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A big step forward in India’s financial inclusion deliberations

Posted on by MSC

(This guest post is originally published at IFMR Trust).

India faces a major financial exclusion challenge. According to the 2011 World Bank Global Findex Survey, only 35% of Indian adults have access to a formal bank account and 8% borrowed formally in the last 12 months. The Reserve Bank of India (RBI) Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (or “CCFS”) was tasked with formulating policy recommendations to close this exclusion gap while protecting the stability of India’s financial system and the safety of customers’ deposits. The CCFS report marks a big step forward in India’s financial inclusion deliberations. We evaluate the CCFS recommendations below, focusing our analysis on the most critical financial inclusion question confronting the RBI: how to regulate non-bank payment actors. We highlight several promising elements in the CCFS report, while highlighting two risks that warrant further attention.

The CCFS report starts off on a strong foot, positioning electronic payments as a central plank in India’s financial inclusion strategy and calling for universal access to an electronic payment system by 2016. This is the right approach. Electronic payments are the connective tissue of a financial system. They enable people to buy goods and services, pay utility bills, and send money to friends and family. They enable governments to disburse social payments and collect taxes. And they enable suppliers to collect payments from buyers. Payments are also the building blocks of financial services. Savings is little more than a sequence of deposit payments and withdrawal payments. Credit involves loan disbursements to the customer followed by repayments to the bank. When poor households are entrenched in a cash economy with no access to electronic payment channels, it drives a wedge between them and the formal financial system by making it prohibitively costly for banks, insurance companies, governments, and other institutions to transact with them.

After establishing the importance of electronic payments in India’s financial inclusion strategy, the report then wisely separates the risks created by payment and deposit activities from those posed by credit. It does this by recommending the creation of a class of narrow banks, or “Payments Banks,” which can offer payments and deposits but not provide credit. The core principle is that a payments provider that accepts funds from the public and places 100% of those funds in secure assets (as designated by the central bank) is not exposed to credit risk. Of course, the RBI must still mitigate the technology, operational, and consumer protection risks associated with Payments Banks, but full-fledged banking regulations are not required given the lack of credit risk.

The report also acknowledges the critical role played by non-banks in extending electronic payment networks into poor communities, recommending that mobile operators, consumer goods companies, and other non-banks be allowed to apply for Payments Bank licenses. While banks are well positioned to deliver credit services, they have struggled in every market to extend payments and deposit accounts into poor communities. By contrast, countries that have carved out regulatory space for non-banks to offer these services have seen dramatic expansions in electronic account access. Indeed, just 4-5 years after the central banks of Kenya, Tanzania, and Uganda allowed non-banks to launch payments and deposit services, 77% of Kenyan adults and 47% of Ugandan adults have an electronic account, while 46% of Tanzanian households have at least one member of the household with an electronic account.

These electronic payment platforms are quickly integrating into national financial ecosystems and radically altering the cost of reaching poor people with financial, utility, and other services. Inspired by the dramatic gains in these countries, central banks in several key markets – including Brazil, Indonesia, Malaysia, Mexico, Peru, Rwanda, and Sri Lanka (among others) – have allowed non-banks to offer payments and deposits.

While these CCFS Committee recommendations promise to catalyze a big increase in financial inclusion in India, we flag two possible risks that could undermine the Committee’s objectives:

First, there is a risk that the Payments Bank licenses will have compliance costs that impair the business case for serving poor customers. The business case for serving poor customers with payments and deposits depends on particularly thin margins and is thus sensitive to changes in the cost structure. While the report wisely recommends that Payments Banks should have lower minimum capital requirements than credit issuing banks (Rs. 50 crore versus Rs. 500 crore), the report also recommends that Payments Banks should “comply with all RBI guidelines relevant for scheduled commercial banks (SCBs).” Given that traditional banking regulations are primarily designed to mitigate credits risks, we worry that this blanket requirement could saddle Payments Banks with compliance costs that are disproportionate to payments and deposit providers.

Second, the Committee recommends that all pre-paid instrument (PPI) providers be required to convert to a Payments Bank or become a Business Correspondent. We worry that this could create an unnecessarily high entry barrier for providers wishing to test new business models in this nascent sector. As mentioned, serving poor households with deposit and payments services hinges on thin margins. Therefore, non-bank payment actors may want to test the viability of this market before converting to a full-fledged Payments Bank. But if entry costs are too high, providers may choose not to enter the space altogether. One alternative may be to allow PPIs to operate (with cash-out functionality) until they reach a certain threshold deposit balance or customers base, at which point they must convert to a Payments Bank. This would create a more gradual path for payments and deposit providers to pilot different business models without establishing a full-fledged Payments Bank at inception.

