How to make financial services work for India’s ‘next half billion'
The Indian financial services industry has made great strides in the past decade. Impressive progress in improving access to formal financial services through bank accounts and an efficient, low-cost digital payments infrastructure has made India a beacon globally for financial inclusion. However, the industry continues to largely serve the urban, richer India and driving usage amongst India’s “next half billion”* continues to remain a challenge. The small business segment too continues to remain underserved by formal financial services.
The financial lives of the “next half billion” (NHB)
As studies around the world have shown, the financial lives of lower-income populations are complex. That is the case with the NHB in India too. Consumers make multiple decisions daily to manage their limited income and to stretch it to meet their needs. The focus is on managing the present, rather than looking at financial goals and working towards those goals. A woman participating in a savings group may be saving toward her child’s education, but she is also aware that this saving is available for a health emergency or can go toward a longer-term goal like home improvement. They seek flexible solutions that balance their need for flow (availability of cash as needed) and illiquidity (simple barriers to prevent withdrawal of any savings for discretionary purpose). Thus, they turn to expensive informal financial channels, mainly for short-term borrowings.
Unsurprisingly, the Report of the Household Finance Committee (2017) constituted by Reserve Bank of India found that Indian households have less than 5 percent of their wealth in financial assets, and insurance penetration is very low. There is also a high incidence of non-institutional debt, suggesting that households are dealing with emergencies and risks through high cost borrowings ex-post as opposed to proactively saving or insuring against risks.
Small businesses – a growth engine short on fuel
There are between 55 and 60 million micro, small, and medium-size enterprises (MSMEs) operating in India today. Collectively, MSMEs employ more Indians than any other sector except for agriculture, and over the past decade have contributed roughly one-third of India’s GDP. MSMEs provided employment to more than 123 million workers in FY 16 in India, according to a report. Yet this contribution remains well below its potential - this sector can be an even more powerful growth engine for India’s economy.
According to a data report, the total GVA of the Indian MSME sector by FY2020 is estimated to grow to $866 billion, at a CAGR of 11.12 percent.
A significant barrier to growth has been the lack of access to formal credit. In 2018, MSME credit demand was estimated to be Rs 45 lakh crore ($600 billion). Roughly 40 percent of this demand is served by the informal sector, where interest rates are at least twice as high as the formal market. An additional 25 percent of MSME borrowing is invisible — through personal proprietor loans (rather than business loans), demonstrating the shortcomings of the formal credit system.
Improving the usage of formal financial services
Our work with entrepreneurs and their customers and the research studies we have supported underscore the need to overcome the following barriers to usage of formal financial services:
Demand side impediments include a lack of trust in formal service providers, low consumer self-confidence in engaging with them, need for flexibility (moving seamlessly between short-term and long-term financial needs), high transaction costs and procedural impediments like paperwork and the need for multiple interactions with providers.
For formal financial institutions
Supply side challenges include a lack of easy customer discovery processes, lack of underwriting capabilities for consumers/businesses with inadequate income records and income volatility, legacy high cost structures that make servicing low ticket/high volume business financially unviable and a lack of unified framework or guidelines to provide high quality and low-cost financial advice.
Entrepreneurs reimagining business models
In the past few years, many nimble fintech firms have emerged that leverage public data platforms (such as India Stack) and seek to serve the NHB and small businesses with low-cost low-ticket financial solutions. Fintechs use alternative/surrogate data for underwriting, and deliver their products to the consumers using technology.
There is an increase in startups that go beyond payments and credit and into areas like savings, investments and insurance, which is encouraging. We are also seeing the advent of neo-banks which eschew a provider and product-centric view of financial services – instead they structure and bundle products that are embedded in the business value chain or life of the consumers.
At Omidyar Network India, we have constructed our financial services portfolio with the thesis that financial solutions relevant to the context of consumers and provided in a low-cost and personalised manner can help bridge the usage gap and increase penetration of formal financial services amongst the NHB and small businesses. The table highlights how these 15 start-ups have designed pioneering business models that address the barriers mentioned above. In the coming years, they and many others like them will take mainstream finance to the masses.
*refers to the 500 million Indians expected to come online through their mobile phones over the next few years. Mainly from the lower middle income and low income segments, the NHB has traditionally been underserved, excluded and disempowered.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)
(Edited by Suruchi Kapur- Gomes)