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Profitable Models for Financial Inclusion

Brij Raj Deputy General Manager & Member of Faculty Reserve Bank Staff College

India must make bold decisions to complete the financial inclusion plan in the quickest possible time and follow it up with a more ambitious plan for economic inclusion to uplift the poor. - Shri M Narendra, CMD, Indian Overseas Bank ABSTRACT Rural India presents a remarkable opportunity for banks and financial institutions to seek their fortunes and bring prosperity to the aspiring poor through financial inclusion. In a fast growing economy like India the poor are the middle class of tomorrow and banks could, therefore, ill-afford to ignore this segment. Banks, however, argue that while the benefits of financial inclusion can be easily understood, the costs of serving the poor can be significant in the short-term, thereby impacting profitability. Banks, therefore, need to take bold decisions and reach out to rural India with strategies and business models which are beyond the realm of conventional thinking. This paper looks at some of the business models and the essential elements of profitable models for financial inclusion. Introduction The Committee on Financial Inclusion (Chairman: Dr C Rangarajan, 2008) has defined Financial Inclusion as the process of ensuring access to appropriate financial products and services needed by vulnerable groups such as weaker sections and low-income groups, at an affordable cost, in a fair and transparent manner by mainstream institutional players. Financial inclusion is important for the poor as it provides them opportunities to build savings, avail credit, make investments and equips them to meet emergencies. The development process so far has not brought balanced economic growth across the country. The need of the hour for public policy and banks, therefore, is to focus on inclusive growth ie growth with equity and make financial inclusion the uppermost policy priority. The high dependence of rural India on the informal financial system is a wakeup call for banks to put in greater efforts towards financial inclusion. Financial inclusion will positively impact the lives of rural Indians and pull millions of them out of the clutches of poverty. It will also provide them with a formal identity, access to banking products/services, payment and settlement

system and a safety net in the form of deposit insurance, etc. The Reserve Banks broad approach to financial inclusion aims at integrating the financial inclusion plans of banks with their business plans and the overarching aim of policymakers is to make financial inclusion a business opportunity rather than an obligation. On the back of a favourable regulatory framework the past four years have witnessed a significant build-up of momentum in the financial inclusion space. During this period banks have been experimenting with various models to effectively deliver on their financial inclusion plans. To support banks in their endeavours, RBI has also deregulated the interest rate on small value loans to encourage greater lending to the poor. Recent advances in technology such as handheld devices, mobile telephones, point-of-sale devices, kiosks, low-cost ATMs, etc have also opened up several delivery channels for providing financial services to the poor. The current decade could, therefore, see the emergence of successful business models as banks begin to view financial inclusion as a viable business opportunity. The need of the hour for banks, therefore, is to develop business models that enable financial inclusion and are also profitable over the medium to long-term. Financial inclusion as a business opportunity Some banks argue that while the benefits of financial inclusion can be easily understood the costs of serving the poor can be significant in the short-term, thereby, impacting profitability. This reflects a very narrow approach to tackling the problem of financial inclusion. Banks would, therefore, do well to draw inspiration from the following illustration given by Dr D Subbarao, Governor, Reserve Bank of India in the context of financial inclusion: A business executive of a shoe company was sent to a large developing country to assess the market potential there. What he saw was millions of people going without shoes. He came back and reported to the management that there was no business potential there because no one wore shoes. A few months later, the strategist of a rival company went and saw the same picture. He came back and reported to his management that there is tremendous business potential in that country because of the number of shoes they can sell. Ultimately, it is a question of mindset, and it is only the change in mindset of all concerned stakeholders that can make financial inclusion a reality.

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Bankers should, therefore, change their mindsets, view financial inclusion as a viable business proposition and adopt innovative methods and low-cost delivery models to reach out to the poor. They should study the different markets across India thoroughly and offer region-wise customised products and services riding on the higher levels of trust enjoyed by them over the other financial service providers in rural India. Benefits of financial inclusion There are several benefits for banks from pursuing financial inclusion. Financial inclusion initiatives would provide banks with a low-cost and stable source of funds, helping them improve their asset-liability management (ALM). The potential to tap the rural areas for raising low-cost and stable deposits is high. In urban areas whenever interest rates start rising banks are faced with a higher interest outgo on account of migration of deposits from savings to term deposits. This type of churn, however, would be far lower in rural India as financial literacy levels there are far lower. Therefore, ensuring a good mix of rural and urban deposits becomes strategically important for banks. Rural India can also help banks significantly increase their low-cost current account-savings account (CASA) deposits, thereby, helping protect margins and spreading the business risks. The fast growing activity in the rural credit markets also offers banks excellent opportunities for boosting their retail loans and ensuring a balanced mix of retail and corporate loan exposures. Opening savings accounts for rural Indians can be a winwin proposition for banks, customers and governments. Once the bank accounts are opened customers can receive payments in these accounts directly from governments towards subsidies through direct cash transfers, social security transfers and Mahatma Gandhi National Rural Employment Guarantee Programme (MGNREGA) wages into their bank accounts of beneficiaries through the Electronic Benefit Transfer. This will minimise both transaction costs and leakages and banks can gain from the float income in these accounts as several hundred million bank accounts are opened. Further, the savings of the rural poor would be brought into the formal financial system and channelised into investment. Banks would also be able to reduce their dependence on bulk deposits ie purchased liquidity and effectively manage liquidity risks and asset liability mismatches. Profitable models for financial inclusion Several models have been tried across the world, namely, no-frills accounts banking, branchless banking (business correspondent model), banking without a bank (using mobiles as conduits for financial transactions), microlending, etc for pursuing financial inclusion. Global

