My colleague and I were once asked at a conference, “So, how exactly does a bank account reduce poverty?” Great question.

If you are a low-income household, among the myriad range of challenges competing for your time and attention; there are two that very likely claim the lion’s share: the everyday problem of managing income-consumption timing mismatches; and the problem of building, over a long term, lump sums that help finance the households’ lifecycle goals such as education, housing and marriage. Portfolios of the Poor provides insightful narratives on the nature of these challenges. In recent years, the imperative to find high-quality solutions to these problems has been well-recognised.

By and large, these problems boil down to one issue: lack of convenient access to ‘accounts’ where one can receive, store and withdraw flexible amounts of value in a safe and remunerative way. This account need not necessarily be a bank savings account. Based on the client needs, the nature of this ‘account’ may change as do priorities around key features—liquidity, returns, and inflation protection.

For short-term consumption smoothing, liquidity is essential, so a regular bank account would suffice. For medium-term building of lump sums, a balance of liquidity and inflation protection is required; an account (such as a money market fund) that tracks inflation and has reasonable liquidity should do the trick. Further, for long-term retirement savings, significant real returns and illiquidity are the cornerstones of the mechanism. A pension account with underlying exposure to equity would be relevant here. No matter what the nature of the account, since in these accounts the client is taking risk on the institution, regulation must ensure that only well-capitalised, prudentially regulated institutions with sound financial management are allowed to offer these accounts. Of course, localised institutions (like community development institutions) may be useful for reaching the last mile with the facility; they should only do so as agents to the larger institutions holding the accounts.

In the Indian context, a majority of all ‘accounts’ are either held as cash at home or in a savings account with a bank that yields 3.5% annual nominal returns (negative real returns given that India’s current inflation rate is hovering around 9%). Forty-one percent of the adult population in urban areas and 61% in rural areas do not have access to even this (sub-optimal) type of account. Far fewer have access to money market funds and pension funds. Clearly, there is a long way to go.

Many people believe that it is critical to ensure universal access, at least to a basic bank account.  But then, the question of viability comes in. The pursuit of viability can be aided in two different ways: a) developing viable business models for provision of accounts given their inherent value to a low-income household or b) government defraying costs recognising the policy imperative to do so. Till a few years ago, viability of opening and maintaining low-value accounts seemed almost entirely elusive, and it was presumed that government support was necessary for viability, but there are several promising initiatives on the business case in recent times.

The bulk of the costs associated with opening and operating an account of any type originates from trying to answer two questions: who are you? (Identification/Know Your Customer requirements); and are you who you claim to be you are? (Authentication). These questions have traditionally been answered in expensive paper-guzzling ways.

Disruptive identification and authentication technologies are changing this game. Couple this with the emergence and development of agent-based models (to substitute expensive bank branches and ATMs) and you can have drastically reduced the costs of opening and maintaining small value accounts. While there is early promise shown by some channels, especially those focusing on loan sourcing and remittance, there is a long way to go in India for these accounts to become profitable for providers. Much more needs to be done to increase the volume and value of business through agent networks, especially in remote rural areas. The agent network management also comes with its own share of operational risks, which need to be understood and managed. We, at the IFMR Trust, are working with the State Bank of India to hammer out some of these details that are critical to the success of the agent model increasing outreach to bank accounts.

Role of Government

Government has an important role in supplying public infrastructure that helps improve the viability of opening and operating the accounts.  A stellar example in this regard is the launch of the Unique ID programme in India, which envisages providing a unique biometric ID to each person. We recently interviewed Praveen Chakraverty from the Unique ID Authority to try and understand the impact of the UID on inclusion in India. Similarly, the recent push to get broadband connectivity to remote corners of the country will help in ensuring real time, low cost transactions on these accounts.

In addition to infrastructure, is there a case for the Government directly bearing the cost of opening accounts?

Since savings facilities benefit only the account holder directly, there is no public good argument. However, since many low-income households receive government benefits in cash (a trend that is likely to intensify), even if one beneficiary in a village doesn’t have the account, the government will need to spend money to get the entitlement to the person. Viewed from this perspective, there may be a case for the government to subsidise the channel that opens and maintains such accounts. But this should happen in a time bound manner, with an understanding that financial institutions will need to ensure the viability of maintaining the accounts based on revenues from clients.

Such an approach has been taken by the New Pension Scheme – Lite, the informal sector pension scheme, to get the product started, by paying for initial marketing and distribution costs, and even making fiscal transfers to get people enrolled during the initial years of the scheme. In the absence of such support, there is a major risk of the financial inclusion opportunity getting lost due to the banks’ inability to develop business models in the short run. In the long run, the future of these channels lies in developing viable business models through myriad services, with the government only playing a facilitative role by regulating the sector and supplying public infrastructure.

Going back to the original question, a savings account by itself is no silver bullet for alleviating poverty but it allows low-income households to manage small and irregular flows in a manner that every day and long-term goals can be managed better which is a worthy objective in itself.

— Bindu Ananth is the President of the IFMR Trust. The author thanks Suyash Rai and Nitin Chaudhary for valuable inputs.

The next post in a new CGAP series on savings. We look forward to your comments in the coming weeks.