India’s enabling triangle for financial inclusion

Posted on by MSC

In our earlier blogs, we expressed our concerns around the growth of the digital divide, as the focus for financial inclusion shifts to FinTech and superplatforms as “the definitive solutions”. While these solutions typically require smartphones, many of the poorer households in Asia and Africa simply do not have access to the devices. Neither do they have access to the bank accounts that are typically required to use the solutions effectively.

While there are potential solutions that could empower those without access to smartphones through the use of agents, it is also clear to us that successful efforts to foster financial inclusion involves three inter-related and mutually-reinforcing components. These are:

1. A national digital ID system, bank accounts, and, ideally, mobile phones for all

2. Bulk payments,  which are typically government-to-people (G2P), to drive uptake and usage and thus foster trust in the digital ecosystem;

3. A seamless, interoperable payments system.

This is why everyone is so excited about the digital ecosystem currently under development in India. It combines these three elements. In this blog, we examine these in some detail:

1. A seamless, interoperable payments system

 Unified Payments Interface (UPI): The UPI was developed by the National Payments Corporation of India (NPCI). The NPCI already operates the RuPay payments infrastructure as a lower cost rival to Visa and MasterCard to permit banks to interconnect and transfer funds. The NPCI was established by the RBI and Indian Banks’ Association (IBA) in April, 2009. It aims to consolidate and integrate India’s numerous payment systems and thus create national, standardised business processes for all retail payment systems.

The UPI provides a single, digital interface across all systems for smartphones (but not feature phones) linked to bank accounts. It provides users with the ability to make payments using 1-click 2-factor authentication, using just a personal smartphone without requiring any acquiring (swiping) devices or physical tokens. The diagram below illustrates this in detail.

To do this, the UPI allows  a unique digital identifier for every bank account in the country, which can then be used to send money using India’s existing Immediate Payment Service (IMPS). The unique identifier is almost like an email address or an assigned name as well. It allows users to transfer money 24/7 and instantaneously to any other account in the country without requiring either a digital wallet, a credit card, or a debit card.

As a result, UPI users can make payments simply by exposing their unique identifier (the Virtual Payment Address (VPA) without sharing account details. The UPI also offers both individual users and business entities with the ability to send payment or “collect” requests to others with a “pay by” date. Users can also delay payment requests for later payment before the collection expiry date without having to block the money in their accounts. Users can, therefore, use their mobile phone to “pay” someone (push) as well as to “collect” from someone (pull). In the future, users will also be able to pre-authorise recurring payments, such as for school fees, subscriptions, and utility bills, with a one-time secure authentication and rule-based access.

UPI offers a fully interoperable system that incorporates all players in the payment ecosystem without silos and closed systems, allowing users to transact from and to any bank. In the long-term, it is likely to result in the phasing out of debit and credit cards and point-of-sale devices—except perhaps in places where many foreigners frequent. Similarly, mobile wallets are likely to face a challenge from the rollout of UPI.

With the arrival of UPI, the 14 million merchants in India will be able to accept digital payments with ease. It has the potential to make every merchant, or indeed each individual, a cash-in and cash-out agent and accelerate the rollout of a “cash-lite” India. And, of course, both Google Pay and WhatsApp payment system are riding on UPI.

BHIM Aadhaar Pay BHIM Aadhaar Pay was launched in early 2017 to make payment to merchants with biometrics instead of relying on other form factors like phone, cards, etc. The merchants can download the app and, using a certified biometric scanner, accept payment. To make a payment, a customer simply needs to enter their Aadhaar number in the merchant’s app and select the bank from which they wish to make the payment. The customer’s biometrics, which is typically the fingerprint, is then used as the password for the transaction.

