Leveraging Fintech for Risk-based Pricing & Personalisation

By Bindu Ananth

Much of the focus of fintech vis-Ã -vis financial inclusion has been on payments and the ability to transfer money with relative ease using a mobile phone and an app such as the Unified Payment Interface (UPI)/Bharat Interface for Money (BHIM), or using the USSD protocol in case of feature phones. Here, I want to discuss two fintech applications that have received less attention, but which can be transformative for financial inclusion. These include risk-based pricing of microloans and personalised financial advice.

A central feature of finance, especially lending, is information asymmetry. The customer knows more about her creditworthiness than the lender. This is aggravated if the customer has no collateral to offer, which would otherwise serve as a ‘signal’ to the lender. Therefore, there is often a significant risk premium built into the pricing of the loan that buffers the profitability of the lender against credit losses. But we expect that over time, as lenders learn more about the creditworthiness of various customers, the same will be reflected in lower risk premiums.

However, if you look at the microfinance industry as an illustration, you will see in spite of several customer groups having over 10 years of credit track records (this data is available through the credit bureau for at least five years now due to the guidelines of the Reserve Bank of India or RBI), pricing to customers has remained largely the same (the annualised percentage rates of interest lie between 22 and 26 per cent) and there is no distinction between newly-acquired and vintage customers. At the same time, one growing category of fintech companies is digital credit providers – they underwrite loans to customers based on a combination of data points such as credit record, tax data (if available) and bank statement analysis, among others. Some companies also take as input psychometric data such as entrepreneurialism and honesty in dealings to construct a picture of the customer. To a large extent, microlenders and digital lenders currently serve different customer segments – the former tends to serve more unbanked customers and informal sector workers. But these two worlds will soon collide and it is reasonable to expect a lot more risk-based pricing for these customers that will take as input various aspects of a customer’s behaviour and attitude. This will be the great leveller in retail credit: A poor woman who is an agricultural worker with a strong repayment ethic and ambitious goals for the future should be able to borrow at the same risk premium as her urban counterpart who is a salaried worker.

While the rich have private bankers that provide customised financial advice, this service is equally important to low-income households for whom even small financial mistakes can have costly consequences. Yet, most efforts in financial inclusion take a standardised view of customers and have cookie-cutter distribution models.

There have been a few experiments in customised distribution approaches, notably the Kshetriya Gramin Financial Services (KGFS) model that uses a combination of product rules and trained front-line employees in remote rural markets. However, by and large, customisation has been associated with high operating costs and the need for specialised staff at the customer interface. Fintech will mount a significant challenge to this traditionally-held wisdom. One application of fintech, specifically the supervised machine-learning models, is building recommendation engines that can construct customised financial portfolios based on inputs such as age, risk-taking ability and investment horizons. Even if in the near future it does not seem likely or even desirable that a rural customer uses a recommendation engine of this nature in a self-service mode, say, through an app to buy mutual fund and insurance, this can be plugged into systems and processes of existing service providers with a sales force that interacts with this customer segment. Such integrations can significantly enhance the quality and comprehensiveness of the proposition to the customer relative to the mono-product focus (usually loans) prevalent in financial inclusion.

Finally, some cautionary thoughts. Financial inclusion has been notoriously driven by supply-side considerations and poor understanding of customer needs and preferences, resulting in outcomes such as dormant bank accounts. It is not obvious that fintech-based approaches will not fall into the same trap. For example, proponents of mobile banking for financial inclusion have not sufficiently appreciated the challenges regarding a woman’s access to private transactions on the phone even where the household has a phone. Many women seek confidentiality even from other members of the household when it comes to financial transactions, particularly savings activity. Local language interfaces are difficult to support on Chinese-manufactured feature phones that account for a large share of the rural market. These have important design implications and must be taken into account if fintech has to reach its potential. Confidence of the customer is an important factor in widespread adoption of these services. Besides good design of services and affordability, this requires a regulatory framework that enhances customer protection and providers not taking a narrow ‘buyer beware’ approach.

