3
Jul

Insights from the “Digital Credit Roundtable” hosted by the Future of Finance Initiative

(This post is authored by the Future of Finance Team at the IFMR Finance Foundation).

In the first post of this series on the three Future of Finance Initiative (FFI) workshops hosted in April, we focused on the workshop on digital payments. This blog summarises the key insights from the second workshop on digital credit. The workshop was attended by  providers  from across the credit ecosystem in India. We thank the participants for their frank and open views presented at the discussions.

India is one of the most underserved credit markets in the world, with only 15% of the households borrowing from formal channels.[1] Emerging digital lending models have the potential to address this gap. These models range from online marketplaces and online lenders (originating loans on behalf of traditional institutions or lending themselves) to P2P players (connecting individual lenders to borrowers via a platform). Given the entry of all these new technology oriented providers and intermediaries, we wanted to understand responses to our core questions to players across the digital credit space:

  • How are providers providing solutions relevant to new market segments?
  • Where are the risks and vulnerabilities across the chain of the players and processes in the digital credit ecosystem?

The Growing Role of Non-bank Entities in Digital Credit

An early insight that participants shared at the workshop was that there is no shortage of demand or supply for credit in India today, rather that we lack mechanisms in the market for the appropriate deployment of supply. It was also emphasised that role of fintech providers in India is fundamentally different from markets like the US: while fintechs in US focus on a generally well-banked population often in competition with established banks, Indian fintech firms are also trying to expand the market and provide services to the underserved.

The key question facing the Indian market is whether providers dis-intermediating the chain of credit will partner with banks or compete with them in order to provide services to customers. Two market trends described within this context:

a) P2P lending platforms partnering with banks

Participants reflected that traditional banking is limited by legacy systems and regulations. Some banks have taken a progressive view of the developments, with early trends emerging of P2P platforms tying up with banks to source customers and help with the early stages of the customer verification process. These partnerships are making certain assets classes—such as consumer and SME loans through e-commerce platforms—more accessible to traditional banks.

b) New strategies by digital lenders and P2P platforms to reach customers not previously accessed by traditional lenders

Providers in the digital credit market are also using new strategies to diversify the base of customers to whom they lend such as building partnerships with e-commerce platforms to use their data and advertising and targeting new customers. For instance, some P2P platforms have tie-ups with travel and holiday planning sites to offer loans to vendors listed on the site.[2] These partnerships have opened up access to new customers for SME and consumer loans who may not have been previously accessible to lenders.[3]

New Service Providers in the Chain of Digital Credit

Next the discussion moved on to the range of players in the digital credit scene. To frame the discussion, we presented a list of all the stakeholders involved in the provisions of digital credit to the participants (Table 1) – based on our understanding of the credit ecosystem.

Table 1: Digital Credit Stakeholders

Source: FFI (2017)

The participants observed that the above list is likely to evolve as emerging players involved in providing digital credit and related services are currently discovering and experimenting with different business models.

Despite the changing nature of the industry, participants agreed that the majority of digital credit operations are the same as those in traditional lending. However, certain processes such as risk origination and risk assessment have evolved because of increased access and use of customer data.

Emerging Pain Points for Digital Credit

The discussion moved on to the operational pain points faced by providers and their intermediaries.

Low awareness of data-related risks: The chief concerns of the attendees centred on data protection and privacy. The participants felt that the average Indian consumer’s awareness of data related risks is minimal. Educating customers about privacy and data protection issues is crucial. The providers at our workshop took their own roles in this process very seriously. Participants also believed that customer data should not be shared without explicit consent. However at the same time, they conceded that it is often unclear for consumers to know what they are giving consent for.

Participants also highlighted that risky customer data practices already exist and are not unique to the digital credit space. For instance, participants discussed the large role that Direct Selling Agents (DSAs) have traditionally played in the selling of financial products by contacting potential customers. Currently, DSAs are a weak link when it comes to securing customer data, since there is no clear procedure to monitor and sanction these agents.

New data for credit assessments: Next the participants discussed the use of alternative data based assessment for lower income customers – to widen the potential to offer credit products to them since they often do not have more traditional credit scores to support assessments of credit worthiness. It was emphasised that standardised credit products can lead to financial exclusion due to exclusionary eligibility criteria.

In this context, the question of privacy arose – specifically, whether certain types of alternative data could compromise the privacy of individuals and whether this was a valid consideration. Participants’ views were divided on the importance of this question to the end customer – with some musing that privacy could be a “luxury” problem and others priding themselves on placing strong value on their data privacy practice.

