23
Nov

Structuring a Fund Platform for Financial Inclusion in India

In the latest edition of Securitisation & Structured Finance Handbook 2016/17 (published by Capital Markets Intelligence) Ravi Saraogi, IFMR Investments & Robin Tyagi, IFMR Capital, have authored a chapter on Structuring a Fund Platform for Financial Inclusion in India. The authors present the use of structured finance in designing a fund platform for greater capital market access for financial inclusion in India and highlight the potential that structured fund platforms have in attracting market participants to access the bond market.

Abstract:

This paper presents the design of a fund platform using principles of structured finance to enable greater capital market access for financial inclusion in India. A structured fund platform can tide over a tepid bilateral bond market and match the needs of investors and investees more efficiently. Central to the designing of a structured fund platform is quantifying the default risk in such structures. Accordingly, the paper specifically focuses on using the technique of Monte Carlo simulation to estimate risk. The results highlight the potential that structured fund platforms have in aligning disparate investor and investee needs. The paper has been divided into five sections. The first section gives an overview of the bond market in India. In the second section, we emphasise on the need for a structured finance approach to tide over frictions in capital markets. The third section provides the broad construct of the fund structure used in this paper to illustrate the methodology for risk estimation in fund structures. The fourth section gives an overview of the rating methodology used. The last section presents the output and concludes.

Click here to download the paper.

3
Oct

Financial Inclusion: Indian Women Have Something to Bank On

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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.

26
Sep

The Nexus of Financial Inclusion and Stability: Implications for Holistic Financial Policy-Making

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Guest Post by Dr. Martin Melecky, Lead Economist, South Asia Region, World Bank

Both financial inclusion and financial stability are high on international policy makers’ agenda. For instance, the G-20 has called for global commitments to both advancing financial inclusion (the Maya Declaration and the Global Partnership for Financial Inclusion) and enhancing financial stability (the Financial Stability Board, Basel III Implementation, and other regulatory reforms). One challenge is that there can be important policy trade-offs between the two objectives.

A rapid increase in financial inclusion in credit, for example, can impair financial stability, because not everyone is creditworthy or can handle credit responsibly—as illustrated in the last decade by the subprime mortgage crisis in the United States and the Andhra Pradesh microfinance crisis in India. In addition, trade-offs between inclusion and stability could arise as an unintended consequence of bad or badly implemented polices.

At the same time, there may be important synergies between inclusion and stability. For example, a broader use of financial services could help financial institutions diversify risks and aid stability. Similarly, financial stability can enhance trust in financial systems and the use of financial services. It follows that understanding the synergies and trade-offs is paramount for policy makers who strive to advance financial inclusion and stability in tandem.

When evaluating financial sector outcomes, and prioritizing the design and implementation of alternative financial policies, policymakers could miss important aspects by ignoring the interactions between financial stability and inclusion. To illustrate this point, it is useful to consider the following intuitive framework:

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Deploying policies to achieve financial stability and policies to achieve financial inclusion may not deliver the intended results if there are major tradeoffs between the two outcomes. But if the deployed policies can generate synergies between inclusion and stability, mutual reinforcement of the two goals can occur. The last term in the equation above highlights the possible interdependence between inclusion and stability, which can thus either add or subtract from the independent goals of stability and inclusion. While most studies and policies have typically focused on either achieving the outcome of stable or inclusive financial systems independently, limited attention has been paid to the interdependence between the two outcomes.

In a recent paper, Cihak, Mare, and Melecky examine a wide array of measures of household and firm inclusion to estimate an overall tradeoff between financial inclusion and stability. They find that, particularly for individuals, the use of financial services is negatively correlated with higher bank capitalization. Moreover, there is a positive correlation (tradeoff) between many inclusion indicators and the costs of banking crises. Greater financial inclusion (increase in account ownership or debit card penetration) is associated with more costly financial crises (output and fiscal costs, as well as the peak NPL ratios during crises).

