Mystery of capital and demonetisation of currency


Picture credit: Business Standard, Nov 10, 2016

If you follow Stuart Rutherford or Jonathan Morduch’s work, it is quite apparent that the poor lead complex lives and constantly deal with financial decisions. Most people associate poverty with the absence of savings, which is a flawed assumption. The poor do save, but they do so in assets that are illiquid, or cannot be transformed easily into capital. For instance, a house is an asset, but not when it does not have property documents that are recognised in formal markets. This restricts the ability of the house to be traded outside of known circles, and limits their ability to transact in formal financial systems.

This illiquidity is not unknown to the poor and to overcome it,they do one of two things. “Farm out their liquidity” to neighbours i.e. give their money to a neighbour in need so they would respond appropriately in their own time of need. And they bury cash in a pot in their homes, or store it in a hole in the wall or under a mattress. For a long time, this behaviour appeared to be caused by a lack of access to formal institutions. Research now shows that people tend not to use formal financial services for savings, although they may borrow from these institutions <;. Underlying this low usage of accounts is the lack of trust in formal financial institutions. They would much rather trust the local savings groups, or dig up that pot in their house when they needed money for emergency.

As much as this is true for poor households, this holds water for the large set of enterprises that are classified as “informal” or “unorganised”. While statistics for the sector are far from accurate, surveys suggest that about 86-92.4% of the work force is engaged in the informal sector. Most of these institutions lack access to formal credit and operate in largely a cash based economy. Schneider and Buehn, in their article titled “Corruption and shadow economy: like oil and vinegar, like water and fire?” state that in country contexts where corruption is rife, institutions may choose to remain informal. This informality brings with it the ability to escape bureaucracy and avoid paying a fine to a corrupt official, but it also means undercapitalisation and lower benefits to the economy in the long run.

How does all of this link with the recent demonetisation conducted by the Indian government? There are two ways to ensure that the shadow economy does not exist. One, is to nudge informal enterprises to formalise, to ensure that property titles are clear, etc. The second is to reduce corruption. Tackling one of these without addressing the other does not solve the problem since they both are part of a vicious cycle that feed off each other. In what causes inconvenience to many, but breaks this vicious cycle in the long run, the Indian government’s move to demonetise currency tackles both challenges with one stroke. The benefits can be explained by examining some of the mysteries, which make it harder for poorer and informal economies to compete with more formal ones that Hernando Soto outlines in his book “The Mystery of Capitalism”.

  1. The mystery of missing information: We don’t know the extent of the cash economy. One can have estimates, but it is hard to know accurately. Until people declare this so we are able to capture the number accurately. Until September 30, the government had a scheme for voluntary disclosure of their income. Assuming that there would still be people that did not declare their incomes, demonetising currency leads to a state where people could either forego the value of their currency or exchange existing notes for new ones that are recognised. The latter solves the problem of missing information.
  2. The mystery of capital: In order to unlock the value of assets, one needs to “go beyond physics to touch the hen that lays the golden eggs”. Revealing one’s earnings in the process of exchanging notes that are defunct, one ends up revealing the sources of income and where the capital is generated
  3. The mystery of political awareness: We have known that there is a lot of value in the informal sector, but have not known how to benefit at a macro level from this wealth. If we assume that there is benefit in dealing with a closed circle to meet one’s financial needs, Metcalfe’s law dictates that a larger network would yield higher benefits to the actors involved. (For e.g. one telephone is useless, two is better, but when everyone in the world has a telephone, you change society)

None of these, however, ensure that what caused the problem in the first place does not re-occur.

What does the government need to do to ensure demonetization is successful?

  1. Ensure that the poor are not inconvenienced in the transition to new currency
  2. Solve the problem of corruption in the long run: there is nothing currently that prevents small enterprises and households from being targeted by corrupt officials in the aftermath of the demonetisation to ensure they continue to fill their pockets
  3. Ensure banks are accessible and use the interaction to build trust with customers
  4. Make it easier and cheaper to transact without cash

We must remember the words of Ronald Coase in his speech titled, The task of the society:

Economics, over the years, has become more and more abstract and divorced from events in the real world. Economists, by and large, do not study the workings of the actual economic system. They theorize about it. As Ely Devons, an English economist, once said at a meeting, “If economists wished to study the horse, they wouldn’t go and look at horses. They’d sit in their studies and say to themselves, ‘What would I do if I were a horse?’”