2. A national ID system and bank accounts for all

  • The Aadhaar national biometric digital identity system. More than a billion Indians, well over 85% of the eligible population now have unique biometric digital identity cards. Their biometric data (fingerprints and iris scans) is held on a large database overseen by the Unique Identification Authority of India. Under the current regulations, this allows KYC/AML for basic account openingand for authenticating transactions. Aadhaar is the foundation for the India Stack (see below).
  • The Pradhan Mantri Jan-Dhan Yojana (PMJDY): In 2015, the Government of India launched the PMJDY financial inclusion scheme to provide banking to all households without access to the formal financial system. PMJDY provides debit cards, insurance, pension facilities, and overdraft to beneficiaries. Within two years of the launch of the scheme, banks and their agentshad opened 310 million accounts. While MicroSaveestimates that around a third of these were opened by people who already had another bank account, the impact in terms of access to basic banking services was impressive. PMJDY-2.0 was launched in August 2018 with enhanced benefits including the doubling of the overdraft limit to INR10,000 (USD139) and INR200,000 (USD2,778) accident insurance cover for RuPay cardholders.
  • Mapping mobile phones to bank accounts and the India Stack: The next key part of the development of the ecosystem will be to map account holders’ mobile phones to their bank accounts. The mapping exercise will allow them to conduct transactions and begin to fill their “digital locker” with transaction data from their phones, as well as other Aadhaar enabled devices. This key data will complement other key records, such as education certificates and land titles, also stored in the locker – thus creating a “digital footprint” to inform financial service providers.

An ever-increasing proportion of India’s adult population now owns smartphones – a figure that is set to rise to 50% by 2020. Those with smartphones will, (subject to trust and connectivity issues) be able to use the UPI. The UPI will allow both push and pull transactions, using basic identifiers similar to email addresses or telephone numbers. Currently UPI is free, thus removing the need for merchant discount rates and other charges for making payments. This effectively enables merchants and individuals to use the UPI in the same way as they currently use as a point-of-sale device to effect transactions and receive payments.

All these paperless, presence-less, cashless transactions will create a digital footprint, stored in the user’s digital locker. The India Stack offers open application programming interfaces (APIs), which thus encourages the full force of local and international creativity to leverage the ecosystem and offer value to users in a variety of ways.

3. Bulk payments – typically government-to-people (G2P) payments – to drive uptake and usage and thus foster trust in the digital ecosystem

Government-to-people (G2P) Payments: The Government of India transfers around USD 71 billion to its citizens every year. These transfers comprise cash as benefits and pensions, as well as kind as grains, kerosene, and fertilisers, among others. This provides a tremendous opportunity to kick-start financial inclusion by using these transfers to seed digital money into bank accounts. Furthermore, the savings that arise from digitising these payments and linking them to biometric identity are breath-taking – and enough to pay for the cost of rolling out Aadhaar every 4-6 months. The estimates of what is quaintly referred to as “leakage” suggest that for many schemes, as much as 40% of the amount transferred does not reach the intended beneficiaries.

However, there are a surprising number of challenges to digitising G2P payments effectively. These range from the basic need to link bank accounts to Aadhaar numbers, to ensuring that there are adequate agents and retail outlets. The availability of adequate outlets would allow beneficiaries to cash-out and then buy grains and other items if their benefits are transferred directly in cash to their bank accounts.

These three ingredients come together in India’s remarkable digital ecosystem to create the basis for not just financial inclusion but to create digital footprints for the poor. This begins the journey to “democratised credit” – as the diagram below highlights.

Each of these three key ingredients plays a synergistic role:

  1.  National ID, bank accounts, and mobile phones provide the foundational layers and channels for people to enter and participate in the digital financial ecosystem;
  2. Bulk payments (typically G2P transfers) push the digital value into these accounts and thus encourages their use and development of trust in digital money as opposed to paper money;
  3. Based on this, the seamless, interoperable payments system encourages further use of digital money, thus building the digital footprints that will allow people to participate fully in the financial system, and to derive real economic value from it.
  4. Each of the three is essential to achieving meaningful financial inclusion – as we have seen that simply opening bank accounts is not enough.

DBT in education: A study of delivery of in-kind benefits to secondary school Students in Uttar Pradesh

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In the field of education, scholarship programmes have seamlessly moved into the fold of DBT. Money is being transferred into the bank accounts of beneficiaries rather than being handed over as cheques. In-kind transfers have begun using Management Information Systems (MIS) platforms for multiple functions and are now being termed DBT.

MicroSave conducted a study in Uttar Pradesh on DBT in education. The study specifically looked at in-kind benefit transfers to school going children and is based on primary qualitative research and allied techniques. The sample was taken from the districts of Gorakhpur, Lalitpur, Lucknow, and Meerut to ensure a representative sample for the study. The Department of Secondary Education (DoSE) distributes benefits to a targeted section of students between classes IX-XII as announced by the Government of Uttar Pradesh from time to time.

