A batsman strikes a ball during a cricket match at the Bombay Gymkhana in Mumbai (Photographer: Dhiraj Singh/Bloomberg)

Financialisation Of Savings: Pad-Up Before You Go In

Indians are finally moving from physical savings in real estate and gold towards financial savings. While everyone agrees this is good for the Indian economy, the pace of change may be a little too rapid.

Tarun Ramadorai, a financial economics professor at Imperial College who headed the Reserve Bank of India’s committee on household finance, said that along with the extent of participation, the manner of participation is also important.

Using a cricket analogy, Ramadorai told BloombergQuint that when you go in to face a fast bowler, “you don’t walk in wearing a t-shirt and shorts.” “You wear pads, you wear a helmet that enables you to participate in the sport in the way you ought to,” Ramadorai said while explaining that a basic set of products, such as low-cost index funds, must be made available to savers moving into the financial markets.

“It is perfectly fine to take the risk. The big question is whether the people entering the market now understand the risk-return trade-off,” he asked.

The average Indian household holds 84 percent of its wealth in real estate and other physical goods, 11 percent in gold and the residual 5 percent in financial assets, the RBI committee on household finance had found in its 2017 report. Since then, there has been a surge of interest in capital market investments via mutual funds, in particular. While this is desirable, Ramadorai questioned whether the shift has been too rapid.

The thing that worries me when I see rapid participation in financial markets is—are people really aware of what they are doing when they are entering the stock markets? Do they understand which funds to invest in? Do they understand that past performance is not a guide to future performance? If not, does that mean that if there is a small downturn, people start walking out of the stock markets? So while we are happy to see the transition, one might have wished to see a transition that it is a little less rapid.
Tarun Ramadorai, Professor of Financial Economics, Imperial College

Ramadorai explains that while it is good to see savers participate in investments with a “positive risk premium”, research shows that the benefits that savers can realise from such investments depend on the way in which they participate.

As an example, Ramadorai explained that research into 20-30 million demat account holders in India in the decade from 2002 shows that smaller demat accounts remained constant over a period of time, while larger demat accounts continued to grow. Analysis of this data had revealed that this is linked to the volatility of the smaller portfolio vis-a-vis the larger portfolio.

“The larger accounts, which are good at diversifying much more efficiently, have a more efficient risk-reward trade-off over the long run. Put differently, if you enter the market with a small portfolio and you churn your portfolio rapidly, the likelihood of losing your all is very high,” Ramadorai.

Such adverse experience can then have a long-term negative impact on financialisation of savings.

Financialisation Of Savings: Pad-Up Before You Go In

Rural Household Finance

Commenting on aspects of rural household finance, Ramadorai said that finding a way to bring informal sources of finance into the formal fold is important.

The RBI committee on household finance had found a high reliance on unsecured debt in India. “Most Indian household debt is unsecured (56 percent), which as we will see, also reflects an unusually high reliance of Indian households on informal, non-institutional sources of lending such as moneylenders and intra-family loans,” the report had said.

Instead of wishing away this informal credit system, Ramadorai suggests India start discussing ways to bring it into the formal fold.

The question is whether their is a way for us to start bringing that informal lending into a formal environment. The solution historically is—let’s ban informal lending. But they are addressing a felt need. They have better distribution networks, they have better information, there are historical networks they have built-up....Yes, the interest rates are very high but that also reflects the marginal benefit to the beneficiary.
Tarun Ramadorai, Professor of Financial Economics, Imperial College

Attempts made in this direction by the RBI in the 2006-07 period had failed but Ramadorai believes its an effort worth restarting.

Ramadorai also believes that opening bank accounts, under schemes like Jan Dhan, is not an end in itself in terms of financial inclusion. With penetration of bank accounts now high, it is important to hand-hold new-to-banking customers till the time they become accustomed to the formal financial system.

I think the focus on financial inclusion has been great, he said. “But in some of my work across emerging economies, what we are showing is that once you take the focus away from just including people in the formal financial system, you still have a long way to go.”

Ramadorai explains that customers new to the financial system need to be carried along up to a point where they are capable of making sound financial decisions by themselves. “Life after financial inclusion includes work on household finance and that remains crucially important. I think we are at risk of saying—oh, we have included so many people..job done.”

Watch BQ Conversations With Tarun Ramadorai: