Indians Borrow From Moneylenders To Avoid Administrative ‘Nuisance’: RBI Report
India’s households are piling on unsecured debt from informal sources, RBI report says.
Indian households continue to have high levels of unsecured debt from informal sources like moneylenders, putting them at risk of falling into a debt trap, a study by a central bank-appointed panel has found.
Such a dependence on unsecured loans leads to higher costs and traps households in a long cycle of interest repayments, according to a report by the Household Finance Committee released by the Reserve Bank of India on Thursday. “We note that this phenomenon has been well-documented over the decades, but nevertheless remains stubbornly persistent,” the committee said.
The reason why these households prefer informal sources of funding is because they have a low nuisance factor, according to the committee. The average Indian household associates the formal banking system with high administrative burden and complicated paperwork, it said.
The committee is an inter-regulatory group consisting of members from the banking regulator, the Securities and Exchange Board of India, Insurance Regulatory Development Authority and Pension Fund Regulatory and Development Authority, and was chaired by Tarun Ramadorai of The Imperial College, London.
The central bank said the penetration of insurance products is very low in Indian households, which is a significant concern owing to the risks emanating from excess rainfall, health shocks and natural disasters. More worrying is the habit of Indian households borrowing high-cost debt after a shock as opposed to insuring themselves in advance, it said.
This is an important observation, since it suggests that efforts to reduce informal lending will likely fail in an environment in which households are not sufficiently well-insured against risks.Report of Household Finance Committee, 2017
According to the committee, this finding might be due to tight constraints on Indian household budgets which do not allow them to buy insurance in advance, or because of adverse selection, moral hazards or other issues which may cause the insurance premiums to become unaffordable.
This could be overcome by strengthening the public provision of health and social welfare services.
For the median Indian household, shifting from non-institutional debt to institutional debt can lead to gains equivalent to between 1.9–4.2 percent of annual income on an ongoing basis, or equivalently when capitalised, to upward moves along the current Indian wealth distribution of 2.5-5.5 percentage points.
In terms of assets, Indian households are still dependent on physical assets especially gold and real estate, which is unusual when compared internationally and also unusual for younger households, the report said.
Despite the high holdings of real estate, mortgage penetration is low early in life, and subsequently rises as households age. This is also at variance with Indian households’ counterparts in other countries, where debt has a characteristically hump shaped pattern over the lifecycle.Report of Household Finance Committee, 2017
One major issue for a distorted assets and liabilities picture in Indian households is the lack of unified framework or guidelines for the provision of high quality and low-cost financial advice.
According to observations made in the report, Indian households need customised and cost effective financial products. These products would need to be made available without any issues surrounding incentives to those providing it. The report also recommended that complicated paperwork and bureaucratic impediments be reduced, by ensuring that the terms and conditions of financial products are made simple and intuitive to the intended customers.
As part of its recommendations, the committee proposed a set of sector-specific recommendations to improve the functioning of mortgage, collateralised lending, insurance, pensions, and gold markets.
“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,” the committee report said.
The committee suggested 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. It also proposed 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 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 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.Report of Household Finance Committee, 2017
The committee stressed the need for flexible regulatory processes to further encourage financial innovation that will benefit households. It proposed the creation of a regulatory sandbox to allow regulators to facilitate small-scale tests by financial technology firms.