Need for standardised borrower assessment, fair lending requirements and front end provider liability: Typically, assessing a borrower’s credit worthiness involves gauging the ability to repay, intent to repay and identity. This process is standardised in countries like the US and the UK. However, in India there is no standardisation of the borrower assessment process. This exacerbates the challenges of evaluating customers.

In the US, the fair lending requirements practised by foreign banks prevent discrimination based on pincode, race etc. Equivalent provisions do not currently exist in India. However, in the US, discrimination is implicit within lending practices — in a black box form. As a result, American lenders do not share their assessment processes.

All the participants agreed that in the case of any customer harm arising, the customer-facing institution must take responsibility and liability — irrespective of the dis-intermediation of the chain of credit in the digital context. There cannot be a situation where the customer’s rights are spread across multiple entities.

Regulators need to factor in market development and stakeholder perspectives: Participants highlighted the need for regulators to let the industry take a meaningful size and shape before introducing guidelines. If regulations supersede the industry’s development, they can shape the formation of industry (instead of market forces).

The attendees also remarked that digital lenders have no formal forum for engagements with key regulators, making it tough for them to feedback ex ante about the possible impact of proposed regulation on the market and on customers. One recent initiative that participants discussed was the Digital Lenders Association of India (DLAI), which seeks to work closely with the government, regulators and policymakers on behalf of those involved in core lending business and facilitators in digital lending.

Overall, the workshop helped us get an insight into the role of the various actors who participate in the digital credit ecosystem in India, and their perceptions on managing risks to customers.


About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.


[1]See: All-India Debt and. Investment survey (2014) http://mospi.nic.in/sites/default/files/publication_reports/nss_577.pdf
[2]See: http://www.business-standard.com/article/companies/alok-mittal-returns-as-entrepreneur-launches-platform-for-smb-lending-115100100047_1.html
[3]See: http://www.amazon.in/b?ie=UTF8&node=8520691031

30
May

Insights from the “Digital Payments Roundtable” hosted by the Future of Finance Initiative

(This post is authored by the Future of Finance Team at the IFMR Finance Foundation).

In April, the Future of Finance Initiative (FFI) hosted a series of closed door workshops with a small set of digital financial service providers focusing on payments, credit and investments. The primary goal of the workshops was to map the “transaction journeys” of individuals using digital financial services in India and identify points of weakness from a supply side perspective. This helped us get a clearer understanding of the emerging customer level vulnerabilities in the Indian digital financial landscape. This blog summarises key insights from the first workshop that we hosted on digital payments. The discussions were held under the Chatham House Rule, so this post is limited to overall themes without attributing comments to participants. We thank the participants for their frank and open views presented at the discussions.

The payments ecosystem in India has undergone rapid evolution in the recent past. Post demonetisation, the big push from Government to scale up digital payments has been front-and-centre on the policy and industry agenda. Given all of this, we wanted to understand:

  • How are providers providing solutions relevant to new market segments?
  • Where are the risks and vulnerabilities across the chain of the players and processes associated with making a digital payment?

We posed some of these questions to the carefully curated set of participants of the digital payments workshop. They reflected players across the payments ecosystem in India including wallets, payment system operators, payment gateways, card payment processors and software developers.

New customer segments need new products tailored to their needs

The workshop kicked off with a discussion on broad trends and considerations emerging for those working in the payments industry in India. A key observation was that new segments of customers are being brought into the digital payments ecosystem who are different in their capacity to absorb any losses, compared to existing customers. This opens up new opportunities and responsibilities for providers, including on product design and innovation.

Specifically, financial services tailored for low income consumers, have not evolved in the Indian financial market — unlike other sectors such as telecommunications (where for e.g. different levels and durations for phone recharges are available). As an illustration, most credit cards are set up for 45 days cycles as they are aimed to cater to “salaried’ employees who earn once a month. However, there are no cards with 20 days cycles for people earning twice a month or at more frequent intervals (such as those in part-time work or the informal sector). In the future, such a segment could be served by small finance banks and payment banks, potentially in partnership. Some participants felt that this approach to banking could be a more effective for fostering financial inclusion than recent government schemes which scale-up inflexible products (such as no-frills bank accounts).

Services providers in the chain of payments

The FFI’s focus to date has been understanding customer-level risks in digital finance. We wanted to use this opportunity to test our concerns with providers involved in payments transactions. To frame the discussion, and locate the various parties in the chain of a payments transaction, we presented a simplified schematic of our understanding of the payments ecosystem to the participants.