Let’s actually go and study horses before we scream success (or failure) from rooftops.


India’s $1.3 bn crop insurance

The Guardian’s headlines this morning stated “Thousands of farmer suicides prompt India to set up $1.3 bn crop insurance scheme”. The programme is meant to be a direct response to news of farmer suicides in rural areas, with two successive years of drought. Amongst various reports is one that states that over 300,000 farmers have committed suicide since 1995. News of such deaths is indeed tragic and while it must be examined closely to address the underlying issues, the structure of the current crop insurance scheme does little in this regard.

One can understand the urgency to woo the agricultural community in the light of protests held earlier last year on a bill that made it easier to take over farm land for large projects. Second, the results of two state elections, Delhi and Bihar make the upcoming five elections; i.e. Tamil Nadu, West Bengal, Kerala and Assam in 2016 and that of Uttar Pradesh in 2017, extremely important. It is no coincidence that all of these have large farming communities. Also, data shows that all of these states have shown a high level of farmer suicides in the past decade (see chart below).


While it is right to sit up and respond to this statistic, elections notwithstanding, would the new Pradhan Mantri Fasal Bima Yojana (PMFBY) be the right solution?

What does the PMFBY entail?

The highlights of the scheme are as follows:

i) There will be a uniform premium of only 2% (of the value of the crop) to be paid by farmers for all Kharif crops and 1.5% (of the value of the crop) for all Rabi crops. In case of annual commercial and horticultural crops, the premium to be paid by farmers will be only 5% (of the value of the crop). The balance premium will be paid by the Government to provide full insured amount to the farmers against crop loss on account of natural calamities.

ii) There is no upper limit on Government subsidy. Even if balance premium is 90%, it will be borne by the Government.

iii) Earlier, there was a provision of capping the premium rate which resulted in low claims being paid to farmers. This capping was done to limit Government outgo on the premium subsidy. This cap has now been removed and farmers will get claim against full sum insured without any reduction.

iv) The use of technology will be encouraged to a great extent. Smart phones will be used to capture and upload data of crop cutting to reduce the delays in claim payment to farmers. Remote sensing will be used to reduce the number of crop cutting experiments.

The PMFBY is slated to replace the existing two schemes i.e.. National Agricultural Insurance Scheme (NAIS) as well as Modified NAIS (MNAIS). The target is to increase uptake of crop insurance from 23% to 50%.

Challenges with the current design:

Before analysing whether the crop insurance programme would actually result in a reduction in farmer suicides, it is important to state that insurance can play a role in reducing distress faced by a farmer in case of crop failure.

Variability in weather and uncertainty of crop yields has been a challenge across the world for farmers. In India, it is exacerbated due to the changing climatic conditions, combined with a set of farmers that is extremely dependent on the weather for farming. Add to this, poor economic conditions of most farmers and a lack of adequate cushion to deal with crop failures and one has a situation of agrarian distress. At the macroeconomic level, there are other issues that further contribute to this dismal situation. Revenues have been stagnant, while cost of inputs has been increasing. Most farmers do not have access to formal, institutional credit (less than 15% access institutional credit) and have land holding that are extremely small, limiting the use of technology and further impacting yield.

However, the challenges that existed with the NAIS continue to exist with the current crop insurance scheme since it is still yield based and not weather based.

  1. Yield based schemes are hard to administer since the systemic nature of agricultural risk goes against the working of insurance policies (i.e. the belief that the event would impact only a small section of the insured population), making it hard to calculate premium and indemnity
  2. There is a scope for moral hazard, especially when the proportion of subsidy borne by the Government is higher than that borne by an individual
  3. There are challenges of viability due to the uncapped subsidy offered by the State

It would be much better to have a weather based insurance product that pays indemnities based on realisation of an index which is correlated with actual losses. This would also be automatically triggered reducing the claim payout time.

