Various studies have revealed that consumption is usually much less volatile than income, indicating a fair pattern of inter-temporal savings, even amongst the poorest households. But despite this active level of financial management, these households have no recourse to formal financial systems.
Policymakers in India have recognised that improving current systems and designing new, innovative systems to reach the poor will require radical improvements in cost efficiency and an associated change in the existing set of regulations.
The RBI has in recent years put in place several regulations to encourage financial inclusion by granting greater freedom to the concerned players while simultaneously seeking to protect the interests of the target populations. While many of its regulations have created an enabling environment for inclusion, some, understandably, have limited the progress that could have been made. This is an outcome of the ?Regulator?s Dilemma?, a term coined by David Porteous: How can regulators balance their need to promote broader access to financial services with ensuring the stability of the financial system? This is a fine balancing act, failure to achieve it could lead to the choking of incipient attempts at providing universal access or financial destabilisation and the bankruptcy of the vulnerable.
Changing Transaction Nature
Ultimately, regulations have to be designed keeping in mind the risks involved. The risks will vary with the model adopted, whether the model is transformational or additive to banking. In addition, regulatory coordination will have to be achieved amongst the respective regulators to ensure they are not working at cross purposes.
Since the current regulations touch upon the participatory capacities of players across all the concerned sectors, this discussion is segmented according to the regulations applicable to each sector. Which sectors are expected to play a leading role in expanding financial inclusion? Banks and mobile operators will be in the spotlight, along with any other companies that may partake in the business correspondent (BC) model. The chief regulators to walk the tightrope, then, are the RBI, TRAI and to a limited extent, the Competition Commission of India.
Many people shun banking due to the prohibitively high minimum account balances and transaction charges. One of the first steps to promote inclusion was thus aimed at making accounts universally affordable and accessible. The RBI directive in 2005-06 permitted banks to open zero-balance, no-frills accounts.
Know-your-customer (KYC) norms were also relaxed for people with account balances of less than Rs 50,000 and whose total credit would not exceed Rs 100,000. In all other instances, KYC norms are quite strict and seek to prevent money laundering and terror financing (often called AML/CFT). However, in effect KYC was hindering inclusion as the financially excluded often either live in temporary homes or lack the requisite documentation.
The rapid expansion of card-based payments systems was also noted by the RBI. It has traditionally been wary of deregulating the payments space, especially in the case of electronic channels. The 2007 Payment and Settlement Systems Act provided for the regulation and supervision of payment systems such as card-based ones and designated the RBI as the authority for that purpose.
The 2008 Rangarajan Committee on financial inclusion recommended that each branch of PSU banks should open at least 250 new accounts each year, or a total of 12.5 million new accounts a year. According to C Rangarajan, ?Access to finance by the poor and vulnerable groups is a pre-requisite for poverty reduction and social cohesion. This is a modest target, which banks can achieve easily.?
Then in December 2009, the RBI stated that money transfers up to Rs 5,000 could be conducted without a recipient account, i.e. an account-to-cash transfer, facilitated through ATMs or BCs. This directive was aimed at bringing remittances into the formal channels. Additionally, for purposes of a bank transfer, only the recipient needs an account, not the migrant himself. This is a big positive for migrants who stay in temporary accommodation and are unable to fulfill the KYC norms.
In January 2006, the RBI allowed banks to use non-bank BCs as agents for financial service delivery. BCs were to act as a last-mile infrastructure, a cost effective alternative to additional branches.
This is a model that is in line with the experiences of several developing countries. In fact, a 2008 CGAP report (Regulating Transformational Branchless Banking) found that across countries, the most critical precondition to branchless banking was the authorisation of retail agents as cash-in/cash-out points.
The BC model started off with a host of restrictive regulations, tempering expansion. For starters, banks could only use non-profits as BCs. The RBI?s primary concern with allowing for-profit corporates to participate was the fear of commercial exploitation of vulnerable groups, and of an overly-aggressive expansion of the model by players that were outside its regulatory jurisdiction.
It was only in 2009 that individual for-profits were also allowed into this sphere. This dilution allowed the ubiquitous kirana stores, gas stations and PCOs to serve as BCs, but it was still not enough to achieve large scale deployment. Finally, in September 2010, the RBI permitted banks to engage all companies except for NBFCs as BCs, removing a major regulatory barrier for the scaling up of the BC model.
Despite this significant relaxation, BCs are still very restricted in that they must operate within 30km of a bank branch (up from the initially stipulated 15 km-radius), ostensibly to ensure a degree of monitoring by bank officials. This limited private sector banks? participation in the BC model, given their low rural penetration. However, the RBI directive allowing entry of all companies into the model also determined that state level bankers? committees could optionally relax the 30-km rule in under-banked areas. It appears that change is on its way here, too.
