Indian households can benefit greatly by re-allocating assets towards financial markets and away from gold. However, high transactions costs and bureaucratic impediments create a high nuisance factor for households hoping to engage in formal financial markets, says a report.
The report 'Indian Household Finance" prepared by the Household Finance Committee, says, "Indian households require customised financial products that account for their unique economic conditions, longstanding traditions, idiosyncratic life goals, and the complexity of their financial circumstances. These products need to be relevant to households, in the sense that they should be delivered in a manner that is free from incentive problems, at a price that is fair, and dispensed alongside financial advice that is in the best interests of households. However, complicated paperwork and bureaucratic impediments can exacerbate feelings of embarrassment and shame for low income and poorly educated households in their initial engagement with financial markets. Financial product terms and conditions should therefore be explained to households in a manner that is both intuitive and salient."
From the empirical analysis of several household surveys, the Report found that Indian households strongly associate formal banking institutions with large administrative burdens and complicated paperwork. While participating in formal financial markets, households also face trust issues. "We find that these arise from households’ often negative perceptions of formal providers, which are exacerbated by occasional poor experiences with unscrupulous providers. These trust issues appear to correlate highly with the income level of the household, and low-income households often report their belief that access to financial products is the prerogative of elite groups in society. This lack of trust in financial institutions helps to explain the tendency of households to eschew financial products and to invest in instruments such as gold instead," the Report says.
Pointing out the high complexity of Indian household's financial needs, the Committee headed by Professor Tarun Ramadorai from London-based Imperial College, says, effective policies in Indian household finance needs to attempt to complement, or at least recognise, longstanding traditional approaches to financial management in order to be effective. For example, there is a particularly high demand for gold in southern Indian states, which is further evident that traditional and cultural factors are strong determinants of allocations.
Other members of the Committee are Dr Pawan Gopalakrishnan from Reserve Bank of India (RBI), Suresh Mathur from IRDAI, Prabhas Rath from SEBI and Dr Alpana Vats from PFRDA.
The Report says self-reported financial goals of households are often driven by 'life events', such as marriage, which disproportionately affect the household budgets of the poor because of the high fixed costs of such events. "This highlights the importance of traditional social insurance in driving household financial decisions. Notably, such life events appear to be more important to households than goals such as financing education," it says.
There are the usual lifecycle and wealth considerations leading to different demands by households. Decisions concerning homeownership, savings product choice, insurance, pensions, mortgages, and emergency credit are inter-dependent and interrelated, increasing the total complexity burden on household decisions.
The Committee says there is no unified framework or guidelines for the provision of high quality and low cost financial advice to Indian households.
Here are the main observations of the Committee about Indian household finance:
1. Indian households require customised financial products that account for their unique economic conditions, longstanding traditions, idiosyncratic life goals, and the complexity of their financial circumstances.
2. Such customised financial products are required at low marginal costs of servicing additional households. That is, they need to be scalable.
3. These products need to be relevant to households, in the sense that they should be delivered in a manner that is free from incentive problems, at a price that is fair, and dispensed alongside financial advice that is in the best interests of households.
4. Complicated paperwork and bureaucratic impediments can exacerbate feelings of embarrassment and shame for low income and poorly educated households in their initial engagement with financial markets. Financial product terms and conditions should therefore be explained to households in a manner that is both intuitive and salient.
5. Technological solutions hold significant promise for providing customisation and scalability simultaneously, and technological interfaces can help in depersonalising potentially embarrassing face-to-face interactions when households are making financial decisions.
6. Given the cognitive/behavioural issues that we uncover, “nudge” solutions, where sensible default options are provided to households also appear appealing to improve Indian household finance outcomes.
Here are the recommendations from the Committee about promising solutions in Indian household finance:
1. We propose a set of sector-specific recommendations to improve the functioning of mortgage, collateralised lending, insurance, pensions, and gold markets. We believe that these “old fashioned” recommendations are potentially helpful in fixing obvious gaps in Indian household financial markets, and are an important complement to the technology-based solutions, which we also propose. We also propose improvements to official survey data on Indian household finance, in an effort to spur more detailed analysis and research of these issues in the future, and to assist
in the implementation of evidence-based policy.
2. At present, financial advice regulations are product-specific and vary across regulators. We make proposals about the current structure of financial advice in India. We suggest a set of standardised norms across regulators for financial advice to be implemented in a phased and unified manner, supported with a fiduciary standard for financial advisors. We propose that the provision of financial advice be clearly separated from the distribution of financial products, and provided in a manner that avoids conflicts of interest. We also discuss the promise of robo-advice, which appears to offer both scale and customisation, which, as discussed earlier, are twin
imperatives for Indian household finance.
3. We propose a number of measures to streamline the delivery of and access to financial products that are relevant for Indian households, to eliminate or reduce informal transactions costs, such as filling in forms, bureaucratic impediments such as certification and verification costs, and costs arising from any uncertainty in knowing when approvals will happen. In particular, we propose that the total time and effort taken to engage in the financial market be substantially reduced through a combination of digital end-to-end distribution networks and the movement of know-your-customer (KYC) requirements into purely paperless form (i.e., eKYC). We also propose that regulators and service providers strive to enable quick, cost-effective, and seamless switching between financial service providers.
4. We suggest improvements to the electronic collateralised lending registry (CERSAI) to aid the development of this important market, as well as improvements to the RBI’s recent policies on account aggregation to help households form a comprehensive and integrated view of their financial situation.
5. We describe a minimum set of financial products, which Indian households should have in order to effectively harness the benefits of formal financial markets. Many of these products already exist, and indeed, are being delivered to households via government programmes such as PMJDY. Nevertheless, we believe that it is useful to provide this list for several reasons.
a) To serve as a checklist that can be used to evaluate progress on participation and use of household financial markets in India.
b) Where this is not already the case, products on the list could be made readily available to households, either seeded automatically at the point of PMJDY account opening (or added later to PMJDY accounts as a default but “opt-out” option), or by automatically pre-qualifying households to access all of these products at the point of e-KYC for any single product.
c) While households will have access to the essential minimum kit of assets by default, we propose requiring (either or both of) explicit opt-ins and mandatory education before households access more complex products. This is not to inhibit households from portfolio optimization, but rather, to permit an opportunity for households to reflect on whether the added complexity will appropriately serve their needs.
d) We recommend additional design features which could simplify access to, or improve the use of, several of the simple products which are currently out in the market.
6. We recognise that technological solutions to household finance problems often rely
on households sharing personal data with financial product providers. This raises obvious issues of privacy. While this is not the principal focus of our recommendations, we do provide thinking about a sensible framework for data privacy in Indian household finance, and suggest the adoption of a rights-based privacy framework in contrast with the more common consent-based privacy framework.
7. Finally, we stress the need for flexible regulatory processes to further encourage financial innovation that will benefit households. Towards this aim, we propose the creation of a regulatory sandbox to allow regulators to facilitate small-scale tests by financial technology firms. In such a carefully controlled environment, certain regulations may be temporarily relaxed, and households can be allowed to participate in new products. The goal is to collect empirical evidence which can ultimately lead to better policy solutions, whilst simultaneously evaluating the risk of any new
product or technology. Such an institution can provide a structured avenue for regulators to engage with the financial supply-side, develop innovation-enabling regulations, and holds promise to facilitate the delivery of relevant, customised, and low-cost financial products to Indian households.