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The Mor Committee – Giving credit where credit is due (Part I) The role of Non Bank Financial Companies (NBFCs)

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The Role of Committee Financial Companies (NBFCs)

The Mor Committee on “Comprehensive Financial Services for Small Businesses and Low-Income Households”  has recommended some very bold, as well as several transformational steps, to reconfigure the delivery of credit to the ‘un-served’ and ‘under-served’ in India. In this blog, we analyze some of the recommendations in the section on credit that the Reserve Bank of India (RBI) could adopt and implement without disrupting the overall financing institutional structure (which may take time).

The Committee recommends allowing non-bank financial companies – non-deposit-taking (NBFC-ND) to act as business correspondents (BCs) for banks. The NBFC-NDs include, of course, NBFC-microfinance institutions (NBFC-MFI). Some NBFC-MFIs are already offering BC services having set up entities that are allowed to act as BCs. Allowing NBFC-MFIs as BCs will remove the additional complexity of having to set up and manage new entities, and will provide more opportunities and incentives for MFIs to provide a fuller range of bank and non-bank products. This clarity will also remove many of the barriers that have prevented MFIs taking up this role in the past. (See Are Banks and Microfinance Institutions Natural Partners in Financial Inclusion?)

“The BC channel has enormous potential in the long-run, and there are obvious synergies between large banks and grass-roots MFIs. However, while banks’ interest is dominated entirely by the need to fulfil customer acquisition mandates, their activities will remain focused almost exclusively on channel development. MFIs can only urge banks to refocus attention on the product proposition, but they cannot themselves make it happen. … The entire sector is still searching for a blueprint, and MFIs have valuable inputs to bring to that”.

–          Ignacio Mas et al. in Are Banks and Microfinance Institutions Natural Partners in Financial Inclusion?

Around 12,000 NBFCs-ND, spread all over the country, have the potential to add many more spokes to the distribution nodes of the country’s over 109,811[1] bank branches. NBFCs are the only entities (other than banks) effectively providing financial services in underserved areas. Many NBFCs have managed to win the trust of the consumers, something that hardly any BC institution has been able to accomplish in the 7 years since the inception of the model – not least 0f all because of the high levels of churn amongst agents (see Behind the Big Numbers: Improving the Reach and Quality of Agent Networks in India). In particular, the NBFC-MFI category has a large presence in rural areas. In 2013, 41 MFIs that reported to Microfinance Institutions Network (MFIN) reached out to a total of 25.16 million clients through a network of 9,224 branches (See MFIN Micrometer). Thus with NBFCs-ND included in the BC space, the model would not only broaden but also deepen the provision of financial services in the under-served areas. And, of course, offering BC services provides NBFC-MFIs with many strategic opportunities and operational advantages (See Microfinance in India – Is Business Correspondent the Way Forward?).

“MFIs are potentially an excellent channel and product development partner for banks, as long as they have the capacity and resources to dedicate to it. MFIs can help all stakeholders to leverage their existing engagement with the customers. In this way, MFIs’ core competence of customer engagement and management can be more fully exploited”.

–          Ignacio Mas et al ibid

There seems to be no cogent reason why NBFCs were precluded from acting as BCs earlier. As the report states, the risk of commingling of accounts can be managed by daily settlement, something that should not be too difficult to ensure using technology. Other mechanisms such as cash-account collateral and transaction limits, which the banks apply to the BCs anyway, will also be applied in the case of NBFCs. In return, banks would get access to the brick and mortar infrastructure of the NBFCs; relatively well-qualified staff; relatively better financial and operational risk management culture than the current BCs; deep knowledge of the low-income market segment; and familiarity with the use of technology.