The CCFS report is the most comprehensive and forward thinking central bank policy assessment we’ve come across. If the Committee recommendations translate into regulations, we believe it would trigger a significant expansion in financial inclusion in India. The task now is to ensure that non-bank payments regulations are proportionate to the risks involved.

Dan Radcliffe is a Senior Program Officer and Rodger Voorhies a Director in the Bill & Melinda Gates Foundation’s Financial Services for the Poor team.

The Mor Committee report – Will payments banks be revolutionary or evolutionary?

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One of the more debated aspects of the Mor Committee’s report on “Comprehensive Financial Services for Small Businesses and Low-Income Households” is the proposal for the new class of banks, in particular, the “Payments Banks”. While it is probably a stretch to assert that this is an “incremental step” from the existing (Pre-Paid Instrument Issuers) PPIs, it is fair to say that, “Actually it is becoming a norm worldwide”.

The EU Payment Services Directive was implemented across the European Union in 2009 specifically “to increase pan-European competition and participation in the payments industry (also from non-banks)”. The Central Bank of Kenya’s regulation, which gave rise to M-PESA and is used as a model by many, allows mobile network operators (MNOs) to offer payment and deposit services (backed by a trust account in a scheduled bank). And more recently, Brazil established a new regulatory framework to allow non-bank e-money issuers (see below).

Central Bank of Brazil issued the much awaited medida provisoria (MP) for mobile payments.  The bill establishes the regulatory framework to allow non-bank eMoney issuance; and while at the moment it is only a general directive that defines what constitutes a payments scheme, which actors can be involved (MNOs, digital wallet providers, card companies and merchant acquirers), and the ability of the central bank to regulate such schemes, it is already paving the way for a number of commercial partnerships to go to the market.

–          CGAP Blog, August 2013

As I noted in June 2013 through the MMU blog “Can India Achieve Financial Inclusion Without the Mobile Network Operators?”, “… if the Reserve Bank of India really wanted to turbocharge financial inclusion it would allow MNOs to act as issuers of e-money with proportionate supervision as discussed by CGAP. The reality is that clear and simple rules applied to non-bank mobile money providers can mitigate potential liquidity and solvency risks, as has been pointed out by the GSMA”.

If (and this is, of course, a big if) the Reserve Bank of India (RBI) does implement this particular recommendation of the Mor Committee, it has the potential to have a significantly beneficial impact on financial inclusion. Why so? Why can banks not offer these basic payments and small deposit services to the low-income market, particularly when international experience shows that MNOs can?

As MicroSave has pointed out, history strongly suggests that mainstream banks are still unwilling to do this for several reasons:

  1. Poor people’s financial activity is characterized by high volumes of low-value transactions – the perfect description of a traditional banker’s nightmare. Mass market, dispersed distribution is the core business of MNOs – they thrive on handling and making money on, high volumes of low-value transactions.
  2. It takes time for banks to make a profit on digital financial services as doing so typically requires them to offer a suite of products on the digital platform. Nonetheless, this is indeed feasible (even in India) – see Great Business for Banks – So Why Are They Slow To Build Agency Banking? It is easier for MNOs to make digital financial services a viable offering in the early stages of deployment because of the potential to reduce customer churn and to reduce the costs of airtime distribution – see Is There Really Any Money In Mobile Money?.
  3. Most banks simply do not see the business proposition at the base of the pyramid or are too busy responding to more traditional high value, low volume opportunities offered by the burgeoning middle classes in India.
  4. Furthermore mobile- (as opposed to card-) based systems allow person-to-person and person-to-business payments (utility bills, etc.) without using agents – thus offering an important user value proposition. (Although MicroSave’s Rapid Agent Assessments of the leading PPIs in India in 2011-12 suggested that only a few of their clients have used this facility to date)

Even though the banks seem largely unwilling or unable to roll out and/or leverage business correspondent (agent) networks, they will, I strongly suspect, lobby aggressively to ensure that MNOs are not allowed into the payments/deposits arena through a provision for Payments Banks. After all, payments and deposits are the preserve of banks – enshrined for centuries by rigid regulatory environments.

