India: On the Path to Financial Inclusion

For any country’s socio-economic parameters to progress sustainably, it demands an efficient financial system that can mobilize savings and allocate it efficiently for productive investments. My experience of working in various financial services companies taught me the foremost financial needs demanded by (a) the upper-income people is choice, i.e. choice of types of products, often with innovative features which gives HNIs something new to talk about, (b) the middle-income people is planning, i.e. a financial plan to allocate their hard-earned savings in a way that they are able to beat inflation in the long-term, and (c) the lower-income people is credit, i.e. small-ticket credit to raise working capital for self-businesses, since wage-based job opportunities may be unevenly spread across regions of the country. Each of these three segments needs to deepen financial inclusion in their own way for their economic progress, and these three needs are critical to achieve that!
Let us start with lower-income people, most of whom are yet to enter into financial services. While India has been a savings-oriented society (with a gross savings to GDP ratio in early-30%) and has better-developed financial regulations, it is highly concentrated. Large swathes of people are yet to benefit from this system. It is essential that each person accesses this, so that a broader base of population gets the benefits of India’s growth. Otherwise, economic distress will remain as a cause of migration and socio-economic imbalances a cause of crime.
Both supply and demand have a role here. On the supply side, steps have been taken to increase the penetration across the country. In banking, the government pushed retail branch presence and banking-correspondents across the hinterland.  It has set up service-centers across India to help people with digital payments. Centralized banking was implemented years ago, enabling location-agnostic access. In lending, incentives have been given to the broader population via interest-rate subsidies on small-ticket home loans. Incentives in cash-credit limits are given to MSMEs, as they employ a large portion of our population. Since many households save in gold, gold loans gave the ability to raise credit. In investments, it allowed mutual funds to charge an additional expense on assets mobilized from towns beyond the largest 15 cities. Bank staff got targets to promote deposits as a product. In short, various steps have been taken to boost the supply of financial services for a broader base of population, and continued investments in these will help ensure raise penetration levels even further. But supply aside, demand remains a challenge!
On the demand side, acceptability is the issue for this segment. Rumour-mongering against banks by dubious money-lenders and chit funds impacted the acceptability of banks amongst bottom-of-the-pyramid people. RBI data shows two-thirds of Indian household savings is in physical assets, while only one-third in financial assets, within which 90% is in bank deposits or life insurance alone. Moreover, as much as 36% of bank deposits comes only from the four largest metro cities, showing the rest of the country saves far less. A reason has been acceptability. Reversing this will need continued education and awareness drives, and punish exploitative and fraudulent conmen. The country is seeing efforts. The government has invested in financial awareness. Companies are investing in financial education through CSR. Targets to bank staff to raise bank-deposits are under focus. The law authorities are acting against wrongdoers. Continued efforts in these directions will help channelize the monies into the banking system, at least where penetration has reached. Not falling prey to fraudsters and exploitative lenders has a social dimension, as much as economic. Local money-lenders are notorious for exploiting peoples’ compulsions, making them think they have no other option. Educating people that they have better options is an imperative to push acceptability. As their monies enter the banking system through liability products, their ability for asset products also improves. Many lower-income people do not have credit histories, more so as many rarely use banks as a habit. Once they are shown the benefits of banking habits, they can get better access to credit; which is cheaper than the loans they otherwise take from local money-lenders. It is this credit that this population segment needs to boost its economic activity and financial inclusion, and thus create progress by enhancing their incomes!
Let us turn to middle-income people, most of whom entered financial services but are yet to benefit in real-terms. As per RBI data, the average Indian wallet grew poorer from 2008 to 2014, as the differential between the YoY change in India’s Per Capita NNP and the YoY change in Consumer Inflation moved south. While the last two years saw macros improve, real income does take a hit if economic conditions are not supportive. Moreover, wealth became concentrated; a Credit Suisse report showed the Top-1% of India’s adults held 58% of its wealth, up from 36% in 2000. While the impact on specific segments of society differs based on incomes and demand basket, it is imperative people make their savings work in real-terms, by planning appropriately.
