In this guest post on, Rama Bijapurkar argues that despite the attention that the base of the pyramid has attracted over the past decade, most poor people still do not have access to well regulated, scalable, and diverse financial services and most SME do not have access to the needed working capital loans to sustain and grow their businesses. The problem occurs at the nexus of traditional financial institutions (banks) government regulators and existing microfinance institutions. Most problematic in India is that the traditional financial institutions offer a myriad of saving, investment, credit, and insurance products but can not do so profitably to the poor. This problem is not addressed by microfinance institutions as the government does not allow these entities to provide savings products to their clients for fear of corruption and the potential political fallout if millions of poor Indians had their savings wiped out. Closer coordination between these three entities is required to provide a fundamental financial pillar of inclusive growth.

By Rama Bijapurkar

Why does the world’s banking industry find it so hard to give people on modest incomes access to basic savings accounts, affordable credit, remittance services and opportunities to buy investment and insurance products?

In many emerging markets the low income consumer is served by ‘mom and pop’ service providers who are outside the organized sector and hence not regulated. They offer consumers no protection from usury, or from a failure to deliver promises, or from signing ‘buyer beware’ contracts where the consumer’s lack of knowledge and desperation make him any easy target for exploitation.

They also do not offer necessities like health or life insurance, leaving the modest income person to rely on family and friends when disaster strikes.

This lack of access to formal sector financial services and products applies not just to households and individuals but also to micro enterprises, where working capital, money for investment in building and improving a business and the financial cushion needed to see it over bad patches often just aren’t available.

The problem is that the formal sector has yet to develop business models that can offer these consumers what they need at a price they can afford, and still make a profit. In fact, at the level of individual transactions the formal sector often loses money dealing with low income consumers – the more business you do, the more money you lose. So why bother with these consumers?

The ‘social responsibility’ answer is that inclusive development is essential for the stability of our world and is a key priority for countries like India. There is, however, a sound commercial answer as well.

Modest income consumers will continue to form a large part of the emerging world. For example, in 2015, 60 per cent of India will have an average per capita income of less than $2 per day (at 2004-5 prices, of Rs0.50 for one US dollar).

However, while customers in lower income groups of emerging economies may be individually poorer than their counterparts in developed markets, collectively they are much richer. Furthermore, because they live in fast-growing economies they will double their income every seven to ten years, and hence are – or at least ought to be – a lucrative market segment for financial services providers.

Even the so-called middle and upper classes in emerging markets still earn a fraction of the income of their counterparts in developed markets and will continue to do so. For example, in 2015, China will have a per capita income lower than what Poland had in 2005. So learning to serve modest income consumers and make a profit doing it is the need of the future.

In India, financial inclusion is occupying the minds of bankers and insurance companies because inclusive growth is a key national priority. That brings regulatory pressure. Quotas exist for so-called priority sector lending to agriculture, where a large number of the rural poor are employed, and to small businesses. The latest regulatory move on this front stipulates that they must be directly lent to by banks, and that assets purchased from elsewhere will not qualify as priority sector lending.

There are several non-banking finance companies (NBFC) and all microfinance institutions in India do profitably serve modest income consumers. However, most of them are not allowed to offer products like savings accounts, which give them access to low-cost deposits, as they do not fulfil capital adequacy requirements applicable to banks. Most of them borrow from sources such as banks, corporate institutions and wealthy individuals, to lend the money on at higher rates of interest.

While they act as sales agents for investment and insurance products, the fact is that no one is creating products to meet the unique financial requirements of affordability and acceptability for this customer group.

The biggest problem for formal sector financial service providers is the high cost of getting products to the customers (the last mile) and the high cost of servicing a large number of low ticket-size transactions. The hunt is on for ways to smartly decrease this cost.

Technology is a boon. India today has more mobile phones than bank accounts and the use of mobile phones and text messaging can bring costs down significantly. However, while there is no technology challenge to this, there is a regulatory challenge. Telcos cannot be banks – they need to ally with banks so that they act as the ‘front end’ for banking transactions, which is where the regulation and consumer protection sit.

Trials are under way to make every small retailer a point of money collection, and money disbursement, using technology for efficiency. While several trials have been completed, the same problem persists: who will regulate this network? It has to be connected with a bank and the point of transaction is merely an ‘outreach’ point for an underlying set of bank accounts.

The Reserve Bank of India has brought in a bold new policy allowing banks to have ‘banking correspondents’ who will go out and do the last mile of banking for them. For exmaple, Janalakshmi Financial Services Ltd, a Bangalore based microfinance company, is the banking correspondent for Axis Bank, a major private sector bank in the country.

Under Indian regulations, Janalakshmi on its own can only lend to its customer base of very modest income consumers and not accept deposits from them.

This puts it at a disadvantage of being unable to offer a full suite of financial products and asset and liability products or holistically help its customers with financial planning. The latter is a key element of this business – teaching customers how to save, how to borrow and how to repay in a disciplined fashion. With the Axis Bank relationship, Janalakshmi can now do all of this.

No frills bank accounts are already in existence as a means of profitably serving small balance customers. The product prohibits ATMs. It also limits the number of deposits and other transactions from such accounts.

However, this is just part of the story and part of the challenge of financial inclusion. Solutions to other hurdles have yet to be found.

Customers are often much happier dealing with a local money lender because they get the money as soon as they need it without too much ‘process and paperwork’ delays. When you have very little money and need the extra money as soon as crisis hits there is little room for planning. The local money lender also understands social situations much better and knows that being poor doesn’t mean not being proud. Consumers tell us how their agent comes every day on a bicycle to collect the day’s money, but doesn’t come into the house when guests are there or when the husband is there, if the husband is unaware that the wife has taken out a loan. When jewellery is pawned, he understands that there are weddings where the jewellery needs to be worn and will make arrangements to loan the jewellery back for the occasion. We even know of a pawn broker who has diversified into making non-gold cheap imitation jewellery so that no one will ever know!

Rama Bijapurkar is an India-based independent market strategy consultant and member of Aviva’s Future Prosperity Panel