If the government is truly serious about addressing agrarian distress, they should also address the challenge of access to timely, institutional credit and ensure an easy claim settlement process.

Will this reduce farmer suicides?

It is simplistic and populist to assume that the launch of a crop insurance policy would reduce the number of suicides. While insurance is an important component to reduce distress faced by a farming household, the causes that result in a suicide may be far more varied. In a study conducted by Shamika Ravi and Mudit Kapoor, less than 5% of the farmer deaths were found to be due to debt or bankruptcy. In fact, in an op-ed, the authors state that “In stark contrast,  poor health, mental and physical, accounted for 30% of all suicides..”. In fact, as a country, poor health leads to seven times more suicide than debt or bankruptcy.

Given this statistic, the current government should perhaps consider improving the health system and addressing mental health issues rather than stop at the populist measure of crop insurance schemes. That would lead to a happier farming community and perhaps a happier population.

(Picture source: The Guardian)




2015 Brookings Financial and Digital Inclusion Report: good news for India

The Brookings Institute released their 2015 report on financial and digital inclusion, which compares digital financial usage and access across 21 countries including India. Amongst other things, we certainly have cause to celebrate in India, for ranking number 1 in country commitment to both digital and financial inclusion. Also, India is the only country to have completed targets in key policy areas that were outlined as a part of the May 2015 ‘Maya Declaration on Financial Inclusion’.
The biggest contributor to this has been the new payment bank licenses and the fact that the new licensees include telecommunication operators, thereby bridging the gap between the Ministry of Telecommunications and the Department of Financial Services. The report also points out that women can benefit from greater access to mobile money and we may well see a reduction in the gender gap in financial access. Further, the usage of smart phones might result in a higher uptake than regular phones.
Both in terms of financial inclusion as well as increased digital usage, India is certainly on the cusp of exciting times. Given the intuitive nature of smart phones and their increasing importance in ensuring uptake of financial services, the next step for the government might well be to remove barriers to availability and affordability of smart phones. We would do well to refer to a 2011 study in Brazil which pointed out that a reduction of taxes by 1 bps led to a doubling of the subscriber base. We would do well to realise that the smartphone is possibly no longer a luxury but a necessity. In the meanwhile, we should uncork the bubbly for a job well done.

Digital financial inclusion sans consumer protection

A few weeks ago, I happened to stop over at a popular fast food restaurant where I used my debit card to make a payment. Their card machine “hung” after I typed in my PIN number and they had to re-swipe my card. Now, usually I get an update on my mobile, but on that day I had left my mobile at home. When I got back home I realised that my account had been debited twice. Naturally, I was livid. Not that the amount was large, but the principle of it! So I called up the customer care who politely directed me back to the merchant, who (luckily!) was not far from home. So I went back and demanded to be refunded and was shown a notice that said in such a case, we were to contact the bank and they could not do anything. The manager at the fast food joint also assured me that if the transaction were not reversed in 14 days (!!), I could get back to him.

In a separate incident, my colleague was at a bar, and her card was swiped for 180,000 instead of 1800/-. Of course, that was a much bigger hit and caused many alarm bells to go off in my head and hers.

Eventually both transactions were reversed, but the two incidents tell us many things need to be put in place before the government decides to incentivise digital financial inclusion in India.

1) Training of front line staff at retail outlets

2) Proper mechanisms for customer protection

3) Clear recourse mechanisms in case of errors

What if our transactions had not been reversed? What if the account belonged to someone from a low income household, who had just enough money that had to be used for a medical emergency? Or a wedding? And 14 days to reverse a transaction that takes less than 30 seconds one way?? Does the government not think about the loss of interest/ emotional cost when your savings account is debited with 180,000 instead of 1800?

Today, the only recourse mechanism available is to call a call centre where a bored, and ill trained customer service executive takes the request and does not commit to any TAT for the error to be rectified. If one belongs to a low income household, chances are that the call centre would not be called at all. In the circumstance that someone does decide to call the call centre, there is such little information provided and so little confidence generated in the services of the bank, that I would be very worried.

