7
Jun

Aadhaar’s Potential for Financial Inclusion

By Bindu Ananth & Malavika Raghavan, IFMR Finance Foundation

We should care deeply that millions of Indians are still turning to expensive informal financial services in the face of seasonal and volatile incomes, despite years of trying to improve access to basic financial services. Any innovation with a promise to provide disruptive solutions deserves careful attention and a concerted effort to ensure success. It is in this spirit that we approach the Aadhaar debate.

Test and learn—but then evolve

For years, our country’s financial inclusion strategy tried to expand access by opening more bank branches. One reason this has not scaled is because providers face high operating costs for “low-value” services, driven in part by physical “know your customer” (KYC) procedures and paper-based verification of transactions. Previous work by our colleagues Anand Sahasranaman and Deepti George showed that the cost of delivering a rural loan of Rs10,000 through a branch could be Rs4,153 (41.53%) for a public sector bank and Rs3,207 (32.07%) for a private sector bank.

Aadhaar and IndiaStack have held out the promise of overcoming these costs using technology—through e-KYC for users, remote verification of transactions and lowering transaction costs of payments. Taken with other inclusion efforts, we are within striking distance of every Indian having access to a bank account and being able to easily send and receive payments. Not a panacea by any means but a definite milestone for inclusive development.

However, we have also arrived at an inflexion point for the unique identifier (UID) system. If the first part of the task for this system was about technology implementation, now it faces an important next step—creating trust and confidence in that technology and the institutions that administer and oversee Aadhaar. We must have the openness and the humility to leverage the potential of Aadhaar to deliver access to basic services while continuing to work on gaps and weaknesses, some of which we will only learn as we go.

Improving protections for users

We have some specific suggestions that need immediate attention with respect to financial service providers, the Unique Identification Authority of India (Uidai) and users, when considering Aadhaar and its use in digital financial services.

We must make providers liable to put customers back “in the money” for failed/unauthorized transactions: it is important that the users of Aadhaar-linked accounts and Aadhaar-enabled payment processes do not bear the costs of failures in this system as the volume of digital payments increases. The Reserve Bank of India (RBI) has taken the right steps by releasing a draft circular on limiting liability of customers in unauthorized electronic banking transactions. We need to move this into live regulation and extend it appropriately for non-bank providers and third parties.

Over 1.15 billion Aadhaar numbers are now in existence. Such a massive public database containing citizen information needs clear audit and accountability procedures.

We should support an independent observatory to monitor Aadhaar-based transactions: more hard data about the successes and failures of Aadhaar-based transactions will help drive an informed discussion about the system’s efficacy. An independent body monitoring Aadhaar transaction failures and user experiences, and publishing this data periodically, could be a strong accountability mechanism and improve Aadhaar.

We need a “living will” for Uidai: in large-scale projects of this nature, it is helpful to think about worst-case scenarios. In the banking world, “living wills” have been an interesting policy tool to force systemically important institutions to lay down their game plan in the event of bank failure. Similarly, no matter how improbable it might seem today, it would be useful for Uidai to lay out a plan to deal with a severe security breach.

We also need to reform the Aadhaar redress mechanism: currently, we have an opaque redress and complaints system at Uidai, especially a concern since the Aadhaar Act empowers only Uidai or its officers to initiate proceedings for disclosure or misuse of users’ information. Renuka Sane and Vrinda Bhandari’s writing addresses these lacunae clearly. We need a new framework and investment to set out accountability, reporting and performance expectations of Uidai on the Aadhaar grievance process.

We need market conduct oversight for data use by firms across the financial sector: in addition to stronger data protection laws, we need active oversight for firms using personal data. This applies more widely to the financial sector, but we highlight it in this discussion since Aadhaar-seeding of bank accounts is rising, requiring enhanced monitoring to prevent risks, and as more financial firms use IndiaStack as authorized user agencies. We must actively supervise how these firms and government use the Aadhaar system in conjunction with other customer data they hold.

We need to protect the privacy of all residents of India across all platforms, including Aadhaar: the idea that poorer people are less entitled to privacy should be dispelled. Compromising financial privacy could set back wider financial inclusion efforts, if improper disclosure of data leads to denial of credit or reputational harm. This issue goes well beyond Aadhaar, but the ubiquitous use of the Aadhaar number, including for finance, makes this more pressing.

To conclude, a project such as Aadhaar with implications for transforming service delivery must be strengthened in specific ways discussed here so that confidence and trust in the system grows.

This article first appeared in Livemint.

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

fi_031016_1

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

img_260916

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:

figure_260916

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

figure1_260916

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

figure2_260916

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.

capital_forbes

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.