Figure 1: Card Not Present[1]: Online Payment Schematic


Source: The Future of Finance Initiative (2017)

The black arrows track transaction data flows and the green arrows tracking funds flows in the back end of a typical payments transaction. Participants agreed that this reflected the flows of a standard payments transaction. This schematic has remained broadly the same at the back-end for most forms of payments, but the challenges from the push towards newer forms of digital payment methods arise mainly due from (1) the variance among front-end customer-facing applications (2) increases in volumes of transactions and (3) the related data. 

Pain Points include security, transaction failures and policy uncertainty  

Discussions then followed through the afternoon about the operational aspects of completing payment transactions and pain points in the current scenario.

Data protection and data security: Payment services providers generally include clauses in their terms and conditions regarding customer data use. However the practices around this vary vastly. A key concern with direct impact on customers relates to data security, given the amount of data collected, stored and transmitted digitally in the payments process. ISO 27001 is the key global standard to which players in the payments industry generally aspire to. It was observed that full compliance with the standard was unaffordable for most providers, though the majority of them complied to the best extent possible.

Issues with the Payment Card Industry Data Security Standard (PCI DSS) — the industry standard for policies and procedures aimed at protecting data in card and payment transactions –- were also discussed. Adherence to all aspects of the PCI–DSS was patchy across industry participants. The standard does not have an enforcement body (being an industry standard with compliance driven by the requirements of other payment brands and acquirers). Concerns were raised that certain payment gateways and services were falling foul of the requirements without being censured –for example, by storing CVV for extensive periods of time in contravention of PCI-DSS.[2] It was pointed out that the PCI DSS provisions are from a pre-mobile era, and tend to be web-focussed. This results in gaps arising even in these standards with respect to data security for mobile transactions.

With regard to future regulation, participants stressed the need to balance the costs of compliance to be measured against evaluations of risk carefully when regulations are being formulated.

Hardware security: Hardware security is often overlooked in discussions around payments security. Participants discussed the absence of hardware checks for mobile phone handsets or regulations limiting pre-installed applications on mobile phones. This opens up the possibility of phones manufactured in other countries being sources of data theft and spyware. For instance, in 2016 firmware was found on Chinese manufactured smartphones being sold in the US which transmitted personally identifiable information (PII) to servers in China via a back door.[3]

To raise consumer awareness of security vulnerabilities and to drive providers to adopt better security practices, one idea suggested was to develop standardised indicators on apps and webpages to give usersSource: hostcats.com (2016) an immediate indication of the level of security. An existing example of this is the green lock HTTPS URL marker (right) currently used to indicate that a web browser holds a Secure Socket Layer (SSL) certification.

Transaction failures and frauds: Participants noted that the payments industry needs to improve on the failure rates for transactions to avoid affecting consumer confidence and usage. There was consensus that the regulator could play a constructive role in publishing aggregated information about transaction failure rates to incentivise higher data security standards. Providers themselves would shy away from publishing this kind of data individually. However, aggregated data published by a neutral third party or regulator could drive the providers to measure themselves against this benchmark and aspire to better rates.

Regulatory uncertainty and intervention: Participants discussed concerns about the impact of regulatory uncertainty along with how prescriptive regulatory standards had the potential to stifle innovation. Providers were concerned about competing with Government sponsored payments products and services and were anxious about Government subsidies and price caps that could put pressure on market prices, and introduce uncertainty for providers who were seeking to be commercially viable. There was also discussion on the need for having a level-playing field for new payment service providers as against established providers like banks.

Overall, the workshop was a fascinating deep dive into the perspective of the various actors who participate in making a payment transaction possible – while keeping the customer’s experience and concerns at the heart of the discussions.

—-

About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.


[1] Card not present (CNP) refers to a purchase a consumer makes without physically being present or presenting his or her credit or debit card at the time of purchase.  CNP transactions often occur online and are conducted by consumers without the actual in-store credit card swipe – which is likely the major direction of travel, as more digital payments are made over mobile/internet to pay for goods and services.

[2] For more see: https://www.pcisecuritystandards.org/pdfs/pci_fs_data_storage.pdf

[3] For more see: http://gadgets.ndtv.com/mobiles/news/chinese-firm-installed-back-door-on-thousands-of-smartphones-says-it-was-a-mistake-1626136

21
Jun

Building Natural Catastrophe Protection for Low-income Households – Notes from the Joint Workshop hosted by Asian Development Bank and IFMR Holdings

flood_CW

By Vipul Sekhsaria & Nikhil John, IFMR Holdings

Natural catastrophes, whether in the form of the severe drought that regions like Bundelkhand are currently witnessing or floods, like the one which deluged Chennai in 2015, leave behind them a tale of destruction that is both unparalleled and deeply disturbing. Natural disasters cost India $3.3 billion in 2015[1], the figure not accounting a crucial factor – “loss of livelihood”.