Enablers For Direct Benefit Transfers Of Fertiliser Subsidy

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In the previous note “Barriers to Direct Benefit Transfers for Fertiliser Subsidy”, we discussed various barriers to in-kind and cash transfers for fertiliser subsidy. This note discusses potential solutions to improve in-kind transfers and suggests few ideas for cash transfer pilots for fertiliser subsidy.

Barriers to Direct Benefit Transfers for Fertiliser Subsidy

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Fertiliser subsidy is the second-largest that the Government of India provides after food subsidy of which the budget amounted to INR 700 billion (USD 10.78 billion) in the financial year 2018–19. In the Union Budget 2016–17, the Indian government proposed to bring fertiliser subsidy under the Direct Benefit Transfer (DBT) programme to streamline its distribution. Read our article for more.

Managing loan repayments

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The use of credit is an essential part of how low-income households manage to smooth their consumption in the face of “double-whammy” combinations of income and expenditure shocks. The big push for microcredit in the past decade has led to an abundance of microfinance providers and other providers that offer standardized products.

Blankets and wine for financial inclusion – Beyond digital access

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Is registration for mobile accounts (wallets) really enough? What is an ideal measure of financial inclusion? The Alliance for Financial Inclusion (AFI) defines a core set of indicators for measuring financial inclusion. The first dimension is access to the services and products that formal financial institutions offer. Yet to achieve meaningful access, we have to solve the significant problems related to float and cash liquidity at the agent level – even in many mature digital financial services markets. Indeed this begs the question – are we serving wine to customers who need blankets?

Services such as KopoKopo add value to merchant services by providing them credit to expand their business. Meanwhile M-Kopa Solar and similar PAYGO providers connect thousands of households to affordable solar power through mobile money. While we acknowledge the accomplishments of such existing services, we are still far from getting the fundamentals right.

In this post, we highlight the need for digital financial service (DFS) providers to invest even more in adapting their products and services for this segment, even in the so-called mature digital economies.

The flood is still here

A story is told about a great flood that was threatening to wipe out an entire island. There were many people on the island who were in danger. Some could swim, a few had small boats, but the majority were helpless. A ship that was passing by arrived to rescue the people. In desperation, a number of islanders started taking to the waters with makeshift equipment – the kind that they use to try to cross the Mediterranean from Africa to Europe. The ship got there on time. A significant number were ‘on-boarded’, albeit in bad shape. At least their lives were saved.

There were, however, a much bigger number of islanders yet to be saved, but people feared that the ship was already too overloaded. A great debate then began between the master of the ship and his handlers. Should they give some blankets and wine that the ship had in stock to the people on board who were cold and starving and then take them to safety? Or should they toss the merchandise overboard to reduce the weight, then save some more islanders in need? The flood in the story represents poverty and the ship represents basic access to products for financial inclusion. The blankets and wine are value-added digital products and the drowning islanders would be the financially excluded.

A middle-ground solution to this dilemma could be to toss the wine and give blankets to those on board while trying to save more people. I am not an expert in nautical matters, but the message is straightforward. If we wish to help people out of poverty through basic access to financial products, it would require us to ensure that this access can provide the products that deliver meaningful value and help low-income customers manage their lives better.

Access: The cost of cash-to-digital-to-cash exchange

Even though digital financial service providers offer digital wallets to many who would not otherwise have formal financial services, the micro-economies they operate in are largely cash-based. This means agents have to incur the cost of rebalancing frequently or deny service to their customers. Some agents have improvised and developed coping mechanisms like private social media groups to ensure that they have the money or float to serve customers. The onus is, however, on DFS providers to invest more in smart cash and float management solutions that help agents ensure that cash or float is always available, regardless of whether they are in urban or remote areas.

The second dimension of financial inclusion according to AFI’s core-set is sufficient ‘usage’ of these services. We may assess this by how often and how conveniently low-income users are able to receive, send, and spend their money. This requires solving the cash conundrum to create an environment where even low-income customers can easily spend their money digitally.

Usage: Illusive digital ecosystems and merchant acceptance

The digital ecosystem is not yet ubiquitous enough in many countries, including East African markets. This prevents users from using digital funds to pay for very much. As a result, digital funds must be converted, often at significant expense, into cash to be used. This, in turn, discourages poor people – and particularly micro-entrepreneurs – from accepting digital value.