Also, bad experiences such as the anecdotes describe above only worsen uptake amongst their peer group. Our government, banks and current policy makers would do well to make sure we have the where-with-all to deal with the challenges that  can emerge from faceless and digital transactions, and develop policies that are more customer friendly. Else, this is likely to meet with a similar fate as no-frills account: i.e. low usage.

Too much praise, far too early

In the valedictory address at the International Conference on National Payments Schemes organised by NPCI, delivered by Mr. Mundra, Deputy Governor of the Reserve Bank of India, there was considerable focus on the linkage between payments systems and financial inclusion. (Full speech can be accessed here). While the Reserve Bank of India, in the past few years, has for the most been making policies that encourage financial inclusion, the speech delivered reveals that there continues a gap in understanding the complex lives of low income households and the role that banks, amongst other financial institutions can play, as opposed to the current role that they do play. The danger in not acknowledging this gap is implementation failure, yet again.

Myth 1: Financial inclusion in its simplest form refers to banking inclusion where the endeavour is to link the unbanked population with the formal banking system by opening their bank accounts

Financial inclusion, at its simplest form, could mean access to any financial product from the formal financial system. It is patronising to think that the point of entry has to be a bank account. While this might be desirable from a banker’s point of view, the reality is that several bank accounts continue to remain dormant. It is limiting to define financial inclusion as merely access to a bank account, when there could be multiple factors that prevent customers from using the account in their day to day lives.

Myth 2:  To inculcate the banking and savings habit amongst the people, it is important that all individuals have bank accounts where funds could be held – which initially could be through remittances in form of direct benefit transfers under the Central /State Government schemes.

Bankers assume that low income households do not save and the habit needs to be “inculcated”. Secondly, the statement assumes that DBT can help build a savings balance. Most DBTs are subsidies that are passed on by the government for essential services like LPG, scholarship, etc. It would be naive to believe that this is money that a low income household can afford to keep idle in a savings bank account.

Myth 3: The PMJDY scheme launched by the Government of India has achieved stupendous success in linking the unbanked with the banking system. Bank accounts have been opened for nearly 99.99 per cent of the households in India which has brought in 150 mn new customers coming into the banking system fold while nearly 135 mn RuPay debit cards have also been issued.

While the current government has been posting numbers on their website regarding number of accounts opened and cards issued, the PMJDY is beginning to show it’s weaknesses. (See article on this here, and here). One can call this skepticism, but the claim that 99.99% of the households in India now have a bank account is odd, when just six months ago, bankers were the biggest barriers to opening bank accounts as indicated by Amy Mowl and Camille Boudot in their barriers to banking paper in 2014. (Reference:

Second, the Financial Inclusion Insights study revealed that most individuals are not comfortable with digital inclusion and lack trust and most bank accounts continue to remain dormant. The study was released in December 2014, so the shift in sentiment in just 5 months is implausible.

Myth 4: Aadhaar based payments, through linkage of biometric identifier with bank accounts, is facilitating the benefit payments to bank accounts of millions of beneficiaries, and will have significant on financial inclusion efforts in the country.

The Supreme Court re-confirmed in March this year that citizens of India cannot be denied benefits if they lack an Aadhar card (see article here). Despite this ruling, financial institutions, seem to continue to see this as an important step to financial inclusion.

What strikes me as a challenge is that none of the above address operational issues faced by low income households, which can act as a higher barrier to use.

What actually needs to be done in the payments space?

Usage and uptake of any service improves when customers see the relevance of the service in their lives. For far too long, financial institutions have seen provision of services such as an ATM card as an add-on benefit. If one truly expects low income households to begin using payments platforms, the following steps need to be taken:

1) Allow withdrawal from any ATM without charging a fee

2) Remove/increase cap on ATM withdrawals for all accounts

3) Allow for multiple withdrawals without charging a fee, even if the amount withdrawn is small

4) Allow ATMs even in remote, rural India to be open 24×7. Anecdotal evidence suggests that in rural India, following a spate of crimes, ATMs operate at the same timings as banks

5) Engage customers , especially from low income households, in a manner that helps build their trust towards digital platforms: this could include providing clear and speedy recourse mechanisms when transactions fail, protecting the rights of the customers and assuring them of speedy service at all times.