Amongst the ones who are hit during a natural catastrophe, the impact is most severe on low-income households and ones living below-the-poverty line. Natural disasters such as floods, droughts, cyclones and earthquakes keep pushing a majority of these households back, curtailing their attempts to move to a higher financial path every time such a catastrophe strikes.

According to a report, “An annual global investment of $6 billion in disaster risk management strategies would generate total benefits in terms of risk reduction of $360 billion[2] (suggesting a 1:60 ratio of cost to benefit) but sadly it adds that this is equivalent to just a 20% reduction of new and additional annual economic losses due to natural disasters. In the Indian context, as a nation we will be spending close to $9 billion over the next 5 years towards disaster risk management, but the question remains, is that enough?

While government expense on disaster management will surely mitigate the effects of disasters in terms of preparedness, but how does one go beyond the insured assets and insured lives, particularly given that insurance penetration is very poor, especially in low income groups?[3]   Solutions for the low-income household and business should not only insure hitherto uninsurable assets, uninsured lives, but also protect livelihoods and income streams.

With an endeavour to think through the challenges & opportunities that catastrophic risk entails and take the first steps in finding a solution to protect low-income households in India from the aftermath of natural catastrophes, Asian Development Bank & IFMR Holdings organised a joint workshop on June 2-3, 2016 towards this. The workshop brought together high quality originators, data scientists, climatologists, insurers, reinsurers, social impact investors and the regulator under one roof.

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Finding a solution to protect customer households and businesses as well as the originators that have a relationship with such households and businesses was the imminent theme of this workshop.What we can think of, we can do”, as Sucharita Mukherjee, CEO of IFMR Holdings put it, was the underlying spirit that drove the particiapnts. Delivering the keynote address P.J. Joseph, Member, Non-Life, Insurance Regulatory and Development Authority of India (IRDAI), very clearly suggested how insurance penetration continues to be extremely low – only 0.9% of GDP is protected by non-life insurance. He added how only 8% of economic losses were insured and thus there was a need for out of the box solutions for catastrophe risks. The premium collected by the non-life industry for natural catastrophes amounted to about INR 4,500 crore annually whereas the loss from the Chennai floods alone stood at about INR 14,000 crore said R. Chandrasekaran, Secretary General, General Insurance Council, in his opening address. He added, although tax rebates initially helped give impetus to product take-up, today tax rebates are not the foremost reason why people buy health insurance, a similar approach might be worth considering for catastrophe protection covers.

Udaya Kumar, MD and CEO of Grameen Koota, in his talk highlighted the difference an ideal natural catastrophe protection solution can bring to the lives of low-income customers served by his organisation. He expounded on how natural catastrophes initiate vicious cycles of poorer life to the already poor and how a safety net provided by catastrophe insurance can make clients more resilient and aid the organisation’s efforts on financial inclusion.

Bama Balakrishnan, CRO of IFMR Capital later shared analysis of how some of the originators had medium to very high risk exposure to their net worth owing to catastrophe risk and how this continues to be a barrier to financial inclusion, keeping originators away from high risk prone geographies.

In addition to having specialists present their insights on key issues and participants engaging themselves in group discussion on key themes, the workshop also provided for a couple of panel discsussions.

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The first panel discussion was on the different types of catastrophe risk protection products that exist globally and in India. In addition the panel deliberated on what are the data, risk models and loss curves available and how can these be improved? The panel consisted of Dr. Murthy Bachu, Principal Hydrologist at AON Benfield Analytics, Alex Chen, CEO of Asia Risk Transfer Solutions (ARTS), Ulrich Heiss, Senior Advisor, Sector Project Insurance at GIZ, Pushpendra Johri, VP of Risk and Insurance at RMSI, Vineet Kumar, Head Cat Perils Asia at SwissRe, in a discussion moderated by Arup Chatterjee, Principle Financial Sector Specialist, Sustainable Development and Climate Change Department at the Asian Development Bank (ADB). Key learnings from the panel:

  • Natural catastrophe risk has been a subject under discussion in India for more than two decades; lack of robust data, event curves and loss models have prevented the development of holistic solutions, said Arup Chatterjee. The wait for perfect data might never be over, but there already exists a large understanding by data scientists and climatologists that is more than sufficient for natural catastrophe-specific products in India.
  • Pushpendra Johri suggested availability of flood model based on 50 years of river flow data and 109 years of rainfall data with RMSI. He added that there is enough data to begin, but data reporting in the future will be a key game changer to make products more affordable in the long-run.
  • Affordability is crucial; but one should also examine incentive-alignment of various stakeholders within a value chain to arrive at innovative ways of structuring the product premium payment. In one such example, while the cotton farmer is the end recipient within the value chain, it is the cotton buyer who pays for the premium. The increase in cotton produce directly affects the buyers business and a more resilient farmer means higher profit for the buyer entities.
  • Role of technology in e-delivery needs to be explored against best practices around the world and new innovations waiting to emerge.
  • A good starting point appeared to be in the form of a parametric insurance product that transcends the exposure only to assets and looks at items like loss of income and livelihood as the important factors in deciding the amount of insurance cover.
  • With a deep understanding of their customer needs, geographically specialised originators like microfinance institutions, small business lenders, affordable housing finance institutions and similar institutions in financial inclusion are aware of the impact of natural disasters on the lives and livelihood of their customers’ in absence of any financial protection.
  • Catastrophe risk affects credit markets including interest rates, losses on loan causes capital erosion for financial institutions. Re-capitalising and de-leveraging are two options in the aftermath of a disaster, though both with their negatives. Recapitalisation is not so forthcoming and deleveraging affects the financial institution’s capability to lend. Residual risk management can be supplemented by catastrophe risk insurance products. Insurance and re-insurance play an important role in the underlying catastrophe risk – linking credit, risk and savings can result in appropriate risk financing strategies said Christine Engstrom, Director, Private Sector Financial Institutions, Private Sector Operations Department of ADB.
  • Originators acknowledged the geographical risk they carry at an organisational level for operating in such markets and lending to customers highly exposed to natural disasters.

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Another star panel moderated by Sucharita Mukherjee, which had Brahmanand Hegde, MD and CEO of Vistaar, Udaya Kumar, Vaibhav Anand, Head Risk Analytics and Modelling of IFMR Capital, Easwar Narayanan, COO of Future Generali, K. Venkatesh, CEO of IFMR Rural Channels, and Ulrich Hess deliberated on informal ways of managing risk by low-income households like income diversification, investing in gold (especially in South India), and investing in other assets like land. Key learnings from the panel:

  • The poor are much more risk resilient than what one can imagine and their ability to bounce back is very high if supported by the right tools, said Udaya Kumar. A catastrophe insurance product could just be that tool.
  • Greater concentration on a quick loss assessment and claim settlement is important.
  • Simplicity of the product cannot be over-emphasized, element of instant relief to the affected households will make it more receptive.
  • Customer contact post disaster is very important as the customer’s trust in the entity that serves them is critical.
  • One of the insurer panellists asked, “Why do people insure motor and health?” the group unanimously agreed that a large reason is that people feel the immediacy of the loss.
  • Idiosyncratic risks are much easier to perceive and customers avoid planning for more systemic risks like disasters world over.
  • Awareness programs can make a difference. Examples cited suggest that campaigns that continued for multiple years saw much higher uptake in other insurance schemes, as signs of losses emerged and more customers realised its value.
  • The use of technology for loss estimation – innovation at delivery and claim settlement can also be a game changer in faster and more accurate claim settlement. For example, if parameterised products are more cost effective than indemnity products, how can technology magnify the intelligence of the indices that parametric products are dependent on? Technology can have a role to categorise the income classes and the duration of the loss of income by studying these models and adding that to the index can be one such way as pointed by one of the panellists. Left to the customer for what cover to choose, they will always choose the cheapest product and hence intelligent indexing can be of good use.
  • Can the government and CSR activities of institutions contribute to a risk fund? Participating Development Finance Institutions (DFIs) committed their support in running pilots, building better risk and loss models and further in normalising prices in the short run with a goal to make the product affordable.
  • One of the points that came to the fore is that financial institutions are reluctant to sell these kinds of products – but the panel agreed that the profitability cannot be measured for each product line and as long as the product enhances customer resilience – the indirect beneficiary is the institution the customer borrows from.

Armed with all the inputs from the speakers and the panellist the entire group spent the first half of the second day working in multiple small groups to come up with product pilot ideas. It was as if all the participants had taken upon themselves to forge a definite way forward and so it was.