The report does not delve into whether the NBFC BCs should also offer credit products on behalf of banks. Instead, it leaves this issue to be sorted out by individual banks as part of their business strategy. It is not difficult to imagine that banks may have products that have some complementarities because of the inherent nature of the balance sheet structure of two types of entity. Nonetheless, all said and done, the NBFCs will pose competition to the banks in terms of many other products, especially low-value, and short-term consumer loans (where they clearly have an edge already). This is an issue that needs some more thought given the earlier experience of direct selling agents (DSA) model of banks. We need to learn from the operational risks faced by the banks that used DSAs for credit origination. Many banks had to finally abandon the DSA model in favor of in-house staff for better underwriting standards, conservative loan to value and therefore better portfolio quality of credit products.

The Reserve Bank of India needs to allow banks to choose from a wider menu of distribution channels to realise the dream of financial inclusion. NBFCs, including the NBFC-MFIs, present an obvious choice and a highly credible BC option for their inherent strengths in terms of their physical presence in under-served and geographically challenging areas. The NBFCs, as quasi-banking outfits, are better equipped to retail financial products and therefore have a distinct advantage to operate as BCs. The NBFCs are also better prepared to handle the operational risks of BC business compared to other BC managers.  The Mor Committee’s recommendations on this deserve not just attention but also implementation.

[1] As on October 05, 2013. Includes administrative offices.

G2P Payment Delivery in India

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India has become one of the front runners in undertaking G2P payments. Introduction of Aadhaar enabled biometric payment system demonstrated the active role played by the Government in delivery of these payments. In this video, Amir Hamza, highlights the current G2P payment structures, the pitfalls with the system and improvements envisaged that could make the payment model work effectively

The ambitious Mor committee report – Challenging Indian norms

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The Reserve Bank of India (RBI) Committee on “Comprehensive Financial Services for Small Businesses & Low Income Households” headed by Dr. Nachiket Mor has released a report that challenges us all. It is a magnum opus of 265 pages that is surprisingly readable and builds on, and significantly extends, the 2008 Rajan Committee report to the Planning Commission entitled “A Hundred Small Steps: Report of the Committee on Financial Sector Reforms”.

The Mor Committee report is, in the Indian context at least, both visionary and, for many at least, little short of revolutionary in its approach. Small wonder then perhaps that the Economic Times notes, “bankers feel most proposals are either impractical or ambitious”. Are bankers really not just conservative, but also devoid of ambition when it comes to financial inclusion? The evidence suggests so – see for example “Branchless Banking Update: Should We Bank on Phones or the Post?”

“This Report … makes a conscious effort to redress this balance and issues of risks and costs have been kept at the very center in the discussions of each of the strategies for providing better access to financial services to small businesses and low-income households.”

The Committee’s recommendations are firmly market-led approach rather than the top-down, directives that have failed to deliver financial inclusion over the last two decades. The report recognizes that banks have business imperatives that shape their behavior much more strongly than even the most stringent diktat from the RBI or Ministry of Finance. This was most recently highlighted in 2012 when the Ministry of Finance sought to impose a cluster-led approach to driving business correspondence (see MicroSave Policy Brief #7 “Is the Business Correspondent Model in Policy Paralysis?” for a discussion of this episode).

The Committee recommends the removal of many of the provisions that have so hampered bank lending to the poor and made the business correspondent (agent) model so unattractive to banks. So, for example, the Committee recommends the removal of the requirement for banks to price farm loans below Rs. 3,00,000 at 7%, noting,  “[from the] perspective of Stability that entails sustainable pricing, banks must be allowed to freely price these loans based on their risk models”. Similarly, the Committee recognizes that banks need to charge low value accounts for their transactions. If they cannot charge, banks will either make a loss on those accounts and/or actively seek to avoid opening/making transactions on those accounts – as we have seen so clearly in the years since the Khan Committee’s report “Financial Inclusion by Extension of Banking Services – Use of Business Facilitators and Correspondents” in 2006. This has been well documented by many including, for example, “No Thrills – Dormancy in No Frills Accounts”.  Furthermore, MicroSave research clearly shows that poor people are indeed ready and willing to pay for high quality, convenient financial services – see for example “The Answer is “Yes”—Cost and Willingness to Pay in India”. All this is common sense to the outside world, but for many in India, this may require a revolution in their thinking.