Ultimately, we need a largely digital ecosystem that allows even a street vendor to spend most of their money at other small and micro-businesses. Merchant services are typically designed for medium-sized enterprises that may already benefit from more advanced banking services at the back-end. Point-of-sale devices for merchant services such as Quickteller in Nigeria and 1-tap in Kenya typically exist either at a steep price-point or make overbearing demandson micro-businesses. Safaricom’s One-tap partially addressed this by pricing their device at a relatively affordable KES 2,000 (USD 20). However, this is an exception and there are few other examples in developing markets.

Some providers such as Equitel1 in Kenya and Paytm in India have offered free peer-to-peer transfers for customers. Customers indeed use them to send and accept micro-value payments. We recognise that such users who accept payments in this way may not meet relatively stringent requirements, such as tax compliance for small and micro-merchants. Considering that a significant proportion of micro-businesses in developing markets operate informally, merchant services designed for them must be both simple and affordable. These small merchants require a tailored and targeted design of products. Targeted design of services may require more creative incentives but could graduate these merchants to become long-term business partners for providers.

Policy can also encourage digital payments by waiving charges for low-value transactions. Towards the end of 2017, the Government of India waived the merchant discount rate2 (MDR) for transaction values below INR 2,000 (approximately USD 30). The Government of India has been paying the banks on behalf of merchants and customers to encourage usage and acceptance of digital payment methods.

Quality: Products not tools

The quality of digital financial products is AFI’s third dimension of financial inclusion and is, at best, still nascent for low-income consumers. Remember those who could swim and had small boats from the story of our drowning island? These are those who we colloquially refer to as ‘cuspers’ – a demographic that is just shy of the proverbial middle-income or thereabouts. We recognise that laudable efforts have unlocked more financial services for the cuspers and the middle income, who comprise the wine from our analogy. But wine is not the best sustenance for our islanders – in the same way that the digital products on offer are not the most appropriate.

The swarm of digital savings and credit products that have invaded developing markets offering easily accessible loans is a good example of this. Unfortunately, the results bear striking resemblance to microfinance in its early years. As highlighted in MicroSave’s recent research in Kenya, the burgeoning digital credit products do not yet offer low-income borrowers real value. In contrast to the celebration of digital transactions and consumer loans, there is very little discussion around or evidence of digital micro-savings. Typically, users do not save for a future expense or aspirational investment. Instead, they only save to try to game digital credit systems to qualify for higher value loans.

There is a real need for appropriately designed tools to help the low-income segment manage their limited resources more effectively. As we can see from the growing array of fintech offerings, the digital revolution enables us to do this. But it will require real focus as fintech is irrelevant for most people in the low-income segment, as providers have made little effort to tailor interfaces or use-cases for this market.

The vast majority of fintech providers develop solutions for the affluent and middle classes. This makes logical sense – these segments have the money and connectivity to use the solutions. Furthermore, fintech developers typically come from this background. They, therefore, understand the challenges this segment faces and thus the opportunities it provides. In contrast, when and if fintech developers focus on the low-income segments, they tend to create solutions and then look for problems to solve in preference to understanding the needs, aspirations, perceptions, and behaviour of the poor first.

Ultimately all that matters is impact – do not let them drown!

The fourth dimension of financial inclusion according to AFI is impact. Digital financial services have definitely had an impact on the lives of both users and non-users of such services, including through direct and indirect employment. However, we are yet to solve a number of fundamental design issues with these products. A few exemplary outfits such as Twiga Foods have taken an ecosystem-based approach to understand the low-income segment and solve their financial and social inclusion issues. Real value, as Twiga has shown, can go beyond accessing formal financial accounts to solve day-to-day problems like accessing markets to buy and sell products.

Such success needs to cascade further down the consumer income brackets. Improving access to financial products, usage of the services, and quality of those products and services for the lower-income segment requires significant investments from financial service providers, and especially fintechs, if they wish to look beyond offering traditional one-size-fits-all products.

1Equitel has recently withdrawn their free peer-to-peer mobile money transfers, although their website maintains that on-net (equitel-to-equitel) transfers are still free.

2MDR is the fee that the store accepting your card has to pay to the bank when you swipe it for payments. The MDR compensates the bank issuing the card, the bank which puts up the swiping machine (Point-of-Sale or PoS terminal) and network providers such as Mastercard or Visa for their services