Furthermore, if the central and state governments were to implement the 3.14% commission rate for processing electronic benefit transfers recommended by the Taskforce on Aadhaar Enabled Unified Payment Infrastructure (something that the Mor Commission also exhorts the RBI to advocate), the banks might see this as the key anchor product on which to base a serious foray into the under-served low income market. So they will be keen to keep this territory for themselves.

But I suspect that if MNOs were indeed allowed to set up Payments Banks, thus freeing them from their current dependence on traditional banks, this would focus the traditional banks on the opportunities in the under-served low-income sector much more quickly.

There is, after all, a deep DNA disconnect and a profound trust deficit between the two types of organization. In all the many countries across Asia, Africa and Latin America where MicroSave has provided consultancy on digital financial services, MNOs have consistently asked for advice on how they might offer digital financial services without banks; and banks have asked how they can offer digital financial services without MNOs.

In Kenya, the banking industry is running scared of Safaricom’s M-PESA, which now has nearly 20 million customers and has started to use its immense data set on voice and financial transactions to inform lending decisions of its partner bank, the Commercial Bank of Africa, which offers small-scale deposits and on-demand, emergency loans over the mobile phone through M-Shwari. While M-Shwari, in its current form, has many shortcomings, it has proved remarkably popular and demonstrated that low-income people do want to save and are happy to do so using the mobile phone and that there is a large demand for what are relatively high-cost emergency loans. (The latter is, of course, an opportunity that would remain the sole preserve of traditional banks).

A provision for Payments Banks would allow MNOs to offer real value-add payment and deposit services to their customers and leverage their existent networks of more than 1.5 million agents to distribute and service these. See Can MNOs Lead the Way for Banking the Excluded? (1 of 2) for details of this; and Can MNOs Lead the Way for Banking the Excluded? (2 of 2) for a discussion of the likely challenges for MNOs entering this market in India. With this type of infrastructure, if MNOs were allowed to set up Payment Banks, and these, in turn, offered the Mor Committee’s Universal Electronic Bank Account (UEBA) it is indeed just about feasible that, “… by January 1, 2016, each Indian resident, above the age of eighteen years, would have an individual, full-service, safe, and secure electronic bank account”.

An exciting, revolutionary, prospect!

Building Viable Agent Models in India

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“MicroSave was asked to present evidence to the Reserve Bank of India’s Committee on Comprehensive Financial Services for Small Businesses and Low Income Households. The Committee wanted to know about our extensive experience of agent networks in India.

This powerpoint presentation highlights the

1. Status of agent networks in India;

2. Design features of a successful agent network

3. Recommendations to the Committee,

4. Examples of successful agent networks”

Emerging Trends for Agent Networks in 2014

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https://www.microsave.net/helix-institute/Talking about the world’s most ambitious research project on agent networks, Mike McCaffrey, Head of Digital Financial Services – Africa, highlights three key trends to watch out for agent networks in 2014; inter-connectivity, liquidity tethering and fraud. Mike also introduces The Helix Institute of Digital Finance, a world-class training institute for digital finance (mobile money and mobile banking) practitioners.

Bill payments —The secret to sustainability?

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We can probably all agree that “sustainability” is a very tired noun. We use it to describe our wishful hopes for everything from human life on earth to improved supply chain management. And the reason we can’t quite give it up is because our need for a more equitable and enduring ecology, economy, and society remains as urgent as ever.

Mobile banking hasn’t really achieved sustainability yet. Everyone talks about it as an almost done deal. Nevertheless, cash still trumps all. Even for the success stories  like M-PESA, MTN Mobile Money, Tigo Cash, and Airtel Money. Money seldom resides on any of these phones for very long before it’s cashed out. Small emergency funds and savings don’t last long either for customers whose lives are beset with periodic, expensive crises.

No, it’s not about remittances

Remittances would certainly seem to be the steady drip that turns into reliable revenue streams for mobile operators, bank partners, and other commercial interests involved. But the sending and receiving of a percentage of migrant wages are not the enduring “customer need” on which the truly sustainable business propositions depend.