As far as operational issues are concerned, in 2009, banks were allowed to accept reasonable service charges from the customer to ensure the viability of the BC model and, although there is no specification of the ?reasonable? charge, this reflects a change in policy mindset from mere poverty alleviation to encouraging overall rural economic development. Further, banks may pay a reasonable commission/fee to the BCs as an added incentive.
However, document verification can only be conducted by banks. Account opening through BCs is thus not an immediate process, customers must return to the BC a second time for their first transaction. This potentially slows adoption of the BC model, but seeks to ensure a responsible verification process.
India has over 730 million mobile connections, with teledensity exceeding 65%. In contrast, only 50,000 of India?s 600,000 villages have access to finance. It is well recognised that allowing mobile service providers (MSPs) into the banking sphere can significantly increase the reach of financial services.
However, the RBI prefers the bank-led model for financial inclusion. It opines that attempts across the world by mobile companies to enter the banking space without any bank cooperation have met with little success. It is also not in favour of such independent entries by MSPs. Its main concern with such a model is their limited transaction ability and the lack of inter-operability among networks. Thus, MSPs can currently only enter the banking space through the BC model, in tie-ups with banks.
Prevailing regulations were not designed with the convergence of telecommunications and finance in mind, and still have gaps and ambiguities. The RBI did issue certain operative guidelines for mobile banking in 2008-09, amending the same in December 2009 to set higher transaction limits. The caps on transfers and transactions involving purchases were raised from Rs 5,000 and Rs 10,000 respectively to Rs 50,000 each. Further, end-to-end encryption was no longer required for transactions of less than Rs 1,000.
Currently, 39 banks have been granted approval to provide payment services using this channel and 34 of these banks have started operations. On an average, 5.5 lakh payment transactions worth Rs 56 crore are being processed through this channel each month.
But given the nature of this platform, and the rapid changes, the roles of the regulators are still unclear. Last June, TRAI and the RBI reached an initial agreement to ensure a smooth roll-out of m-banking; TRAI will deal with all interconnection issues while RBI will look into banking aspects like the daily transaction limits, KYC guidelines and verification criteria. Thus, the two regulators seem to have reached a neat coordination, for now.
A report submitted in January by an inter-ministerial group constituted in 2009 to frame rules for financial services on cell phones recommended, amongst other suggestions, opening no-frills accounts linked to mobile phones in unbanked areas. It recommended that customers operating accounts through cell phones must pay a 2% commission to the bank, and that the bank must in turn pay the MSP Rs 2.25 per transaction or 1.4% of the total amount.
It still remains to be seen to what extent these recommendations are implemented. However, last month, TRAI reported its intent to fix mobile tariffs for financial services to ensure affordability. At present, tariffs are determined by market forces, but TRAI believes tariff regulation is essential to encourage mobile banking amongst the unbanked, where cost of delivery assumes greater importance.
The Micro-Finance Institution (MFI) sector has been largely unregulated till now, because most MFIs have been registered as societies or trusts, which aren?t subject to any financial regulation. Non-profit MFIs have been prohibited from collecting deposits by the RBI because of the collapses of several NBFCs in the 1990s, and are only involved in the credit side of banking. Only NBFC-MFIs rated by credit rating agencies may accept deposits.
The recent spate of farmer suicides in Andhra Pradesh, which led to a credit freeze for its MFIs, prompted the government to set up the Malegam committee to address the problems relating to their functioning. Clearly MFIs have struggled even with their core business. The committee came out with its recommendations on the January 19, which included:
* Creation of a new category of NBFCs under which MFIs may be regulated by the RBI
* Rs 15 crore floor on net worth
* Rs 25,000 cap on loan sizes and
* A ceiling of 24% on interest rates
A decision regarding the implementation of these recommendations is expected in a month. Till then, Andhra Pradesh will be subject to the Microfinance Institutions Ordinance, 2010, under which MFIs must be registered with district development authorities, state their areas of operations, employees and credit status. They can, since September 2010, of course also act as BCs for banks.
Several strides have been taken by the RBI in easing the regulatory environment to enable the entry and scaling up of participants. However, much more still needs to be done to ensure continued growth in this sector. For example, MSPs will have to provide inter-operable services by setting up some sort of clearing/settlement system, which will invariably involve the National Payment Corporation of India as a facilitator. Besides, banks will never have strong incentive to cater to poorer segments as long as their revenues come from floats and not from transactions.
While the RBI is currently marketing the FI paradigm through the bank-led model, it isn?t averse to giving centrestage to non-bank actors. Banks need to act quickly on the privileged position they currently enjoy.
Since financial inclusion through non-traditional modes is a new concept, and banking alliances with BCs a recent phenomenon, much is still to be learned over the coming years about customer protection issues, AML/CFT concerns, and the feasibility of various models. Regulations will have to keep evolving, and it shall be interesting to follow this evolution, which is already in motion and beginning to tangibly modify the financial landscape.
?The writer is an economist at the Centre for Financial Inclusion, Indicus Analytics. You can reach him at email@example.com (The third and last part of this series will be carried on February 27.)