“An important issue behind the reluctance of banks has been the requirement to bundle a number of free transactions along with a basic bank account … it would be important for policy to move away from the notion of forced bundling (which is equivalent to hidden subsidies) to a strategy in which the customer needs to pay for every transaction but has a choice of competitive channels through which she can access her account at an affordable cost.”

The Committee report also makes the argument for a diverse approach to deliver financial inclusion, noting that there have been a series of one size fits all approaches (cooperatives, regional rural banks, SHGs etc.) that have been promoted as cure-all silver bullets. Each has played a role in expanding financial access (we should remember that in comparison to much of the developing world, India’s financial inclusion statistics are enviable), but none have truly delivered. Given the diversity of India, it is perhaps surprising that this point has not been made before – or at least that the need to encourage a wide range of actors and partnerships has not been more clearly articulated in, and supported by, policy. Partnerships leveraging new and innovative technologies such as mobile money and the Aadhaar unique identification system provide tremendous opportunities, see for example “Can Mobile Network Operators Lead the Way for Banking the Excluded? (1 of 2)” and “Can The Unique Identification Authority of India be a Saviour of Financial Inclusion?”

“The danger of developing too specific or prescriptive of an approach towards comprehensive financial services is that it will become very quickly outdated and the design will begin to act as an impediment to change instead of being an enabler. … the best way to proceed would be to articulate broad principles that do not vary with financial or technological innovation but instead have a timeless character.”

However, Professor Sriram of the Centre for Public Policy at Indian Institute of Management, Bangalore and Member, Advisory Council on Financial Inclusion and Payment Systems, UIDAI, in The Mint, suggests that the Mor Committee has put all its eggs in the Aadhaarbasket. This is clearly not the case in the context of credit, where the Committee recognizes the role of NBFCs, microfinance institutions, and self-help groups. However, in the context of savings and (to some extent) risk management or insurance services, it is reasonable to assert that in the current market environment a business case can only be credible if it built on Aadhaar enabled technology. Aadhaar has the potential to remove the extraordinarily high cost of account opening and offers low-cost authentication. So the idea of creating a Universal Electronic Bank Account for all as an integral part of the Aadhaar process is an excellent one. (Of course, encouraging the use of this account will be challenging but by no means, impossible see “The Mor Committee Report – The Demand Side Conundrum”). But it is also reassuring to see the Committee recognize the limitations of Aadhaar in places with low connectivity and suggesting PIN-based authentication as an alternative as well. But it should be noted that the Mor Committee is not wedded to Aadhaar. The idea is not to make Aadhaar mandatory, but rather that it is currently the readiest and enabling platform available and can be leveraged … if tomorrow a better platform emerges, then banks should also consider that.

“The Committee recommends that authentication for the purpose of transactions happen in either of three ways:

a. Fingerprint in combination with the Aadhaar number or the bank account number (Token-less authentication)

b. One-time Password (OTP) in combination with the Aadhaar number or the bank account number (Token-less authentication)

c. PIN in combination with the Aadhaar number or the bank account number (Token authentication)

The Mor Committee has been criticised in the MicroSave LinkedIn Group for focusing on what needs to be done to achieve financial inclusion rather than the details of exactly how it should be done. And Professor Sriram also notes, “The report provides lip service to the last mile and concentrates on financial sector architecture”.  But the Committee offers a sound approach to this challenge. After all, it is impossible to detail out the ways to deliver the last mile and each type of financial service provider is likely to have its own approach to doing so.

So long as there is a credible business case, it is fair to assume that the extraordinary Indian entrepreneurial spirit will find a way to deliver convenient and accessible financial services. Indeed, it is much more likely to do so when the business case is clear than when cajoled to do so by the RBI or Ministry of Finance. Now, of course, the excesses of the Indian entrepreneurial spirit were on alarmingly graphic display in the 1980s when many Non-Bank Financial Companies (NBFCs) went bankrupt – an episode seared on the consciousness of all Indian regulators. So while letting a thousand flowers bloom, the regulator will have to keep a close eye on the nursery.

