The problem of borrowing from non-institutional sources such as moneylenders is not merely present among the poor in India, even the rich are heavily reliant on such sources for finances, says a latest RBI report. According to RBI data, unsecured debt (such as unsecured loans from money lenders, loans from family and friends) accounts for two-thirds of total liabilities for the very poor, and one-third for the rich. The problem is indeed very deep rooted, and RBI says if it remains unchecked, it will lead to households becoming trapped in a long cycle of interest repayments. This is problem unique to our country, says the report.
“Quantitatively, unsecured loans account for 23% of total debt in China and 39% in India, while they play a negligible role in the financial systems of developed countries (with the exception of the US, where households rely relatively more on short-term debt for both daily expenses and for purchases of durable consumer goods),” the report observes.
The reliance on moneylenders and an aversion to more formal channels such as banks also differ by states in India. While poor states such as Bihar have nearly all of their loans from unsecured debt (82%) and nearly 80% of it from ruthless moneylenders, states such as Goa have only small amounts of unsecured loans, as well as low fractions originated from non-institutional sources. “In states such as Tamil Nadu, where households store a high fraction of their wealth in gold, they also have more than 40% of their total debt in the form of gold loans – further suggesting that gold plays multiple roles in household balance sheets, and that solutions to sub-optimally high gold holdings will need to consider these different dimensions of its use,” says the report.
Exploring reasons for such high reliance on moneylenders, RBI says that the households face a lot of unexpected events such as loss of crops and livestock, medical emergencies, and the effects of natural disasters.
RBI says that a reallocation to more formal sources of credit such as banks and secured debt, will help the households to move up in the overall wealth distribution, thereby improving their financial position significantly. “Households shifting from non-institutional to institutional debt can move between 2.5 pp and 5.5 pp up the wealth distribution,” says the report.
Apart from unsecured debt, RBI brings out other striking differences between India and the developed world: “Households in advanced economies hold substantially more financial assets than their Indian counterparts, are much more likely to finance home purchasing with a mortgage, and allocate a sizeable fraction of their wealth to retirement savings over the course of their lifetime.”
RBI has three suggestions to the Indian households: chuck gold, plan your retirement corpus and finance your home with a mortgage. RBI says that the Indian investor allocates a dismal 5% of his entire portfolio to financial assets. A whopping 84% is invested in real estate and other physical assets, while 11% is invested in gold. Elaborating on the benefits of moving from gold, the apex institution says, “If households in the middle third of the gold holdings distribution re-allocated a quarter of their existing gold holdings to financial assets, the wealth gain in real present value terms accruing would be sufficient to move these households roughly 1 percentage up the current Indian wealth distribution.”