This article first appeared in the latest edition of Business Today magazine under the headline ‘New Tools’.


The Innovative Finance Revolution

Foreign Affairs magazine in association with The Rockefeller Foundation has published a special issue titled “The Innovative Finance Revolution”. The issue focuses on how innovative finance, characterised by financial tools such as pooled insurance and securitised debt among others, can put the power of private capital markets to work for the public good and can unlock new resources and lead to cost-effective interventions.

Img_FAThe report features essays that lay out the context of innovative finance, and focuses on innovative finance solutions, technological innovation and policy frameworks. As part of this publication, Sucharita Mukherjee, Deepti George & Nikhil John have authored a chapter titled “Investing in the Transformation of Financial Access in India”. In the chapter the authors lay out the financial access scenario in India and provide a perspective on the innumerable challenges that a well-functioning financial system can effectively mitigate for India’s individuals, households, enterprises and local governments and IFMR Holdings role in addressing it. Through the chapter they highlight the underlying core philosophy that drives all our efforts and the work of each of our entities towards our mission of ensuring that every individual and every enterprise has complete access to financial services.

You can read the full publication here and the particular chapter here.


NBFCs’ Collection Efficiency Takes a Hit Post Demonetisation

By Bindu Ananth & Kshama Fernandes

Non-banking finance companies (NBFCs) represent an important linkage between the formal banking sector and informal segments of the real economy in India (wage labourers, smallholder farmers, unorganised retail, and domestic workers) through the channelling of credit from the former to the latter.

They have a significant presence in the microfinance, small business finance and commercial vehicles finance segments. Of the 11,682 NBFCs registered with the Reserve Bank of India as of end-March 2016, 209 were systemically important non-deposit taking NBFCs which are subject to more stringent prudential norms and provisioning requirements. Loans & advances by these entities alone accounted for around Rs 10.7 lakh crore. Through the data lens of collection efficiencies and disbursement volumes of over 100 NBFCs, we take stock of the impact of demonetisation on them. This also provides insights on the ultimate impact on the informal economy in India.

From November 9 onwards, NBFCs were not permitted to accept repayments in Rs 500 and Rs 1,000 denomination notes. Given the lack of access to bank accounts, most NBFCs accept repayments in cash from their customers. The average collection efficiency of microfinance NBFCs was 99.02% for the 12 month period preceding Nov 16. As of end November, collection efficiencies dropped significantly for these NBFCs and ranged from 60% to 90%.

Vehicle finance NBFCs reported a collection efficiency ranging from 60% to 70% with a higher cheque bounce rate and reduced overdue collections. Vehicles engaged in the movement of goods/ passengers which are “discretionary” witnessed an increase in idle time of 15-20 days a month from the normal levels of 8-10 days. Nondiscretionary goods, including agri produce and dairy, witnessed a lower impact.

Small business lending NBFCs reported a collection efficiency ranging from 65% to 85% with entities lending to small manufacturers and traders being at the low end of the range. Informal salaried customers have been as affected as self-employed customers with collection efficiencies of around 70%. This is true across urban and rural locations. In the affordable housing finance segment, collections continue to hold strong. These are largely selfoccupied homes. LTVs in this segment are much lower and reflect significant borrower equity in the asset. The norm for fixed obligation to income ratios in the informal segment is significantly lower and may provide a reasonable cushion to absorb short-term cashflow shocks.

Many microfinance NBFCs had put disbursements on hold for all of November 2016 and are now restarting disbursements gradually. Some restarted disbursements partly from their own collections. In the vehicle finance segment, disbursements are at 50-60% of normal levels on account of the slowdown in demand. Fresh disbursements in the small business lending segment have almost stopped with fresh logins dropping to 25% of the normal monthly volumes. Overall, disbursements have been affected also due to shortage of currency in the banking channel and a weekly cap on cash withdrawal. Going forward, we also expect an impact on disbursements in used vehicle finance due to the anticipated crunch on margins for fresh borrowing by the end-customers.