Interestingly, synergies between inclusion and stability are almost equally probable as tradeoffs—as indicated by the two-peak (bimodal) histogram or correlations in Figure 1. Dissecting financial stability into resilience measures, volatility measures, and crises measures reveals that financial inclusion can help mitigate volatility of growth in bank deposits and the volatility of bank deposit rates. While financial inclusion of individuals, such as account ownership, use of electronic payments, formal savings and credit, help reduce the volatility of bank deposit growth and bank deposit rates, savings by firms can help enhance financial stability across all three dimension: resilience, volatility, and low probability and cost of crises.

Figure 1: Although tradeoffs between financial inclusion and stability prevail on average, synergies between the two outcomes could arise with almost equal probability

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The relationship between inclusion and stability is systematically influenced by country characteristics, such as financial openness, tax rates, education, informality, population density, and the depth of credit information systems. While financial openness and formalization of the economy increases tradeoffs between inclusion and stability, low tax rates, education, and credit information depth help generate synergies between the two goals (Figure 2).

Figure 2: The inclusion-stability nexus is systematically influenced by country characteristics

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Greater financial openness and movement of capital is particularly challenging in middle and low income countries, which tend to have a limited capacity to manage capital flows and ensure prudent and efficient allocation of the funding to creditworthy firms and individuals.

Countries with higher informality, as measured by the number of years firms operated without formal registration, experience a lower tradeoff between financial inclusion and stability. A potential explanation is that previously informal firms that enter the formal sector tend to be greater risk-takers. Being higher risk-takers may have allowed these firms to earn higher returns to pay for more expensive informal credit. Because risk appetites are unlikely to change fast after becoming formal, rapid increases in credit to previously informal firms that enter the formal sector should be monitored for potential threats to financial stability.

Low tax rates may generate synergies by stimulating precautionary savings due to smaller social safety nets and greater probability of unexpected increases in taxes. Education can generate a positive relationship between inclusion and stability by improving financial literacy and responsible financial inclusion that helps the financial system reap the benefits of economic scale and risk diversification.

The depth of credit information systems generates synergies by improving screening of creditworthy customers, including new users of credit, and aids stability by, for example, improving the accuracy of estimations of expected losses. Finally, greater information depth also promotes competition in oligopolistic markets, decreases the cost of finance, and encourages more firms and people to start using a financial service or use more than one financial service. Particularly if financial policy focuses on advancing the financial inclusion of individuals, complementary policies to deepen credit information systems could help mitigate the estimated tradeoffs with financial stability.

These findings have important policy implications. Because tradeoffs and synergies between financial inclusion and financial stability are significant, they need to be addressed in policymaking. In many countries, multiple government agencies (in many countries the central bank and other financial supervisors) and ministries (in many countries the ministry of finance, economic development, or strategic planning) are responsible for policy on both financial inclusion and financial stability. Therefore, the tradeoffs and synergies must be addressed at a high enough policy-making level to ensure effective coordination. One important tool to formulate high-level policy for the financial sector are the financial sector strategies that could be exploited for that purpose (Maimbo and Melecky, 2015).

12
Sep

IFMR Capital: The Money Conductors

The latest edition of the Forbes India magazine features a cover story on IFMR Capital. The story traces the origins of IFMR Capital, its evolution over the years and how its work is translating into financial access for high-quality partner originators that it works with.

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It is our mission to reach out to Indians who find it difficult to get a housing loan or a business loan because they are not part of the formal system. Banks and financial institutions that have the capital do not understand these segments. Our job is to bring in capital to originators who provide finance to informal sectors,” says Kshama Fernandes, managing director and CEO, IFMR Capital.

Over the last eight years, IFMR Capital has facilitated capital to the tune of around Rs 30,000 crore to 100-odd originators, serving 25 million end borrowers.

Read the article here.

5
Jul

How Do India’s Payments Banks Measure Against Key Principles for Financial Inclusion?

Guest post by Liliana Rojas-Suarez, Center for Global Development

Only about half of Indian adults have access to an account of any kind. The number is even lower for the poorest 40 percent (World Bank, Global Findex 2014). Furthermore, there are only 13 commercial bank branches per 100,000 adults (IMF, Financial Access Survey 2014). Keeping in mind the low levels of financial inclusion in the country, the Indian authorities have developed a broad strategy to improve access to financial services, as outlined in the report by the Committee on Comprehensive Financial Services for Small Business and Low Income Households, led by Nachiket Mor. Among the committee’s recommendations, payments banks are one innovative tool to further India’s goal of greater financial inclusion.