experience has, however, revealed that there is no one size fits all type of solution to the problem of financial inclusion and the above models have succeeded differently across the world. The Reserve Bank has, therefore, studied various models for financial inclusion before deciding upon the business correspondent (BC) model for India. Banks have been advised to leverage the benefits of low-cost technology solutions and appoint BCs ie agents of banks who would serve as the Doorstep Bankers and provide the last mile connectivity and reach out to millions of rural Indians. The BC model has been a major success in Brazil, which has a similar demographic profile to India. According to an article Financial inclusion models from around the world, (Forbes India, November 2010), the major reason why the BC model has worked there is that the authorities established a strong business case for BCs. For example, the payment of bills of any kind is required to be done through the banking system using a standard form called Boletos. Bill payments comprised 75 percent of volume (1.6 billion) and 70 percent of value ($105 billion) transacted through Brazilian correspondents in 2008 alone and have been growing. Further, according to a Wharton School study, the average cost per transaction in India at a BC is the lowest at INR 4.50 ($1 = INR 45 approx.) per transaction as compared to an ATM (INR 18) and a bank branch (about INR 45). Finally, Indians are already familiar in dealing with individuals as agents for transacting in financial products especially for insurance, postal savings, etc. The Reserve Bank has made a commitment to a bank-led model of financial inclusion through BCs and has stated that it will support banks in their financial inclusion initiatives by way of information dissemination, sharing of best practices and also through regulatory incentives. RBI has also advised that under their financial inclusion plans, banks at a minimum should offer four products: a savings-cum-overdraft account a remittance product a Kisan Credit Card / General Credit Card and entrepreneurial credit. Banks may additionally offer micro-insurance and micropension products. It is important to note, however, that the Reserve Bank has refrained from deliberately imposing a uniform business model on the banks as it wanted each bank to build its own strategy in line with its business model and comparative advantage. This approach is also expected to ensure better ownership of the business model. Banks would, therefore, need to pursue both conventional and unconventional measures to reach out to the rural masses. They also need to understand life in rural India before they design

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products/services and low-cost sustainable business models for rural India. According to the consulting giant Boston Consulting Groups (BCG) report The Next Billion Consumers (November 2007), profitable business models would lead to a reduction in the cost of manpower, usage of technology for distribution reach and collaboration across industry models. Further, Aadhaar, Indias unique identification system will play an important role in helping the poor establish their identity to meet the banks KYC norms and is, therefore, seen as a game changer in the quest for financial inclusion and harnessing technology for the benefit of the poor. The successful endeavours of some banks are helping gradually shed the notion that financial inclusion is not a viable business proposition. The success story of financial inclusion in Dharavi, Asias largest industrial slum spread over an area of 1.75 sq km and producing goods and services worth several million dollars and home to a million plus people is cited as a case in point. Even though Dharavi covers such a large area and is situated in the heart of Mumbai, it surprisingly did not have a commercial bank branch for a long time. Things, however, changed when Indian Bank in a bold initiative became the first commercial bank to open a branch in Dharavi in February 2007 which went on to register good business. The Union Bank of India too which has taken to financial inclusion initiatives a few years ago calls the rural poor, the new bankable class, is offering a combination of banking products such as a no-frills savings account, microcredit, micro-insurance, remittance facilities and an overdraft facility. The bank also proudly claims that some segments of its remittance facilities for the migrant labourers as also those for the milk and fruit vendors, under the financial inclusion project are already profitable. The RBI has allotted the bank 3,159 villages and as of March 31, 2011, it has already covered 2,511 villages and intends to cover 10 million customers by March 2013 under the inclusion plan. Likewise, southbased banks like the Indian Overseas Bank, Corporation Bank, Indian Bank, etc have also taken up the implementation of their financial inclusion plans both in letter and spirit. Of the 1273 villages given to the Indian Overseas Bank under the financial inclusion plan the bank has already covered more than 800 villages and it expects that the remaining 400+ villages will be covered before December 2011, well ahead of the deadline of March 31, 2012. Post-Office Banking and Insurance - Of late, Post Offices, are being remodeled to undertake last mile connectivity in banking and insurance. Such experiments have proved very successful in countries like Japan. So, when stabilised, it would indeed be a real breakthrough in financial inclusion in our country.