In pockets of UP and Maharashtra, demonetisation has fuelled some political risk factors in the form of demand for loan waivers by local politicians. This needs to be tracked closely and prevented from escalating by local offices of the RBI and the district administration. Going forward, NBFCs will need to re-engineer operations to significantly move away from cash collections. The task of opening bank accounts with full functionality for rural customers is far from complete. The availability of payment mechanisms such as the Unified Payment Interface (UPI) on feature phones will greatly help this category of customers from the advances in this area. There is also a need for a sharp increase in cashin/cash-out points, particularly in remote rural India to facilitate ease of transactions as the progression to cashless/ less-cash economies will take time.

The disruption will have a marginal impact on profitability of NBFCs due to foregone disbursement. We want to share our concerns on the negative liquidity and income impact on customers of these NBFCs which may not show up in collection data of lenders. Salaried workers in the informal sector have been hurt through delayed payment of wages and self-employed workers have seen significantly lower business volumes. Disruptions in credit impact consumption for low-income households in terms of reduced expenditure on essential items such as food and health. There could be a possible loss of trust in formal financial institutions. We need to work hard to restore an environment that will ensure predictability and credibility of these institutions among this large segment of India’s working poor.

This article first appeared in Economic Times.


In the Eye of a Cyclone

By Sucharita Mukherjee, IFMR Holdings

Even as the city of Chennai was grappling with the after-effects of the devastating floods of December 2015, exactly a year later, Cyclone Vardah unleashed its fury, leaving behind a trail of destruction and devastation. At least 16 lives have been lost and more than 12,000 trees have been uprooted due to heavy winds.

The impact has significantly hit the agricultural sector, destroying banana plantations, papaya groves and paddy-fields, causing widespread damage worth up to $1 billion, according to Assocham estimates. An estimated ₹1,000 crore was lost on a single day owing to the unscheduled closure of businesses across the State.

Need for protection

img_cycThe threat of natural calamities looms large in nearly 60 per cent of the Indian subcontinent today, with as many as 38 disaster-prone cities/towns. While little can be done to prevent natural disasters such as cyclones or drought, we can be prepared to mitigate their effects and minimise losses to a great extent.

Catastrophes such as drought, floods and earthquakes not only impact the economy of a nation but also affect the very subsistence of poor and vulnerable communities. Typically, it is the low-income households that are particularly susceptible to the risks. With little or no insurance on their assets and their livelihoods in particular, they have nothing to fall back on. The urgent need is to build catastrophe risk protection markets in India, so that households can manage risks and rebuild their lives and businesses in the aftermath of natural disasters

Natural calamities can severely impact physical assets such as farmland, crops, commercial vehicles, shops, livestock and other sources of livelihood of low income households, in addition to affecting power, transport and communication infrastructure. To make it worse, families incur exorbitant hospitalisation expenses due to injuries and death. The destruction of homes further impairs the household’s ability to use the asset as collateral for emergency loans or to revive other income generating assets.

Over the past decade, local financial institutions or ‘originators’, such as microfinance institutions (MFIs), have played an important role in providing access to finance to nearly 35 million low-income customers. But when it comes to protection against calamities, households in earthquake or flood-prone areas of the country are generally financially excluded by lenders owing to higher risk. For the few who do operate in the areas, a single catastrophe has the potential to erode a significant portion of their networth. The absence of catastrophe risk mitigation products forces the originators to self-insure by either bearing the risk themselves or geographically diversifying. This, however, is not always feasible given that even some of the largest and most diversified originators in the country have 30 to 50 per cent of their capital at risk to a single district.

When cyclone Phailin hit Odisha in 2013, flash floods destroyed large swathes of farmland, the primary source of livelihood for many low-income households. In the days to follow, loan repayments to local originators were affected severely due to hampered communication and heavy rains. Had catastrophe risk insurance been available to MFIs in the area, households would have been able to avail themselves of moratoriums for their existing loans or emergency liquidity support required to rebuild their livelihoods.