For both the workers and their beneficiaries, these payments are an emotionally fraught mix of familial duty, leverage, guilt, resentment, and social expectations. They are isolated monthly payments that, over time, can become irregular and even cease altogether. Remittances are closer to dowries and mafia protection money than they are to a utility bill. Consumers also expect, even if they begrudge, the extra fees involved in these highly personal money transfers.

No surprise, while they are acknowledged as a “pain point” (see Removing the Pain from Using Cash: An M-banking Solution?) most people balk at spending one paise or shilling or pesewa more to pay their neutral, impersonal monthly costs—water, electricity, rent, phones—by phone. “Sustainable” in this instance may actually mean giving up on the short-term (and generally minimal) profits for the long-term benefits of full adoption and use of all the services mobile banking can offer. As far back as 2010, at the MMU conference delegates from TrueMoney-Thailand, Grameen Phone-Bangladesh and Telenor-Pakistan discussed why they started with bill payments.

Embedded fees for both remittances and bill payments seem to differ, depending on the country and social norms. In most cases, any payment involving an agent and cash-out also involves an extra charge. If simply cash-in, as is the case with most bill payments, fees are lower ($.07-.35) and often waived by banks, insurance, and credit agencies. In Pakistan, where bills traditionally never include an extra cost, Telenor started off with small fees and then stopped, bowing to competitive and customer pressures.

The idea that the neutral bills—water, electricity, rent, phone—are more integral to full financial inclusion than remittances is not new. MicroSave has been writing about the potential for E-/M-Banking via remittances and ways of effectively graduating customers since 2009. Two years ago, MasterCard published  Bill Payment, A Demand-Based Path to Financial Inclusion and a CGAP blog Bank-Led or Mobile-Led Financial Inclusionalso makes a strong case for bill payments as a “pain point” that both banks and telecoms should promote in their mobile service offerings. And, of course, ultimately successful digital financial service solutions need a compelling product mix.

Even so, CGAP’s 2013 year-end roundup reports air-time top-up and P2P (person to person) payments still dwarf bill payments. (The most recent figures available are 18 months old, however, and South Asia’s bill-payment adoption appear to be a full third higher than East Africa. So more current—and more comprehensive—data, including from Bangladesh’s bKash and India’s Eko, would be useful before we reach any final conclusions).

Q—and several As

The real question would seem to be why more utilities, landlords, health clinics, credit and insurance agencies, in South Asia, East Africa, and elsewhere, do not actively encourage the throngs of cash-paying customers in their lobbies every month to pay by phone and save everyone a great deal of time and trouble.

And the real answers include:

  1. Too many m-pay promoters (banks, mobile operators, technology service providers) still think they can and should make money off convenience and speed—and then find themselves frustrated when m-payment profits fail to quickly materialise;
  2. Bill payers, even those most bedevilled by cash, generally resist change and/or new technology involving personal finance.
  3. Accounts Receivable also worries—with good reason—about “suspense accounts” (the e-limbo where questionable receipts, disbursements and discrepancies can reside indefinitely). M-PESA’s suspense accounts are infamous.

A dearth of reliable payment gateways for mobile cash in/out transactions in these markets also poses a significant deterrent. Most readers already know of payment gateways as the online systems that authorise and coordinate e-commerce and point-of-sale credit card-purchases. But as customer adoption rates for mobile payments are less than encouraging (see above), the banks and telcos who generally underwrite and support such gateways hesitate to invest – particularly in poor areas.

Utilities and other potential payees, large and small, also delay and debate m-payment agreements without a burgeoning and eager customer base, and without the relative security and improved efficiencies most payment gateways offers.

Online payment systems had even worse problems at the outset. Sooner or later, probably sooner, either a better technology will come along for the bankers and the largest, most ubiquitous payees. Or the cost of cash for all involved will simply become too onerous.

At that point, some magic number between 16-34 percent on all three sides of the transaction triangle—customers, payees, technical/financial enablers—cross Geoffrey Moore’s notorious chasm.

And then the real benefits begin to emerge. Payment and credit delinquency go down, account activity and customer loyalty go up, grievances usually diminish, and financial capability overall seems to improve. Worthy and possibly even sustainable New Year’s resolutions for 2014.

Payment Banks: What can we learn from international experience

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MicroSave’s “Payment Banks: What can we learn from international experience” is a handbook encapsulating 20 years of on-the-ground research and technical assistance; creating successful business cases while serving the mass market. The handbook provides deep insights, from across the globe, around strategy, product development, and agent network development/ management.