As promised in our earlier post that briefly notified the conclusion of the IFMR Financial Systems Design Conference 2011, we will be sharing a summary of the deliberations that happened. These discussions are bucketed into the three broad themes – Origination, Transmission and Aggregation. This post carries the first of these three functional sessions: Origination.
Origination may be defined as the design and delivery of financial services that provide households and firms the ability to manage liquidity (moving resources across time) and risk (moving resources across “states of the world”) in a smooth, convenient and affordable manner. It spans activities/functions such as the design of products to overcome moral hazard and adverse selection, establishing the identity of the customer, underwriting of risk, disclosure of all product and contract features, financial advice, and product servicing on an on-going basis.
Characterising the Present State of Origination in India
In discussing the present landscape of Origination in India, conference participants concluded that there although there is diversity among Originators, they are led by manufacturers who engage in Origination. Financial services get delivered to the end-customer in a disaggregated manner, with the customer being made responsible ex-ante through financial literacy with almost no ex-post responsibilities on the Originators. There is therefore no formal customer protection regulation, and regulations being put in place have been based on institution-types.
The Report Card for Origination in India
Conference participants discussed the current status of Origination outcomes in terms of the two functions of liquidity management and risk management (for individuals and firms). The following salient features stood out:
- While bank savings accounts and borrowings are important tools for households to manage liquidity, in India, roughly half of household savings are in physical assets.
- Informal Originators dominate with respect to low income and rural households, and small firms. Even large firms meet much of their requirements from internal accruals and bank borrowings. The corporate bond market is dormant.
- Use of risk management instruments by individuals and firms is far from ideal. Consequently, majority of households face financial emergencies in the wake of events such as serious injury or illness or loss of job. Firms also have only lately had the opportunity to use derivatives for the same.
Nonetheless, conference participants noted that several nation-wide initiatives are now underway which have the potential to transform the Origination landscape. Discussions centred on the potential impact of the Unique Identification (UID) Project, and technologies and systems to facilitate “digitisation” of financial transactions.
Key themes for the Future of Origination
Conference participants deliberated over the below four themes within Origination.
Increasing the outreach and goodness of fit of Originators
Participants agreed that to dramatically expand the scale and scope of Origination in the Indian financial system, there is a need to develop new approaches to achieve this while not compromising the stability of the financial system in any manner. Various options for achieving the same were considered, and the need for better information in general to expand Origination soundly was stressed.
Threshold operational capability and financial strengths of Originators
Various criteria were pondered upon by participants in an attempt to define what constitutes good threshold capabilities – operational as well as financial – for an entity to be a ‘high-quality Originator’. Attempting to draw out objective parameters for this, the participants deliberated extensively on the role of technological capability to minimise operations risk and the ability of the Originator to commit capital as a means to retain responsibility for the quality of Origination in the Originators’ hands.
Enhancing risk underwriting capabilities of Originators
Given that risk is created at the point of Origination and the safety of the financial system is inextricably linked to the capacities and incentives of Originators to manage risk well, discussions evolved into brainstorming sessions for creating effective mechanisms to achieve better under-writing, especially at the agent level. The group also felt that there were several valuable lessons to be learnt on this front from informal and specialized Originators.
Ensuring good financial outcomes for customers
Participants in this context debated on how best to create an environment with a sustained focus on good financial outcomes for customers while preventing scenarios of conflicts of interest. This group emphasised that integration of financial services is essential to ensuring good outcomes, rather than the current reality of fragmented service delivery. Accordingly, they formulated a couple of blue-prints for further debate, especially to tackle the present problem in the Indian Origination landscape of product manufacturer dominance.
Vision statement for Origination
Following the discussions along the themes discussed above, conference participants converged on a vision statement for Origination.
“A financial system in which there are multiple and diverse Originators providing integrated financial services to individuals, households and firms, evaluating and pricing risks appropriately, and ultimately taking responsibility for good financial outcomes for customers.”
A more detailed summary of the deliberations on Origination is available here.