By Dr Santadarshan Sadhu, Coordinator, NSE-IFF Financial Deepening and Household Finance Research Initiative
The NSE-IFF Financial Deepening and Household Finance Research Initiative is very pleased to announce its final set of proposals selected for funding in this round. We expect, through this initiative, to catalyse a body of high quality research pertaining to critical questions of household finance, financial inclusion and financial deepening. We would like to thank all the researchers who applied to this initiative, making it extremely competitive and setting a high benchmark for future rounds. We would like to congratulate all the researchers whose proposals have been selected for funding and wish them the very best. Here are the selected proposals with a short description of each:
1. Getting our priorities right: Targeted agricultural credit and technology adoption in India
Access to agricultural credit directly influences production through two main channels: Primarily, credit can raise investment in input use and hence productivity; Secondly, credit provides farmers with the opportunity to smooth consumption and thereby increase the willingness to take risks and engage in productive agricultural investments. However, existing evidence on agricultural lending through formal institutions has questioned the effectiveness of priority sector lending as a pathway from poverty. India’s progressive financial inclusion agenda, including the promotion of a wide network of rural bank branches as well as encouraging priority sector lending, provides a unique setting in which to examine the constraints of these hypotheses. We will build on existing research and methods to determine if and how credit influences production decisions and investment, and ultimately productivity. The specific questions we consider are:
i. Does reducing liquidity constraints through formal credit flows encourage farmers to adopt widely available technologies? Does adoption of these improved technologies increase aggregate productivity of major crops?
ii. What is the impact of credit on farmers’ production decisions? Specifically, does credit enable farmers to cultivate more high-risk-high-return cash crops?
iii. Does formal credit allow farmers to make more long-term investments?
2. Quality of investment advice in retail banking in India: An assessment
Understanding that opening of the bank account is but the first step in a much longer journey to financial inclusion, this paper seeks to analyse the efficacy of banks as vendors of retail financial products. The study aims to evaluate if bank based relationship managers sell financial products that are high fee generating regardless of the products that may be more suitable for the customer. The theoretical literature on financial distribution makes a distinction between sophisticated and naive customers and considers naive customers to be particularly susceptible to mis-selling. In this study, we evaluate if even informed customers, i.e. those that understand their financial requirements, and the gaps in their portfolio, are vulnerable to mis-selling in the absence of a regulatory framework that recognises specific customer rights, or requires basic suitability checks in advice and sale of financial products. The study proposes to evaluate the extent and pervasiveness of mis-selling in the banking channel in India. This allows us to measure advisers response when we exogenously vary the types of clients, especially in their financial sophistication in the form of knowledge of and demand for specific products.
3. Examining the adequacy of MFI multiple lending directive by RBI: A study of slum dwellers’ loan choices
While a significant number of households in India do not have access to credit, parts of the country have already experienced crises of over borrowing. Similarly though credit is used for many purposes, it is still not taken as a signal to launch new financial products or product bundles. Though Indian financial inclusion experts in their eagerness to push credit into low-income households have received multiple setbacks, their pursuit has remained relentless. With multiple credit agencies often competing in the same geographical area, over-borrowing and even ghost borrowing has become rampant. In order to put a plug on the rising Non-Performing Assets, the Reserve Bank of India issued new directives for all Non Banking Financial Companies in December 2011 with further modifications in August 2012, restricting the borrower’s freedom in a bid to control over indebtedness. However, we reason that restraining borrowers to borrow only from two MFIs or less will create further problems for both borrowers and MFIs. In a market of illiteracy and informational asymmetries, people with a tendency to cheat can still defect, households may be denied loans at the time of need and rogue MFIs may pre-empt members from other MFIs, thus increasing their retention costs. We therefore aim to study the borrowing behaviour of slum-dwelling households in the city of Pune to gauge the adequacy of the RBI directives in containing over-borrowing and understand whether other financial products can contain their need for multiple loans other than income generation.
4. The Technology of lending: Contract design of informal credit products
The stubborn persistence of high levels of informal credit penetration, and comfortable coexistence of formal and informal credits markets, have re-emerged as important policy and research questions. Potential answers to these research questions have come from scholars in multiple fields, many of whom have focused on South Asia and India. Within economics, a vast literature has explored the causes and consequences of credit market failures, the unintended impacts of policy change, and the interaction of formal and informal credit markets. Within the field of anthropology and economic anthropology, scholars have made major advances in understanding household financial behavior, as well as the social norms embedding informal, semi-formal, and formal credit practices. Despite much excellent work, the research examining credit markets and informal practices have not yet fully explored the role of contract design in informal credit products as a cause and consequence of financial exclusion. Without such understanding, we are left with an incomplete analysis that both inhibits the opportunity for formal sector providers to learn from informal product innovations, and inhibits the clear framing of financial inclusion strategies and policy analysis. This study hopes to remedy the gap in the literature by analyzing the contract features of a clearly defined set of informal credit products in rural and urban Tamil Nadu. Through a careful analysis of the specific contract features of currently available informal credit products, I will show that in contrast to the assumption that access to formal, cheaper credit will result in households shifting away from informal credit options, the notions of access and price should be re-examined, as informal credit products rapidly adapt to changing conditions in the formal sector with a surprising set of contract innovations
5. A Framework for Financial Behaviour Modelling in a Rural, Low-Income Environment
The objective of this action research study is to create an empirically driven normative framework for business decision-making. The research design associated with this objective would be conclusive and not exploratory in nature. Additionally, given that we intend to use observational data as opposed to experimental data, this study will fit under the broad umbrella of a descriptive research design. Our research intends to use both longitudinal and cross-sectional data. Specifically, we intend to use data analysis methods to infer behaviour (defaults on loans, late-payment, cessation of service, etc.) from various attributes demographic details and past financial transactions. We intend to use a series of methods termed as ‘supervised learning’ to achieve this goal. While building credit scores from past transactional and demographic history is the bedrock of modern retail banking, a preliminary literature investigation by the researchers found little academic research in the space of developing such scores in a low-income, sparse transactional history environment. There are also problems in applying the traditional credit scoring models like FICO, CIBIL etc. to score low-income households. The major concerns are that existing prescriptive models were not built for this demographic, and existing methodologies lack the appropriate data to build a robust model. This motivates us to develop novel changes to the existing supervised learning methods, to make them more useful in this domain. The study also intends to validate the created scores with field case studies of mock implementations, and actual pilots.
The final research output upon completion of these projects will be published as working papers by March 2016.