I read an excellent post by Ajay Shah recently that questioned the policy wisdom of emphasising house ownership over rental housing. His concerns stem from hampering the mobility of labour and worsening risk diversification in the portfolios of households. While these concerns are true for most households, they are much exacerbated in the case of low-income families.

Take a typical worker employed in the construction sector earning, say Rs. 4500 per month. He faces two significant risks to income: accident/health shock resulting in temporary or permanent disability and unemployment resulting in temporary or long-term loss of income. Given this inherent income volatility, the obligation of a fixed Equated Monthly Installment (EMI) over a long period of time to finance the house purchase seems unsuitable. While capital appreciation as a motive might make sense for households with more stable incomes and low exposure to real-estate otherwise, the volatility in this case becomes a real stumbling block. A rental contract provides the much-needed flexibility to reduce housing expenditure when shocks occur and also the ability to migrate when the nature of economic opportunities shift, as they are likely to over a period of time. My colleagues have an interesting paper that simulates household wealth under ownership housing and rental housing that makes this point clearer.

While there is no question that the steady growth of the housing finance market must continue, particularly for those households for whom real-estate exposures are low and those that have income streams that are uncorrelated to the performance of the local economy; for self-employed households; households for whom principal income source is a small business prone to economic cycles; and low income households of all types, there has to be an almost complete shift towards a rental market and away from ownership.

Despite all the economic merits, rental markets in India remain vastly under-developed. Development of rental markets will receive a fillip from a) clarifying the entire legal basis of rental markets, repossession and rent control b) facilitating access to developer finance for rental housing c) developing the Real Estate Investments Trust vehicle (REITS) and d) channeling more long-term funding from insurance companies and pension funds to these markets.

In addition to rental ownership-friendly policy, there is also room for interesting business models. Take for example, Aarusha Homes that provides dormitory services to entry level low-income working people at a very affordable cost. This considerably reduces the entry barrier for a young person seeking employment in the city for the first time. The need for flexibility surely results in a willingness to pay.  (Separate post to come on the merits of migration from villages to semi-urban and urban centres)

(I thank Anand Sahasranaman and Nachiket Mor for their insights on this issue)

For every loan of Rs, 10,000 made through a Public Sector Bank rural branch, it costs them about Rs. 4150. The same number for a Private Sector Bank rural branch is about Rs. 3210. Little wonder then that rural branch expansion meets with so much resistance.

In a new working paper, my colleagues Deepti George and Anand Sahasranaman develop a framework to compare costs of rural credit delivery across five dominant channels: PSB lending through its rural branch, PSB lending through a Self-Help Group (SHG), PSB lending through a Micro Finance Institution, Private Bank lending through its branch and Private Bank lending through a Micro Finance Institution. Importantly, they look at costs comprehensively including a) cost of debt b) cost of equity c) transaction costs and d) loan loss provisions.

The magnitude and spread of these numbers is quite stunning.  Channel-wise costs and losses (assuming lending at 12%) look as follows:

Why does any of this matter? From a policy perspective, if the outcome of rural credit expansion is deemed important, shouldn’t these just be viewed as welfare increasing costs just like other subsidies?

What is important to note here is that the same Rs. 10,000 loan to the rural customer has very different costs of delivery across various channels. By prescribing that bank branches ought to be the dominant delivery channel, the financial sector gets saddled with steeply higher costs without any proportionate welfare gain. As the authors note, flexibility to the bank in choosing the lowest cost channel has the potential to achieve the outcome of rural credit delivery with far lower costs. After all, shouldn’t policy making be more about outcomes and less about instrumentality?

A few colleagues and I recently travelled through Varanasi and Mirzapur in Eastern Uttar Pradesh visiting Micro Finance Institutions (MFI) in that region and their clients. I am delighted to report that this region, one of the poorest in India, is a hotbed of innovations.

Cashpor is a leading MFI operating in the region founded by Professor David Gibbons, a thought leader in the area of financial services for the poor.  Operating costs in the MFI model vary between 6 – 12% and one culprit for these numbers in extensive manual data entry processes. Cashpor has deployed a remarkable mobile-based payment and reporting solution developed in partnership with Atom Technologies that replaces the paper-based data entry with real-time mobile entry and reconciliation.

We witnessed the working of this mobile based system in a centre meeting of the Pandeypur branch in Varanasi.  The field officer starts with recording the attendance of each member in the application. Many MFIs believe that attendance rates are an important indicator of group quality. After that, the officer proceeds to record the amounts collected from each client against what was due. The field officer can also record requests for new loan cycles and see future disbursements on the application.

The field officer’s handset is programmed at the back end to access data for only the centres under his responsibility. This is done to cut down on data transfer as both the handset and network connectivity cannot handle large data transfers. When the meeting is completed, the field officer uploads the data to a central database, which the head office can access immediately to understand overdue position, if any. The entire process was smooth and effortless.

When we asked Cashpor staff about the benefits of implementing this solution, they mentioned that eliminating the manual data entry processes saved an entire workday per week! They are preparing for a significant interest rate reduction riding on some of these large productivity gains.