Alternative Distribution Channels in mInsurance and Need for Value Alignment

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MicroSave’s insurance expert, Premasis Mukherjee presented a session on mobile insurance distribution at the International Microinsurance Conference held at Mexico City. The session was based on alternative distribution channels and need for stakeholder value alignment in mobile insurance. Taking an analytical view of the rapidly burgeoning loyalty based mobile insurance paradigm, he discussed various emerging distribution models in mobile insurance. The presentation stressed on the need to understand the business model and business economics of the partner stakeholders in the mobile insurance value chain. He explained why mobile network operators and business correspondent network managers are (or will be) interested in mobile insurance as a function of their business cycle.

The Mor Committee report – The demand side conundrum

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One of the most frequent criticisms of the Mor Committee’s report on “Comprehensive Financial Services for Small Businesses and Low-Income Households” is that it ignores the demand side. The report offers a sophisticated vision of the financial architecture and what one commentator describes as “financial services as a fundamental right” for all. It also provides the guiding principles for implementing the new approach. But the report seems to imply that low-income people’s demand for formal financial services is a given. Is this a fair assumption?

Recent history in India seems to suggest that this is a heroic and optimistic assumption. The poor take-up of No Frills Accounts gives cause for pessimism. But in many respects, No Frills Accounts were designed to fail. Banks were instructed to open these accounts without reference to their use – and so they did exactly that, and dutifully reported to the Reserve Bank of India. See “No Thrills – Dormancy in NFA Accounts”. But this does not mean that poor people do not want bank accounts –MicroSave’s research into this phenomenon revealed that there were a series of features to which poor people aspired and needs that they could clearly articulate … and that poor customers were, in the main, willing to pay for these services.

We know from “Portfolios of the Poor” that poor people have remarkably active financial lives, and need a range of simple formal financial services comprising (at the minimum): (1) a basic transaction account; (2) a recurring deposit account; (3) a working capital loan; (4) an asset acquisition loan; and (5) an emergency loan. See “Financial Services That Poor People Want”.  This is broadly speaking the product range now offered under the much under-rated Grameen II programme, which has seen startling levels of demand for its savings and credit products. See “Lessons From The Grameen II Revolution”.

IFMR’s outstanding KGFS model, build on painstaking action research in three very different parts of India shows that there is demand for and active use of a range of around 15 financial products when they are delivered in a convenient, accessible and affordable manner.  See “The Pursuit of Complete Financial Inclusion: The KFS Model in India”.

But both Grameen II and the KGFS model are “high touch” in nature, and involve frontline staff visiting clients in their villages – on a weekly basis in the case of Grameen II.  Banks are unlikely to adopt such models. For this reason, business correspondent agents will be crucial for the success or failure of the Mor Committee’s vision for financial inclusion.

Outside of Somaliland, where the absence of credible formal banking system, Telesom’s salary and merchant payment focus and free service have yielded spectacular results, few deployments have generated more than 1-2 agent-based transactions per customer per month. And dormancy amongst mobile money accounts remains a perennial problem. This is in part due to poorly designed enrolment campaigns that reward agents based on customers signing up for the service rather than actually using the service, but it is also in part because transactions are expensive and/or because of the limited product suite on offer.

“There are two glaring facts the mobile money industry needs to face up to. First, digital accounts have very little value stored in them, and the practice everywhere is to withdraw any e-money received immediately and in full. This makes people not naturally inclined to pay electronically, except for remote payments for which people will take the trouble specifically to cash in. Second, there is surprisingly little systematic use of electronic payments by formal businesses, a space in which cash and especially checks prevail, even in Kenya”.