Payments banks are different from regular banks. They can only accept deposits up to Rs. 1 lakh per person, roughly $1500, and cannot grant loans. Furthermore, payments banks can only invest their money in safe government securities and other highly liquid assets. Their primary objective is to further financial inclusion by providing access to small savings, payments and remittance services to low-income customers without compromising financial stability. By leveraging technology and tapping into their large networks, these banks might potentially allow millions more people, many in remote corners of India, to operate bank accounts, with often very small sums of money. In August 2015, the Reserve Bank of India (RBI) granted “in-principle” licenses to eleven entities to launch payments banks.

While it is too early to assess results, as these banks are not operational yet, a valid question is whether the regulations governing these payments banks are consistent with fundamental regulatory principles for improving financial inclusion while protecting financial stability and integrity. To answer this question, I compare key characteristics of the payments banks against major recommendations in the recently released report, Financial Regulations for Improving Financial Inclusion, by the Center for Global Development (CGD), a Washington-based think tank. Prepared by a high-level Task Force, the report advances three major recommendations (among others) for expanding financial inclusion in a safe and sound manner:

  • Encourage competition by allowing new and qualified providers to enter the market
  • Create a level playing field between different providers by making the regulatory burden proportional to the risk posed by providers to individual customers and the overall stability of the financial system
  • Apply risk-proportionate Know-Your-Customer (KYC) rules to balance financial integrity and financial inclusion

How do India’s payments banks measure against these recommendations?

Enhancing Competition Among Providers of Financial Services

Payments banks certainly encourage the entry of new, qualified and innovative players. The entities licensed to become payments banks encompass a broad range of sectors, including telecommunications, finance and banking, IT, and postal services. The first payments bank is expected to be operational by the end of this financial year.

The licensing of payments banks is contingent upon various players meeting the appropriate entry criteria. The approved entities need to have a solid track record and ability to conform to the highest standards of service. More details about the licensing process can be found here. A thorough regulatory and licensing regime is crucial for financial stability. After all, India’s experience with expanding rural banks in 1976 without a proper regulatory framework ended in huge losses in 1991. India’s clear licensing requirements for payments banks are consistent with the CGD report’s recommendation to encourage entry of a wide variety of qualified providers of financial services. Of course, given the restrictions on payment banks’ activities, the implications of “fit and proper” are quite different for these banks compared to traditional banks.

Leveling the Playing Field Between Providers of Financial Services

Since payments banks do not undertake credit risk, the RBI has stipulated a minimum capital requirement of Rs. 100 crore ($15 Mn) for payments banks (among other requirements), unlike traditional banks that must meet a capital requirement of Rs. 500 crore ($75 Mn). As these payments banks assume lower risk, it only makes sense that they have to carry a lower regulatory burden.

However, if the entities licensed to become payments banks wish to expand their activities beyond those allowed for payments banks, they would need to be licensed to become full-service banks. Similarly, if the payments bank reaches a net worth of Rs. 500 crore and becomes critical to the stability of the financial system, diversified ownership will be mandatory within three years. Such a risk-based approach is essential to ensure a balance between fostering innovative financial services and ensuring the safety and soundness of the financial system, as recommended in the CGD report.

Applying Know-Your-Customer (KYC) Rules

India has already encouraged improvement in financial access as well as up-take of national ID (Aadhaar) by allowing people to open restricted bank accounts subject to later showing proof of identity. These restricted bank accounts have limits on balances and activities. Similarly, simplified KYC requirements would be applied to “small accounts” transactions through payments banks. Payments banks are expected to encourage the expansion of these types of “small accounts” through their extensive networks. Furthermore, Aadhaar will play a key role in facilitating the take-up of “small accounts” with simplified risk-based KYC processes, as recommended in the CGD report.

While there is no one-size-fits-all solution to improve financial inclusion, there are important lessons to be learned from India’s step to approve payments banks. After India’s previous experiments with different efforts to improve financial inclusion, payments banks offer one promising way towards better financial access. India’s forward-looking vision to leverage digital finance combined with innovation-friendly regulations could pave way for a bright and safe future for payments banks.