Financial inclusion and cash

Varad Pande and Nirat Bhatnagar have an interesting Op-Ed today in Mint about financial inclusion, and about how financial institutions haven’t been innovative to make products that are suited to the poor, and how better user interface can also drive financial inclusion. I found this example they took rather interesting:

Take, for instance, a daily wager who makes Rs200 on the days she gets work. Work is unpredictable, and expenses too can be volatile, so she has to borrow money for buying vegetables, or to pay the doctor’s fees when her children fall sick. Her real need is for a flexible—small ticket, variable amount, rapid approval—loan product that she can access instantly. Unfortunately, no institutional channel—neither the public sector bank where she has a “no frills” account, nor the MFI that she has previously borrowed from—offers such a product. She ends up borrowing from neighbours, often from the local moneylender.

Now, based on my experience in FinTech, it is not hard to design a loan product for someone whose cash flows are known. The bank statement is nothing but a continuing story of the account holder’s life, and if you can understand the cash flows (both in and out) for a reasonable period of time, it is straightforward to design a loan product that fits that cash flow pattern.

The key thing, however, is that you need to have full information on transactions, in terms of when cash comes in and goes out, what the cash outflow is used for, and all that. And that is where the cash economy is a bit of a bummer.

For a banker who is trying to underwrite, and decide the kind of loan product (and interest rate) to offer to a customer, the customer’s cash transactions obscure information; information that could’ve been used by the bank to design/structure/recommend the appropriate product for the customer.

For the case that Pande and Bhatnagar take, if all inflows and outflows are in cash, there is little beyond the potential borrower’s word that can convince bankers of the borrower’s creditworthiness. And so the potential borrower is excluded from the system.

If, on the other hand, the potential borrower were to have used non-cash means for all her transactions, bankers would have had a full picture of her life, and would have been able to give her an appropriate loan!

In this sense, I think so far financial inclusion has been going on ass-backwards, with most microfinance institutions (MFIs) targeting loans rather than deposits. And with little data to base credit on, it’s resulted in wide credit spreads and interest rates that might be seen as usurious.

Instead, if banks and MFIs had gone the other way, first getting customers to deposit, and then use the bank account for as much of their transactions as possible, it would have been possible to design much better financial products, and include more customers!

The current disruption in the cash economy possibly offers banks and MFIs a good chance to rectify their errors so far!

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