While designing their business models, banks would do well to assess whether they are robust and aligned with the banks goals. A successful model should also represent a better way than existing alternatives and also answer management guru Peter Druckers age-old questions: Who is your customer? What does the customer value? How do you deliver value at an appropriate cost? According to Ramon Casadesus-Masanell and Joan E. Ricart, authors of How to design a Winning Business Model? (Harvard Business Review, January 2011 edition) a profitable business model should consist of four elements: a customer value proposition a profit formula key resources key processes The article adds that a good business model should be able to sustain its effectiveness over time by fending off four threats, identified by renowned Harvard Business School Professor Pankaj Ghemawat. They are: Imitation (can competitors replicate your business model?) Holdup (can customers, suppliers or other players capture the value you create by flexing their bargaining power?) Slack (organisational complacency) and Substitution (can new products decrease the value customers perceive in your products or services?). Profitable models for financial inclusion could, therefore, have the following features: i. Offering a clear customer proposition and customised bouquet of products To succeed in their financial inclusion initiatives, banks would need to offer customers a clear proposition and a customised bouquet of product offerings. According to the BCG Report quoted earlier, banks need to offer the following services at a minimum: government payments, savings accounts, credit, remittances and insurance as part of an overall package to attract customers. Each of these offer significant value to customer and enable banks to generate value through transaction fees.

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ii.

Transaction-driven pay-per-use features

To enhance revenues from the financial inclusion drive, BCG has recommended that banks should offer credit products in addition to deposits and remittances and shift their transaction model from the conventional rich man's float-based model to an unconventional yet poor-friendly, transparent pay-per-use model, where customers are charged a small fee for every withdrawal. iii. Scalable business model with simple, userfriendly low-cost technologies Profitable business models would need to be scalable and incorporate simple, user-friendly and low-cost technologies so that investments would be recouped and profits begin showing up as the number of people serviced by a particular branch or outlet increases over time. iv. Collaborate with local agents and for-profit companies According to consulting giant McKinseys report A new idea in banking for the poor by Alberto Chaia, Robert Schiff and Esteban Silva (November 2010), the basic problem of last mile access can be solved if banks can team up with retail outlets (business correspondents) in low-income, often hard-to-reach areas to offer financial services to rural masses, thereby, creating value both for themselves and their customers. These retail outlets could be kirana stores, grocery stores, petrol bunks, post offices, etc. Villagers know the owners/managers of these outlets because they frequent them for other purposes, speak their language and are aware of the local customs and culture. Banks would also do well to take advantage of regulatory relaxations and engage even for-profit entities as BCs as done by Axis Bank, SBI, ICICI Bank, etc for offering financial services / products such as remittance, savings, credit, micro insurance, micro SIP and micro pension by tying up with thousands of retail outlets of Idea Cellular, Airtel, Vodafone and Aircel across the country, thereby, making the benefits of banking available to the Indian rural masses and building a more inclusive society. v. Banks need to learn from both corporate India and the informal sector The rural markets are coming alive and many corporates are now concentrating on the rural areas. Fast moving consumer goods (FMCG) companies, for instance, have unveiled specific strategies that target villages with a population of less than 5,000, known as micro-markets. Late Prof. C K Prahalads work on profit at the bottom of the pyramid (BoP) has helped and encouraged corporates to build sustainable and profitable rural business models. Banks can, therefore, follow their clients