Why this matters to the middle-class the most relates to economic theory. Lower-income people stop consumption or move to inferior-quality products if inflation or income becomes adverse, shifting their demand curve entirely. Higher-income people have better cushion to withstand shocks, or may use channels not easily accessible to the broader population to enhance their situation, like investing offshore. Middle-income people neither want to change their consumption pattern significantly as it means forgoing the quality of lifestyle, nor have easy access to other investment channels. Most of their expenses are non-discretionary, which offers limited room for cutting spending; as compared to discretionary items. If their real income is moving south, it is imperative they plan so that they earn inflation-beating returns and maintain their real-income.
Planning for inflation-beating returns means financial inclusion through advice on products other than vanilla bank deposits. Many middle-class people in India still associate investments with only bank deposits, that too in savings deposits whose average rate has been less than inflation for years. Even fixed deposits have seen interest rates below the inflation at times between 2008 and 2014, a reason why inflation-beating investments is critical. Within financial savings, while bank deposits are a good way to start financial inclusion, it isn’t sufficient. Other than some allocation for liquidity and safety, additional allocation should be spread in products which are capable of earning better risk-adjusted returns than inflation. Other favourite avenues like property and gold are seeing limitations. Property prices have shot up rapidly in the last decade, rendering many unaffordable. Affordable housing finance companies may favour clients buying to reside, rather than invest. Gold remains highly volatile. The rationale of savers to depend on these avenues alone to meet inflation-beating returns looks limited, and there is a strong case to turn to products to meet this need. Retirement products are a case in point. This is where planning plays a role. Planning gives them advice on what combination of products to invest based on their profile and risk appetite. That can further deepen financial inclusion. It is this planning that this segment needs to enhance their returns in real-terms, and thus create progress by enhancing their purchasing power.
Let us move to the upper-income people, most of whom have sophisticated financial investments but are hungry for the next new thing. These people already have a level of financial inclusion, both in asset and liabilities. They have investments in several types of financial products, and taken various types of credit. The range of products in their portfolio may be wide, depending on their sophistication.
But one can still go deeper into this segment. Their absolute net worth is growing due to multiple income channels, plus most of this additional income is available for discretionary spending. The incremental disposable resources each year that can be channelized into financial products can be significant, and a financial company may never have enough market share of one client. There is always scope to deepen the relationship further, and intensify financial inclusion into sophisticated products in the process. The crux is – what would push a high-end client to invest repeatedly? The answer is Choice! Choice in terms of product, choice in terms of product manufacturer, choice in terms of underlying securities it has exposure to, choice in terms of structuring, choice in terms of geographie, choice in asset allocation, etc. This choice gives the client something new to talk and get excited about! It satisfies his natural itch to see a new thing. He may give you meeting-time only if you can capture his interest with innovative choices, not vanilla options.
So how does this connect with the objective of deepening financial inclusion for economic progress? First, his portfolio grows with investments in more products, which gets channelized into the economic system the way it is for every other population segment. But more importantly, it is creating a demand for a more developed and vibrant financial structure. This is critical because as people progress in their lives and move up the ladder, like from middle-class to upper-class segments, the demand for more sophisticated products will increase and there has to be a large enough industry to cater to it. Financial inclusion is a cycle, and there must be adequate capacity to feed that cycle sustainably. That supply is a push towards economic progress. Moreover, as the local financial industry develops, it gives a push to local talent, and not just depend on managers sitting in Singapore or Hong Kong or London. India has seen this movement in the last couple of years, as a number of foreign-owned asset management companies set up shop in Mumbai or Bengaluru with Indian fund managers, rather than abroad with foreign talent. That is another push towards economic progress. Last, it gives a rationale for the HNI to invest his incremental monies domestically, instead of offshore accounts; which has caused concern in many developing countries. That is another push towards economic progress. Thus, it is choice in new, innovative and sophisticated products that this segment needs to deepen their relationships, and thus create economic progress.
In conclusion, as India’s GDP rises, it will open up further opportunities for financial services through banks and capital markets. Efforts to build advisory, manufacturing and distributing capabilities will feed the supply side for financial inclusion, across these three segments for their specific needs. Efforts to build awareness, education and marketing will feed the demand side for financial inclusion, apart from broader-based economic growth pushing incomes for more Indians. The scope for deepening the penetration of financial services across the length and breadth of this country is immense. Banking penetration is about 60%, mutual fund penetration is about 10% and broking penetration is about 2%. With the current government making the right noises about furthering the economic development agenda, it may be an opportune time to deepen economic progress for its people through more financial inclusion!
Image Courtesy: Omidyar Neywork
Originally published here –

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