Before trying to establish the suzerainty of its policies over the rural and poor India, RBI should first establish the hold of our currency, the rupee, on the poor
For many of the poor—rural or urban—in many parts of the world, interest rates are not a monolithic price point balancing demand and supply of credit with variations mainly (if not solely) for credit risks and time duration.
Poor people have been observed to keep currencies for safe custody without any compensation with the same wealthy lender from whom they have borrowed money at usurious rates of interest. This seems irrational but is compelling to the poor to ensure cash flows for upcoming events like marriage, funeral, school admission or sowing. This perhaps addresses their ‘fear’ against an irresponsible husband or ‘lack of self control’ over competing short-term spending itches.
Nothing can explain so many irrational practices (as formal system sees them) in South Africa surrounding funeral finances. A decent funeral is a matter of prestige and social standing (ranks perhaps number one in their Maslow’s hierarchy) and consumes about half or full year’s income. Years of zero interest (or even paying safe-keeping fees) and deposits with funeral societies defeats arithmetic rationality but addresses the anxieties on maintaining social prestige.
As the book Portfolios of the Poor: How the World’s Poor Live on $2 a Day describes, moneylenders to the poor almost always collect interest rates in advance and don’t refund proportionate portion for unutilised period on any prepayment. Yet, just to feel relieved from the burden/shame of indebtedness, the poor pay up most loans ahead of time, thus increasing the ex post interest rates by several percentage points—it’s irrational arithmetic-wise but is rational mental-relief-wise. The book also observes practices where people borrow expensive monies, leaving savings accounts intact due to a silo (use-wise) mentality.
Just no commentator or official has understood the “`10.5 in the evening for `10 in the morning” small trade finances. Simple arithmetic tells us that it is more than 1,800% per annum, even without compounding. But the moneylender, apart from running counter-party risks, also knows the purpose and can get into such business himself or set up someone else who can. So, why should he not get to share the spoils with the trader? In that sense, it is more a share in the joint venture profits, not interest. It is just dividends with a cap, in treasury manager’s parlance.
Surely, in the ladder of social shame, borrowing ranks somewhere subordinate to other social compulsions (gifts and donations in marriages, funerals, festivals, religious functions), medical emergencies, etc. Otherwise, they wouldn’t be borrowing. Borrowing for economic purposes, like for sowing, buying cattle or houses, etc, may be justified on rational grounds. If governments want the poor to become rational, they may have to invest a lot in social education and training to move up indebtedness and make other non-economic needs less shameful than borrowing.
In fact, this sense of indebtedness and shame from failures to meet obligations and social policing has induced repayment discipline amongst the poor. This is a great social collateral which the formal systems refuse to recognise or promote.
Most poor cannot count; even if they can, most don’t Many studies indicate that in their decision on when to borrow, from whom (for some, loans from next-door neighbours are preferred; for others, it is relatives, but for some other purposes it is considered shameful to borrow loans from relatives), and when to repay or prepay, the arithmetic of interest rates weighs far lower as compared to a rational person. Culture, social customs, peer pressure, shame and fear, family pressures decisively overshadow the arithmetic.
Thus, when the Reserve Bank of India’s appointed committee put caps on the interest rates charged by microfinance institutions as the main weapon to deal with some events in the erstwhile combined Andhra Pradesh, it only betrayed its lack of understanding of the financial culture of the poor. The arithmetic of interest rates may work better for formal systems, between banks and financial markets, in cities, and amongst the rich and heavily banked, but not amongst the poor.
The poor level of financial integration and inclusion in India is the result of this lack or refusal to understand the culture. RBI (or its equivalent monetary authorities) should stop their colonising mindset—they should not supplant the financial culture by dictating the price, acceptable instruments and institutions. Formal form over substance KYCs can never match the KYC of the local moneylender, whose self-interest is locked in with his customers’ fortunes.
Establish the role of money first before seeking policy effectiveness Before trying to establish the suzerainty of its policies over the rural and poor India, RBI should first establish the hold of our currency (the rupee) on the poor. For some of more important functions of money, the poor trust its surrogates more. Gold (cows in Swaziland or cattle in many parts of Africa) has much more dominance in store of value function of money, and to a limited extent even in liquidity and transaction demand. Policies and schemes about gold over the years have been rather unimaginative. The high levels of informal economy does not help either.
Some aspects of the financial culture of the poor described above also come out of fear and anxieties, cash-flow uncertainties, ill-timed arrival of cultural exigencies, etc. These can be overcome to a large degree by appropriate insurance whose penetration is very poor right now. Proper insurance on various cash-flow risks that the poor face will release a lot of gold and make the poor adopt more ‘rational’ and self-optimal practices.
Indian authorities should subsume the existing system into the formal network by refinancing moneylenders and accepting social collaterals, finance nidhi companies and chit funds, etc. Instead, they erect barriers against such practices on institutions which seek to use the available conducive social infrastructure.
We should, of course, continue to educate poor communities about the arithmetic so that wherever possible the poor could act rationally, including proper search of alternatives in their own ‘irrational’ markets.
A regulator who fails to have a grip of the market culture, market practices or interact with its participants continuously to gather market intelligence and spot any significant trends and shifts is bound to falter. East Asian societies like Indonesia (as spread out), Malaysia, Vietnam (as dense as India) have not tried to supplant the local systems but have sensibly allowed them to coexist and serve their societies.
V Kumaraswamy, Author of ‘Making Growth Happen in India’. Views are personal