Ignacio Mas in “Beyond Making Payments: Managing Payments”

As can be seen in the graph below from the national representative Agent Network Accelerator research, the vast majority of agent-based systems continue to offer basic wallet and payments services, focusing above all on remittances, bill pay and airtime sales. Unsurprisingly, in the sub-sample of banks offering agent-based services in Kenya, 97% of agents offer savings deposits to a bank – but few banks have accounts and services designed specifically for the channel. To make agent-based digital financial services an integral part of poor household’s lives, we will need to re-engineer the product suite to offer a similar range of products offered by Grameen II and KGFS.

This work is already underway. MicroSave is working with banks in Colombia, Kenya, and South Africa, to name but a few, to develop a suite of savings, credit and insurance products for delivery through these banks’ agent channels. And, of course, the savings and emergency loan facilities offered by Commercial Bank of Africa through M-PESA under M-Shwari are already very popular in Kenya despite some of its limitations and challenges.

“What we need are service concepts that help people manage their financial lives the way in which they think about them. Customers need to give shape to their own user experiences. That means providers must think of products as tools which customers can use in different ways rather than as products that offer specific, inflexible services”.

–         Ignacio Mas & Premasis Mukherjee in “Basing Product Development on Mental Models and Metaphors”

Ignacio Mas has also proposed a system of jam-jar accounting to allow users to set aside money for different needs, projects, and aspirations. This could be enhanced with SMS reminders to save and confirmations outlining how much more is required to achieve the user’s goal – thus facilitating the recurring deposits required to build up what Stuart Rutherford calls “useful lump sums”. The MetaMon project looked at how low-income people in India and Bangladesh think about managing their finances, with a view of identifying metaphors to better describe financial management systems on the mobile phone and thus make them intuitive for poor users.

A range of products will also require different types of agents. In addition to the typical cash in/cash out merchants that service traditional payments based system, providers will have to train and monitor a more sophisticated cadre of sales agents. Sales agents will explain and sell products and jam-jarring systems to prospective customers. This is alluded to on page 57 in the Mor Committee’s report.

The Mor Committee advocates one (presumably cash in/cash out) agent per square kilometer where there are 4oo households. But, given the international experience with basic wallet and payments systems to date, it is doubtful that agents will make adequate income from servicing 400 households. MicroSave’s experience worldwide suggests that an agent needs to service 650-1,000 customers (depending of course on how often they transact) to derive an adequate income. For this reason, too, broadening the product suite and encouraging regular use is essential.

There is clearly latent and unrealised demand for financial services amongst low income households, but to achieve real financial inclusion as defined by the Mor Committee (see box) we will need to work hard to design and provide products tailored specifically for low income households and for agent-based delivery channels. The Universal Electronic Bank Account will be a good start as a “gateway” to the other products. But we should not under-estimate the challenges (and the opportunities) of creating a suite of intuitive and relevant products to help low income households manage their finances. Only when these are in place will we see the transaction volumes that both cash in/cash out merchants and sales agents will need to continue to provide their services.

There is clearly latent and unrealized demand for financial services amongst low-income households, but to achieve real financial inclusion as defined by the Mor Committee (see box) we will need to work hard to design and provide products tailored specifically for low-income households and for agent-based delivery channels. The Universal Electronic Bank Account will be a good start as a “gateway” to the other products. But we should not under-estimate the challenges (and the opportunities) of creating a suite of intuitive and relevant products to help low-income households manage their finances. Only when these are in place will we see the transaction volumes that both cash in/cash out merchants and sales agents will need to continue to provide their services.

 

Choosing An Agent Management Model

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One important question service providers have to ponder prior to entering the market is the agent hierarchy structure. Adopting a model which fits the market will save time, and money, and reduce stress levels for Senior Executives!

The three models below illustrate the most common options available for service providers:

The Direct Agent Hierarchy Model enables the provider to have direct access to agents interfacing with end-user customers. The provider takes responsibility for the operational support and oversight of the agents and ensures overall quality of the agent network. The aspects that service providers control include those which relate to individual agents as well as to the network itself. These attributes pertaining to individual agents that the service providers manage include the agent profile, physical layout of the  outlet, stock keeping levels, liquidity, quality of branding etc. The network related aspects pertain to capillarity of spread – for instance, the number of agents in a locality, the factors which determine the presence of an agent in the locality etc.

