By Abhinav Mishra
Suppose a student boards a cab from the airport to their university. Often, the cab driver will request the passenger to pay him in cash rather than with an online wallet or credit card. After all, the cab company pays him once every ten days, and he needs the funds to meet his fuel expenses.
Incidents like this reflect the stark contrast between a student’s need for an education loan to get an MBA and a cab driver’s working capital requirements. Whereas a student might look for the lowest interest rate option, a cab driver would prefer a small, quick decision, no-frills loan. This illustrates why there can’t be a ‘one-size-fits-all’ solution to the problem of financial inclusion.
Misconceptions about an imperfect solution
Broadly, financial inclusion is the idea of ensuring that individuals and businesses of all levels have access to financial services at affordable prices. To begin with, the initial perception about inclusion is that financial inclusion in itself is good and is an immediate solution for the poor to ascend out of poverty. It takes the poor out of the ‘clutches’ of the ‘evil’ village moneylender and places them in the formal financial system.
The 2008 subprime crisis in the United States painfully demonstrated that this isn’t always what happens. Placing the poor, with limited financial knowledge, in the global financial markets without robust coping mechanisms can actually worsen their situation and make them even more vulnerable. After the 2008 collapse, the credit score of the subprime borrowers further deteriorated and institutions tightened their lending thresholds, driving them out of the financial system.
Lowering the steep cost of inclusion
For any institution to lend responsibly, it has to assess borrower’s risk by evaluating their identity, ability to repay, and collateral. Formal institutions such as banks often incur an extra cost to assess these for the poor because of the lack of identity and transaction trails. The moneylender evaluates these using classified knowledge. Institutions such as self-help groups and the Grameen Bank externalise these risks through social pressure, discipline, and coercion. To achieve scale and minimise cost, they severely standardise their products and operations with minimal decision-making for the end operator.
Further, the ‘exorbitant’ interest rates charged by the moneylender cannot be annualised and compared with the annual rates of the bank. The needs of the poor are different from that of a regular bank borrower. The poor need small, standardised, quick-decision loans which can support their small cyclic earnings and allow a high frequency of payments. The interest rate is not a core issue for these customers, availability is.
Alternative success stories
Building last mile connectivity of formal institutions is not the only answer to financial inclusion. It has been observed in several examples that we can address financial inclusion issues with alternative solutions. For example, picking design elements from different existing models and developing products to suit the requirements of the poor has been a success as implemented under the Association for Social Advancement (ASA) model in Bangladesh. Self-help groups in India achieve success by externalising risks. Through programs that are changing scope by switching from mere credit to savings such as the Pradhan Mantri Jan-Dhan Yojana (PMJDY) scheme, or employing technology to reduce operational costs such as using Aadhar for identification, we can also address the problem of financial inclusion.
A long-term answer?
However, as the size and complexity of the transactions increase, will the current standardised models based on social coercion and trust be scalable? Will it be possible for technology to extract the embedded information within social groups and leverage it for decision-making? What are the possible opportunities to reform the current model?
How to successfully transition the poor from a group lending model to an individual level model is an ongoing puzzle. Factors such as increasing mobile phone penetration, utility payments, records with self-help groups, and Aadhar can help address the issue of the lack of a transaction trail and identification. However, there is a need to develop an enormous infrastructure and administration to materialise this distant dream.
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