The work done in the payments space is not even a complete foundation to ensure that it has an impact on financial inclusion. It would be fool hardy to provide praise far too early: that can be a sure indicator of impending failure.

Trust, finance and urban low income households

At the heart of providing a loan is the ability of the lender to judge the borrower on his/her ability and willingness to repay. This seems fairly rhetorical, until one begins to apply the principle to the lives of small businesses and low income households. Or even regular transactions that take place in one’s everyday lives. One of the small luxuries of living in India, and one that I take for granted, is the ability to give my clothes to be ironed by a couple that has a small push cart at the end of the road. Almost every road and bylane has the local ironing guy, or the istri-wala, who regularly takes clothes, irons it for anything between Rs. 2-5 and returns it in an hour. I have a running account with the couple that iron our clothes because they never have change. And there is always an outstanding balance, which is adjusted against the next day’s potential lot of clothes to be ironed. The transaction amount may be small, but in allowing this adjustment, there is an implicit judgement that I make on the couple and their ability to appear the following day at our doorstep. Of course, one would argue that their livelihood depends on it and so on, but with their mobile cart, they could very easily choose to relocate to another part of the city and find similar clients. Yet, they never do so.

Several low income households have a similar account with the local kirana store where they purchase regular goods for consumption. There are similar mini loans that take place in everyone’s lives, every single moment. The extent to which we use our social network for financial transactions is immense, if we were to make a minute note of each and every rupee that exchanges hands. In rural India, where people are tied to their land, one is almost born into a social network, which has its downside, but can also act as a cushion in times of need. It is not unusual in rural Tamil Nadu to host a dinner or lunch, which is pretty much a fund raiser, for an event in someone’s life. The daughter attaining menarche, someone starting a new business. All of these are events when it is expected that people will contribute money, with the understanding that it will be reciprocated in their times of need.

In urban India, where movement is easier and the possibility of becoming anonymous in a large crowd is higher, one would expect that such relationships do not exist or exist to a lesser extent. However, low income households in urban India are not the homogeneous entity that they are often painted out to be. In more settled habitations or authorised slums, social networks tend to be far more established, often taking the form of active small businesses. The transient slums, on the other hand, are home to a population that is far more vulnerable and inevitably marginalised from all kinds of networks, including social networks that often act as a proxy to financial systems. Understanding the lives of urban low income households can yield a wealth of information that can be used for financial product design.

Licensing “small finance banks”

The Reserve Bank of India today released the final regulations for setting up “Small Finance Banks” in India.  The Reserve Bank of India has taken this step with the objective of furthering financial inclusion by (i) providing savings vehicles (ii) providing credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations.

With this move, the Reserve Bank of India is making a significant shift in the landscape of financial inclusion in India. While on the one hand the step indicates the commitment that the central bank is making to the issue of lip service, the step is likely to have other ripples in the sector.

Priority Sector Assets

The circular requires Small Finance Banks to ensure that at least 75% of their portfolio qualifies as Priority Sector. With the two new banking licenses that were provisionally given earlier this year, this creates a huge demand for Priority Sector Assets. There is an immediate need for banker’s training colleges to begin thinking about, and developing deep expertise in underwriting these asset classes. In the absence of this expertise, credit will continue to flow to a select few resulting in either an under-utilisation of the PSL target, or over-lending to a select few.

Impact on the NBFC-MFI sector

The circular outlines that existing NBFCs or MFIs can opt for conversion into small finance banks. For the microfinance sector that has faced a slew of regulations in the past two years, this offers a clear pathway to the next stage of growth. There are, two options that are available to most MFIs as a result of this circular. They can either opt to be Business Correspondents (BCs) of existing banks, or they can choose to transform themselves into small finance banks. Further, with great foresight, the RBI has also stated that a small finance bank cannot be the BC of any other bank, but can appoint other BCs themselves. Effectively, this implies several small MFIs that are high quality originators in a limited geography, who were hitherto unable to raise debt themselves to act as BCs of banks, allowing for geographical diversification at the level of the bank. Seldom does one see policy that has been thought out in such a systematic fashion, especially with respect to ensuring risk aggregation.

