s Note:

This blog was previously published on Next Billion and is reproduced with permission.

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