to their markets by opening branches/banking outlets in villages as inclusive banking goes beyond the conventional notions of commercial banking. According to the BCG, the informal sector has been a major success in the rural areas. The formal sector must, therefore, learn from the informal sector. It must also innovate and improve service levels in order to provide the same level of accessibility as the local money lender, friend or relative. vi. Subsidiary model to drive down costs According to the BCG, Indian banks should explore the subsidiary route to drive down distribution costs in their financial inclusion drive. Given that the average distribution cost of banks, at INR 5.5 lac per employee, is prohibitive, BCG is, urging banks to consider floating subsidiaries to bring down their human resource costs. These subsidiaries could harness local talent (at a substantially lower average distribution cost of INR 1 lac or less per employee) in rural and semi-urban areas for reaching basic banking services to the un-banked. It is also urging policymakers allow banks to set up low-cost subsidiaries only for the financial inclusion drive. BCG has also assessed that in the traditional model for pushing financial inclusion, the cost-income ratio was about 1000 percent ie the cost of rendering service (at about INR 600) per account exceeds income earned from the account (INR 60). Ideally, this ratio should be around 50 percent. Studies also suggest that a bulk of the borrowing by rural poor is for consumption-related purposes followed by income generation activities and education respectively and the dependence of rural India on the informal channel (money lenders/ friends and family) for credit to smoothen income gaps is still very high. vii. Educate them and take them on board RBI has been advising banks to focus on financial literacy to boost the demand for financial products. Banks should, therefore, make boosting financial literacy in rural India an essential component of their business model for financial inclusion. viii. Ride on government payments In August 2011, the GOI has amended its landmark MGNREGA scheme to ensure that beneficiaries receive wage entitlements under the Act within 15 days through institutionalised channels like banks and post offices. The amendments now make it mandatory under the law for state governments to ensure that every beneficiary has a bank/post office account and the disbursements are made exclusively through these channels. The GOI is also considering shifting to a direct cash transfer programme instead of subsidy for the Public Distribution Schemes. This will also involve banks and positively benefit financial inclusion initiatives. Again, according to the

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BCG, successful models of financial inclusion would, therefore, ride on government payments as an important source of a recurring float providing them another strong reason to push financial inclusion. ix. Innovate and test-market pilot products/services Banks need to realise that the poor find it difficult to save on a regular basis and may also resort to consumption loans to supplement their savings whenever required from a variety of sources to meet emergencies. Banks, therefore, need to keep such realities in mind while designing their products/services for the poor. With some understanding and innovation, over a period of time, banks can also capture a bulk of the rural remittances market, a significant chunk of which currently happens through informal channels. McKinseys report cited above also suggests that financial service providers should test-market low-cost pilots to see which products/services are found acceptable before large-scale introduction. Conclusion Traditional and conventional banking solutions may not be the answer to address the problem of financial inclusion in India. Banks, therefore, need to innovate and think out-of-the-box for solutions to overcome the problem of financial exclusion in India. They need to walk the talk, go the extra mile, deploy new technologies and create financially viable models to take forward the process of financial inclusion in an effective manner. The problem of financial exclusion needs to be tackled with urgency if we want our country to grow in an equitable and sustainable manner. This way banks in India would be doing a great service to the cause of financial inclusion and make their name in history. Banks which are laggards in financial inclusion would do well to speed up because if history is any indication the window of opportunity to capture market share through financial inclusion would be available only for a short period. In a fast growing economy like India the poor are the middle class of tomorrow and banks could, therefore, ill-afford to ignore this segment. Select public sector banks in India have played a pioneering role in financial inclusion and their success should encourage the rest of the banks to put their financial inclusion efforts too on the fast track.

As Dr D Subbarao, Governor, RBI, advised in his remarks at the Bankers Club in Kolkata on December 9, 2009, financial inclusion is a win-win opportunity for the poor, for the banks and for the nation. Because of improving awareness levels aspirations of the poor are on the rise and banks will not be forgiven if they do not rise up to meet these aspirations. It is for the banks to convert what they see as a dead-weight obligation into an exciting opportunity and move on aggressively on financial inclusion that banking on the poor can actually be a rich banking proposition. Banks would also do well to remember the advice given by Late Prof. C K Prahalad in his epic book, Fortune at the Bottom of the Pyramid What is needed is a better approach to help the poor, an approach that involves partnering with them to innovate and achieve sustainable winwin scenarios where the poor are actively engaged and, at the same time, the companies providing products and services to them are profitable. Financial inclusion may be a social responsibility for the banks in the short-run but will turn out to be a business opportunity in the long-term. As Dr C Rangarajan has stated, Financial Inclusion is no longer an option; it is a compulsion. The entire world is looking at this experiment in India and it is important that banks rise up to this challenge and meet it successfully.
References 1. A new idea in banking for the poor by Alberto Chaia, Robert Schiff and Esteban Silva, McKinsey Quarterly, November 2010 2. Social Development Perspectives, M. P. Vasimalai, Executive Director, DHAN Foundation 3. BCG Report, The Next Billion Consumers - A roadmap for expanding financial inclusion in India, by Janmejaya Sinha and Arvind Subramanian 4. Financial inclusion models from around the world, Forbes India Magazine, November 2010 edition 5. Financial Inclusion: Challenges and Opportunities (Remarks by Dr. D. Subbarao, Governor, Reserve Bank of India at the Bankers Club in Kolkata on December 9, 2009) 6. How to design a Winning Business Model? by Ramon Casadesus-Masanell and Joan E. Ricart , Harvard Business Review, January 2011 edition

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