Location of small finance banks

The RBI has categorically stated that there will be no restriction in the area of operations of small finance banks. However, they will have to follow similar branch licensing norms of setting up 25% of their branches in unbanked districts. Unlike a half baked Jan Dhan Yojana, this is a systematic means of ensuring that households even in rural India have access to a complete suite of financial products.

Challenges and opportunities

Contenders for the small finance bank licenses will need strong technology and data analytics at their disposal to ensure that their business model works. One of the key challenges that these banks will face is requisite infrastructure in unbanked locations, whether it is electricity or access to technology. It is high time that investments were made by these banks to understand households in these areas and their needs and requirements, before developing relevant products. As these banks set up branches in remote, rural locations, it is possibly also time to begin thinking about true inclusion: is the branch equipped with facilities that can cater to customers who have physical challenges, the aged, people who need wheel chair access? How can these banks develop GUIs that are accessible by all?

These contenders will also do well to begin by identifying metrics that would truly impact the market segment they ought to be reaching. This cannot be limited to superficial measures like number of accounts opened, or number of insurance policies provided. Instead, banks need to start thinking about metrics like reduced vulnerability or improved wealth of their customers. While such metrics seem harder to achieve, following these would help them succeed. The other factor that would greatly aid better underwriting is getting credit bureaus to share databases with each other.

Responsible journalism and development

I was asked by a friend yesterday if I would like to accompany her for a book launch at Euston by a friend’s friend. Then she added, “you should meet her, she has written about the microfinance situation in AP”. That really piqued my interest and I had to find out who this person was and what she had written about the sector. I was also mildly intrigued. Anyone who had written any sense about the sector is someone that I would have met in the past five years. After a session of googling and trawling all articles written by this person, I came across the microfinance article. There was one, written in the same style as other issues, which I feel contributes to irresponsible journalism.

In the specific context of Andhra Pradesh and microfinance, there were a number of issues that went awry. I do not defend the investors and the incentives that caused promoters to possibly lend aggressively and lead to over-indebtedness. However, media played a significant role in creating mass hysteria and resulting in knee jerk reactions from policy makers. Yes, there are some good things that came out of the microfinance crisis like the use of credit bureaus. But there are many things that we still do not know. For instance, what are households doing for access to finance today, besides possibly borrowing from moneylenders at high rates of interest? What is happening to poverty levels in the state? And my question to all journalists who somehow managed to correlate suicides to microfinance loans is: is there a drop in these rates now? Are people less indebted?

There are several journalists who continued reporting on the issue until it was impossible to get any data from the state on what was actually happening at the household level. That is responsible journalism, because it means people are engaging with the issue and following the impact of various decisions. Unfortunately, the more popular and prevalent journalism seems to be the kind that creates a stir and washes it’s hands off the repercussions of their ‘story’. The more dangerous trend that one notices with this kind of journalism is also the mixing of qualitative data and passing that off as rigorous scientific data. I think journalists need to realise that media is a powerful tool and everyone becomes a stakeholder in the stories they are reporting.


Banana Skins report 2014

I had the opportunity to attend the London Microfinance Club meeting last week where the Microfinance_Banana_Skins_2014_-_WEB was launched and discussed. In the past, I have always used the Banana Skins report as a barometer to check if my assessment of risk in the sector is accurate and in line with larger sectoral perceptions. Also, when I was making investments in the microfinance sector, it helped to both reinforce our own monitoring as well as check for new developments.

The last Banana Skins report was published in 2012 and several interesting changes have taken place since then, particularly in the Indian context. For one, microfinance institutions had to deal with a cap on their operational expenses, making it necessary for management to re-look at their operations and see how to do this. Secondly, the Reserve Bank of India has been bringing about several changes in regulations rapidly. This includes allowing NBFC MFIs to act as Business Correspondents for banks, the proposed licensing of payment banks and two new players in the Indian context were given bank licenses: IDFC and Bandhan. This, combined with the fact that a client could not have more than 2 lenders lending to her, should have MFI CEOs worrying about the strategy of their companies, which I find missing. Third, the cap effectively reduced the ROE of institutions resulting in lower equity investments. This raised the question of long term funding and viability of the sector to continue expanding at the same rate.

