Small regulated loans can change lives

Until two years ago, more than four out of ten adults in India did not have a bank account—a marker that tellingly mirrored the need for financial inclusion. In its conventional definition, financial inclusion means making institutional loans and financial services available at an affordable cost to people who remain trapped in the vicious cycle of low income and coercively high interest rates that loan sharks and pawn shops charge from helpless clients.

It is not only about the poor living in villages. There are millions of families residing in Indian cities and towns who earn their keep by working a bustling informal economy but remain outside the regulated financial services sector.

The current government’s flagship Pradhan Mantri Jan Dhan Yojana seeks to precisely plug this gap. Arguably the world’s largest financial inclusion scheme, it was launched in 2014 to give access to formal banking services to a vast majority of India’s poor. The record in two years: 200 million new accounts with a combined deposit corpus of more than Rs 40,000 crore.

Often coerced into borrowing at exorbitant rates from unregulated shadow lenders on many occasions, an easily accessible and affordable loan or the lack of it, determines a poor family’s advancement to a better life.

In many countries with underdeveloped financial services markets, stories abound where thousands of small savers get duped by so-called deposit-collecting firms. It is symptomatic of two primary attributes: a throbbing cash economy and lack of access to basic conventional financial services to many.

These, along with absence of regulatory oversight, play the perfect foil for deals and schemes to thrive outside the country’s financial system, hoodwinking authorities through a web of shadowy transactions.

Financial inclusion has a direct correlation with overall economic growth, as it shows useful spending and investment trends for policymakers and governments’ macroeconomic managers. The role of small loans in reducing inequality cannot be over-emphasised. Access to a loan from the regulated financial services industry can act as a passport to better living and prosperity. Such small ticket loans can help raise purchasing power and play a crucial role in helping people set up new businesses or expand their existing operations.

As banks opened branches in remote areas after their nationalisation in 1969, India’s savings and investment rate rose steeply from 13 percent to 23 percent. In the early 1950s, GE Money foundation came up with tailored institutional loans in the US to assist households in buying consumer durables. It remains one of the finest examples of how regulated consumer loans can spur growth in the broader economy by triggering a cycle of spending and saving.

More money in the bank has another positive spin-off. India is in dire need of resources to fund its infrastructure needs to build highways, ports, airports, and railways. If India’s savings rate could reach 40 percent of GDP in the next few years, from about 30 percent currently, frugal households could well turn out to be the primary financiers of these mammoth projects.

For millions, a loan from a finance company is akin to an entry ticket into a whole new world of opportunities. Besides freeing themselves from the cruel clutches of loan sharks, it also gives them a “credit score”, a necessary precondition for bank advances.

This is where non-banking finance companies (NBFCs) help plug gaps in the financial system anywhere around the world, including India, and prevent people from falling prey to “shadow banking schemes”.

NBFCs, credible pillar of the countries’ financial systems, complement the banking sector and by extending the reach of institutional finance to the unbanked households and industry including micro and tiny enterprises.

NBFCs’ ground-level understanding of their customers’ income and repayment abilities, as also their credit needs, offers them the advantage create instruments to suit their clients’ specific requirements. Small loan tickets with quite short maturities and affordable overpayment - which fit the best to consumer durable purchases - are often neglected by high street banks. By giving out such small loans, NBFC’s not only improves lives of customers but also helps millions of borrowers first establish a credit score and history and eventually graduate to becoming eligible for loans from commercial banks.

Credit information companies such as CIBIL give a numeric summary of one’s credit history. A credit score is critical for securing a bank loan. It gives the “probability of default” of the individual based on their credit history and tells a bank how likely an applicant is to pay back a loan based on his past record. A high credit score, which implies a good loan repayment record, is viewed more favourably by a bank while scrutinising a bank application.

In India, NBFCs have reported better performance in most parameters when most of the formal banking system was saddled by a mount of bad loans.

According to the financial stability report (FSR) released by the Reserve Bank of India (RBI) last month, NBFC loans expanded 16.6 percent in 2015-16 year, double than the 8.8 percent credit growth that commercial banks reported during the year.

The aggregate balance sheet of 11,682 NBFCs expanded 15.5 percent in fiscal 2016 compared with 15.7 percent the previous year. The gross non-performing assets (GNPA) ratio for the NBFC sector declined to 4.6 percent of total advances in March 2016 from 5.1 percent in September 2015. This implies that as of March 2016, of every Rs 100 lent by NBFCs, Rs 4.6 have turned bad. Contrast this with commercial banks where, at an aggregate level, gross NPAs rose sharply to 7.6 percent from 5.1 percent between September 2015 and March 2016

It is also heartening to note that the RBI has acknowledged that NBFCs have performed better than banks, both as businesses as well as their client profile that hold better repayment records. This is commendable because the regulatory rules for NBFCs are being aligned with banks making these organisations stand out as excellent exemplars of sound business operations and efficient financial inclusion institutions.

As former RBI governor Raghuram G Rajan pointed out in a paper “India and Economic Freedom”, in order for an adult to be able to take advantage of expanded opportunity in a market economy, she has to have been a child with access to reasonable nutrition, healthcare, and education when young. Moreover, going forward, she has to have access to finance so that the lack of wealth does not hamper her. More than anything, it is the lives that such small loans can change.

(The writer is CEO, Home Credit India. Views expressed are strictly personal.)