Catastrophe risk insurance transfers the risk from the household to local insurers either directly or via an originator like an MFI or a small business lender. It is similar to a typical insurance product where the premium is paid by the household in exchange for the cover. When calamity strikes, the insurance provider pays either the loss amount or a pre-agreed amount of compensation to the household. If the insurance cover is at the originator level, the premium may be priced into the financial services they provide and the household may receive an insurance linked payout or better loan pricing. Households could also receive loan moratoriums or credit access in areas that the originator would typically not service. The local insurers can then transfer part of the risk to re-insurers who benefit from the ability to pool risks across households in different geographies. Re-insurers are also able to further de-risk their portfolio by issuing Insurance Linked Securities (ILS), also known as cat bonds, to the capital markets.

Protective gear

Globally there are many products, public, private and via public-private partnerships, that exist to protect against the risk of catastrophes. In 2007, CCRIF or Caribbean Catastrophe Risk Insurance Facility was the first multi-country risk pooling facility, established by the Caribbean governments, to provide quick short-term liquidity to limit the financial impact triggered by a hurricane or earthquake. The idea came from the devastating impact of Hurricane Ivan in 2004 which caused losses in Grenada and the Cayman Islands amounting to 200 per cent of the national annual GDP.

Since inception the facility has made 13 payouts totalling over $38 million to 8 member governments for hurricanes, earthquakes and excess rainfall. In 2012, a bank in Peru purchased an insurance product to protect 3,560 agricultural loans of their farmer clients worth $27.3 million against the extreme weather phenomenon El Niño. Subsequently, late last year, the Peruvian government established a catastrophe insurance facility to protect 5,50,000 hectares of crops against El Niño that protects against losses up to $156 million. Ghana has a 2011 drought index insurance to cover all the growing stages of maize. Mongolia has an index-based livestock insurance programme that protects livestock against particularly strong winters. Of the 14,000 policies sold in 2009, local insurance companies made payments to all 2,117 herders eligible after the qualifying harsh 2009-10 winter.

The market for catastrophe risk insurance has matured in more developed financial markets, growing from $700 million in 1997 to $15.4 billion in 2012. However, the ILS market is dominated by catastrophe bonds that cover risks from North and South America. Not even 1 per cent of the market covers South Asia. The opportunity this presents is that cat bond issuances covering South Asian catastrophe risk clearly offers diversification in a global catastrophe risk market dominated by the Americas and the Pacific.

Understanding the geography

One of the key principles is that geographically specialised local originators that have a deep understanding of the customer base and the regions they serve can better help achieve the national goal of complete financial access. Currently, the risks they face in geographical areas vulnerable to catastrophes are increasingly too large to justify entry and even for the less risk-averse ones that do, the catastrophe risk may impact their survival as well as that of the households they wish to serve.

India’s 7,500-km long coastline poses multiple threats in the form of floods, cyclones, tsunamis, to millions of people living along the coastal areas. As we battle the adverse effects of climate change, our sensitive ecosystem faces further imbalance with 57 per cent of our land prone to earthquakes and 12 per cent vulnerable to flooding hazards. Given this context, building robust catastrophe risk protection markets, an important missing piece of market infrastructure, would undoubtedly benefit the whole economy.

Building resilience, where it matters the most, is particularly critical to making the road to recovery a less rocky path and ensuring that the BOP population which forms a significant part of our economy’s backbone can bounce back. The storm must not last forever.

This article first appeared in The Hindu Business Line.


Financial Inclusion: Indian Women Have Something to Bank On


By Bindu Ananth and Amy Jensen Mowl, IFMR Finance Foundation

For the first time, the majority of Indian women have been financially included. Fresh data show that the proportion of Indian women with individual accounts in formal financial institutions (primarily banks) reached 61% in 2015, a sharp increase from 48% in 2014, lagging men by only eight percentage points. A close look at these numbers reveals opportunities and challenges to build on this quiet, and important, victory.