Another highlight of the trip was watching Cashpor’s officer talk to a group of women about the New Pension Scheme Lite (NPS-Lite), a pension product for informal sector workers with a matching contribution by the Central Government.  He started by asking the group whether they knew women in the village who were finding it hard to support themselves in their old age. Disconcertingly, almost everyone nodded their head. He then spoke about the power of compounding – how small amounts set aside every week could create meaningful lumpsums for old age. We were thrilled that the officer had a perfect understanding of the features of the product and explained the implied illiquidity in a pension product. The women clients had several questions for him, all of which he patiently addressed. It was a powerful reminder of the value of last mile institutions like Cashpor for building meaningful financial inclusion.

Our next stop after Cashpor was at Utkarsh. Set up by a former colleague from ICICI Bank (Govind Singh) only a few years ago, Utkarsh has rapidly emerged as one of the most promising MFIs in India. Here, we saw several innovative client protection processes in place. Notable among them was a grievance redressal system where a client is provided a toll-free line to call Head Office and share any concern they might have. Utkarsh mentioned that they receive several calls every day ranging from enquiries about membership and getting loans to complaints about credit officers not being on time. Utkarsh has tied up with a service provider in Delhi that provides the entire toll-free service, including recording, classification and retrieval of call information. This is systematically analysed and discussed by the senior management of Utkarsh.

Between Cashpor and Utkarsh’s growth plans, Eastern Uttar Pradesh and Northern Bihar look set to have access to basic financial services in the next few years. Both organisations have battled significant odds including infrastructure and operating risks in moving cash. Their success is an inspiration for everyone in the field of financial services for the poor.

What does the asset allocation look like for people living in remote rural India (villages with less than 5000 population)? My colleague Sowmya Vedula and I looked at the data from some of our investee companies and this is what the picture looks like across 250,000 individuals in rural Tamil Nadu, Uttarakhand and Orissa.

While there has been much discussion about demand for gold in recent times, the data reveals that land holdings are a much bigger issue from a concentration perspective. So, why are rural households hoarding these assets instead of financial assets?

In the absence of financial assets like fixed deposits, stocks and pension plans at these locations, rural households are forced to look at physical assets that will give them old age security and inflation protection, among other objectives. Land as an asset has many dimensions. Several of our labourer customers tell us that it is difficult to find wage labour opportunities beyond the age of 45 or so and then owning a piece of land becomes an important strategy to earn in the later years because you can always “hire yourself”. Similarly, in light of the heavy dependence on the local economy, gold is often the only “national asset” available to hedge against local economic downturns.

There is no quick-fix to alter asset allocations of rural households away from gold and land, despite their obvious shortcomings. We have to complete the task of making access to high-quality financial services available and create trust in these instruments and the institutions that provide them.

A recent Economist article says that 70% of Kenyans now use mobile money in some form. The battle against cash is an important one in the larger war against financial exclusion in India as well. Ease of payments makes a number of things easier – including for India’s large seasonal migrant population to send money home and also for a number of institutions such as banks and schools to operate in remote parts of the country.

The payment infrastructure in India consists of 80,000 bank branches, 150,000 post offices, 100,000 Business Correspondents, 88,000 ATMs and 600,000 POS machines. Simplistically, this is one payment point for every 1200 or so citizens. Add the rural-urban divide and the various regional disparities and this picture progressively looks worse.

The important elements of a ubiquitous payments infrastructure are: a national network of cash-in/cash-out points, universal data connectivity, a national switch and payment platform that banks and non-banks can use for clearing, standardisation of user interfaces for the customer to facilitate adoption and an ecosystem of financial product providers and billers that utilise this payments platform to offer a wide range of services. Dan Radcliffe and Rodger Voorhies of the Bill and Melinda Gates Foundation have an excellent new paper that describes the path to digitisation.

What will it take to make payments universal in India with a ratio closer to one point for every 100 citizens and importantly, who will pay for creating this infrastructure?

There are two directions that we may take to finance this infrastructure. One is to use the public good argument that is made persuasively by the Nandan Nilekani Taskforce on Aadhar Enabled Unified Payments Infrastructure. The excellent Taskforce Report makes a recommendation that a last-mile transaction cost of 3.14% with a cap of Rs.20 per transaction be budgeted for based on outcomes such as active accounts. The public good argument is further substantiated by the McKinsey study that estimated an annual savings of Rs.100,000 crores from reduction in leakages and lower administrative costs from having an electronic payments network for the country. So, while the recipient of an old-age pension pays nothing to withdraw her money from her local bank agent, there is a budgetary transfer to banks for effecting this transaction.

The second argument is predicated on the existence of an underlying business model. Here the pre-requisite is that the payments business is distributed across a very large number of payment points (as many as 1 per 100 households). A village resident could walk in to a friendly neighbourhood kirana to top-up her mobile phone and also withdraw a remittance from her ICICI bank account sent to her from an HDFC bank account holder. This will ensure that there is both higher ease of access and less pressure on an individual payment point. For this to work, while akin to the credit card merchant, a single bank may still “acquire” the merchant, the functionality embedded in the POS or the proposed micro-ATM would ensure that one could potentially access multiple accounts in a secured and inter-operable manner. The additional payment infrastructure related investment for the merchant needs to be as low as possible for it to proliferate, ideally an application on an existing mobile phone similar to what has been done by Square and PayPal Here.

Who will own and deliver this network is an open question in India but ubiquity of electronic payments seems within striking distance.