The total financial inclusion (TFI) programme was launched by the government to provide access to formal credit mechanisms to those below the poverty line. However, by focusing on merely opening a bank account and not addressing more fundamental demand-side requirements and challenges, the programme could end up short on its ultimate objectives.

TFI’s effectiveness can be enhanced manifold if economically deprived people are provided access to a broader range of financial instruments, including the more beneficial outputs of recent financial engineering. Further, these instruments can be customized by drawing on gleanings from behavioural psychology which reflect cognitive biases that may distort people’s spending and savings choices.

The omnipresent tug-of-war between immediate consumption needs and inelastic incomes ensures that poor people experience high opportunity costs on savings. They also face self-control problems, whereby they attach a higher value to the present than the future. This boils down to people giving in to the lure of immediate spending against saving for the rainy day.

Photo: Harikrishna Katragadda/ Mint

Recent research in behavioural economics points to the effectiveness of default savings accounts. They transfer a predefined share of income inflows—from, say, the Mahatma Gandhi National Rural Employment Guarantee Scheme wages paid through a bank or post office—into a structured savings account to encourage savings among the poor. The highly successful “Save More Tomorrow" scheme—advocated by Shlomo Benartzi at the University of California, Los Angeles, and Richard Thaler at the University of Chicago—commits savers in advance to allocate a portion of their future income increases towards retirement savings.

Economists such as Harvard’s Sendhil Mullainathan have found evidence to suggest that use-directed accounts, designed to take into consideration people’s “mental accounting choices", are effective at promoting savings. Accordingly, instead of the regular abstract bank accounts, a multi-tiered account with use-directed subheads— “fridge account" or “home account" —can “nudge" people to save more by serving as a constant reminder of what it is being saved for. A “bike" or “fridge" sub-account can even be used to finance regular instalment-based purchases of automobiles or consumer durables.

Annuity payment instruments for children’s education and pensions; loans for building house and small business; and health insurance products can all be linked to the respective savings bank sub-accounts. Governments can, through a conditional cash transfer plan, incentivize savers by making matching or predefined payments into the servicing account. A “self-employment plan" can funnel savings and government subsidies from self-employment schemes to facilitate capital investments in business ventures.

To help deal with the “craving" to spend and to disincentivize wasteful consumption expenditures, restrictions can be imposed on the periodicity and amounts that can be withdrawn from savings bank accounts. They can come as a default option to the account, from which the consumer can subsequently opt out, and could include an elaborate application process and/or multiple branch visits for withdrawals.

This craving to spend reaches astronomical proportions during festival seasons on “temptation goods". Accordingly, higher premiums—interest rate discounts or flat penalties—can be placed on withdrawals timed to coincide with such seasons. Further, “festival offers" of higher rates for specified periods would complement the demand-supply dynamics, given that people tend to withdraw their savings during these periods.

Savings instruments that combine the features of a lottery, being manifestly attractive to the poor, can be used to incentivize people to both save and save longer. Peter Tufano at Harvard Business School has designed premium savings bonds that come with a lottery option in which the buyer can participate only if he remains invested for a certain period of time. The Irish government has a similar tax- and risk-free state-guaranteed savings instrument, Prize Bonds, which offers the chance to win big cash prizes in a weekly lottery.

Agricultural incomes come as harvest-time windfall inflows that, given the self-control problems that afflict human beings, are liable to be inefficiently frittered away. A “harvest plan" annuity instrument, offered to individual farmers and their groups, can attract harvest incomes as term deposits in return for a stable monthly income.

Poor farmers—biased towards the present without being cognizant of it—often procrastinate and postpone fertilizer purchases until later in the season, when they are left high and dry with more want and little money. Appropriate “fertilizer schemes" such as 60-90-day term deposits offered on harvest incomes can leave farmers with enough resources to purchase fertilizers when required. Similarly, a share of payments on government grain procurements can be funnelled into “fertilizer accounts" by default, to be drawn to pay for fertilizer purchases the following season.

In view of the volatile nature of inflation in developing countries, inflation-indexed savings products, especially those with longer tenor, can help mitigate inflation-induced erosion on the value of savings.

Finally, apart from promoting savings, reining in non-essential expenditure and optimally targeting subsidies, such financial instruments enable banks and businesses to effectively access the “fortunes at the bottom of the pyramid".

Gulzar Natarajan is a civil servant. These are his personal views. Comments are welcome at