Who Uses it: Safaricom’s M-PESA started off with this model, Equity Bank in Kenya currently uses it.

Pros: Banks often favour this model because it gives the provider the most direct control over the network, which can appease regulators, enable the offering of more complex products, and direct the most commissions directly to agents without a middle management taking a cut.

Cons: The major drawback is this model is extremely difficult to scale quickly. Moreover, under this model, service providers could potentially get bogged down with operational issues which are often better managed by, and easily outsourced to, a tier of aggregators or master agents.  This level of middle management also often has better market visibility and can more accurately direct where new agencies should be best placed.

The direct agent hierarchy model could potentially be appropriate for smaller markets and providers with gradual growth strategies or limited ambitions (banks just trying to decongest banking branches for existing customers.)

The Master Agent Hierarchy Model, is often incorrectly labelled the “aggregator model”, and is probably the most popular. In this model, the provider appoints a select number of ‘master agents’ who have proven financial and operational muscle to handle recruitment, operational support and management of field level transaction agents. The earnings of master-agents will be a proportion of the earnings of the agents they manage.

Who Uses it: Tigo Pesa (Tanzania); Airtel Money (Kenya); bKash (Bangladesh)

Pros: This model is streamlined for growth, and often telecoms just activate the agent network structure they have existing for airtime distribution to also serve as cash-in/cash-out (CICO) agents   The model also minimises operational costs to the provider, as the cost is usually taken out of agent commissions.

Cons:  However, this also means that the extent of control over the agent network is lower than the direct agent model. There is a management level between the provider and the customer touch point, meaning that monitoring has to be done on more levels, there are more incentives to align, and the ecosystem is one level more complicated for everyone.

 

The master-agent model is appropriate for the larger, more developed markets where scalability of the agent network is considered a competitive advantage.

The Matrix Hierarchy Model in its most basic form is a combination of the direct agent and master agent models in a single deployment. Providers manage some strategic agents directly while delegating control of others to master agents. A number of deployments have found the benefit of this structure including Safaricom’s M-PESA.

Who Uses it: Dutch-Bangla Bank (Bangladesh), MTN Money (Uganda); M-PESA (Kenya & Tanzania)

Pros: With this hybrid model, providers can more incisively choose between quality and quantities of agents in different sub-areas of a country.  They can also easily create centres of excellence, where customers can go when they know they need to make a big transaction or do a reversal, and where agents can do with questions, or to do some operational tasks like rebalance.

Cons:  It is much harder to clearly define roles and responsibilities so that all operations are covered, yet nothing is unnecessarily redundant.  Further, there will likely be different reward systems and KPIs which will have be aligned and managed with sophistication.

The matrix model is suitable for those with a sophisticated head office that can run complex management systems and are planning to offer an array of sophisticated products to different demographics and need a maximum amount of flexibility in their management model.  It is also used in embryonic stages of development where the provider is not sure yet which model to choose and so tries a little of the top two.

Needless to say, all the models have their own sets of benefits as well as challenges. As a rule of thumb, I would put my money on the Matrix Hierarchy Model in the initial stages of the agent network roll-out, and then consider introducing other models progressively, if need be. It provides service providers with the benefit of ‘having their cake and eating it’!

Whichever the model providers pick, arriving at that decision quickly is quite critical. The benefit of determining the agent hierarchy model early is that it has a direct correlation to the agent reward structure, taking into consideration the various intermediaries in the food-chain. By extension, the model adopted has the potential to influence all aspects of the business, including but not limited to strategic planning, pricing, process design, user interface, product attributes etc.

Kimathi Githachuri is Head of The Helix Institute of Digital Finance. As an expert in digital financial services, he previously worked as: Head of Mobile Money at Warid Telecom in Uganda (GSMA Sprinter), Mobile Money Channel Development Manager at Airtel Kenya and Area Sales Manager at M-PESA where he helped build the M-PESA network.

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