In the Indian context, the greatest risk, as expected is political interference. The Andhra Pradesh crisis is testimony to what can go wrong if politics and finance are mixed. I continue to wonder what is happening to low income households in the state of AP. How can a system that drives people into the arms of money lenders be possibly more effective in the long run? The one good fall out of the AP crisis, however, is that the Reserve Bank of India has stepped in to regulate microfinance institutions and hopefully prevent the kind of risks that we saw three years ago. What is unusual as a risk is over-indebtedness that continues to rank fairly high in the list. This comes as a surprise because most microfinance institutions in India now have a credit bureau check and do not lend to customers who are already borrowing from two other lenders. There are two things that might be happening here: one, this could be debt from a bank or an informal source like  a money lender and therefore, is not quite a risk to the microfinance sector as one might imagine. Two, the borrowing from banks as a third loan might be possible because banks are not using the same credit bureaus as microfinance institutions. Which leads me to wonder if there is a need for a banana skins report for the financial inclusion sector as a whole. Why are we not thinking about the risks to large balance sheets as a result of priority sector lending targets?

A new risk that has been stated in the Indian context is ‘strategy’, which is something that I concur with. However, the absence of long term strategy may not be a soft skill input, as is often thought, but the absence of inadequate long term funding to the sector. If CEOs do not have long term funds, how would they plan for and make investments for the next 5 years or a decade?

One cannot deny the importance of local finance/microfinance institutions as an important mechanism for cash flow smoothing for low income households. Given this importance, it is critical that investors and MFIs begin to think of the gaps in the sector and the long term vision to address some of these challenges.

1) Governance: is it possible to create database of independent directors along with their specific areas of expertise which can be used as a common knowledge base by the sector as a whole?

2) Long term capital: Can banks and financial institutions pool in their CSR funds to create a long term fund for microfinance institutions, which specifically targets aspects like investment in MIS, making systems and processes efficient, investing in data analytics and decision making tools?

3) Common infrastructure: Credit bureaus that are used across financial institutions should be uniform. It would not make sense for banks to follow one set of Credit Bureau data while MFIs use another. There is also a need to have data analytics firms that would help understand product development in a more scientific fashion. This should solve the challenge of over-indebtedness.


Thinking in silos

With 1.2 billion people, there is no denying that India is a powerful player to contend with in the world. However, the rich dividends from this demographic strength can only be reaped if there is a shake-up in the current bureaucracy and policy makers begin to think outside of their restricted silos. My analysis of the inability of most bureaucrats to think strategically stems from a selection process that is part of our inherited legacy and was designed to make ‘civil servants’ rather than people who would think and question. Amongst other legacy based systems that we are seeking to change, it is imperative that this one receives high priority. It is also interesting to see that the UK, from where we inherited the legacy has long since moved on, having recognised the importance of selecting people from different walks of life, and the importance of cross pollination of ideas to create effective policy makers.

Especially in subjects like defence or security, it is critical that the people making the policy have a strong sense of changing trends that can lead to possible risks. We have a long way to go in India’s training academies where there is no single institution that aggregates trends and points out areas of synergy. In some senses, the thinking in silos is also symptomatic of poor institutional design, leading to replication of efforts, lack of transparency and creation of power centres, not to mention policies that are not holistic in nature and therefore are bound to fail.

As the world changes and access to information through social media and use of internet increases, the risks that a government faces are bound to increase. There are also other changes that can have an unforeseen effect on internal security. For e.g. climate change, resulting in large scale migration to already over crowded cities with creaking infrastructure that further exacerbates the divide between the haves and have nots, resulting in possible catalyst for unrest and conflict.

Policy think tanks also tend to specialise in specific areas and are unable to expand their understanding to the impact due to seemingly uncorrelated events. In a world where information spreads at the speed of light, the butterfly effect that chaos theorists predicted is a reality. The only way to counter this is to create an ecosystem of institutions that are dynamic and flexible and speak to each other. Then, there is of course, the larger challenge of recruiting and creating a cadre of bureaucrats who are strategic thinkers. That is a tougher battle for India today.