3-6-3 banking costs the poor money

It is almost as if the seething Indian aam admi is finding one more thing to get furious about—there has been a string of financial sector failures in the past few years that have directly affected the wallets of the average Indian. While the telecom and the VIP helicopter scandals add to the widely held belief that people in positions of power or those who have access to them, are corrupt, these are still far away from directly affecting the everyday finances of the household. But the institutional theft from the wallets of the average Indian is something that hurts real time. And we’ve had plenty of these in the past few years. Speak Asia, a multi-level marketing company, lost more than 2,400 crore of retail money. StockGuru lost 500 crore and mis-sold life insurance products cost Indian investors more than 1.5 trillion. The latest is the collapse of the Kolkata-based Saradha Group where more than 20,000 crore is at risk.

India has these periodic blowouts in which the poor lose their savings when a deposit-taking company, like an unregistered chit fund or a multi-level marketing company (MLM), either decamps with the money or collapses under the weight of an unsustainable scheme. Often protected by local politicians, these MLM schemes have perfected the art of staying in the grey area between the turfs of the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi). The first is supposed to regulate deposit-taking companies and the second is supposed to regulate collective investment schemes. These blowouts cause not just economic hardship leading to suicides and push people below the poverty threshold, but in a wider sense put further pressure on the already beleaguered citizen, who has one more reason to get pushed to the brink of anarchy.

So are the regulators to blame—is the solution tighter regulation? Should we just ban all MLM firms and chit funds? Banning stuff is easy, but that’s not the solution. I believe we have a demand supply mismatch in the financial sector with the demand for cash flow management, saving and credit vehicles vastly outstripping the supply. So what are the banks doing? They cater to you and me in the big cities. I knew that Indian banking is urban-centric, but not that it is so heavily Delhi- and Mumbai-focused. Writes blogger Deepak Shenoy: “Mumbai and Delhi account for 30% of all deposits and 38% of all credit” in his 22 April 2013 blog (you can read it here: http://capitalmind.in/2013/04/30-of-all-bank-deposits-are-in-mumbai-and-delhi/). Total savings bank deposits in 2011-12 were just over 15 trillion.

Now look at the size of the non-bank vehicles that Indians use to make deposits and for investment. Chit funds and MLM companies are two popular vehicles for the un-banked. The All India Association of Chit Funds estimates the registered chit fund market at 30,000 crore and that of the unregistered chit funds at 30 trillion. Double that of the Indian deposits. Organized MLMs are about 6,500 crore, but those that operate in the shadows are a multiple of this—a size that nobody is willing to put a number to. Remember, the blowout in just Saradha will be 20,000 crore. On the credit side, the microfinance industry showed that the poor are credit-worthy and that there are profits to be made at the bottom of the pyramid.

Clearly, there is money that seeks financial products at all levels of income and banks are unable to cater to those outside of the urban areas. Formal finance has stayed away from places where the money does not have the comfort of air-conditioners. A former senior banker says that he believes that branches in London are preferred to branches in small-town India by the top management—“they don’t want the small ticket money, it has the stink of their sweat” was his cynical analysis of Indian banks. The 3-6-3 rule of banking is an exaggeration of what a banker does: borrow at 3%, lend at 6% and play golf at 3pm. But at its core nails the problem: lazy banking with little attempt to step out of the big cities and really understand the portfolios of the poor.

Clearly, there is money at the bottom of the pyramid and there is no dearth of enterprise in India. So why do we see so much under-the-surface activity in businesses that mimic banks? Could it be because existing regulation is a lot about preserving the business models of existing banks? What else would explain the reluctance to allow non-bank linked e-payment systems into the country, using the bogey of safety of depositor money? Why is separation of client funds such a tough idea for the RBI to understand—the mutual fund industry has used it successfully for more than 15 years now without a single instance of somebody decamping with investors’ money. Unfortunately, what we’ll get is a knee-jerk reaction that shuts off chit funds and other forms of non-bank finance, further pushing people into the clutches of illegal operators.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at expenseaccount@livemint.com