The group agreed upon critical design parameters for the pilot:

  • Simple to buy (could cover multiple perils, with simple options, structure could be parametric / indexed).
  • Affordable – capturing the pricing benefit of risk-pooling between different entities and different household profiles.
  • The magnitude of the cover should provide for the loss of assets, loss of livelihood, and a buffer at an organisational level to meet unplanned exigencies or provide for households who were affected but couldn’t get compensation since parametric solutions will carry basis risk (may not cover all actual damages).
  • The loan amount can be used as a proxy to determine the magnitude of cover.
  • To design the vulnerability index that can be used to determine the value of cover (one may need a pre-survey to arrive at such a vulnerability index), pre-defined hazard and loss triggers.

The group, including originators unanimously agreed to build protection for catastrophe risk and were ready to be a part of joint initiatives to bring some of the solutions to light.



[1] http://www.firstpost.com/india/natural-disasters-cost-india-3-30bn-in-2015-heres-why-we-should-be-very-worried-2622940.html
[2] http://timesofindia.indiatimes.com/india/Disasters-cost-India-10bn-per-year-UN-report/articleshow/46522526.cms
[3] http://timesofindia.indiatimes.com/business/india-business/Insurance-penetration-in-India-at-3-9-percent-below-world-average/articleshow/46518607.cms

14
Jun

Comments on the Indian Banking Sector at the Stanford India Conference

By Bindu Ananth

I had an opportunity to participate in the excellent conference organised by the Stanford Centre for International Development (SCID) on Indian Economic Policy as a discussant for a presentation by Dr. Rakesh Mohan. My comments drew heavily from a forthcoming paper on “Modernising Indian Banking” by my colleague Deepti George. The transcript is below, would welcome thoughts/feedback:

  1. I want to start by thanking SCID for inviting me to this conference and for an opportunity to discuss this excellent, data-rich presentation on India’s financial sector reforms by Dr. Rakesh Mohan and Prof. Partha Ray. I will focus my comments on the banking sector and financial inclusion aspects.
  1. From all accounts, it appears that the traditional banking business model will face some threat going forward starting with increased competition on the liabilities side. Low cost deposits are a significant factor contributing to the risk absorption capacity of banks’ balance sheets, a hidden capital buffer of sorts. Raghuram Rajan in his Committee’s Report of 2009 calls this the ‘grand bargain’[i]: where cheap deposits were available to banks in an environment marked by low competitive intensity, in exchange for financing Governments and priority sectors of the Government. This is unravelling with significantly more competition expected for the CASA business. This competition is particularly likely to be sharp from the newly licensed category of Payments Banks whose sole focus will be on deposits and payments. Many of these new banks are expected to exploit the adjacencies with their telecom businesses and significantly increase the outreach of the banking sector and ease of depositing small amounts, frequently. Even over the past few years, data shows that there has been a “flight of CASA” to a few banks that are perceived as being strong. This “sorting” is happening even within Public Sector Banks and represents an important nuance to the authors’ observation on reversal of convergence.
  1. As the presentation notes, a number of measures have been launched by the RBI and the Government including the “Indradhanush” package announced in August 2015[ii]. However, most of these measures stop short of addressing the root cause of troubles in the banking sector. NPAs reflect the outcome of decisions made several years ago by banks and while the current debates on provisioning levels are important from the perspective of assessing the fair value of banks, it does not examine the conditions under which these assets were originated and monitored and indeed, how we ensure that these issues are not recurrent themes in the Indian banking sector. A lot is attributed to ownership issues of banks. However, ownership notwithstanding, there are several pragmatic measures that can improve management of banks and oversight by the Board – these have not received much attention. Specifically, adoption of three building blocks: Risk-based pricing of loans, Activity-based costing and Matched Funds Transfer Pricing will ensure more rational pricing of assets by banks even as the ownership issues get resolved.
  1. In addition to actions that can be taken by bank management, the supervisory regime has an important role to play to enable banks to reveal more information on an on-going basis about the true performance of the bank as well as create an environment where more capabilities are getting built within banks. Over the past few years, there has been a definitive shift towards risk-based supervisory approaches. This has been driven by Basel II requirements on banking regulators to undertake the Supervisory Review and Evaluation Process (SREP) of supervised banks, which includes the review and evaluation of the bank’s Internal Capital Adequacy Assessment Plan (ICAAP)[iii], conducting an independent assessment of the bank’s risk profile, and if necessary, taking appropriate prudential measures and other supervisory actions such as based on the severity of risks, requiring banks to follow through on a prescribed Monitorable Action Plan (MAP)[iv]. However, the RBS framework is still historic and partial in its approach because, for example, in looking at credit risk while it does, for the first time, go to the performing book, it only examines the rating migrations that have already taken place, and uses as a measure of concentration risk, only the top twenty assets.
  1. The Ministry of Corporate Affairs and RBI have recognised the urgent need to converge Indian Accounting Standards with International Financial Reporting Standards (IFRS) – the Ind AS has been recommended by RBI to be commenced for scheduled commercial banks from April 1, 2018 onwards. IFRS 9 represents a significant move in that it will require the computation of provisioning based on a forward looking Expected Credit Loss (ECL) impairment model, even for the performing book. This is likely to result in significantly higher impairment provisions and therefore more capital requirements. This will be a watershed moment for Indian banking.
  1. RBI through its Framework for Revitalising Distressed Assets in the Economy[v], the Guidelines on the Joint Lenders Forum (JLF) and Corrective Action Plan (CAP)[vi], the Strategic Debt Restructuring Scheme[vii], has put in place machinery for the rectification and restructuring of stressed assets on banks’ books.[viii]. However, just as with standard assets, there is a need for recognizing and incorporating expected losses into the loss recognition in restructured assets.
  1. Also, the RBI has indicated its interest in moving to a dynamic provisioning framework in which banks will need to make dynamic provisions which would be the difference between the long run average expected loss of the portfolio for one year and specific provisions[ix] made during the year. Thus, this will ensure less P&L volatility[x].
  1. With the accounting for financial assets moving towards better capturing the effects of potential impairment for the remaining life of the asset either through mark-to-market and expected loss approaches, there is broad consensus that these measures will ensure adequate cover for expected losses in the form of better provisioning, while unexpected losses are to be covered by capitalization[xi] and by more efficient use of banks’ capital. Overall, a move from high regulatory forbearance-low bank competencies equilibrium to low forbearance-high competencies would be essential.
  1. I want to spend a few minutes on financial inclusion. Specifically, the differentiated banking design that was discussed, has great potential for combining sharp increases in financial inclusion while preserving stability. This category includes Payment Banks and Wholesale Banks (the discussion paper on this is awaited). After the last round of universal bank licensing in which 2 new banks were licensed, it was clear that it is not possible to find sufficient number of qualified candidates that satisfy “fit and proper” requirements to significantly accelerate the number of banks in the system in the near-term. An integrated banking regulation framework that permits differentiated banking business models appears desirable for a number of reasons:
  • There would be flexibility to approach payments, savings, and credit both independently (in a Vertically Differentiated Banking Design) and to bring them together (in a Horizontally Differentiated Banking Design) when the efficiency gains are high and the other costs are low. Concerns relating to finding fit-and-proper candidates in the case of vertically differentiated institutions would be far fewer and licensing a relatively large number of them would, consequently, be far easier.  These, over time, could also provide a pipeline for future universal banks.
  • The current fragmented regulatory structure creates far too many arbitrage and lobbying opportunities, and in the absence of  a single unifying framework,  measures are continually being taken to respond to them  in a somewhat ad-hoc manner (such as higher capital adequacy norms for NBFCs combined with an easier Non Performing Assets recognition norms and 100% risk weights)
  1. Even as new differentiated banking business models take root, there is a need to reimagine the role of universal banks as one that is no longer engaged as risk originators, particularly in high-risk segments, but rather as being risk aggregators, with freedoms to rebalance their portfolios based on risk-profiles and diversification outcomes that each bank decides for itself.
  1. Given the progress on the JAM trinity and the emergence of differentiated banks, it may well be the case that the credit and payments strategy evolve differentially within the broader financial inclusion strategy. While progress on credit would necessarily have to be much more measured and prudent no matter what strategies are adopted given the inherent risks and customer protection concerns, there is an urgent need to make access to payments ubiquitous & this seems within striking distance. In addition, there is also a pressing need to create an architecture that allows information relating to customer behaviour, in particular, transactions histories with financial institutions, telecommunications companies, and utilities, to be captured and transmitted with high integrity, while simultaneously maintaining the highest standards of customer privacy. The development of this payments and information architecture will not only have enormous inherent value but could also be thought of as “highways” on which a more diverse credit intermediation system can be built. Fortunately, India already possesses the necessary tools to bring about this rapid change. We have a one billion plus strong Unique ID database; a rapidly growing telecommunication network in rural areas with over a billion mobile phone users;  expanding broadband connectivity which is expected to cover every village in the next 12 to 24 months; and multiple credit bureaus which are all very active.
  1. Getting the financial inclusion strategy on the credit side right has important consequences for the economy and the country. Despite the authors’ observation that the financial depth at the national level has plateaued off at roughly 60%, we continue to have fairly low levels of financial depth (credit-to-GDP) in several pockets of the country. States such as Bihar have an overall credit to GDP ratio of less than 16% despite the fact that it has one of the lowest levels of GDP in the country. It is arguable whether the binding constraint is the availability of credit or the opportunities available in the regional economy – but at very low absolute levels of credit availability, this may be a self-fulfilling prophecy. We need a banking sector that is capable of meeting the growth needs of all sectors and regions of the country and for this; the sector has to exhibit a high degree of resilience and profitability.