The Intermedia India Financial Inclusion Insights (FII), an annual, nationally representative survey, confirms that both individuals and households show growth in bank registration, largely driven by the government’s Pradhan Mantri Jan Dhan Yojana (PMJDY) and its emphasis on individual accounts (rather than household). By capturing demand-side data from individual citizens, the FII survey found that overall individual bank account ownership in India increased from 52% in mid-2014 to 63% in mid-2015. While the survey shows growth in financial inclusion for all adults, the gains were the highest in rural areas and for individuals below the poverty line, and, most of all, women. These encouraging numbers suggest financial inclusion is widening to reach the most vulnerable adults in India. Additionally the gender gap has decreased, as Indian men experienced an increase of nine percentage points, from 60% to 69% in the same period. These data mirror other recent studies such as Anjini Kochar’s finding that business correspondents (BCs) have increased the savings of both landowning and landless households in India; with the savings of the landless increasing more than those of landowning households. She explains this difference in terms of the fact that access to a BC increased the wage income and hours of work of landless households, particularly those of women, a likely consequence of the tie-up between the financial system and the MGNREGA.

So, what does this mean for the broader pursuit of economic empowerment for women in India? Does account ownership translate into broader economic and social gains? We looked at evidence from multiple studies and the conclusions are clear — women and their families benefit greatly from individual account ownership. Esther Duflo’s study of South African pensions reveals that when the pension recipient is a woman in the household, it translates into strong health effects for girls in the family. Pascaline Dupas, in her work in Kenya, shows that access to fairly simple savings tools has a significant impact on health-related investments of families. Silvia Prina, in a randomised experiment in Nepal, offered flexible savings accounts to female-headed households with no opening, deposit or withdrawal fees. After one year, the study found that 80% of those offered the account opened one and used it actively. After one year, household assets had increased by 16%. All these studies strongly suggest that the gender of the account-holder matters and drives differential outcomes for the family. As a universally targeted programme, women’s empowerment and economic inclusion were not direct objectives of the PMJDY. But the programme design of targeting individual accounts, and the disproportionate impact this focus has on women’s empowerment and economic inclusion, may prove to be one of the PMJDY’s most lasting and transformative features.

This remarkable achievement for women should now be extended to the remaining 39% of them. This will require commitment to implementation, quality of service, and a willingness to look beyond one-size-fits-all solutions in addressing the diversity of women’s financial needs. For women, some of the features valued most in formal accounts are trust, privacy, and security from theft and harassment. When providers do not treat their customers in a fair manner — particularly low-income customers and women — trust in financial services is eroded. Experience has shown that efforts such as the “no-frill accounts” were abandoned by clients when payments were not received in time, and customers lost confidence in their financial providers. In the FII data, PMJDY holders reported experiencing issues with transactions and account terms. Specifically, they were more likely to complain about banks deducting fees without informing them, and a decrease in available account funds due to mishandling or fraudulent activities. A commitment to customer protection in implementation, and thinking through women’s needs at all stages, are one way to ensure sustainable growth and outreach.

In addition, while technology and digital finance offer a promising solution to some of the traditional physical and other access barriers to extending financial inclusion to all of India’s women, women face a stark “digital divide”. To date only 44% of women — compared to 75% of men — own an individual mobile phone, and the simple difference between owning a phone and being able to “borrow one” plays a significant role in women’s technological skills development and privacy in financial transactions.

Ensuring that first-time users learn that banking is an experience of convenience and trust, and recognising the diversity of needs of Indian women in accessing financial services are the only ways to continue the remarkable trajectory of financial inclusion for women. We must build on this success to extend the gains to other important financial services such as insurance and credit. In this same FII survey, only 15% of women reported having a financial plan for unexpected events. Inability to deal with these events can be devastating for women and their families.

This article first appeared in Hindustan Times.