[i] Chapter 4 from A Hundred Small Steps: Report of the Committee on Financial Sector Reforms, Government of India, 2009

[ii] Indradhanush Plan for Revamp of Public Sector Banks, Department of Financial Services, Ministry of Finance,  August 2015

[iii] The ICAAP is a forward-looking risk-based process that is approved by banks’ boards and submitted to the RBI annually. It sets risk tolerance levels and lays out processes for managing and monitoring risks, stress testing and scenario analysis, and links back to a strategic plan for meeting current and future needs for capital and reserve funds given the risk tolerance levels.

[iv] RBI can require banks to modify or enhance risk management and internal control, reduce risk exposure to specific  risk levels, achieve minimum CRAR levels above the minimum regulatory capital requirements, and so on

[v] Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy RBI, January 30, 2014

[vi] Framework for Revitalising Distressed Assets in the Economy – Review of the Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP), RBI, September 24, 2015

[vii] Strategic Debt Restructuring Scheme, RBI, June 8, 2015

[viii] Master Circular on wilful defaulters, RBI, July 1, 2015

[ix] These are the provisions made for NPAs in accordance with existing RBI circulars

[x] B Mahapatra: Underlying concepts and principles of dynamic provisioning. Keynote address by B Mahapatra, ED, RBI at the Conference on “Introduction of dynamic provisioning framework for banks in India”, organised by CAFRAL, 21 September 2012

[xi] Ibid

9
May

The Lifecycle of Innovations in Financial Inclusion: From Insights to Scale

By Vaishnavi Prathap, IFMR Finance Foundation

The Indian financial sector is poised for sweeping changes to traditional models and we look to embrace game-changing developments in institutional form and digital infrastructure. These developments are expected to bring millions of new individual, household and small-business users into folds of the financial system but in doing so, they also bring unique challenges. How can financial services providers continue to provide solutions relevant to new market segments? What are the lessons to keep in mind in designing new products and delivering services through unconventional channels?

As readers of this blog might recall, we posed these questions to an all-star panel at the inaugural NSE-IFMR Finance Foundation Conference on Household Finance in March this year. The panel comprised of Anuradha Ramachandran, Director-Investments, Omidyar Networks, Ayush Chauhan, CEO, Quicksand, Chetna Vijay Sinha, Chair, Mann Deshi Mahila Sahakari Bank, Deepa Bachu, Co-Founder & CEO, Pensaar & Rajeev Ahuja, Head-Strategy, Retail, Financial Inclusion & Transaction Banking, Ratnakar Bank. In a lively and candid discussion on the challenge of successful innovation for financial inclusion, panellists shared their stories of success and failure, and fascinating insights on what it takes to embrace new technology and new thinking to deliver meaningful financial services.

For us, one of the biggest takeaways from the event was the rich discussion on customer insights. In the video (see below), you will hear many examples where an insightful understanding of the end-user could go on to make or break a product and practical and inexpensive ways in which practitioners can begin to uncover these insights in everyday interactions with customers. When similar techniques were applied to better understand frontline staff and bank agents, it powerfully informed not just product design but also the design of delivery channels and overall strategy.

We also asked the panellists how financial institutions can drive innovation within their organisations, really hoping to understand what elements of the ‘start-up culture’ are important to mimic, or adapt for larger financial institutions. Much to our surprise, we heard panellists strongly recommend looking away from disruptive innovators and more towards seeking to consolidate relative strengths and build on the diversity that exists within financial institutions. Rather than chase the elusive game-changing innovation or at least, even as we chase this dream, it’s equally as important to focus on innovations that are incremental that add efficiency or value to customers today. In this respect, large Indian financial institutions are indeed well-placed to lead the charge in innovative financial inclusion, with a strong commitment to delivering high value and a superior customer experience.

Watch the excerpts from the panel discussion in the video below:

You can also watch the full panel video here and read tweets from the event at #HHFinance.