What household finance tells us about financial inclusion in India

Studying household financial behaviour is about documenting the financial choices households make, and forms a useful approach in assessing the state of access to, and use of formal financial services by Indian households.

The All India Debt and Investment Survey (AIDIS), 2019, released on September 10, provides important information on how households save, invest and borrow. This information allows us to construct the balance sheet of households, thereby helping us understand the level of interaction households have with the formal financial system.

This article presents three key reflections based on the AIDIS, 2019 report, and finds that there is an urgent need to make formal financial services more flexible, and customer centric, in order to increase its usability.

Despite almost universal ownership of financial assets, households in India mostly save and invest through physical assets, and this is true of both rural and urban households.

As per AIDIS, 2019, 95 percent of households (rural and urban) own at least one financial asset. Here financial asset refers to savings and investments across formal financial instruments such as savings bank accounts, retirement accounts, insurance accounts, risk-free products and other savings schemes.

A comparison with AIDIS, 2013, shows that the ownership of financial assets has increased by 31 percentage points for rural households, and by 19 percentage points for urban households. However, this is largely driven by the ownership of bank accounts. Moreover, bank account ownership has not translated into the usage of other banking services.

Less than 10 percent of households use their financial assets for saving and investment needs, and largely rely on investments in physical assets such as land and building, machinery, and transport equipment. This is an important finding as it speaks to the relevance of these products and services for households. Given the diversity among households in India, there is a need to design products that match the financial profile and socio-economic context of each household segment.

Access To Institutional Credit

Between 2013 and 2019, in both rural and urban areas, the percentage of households with formal credit has increased, and the percentage of households with informal credit has decreased. Moreover, formal credit accounts for two-thirds of the total amount of outstanding debt among rural households, and is higher for urban households with 87 percent of total amount of outstanding debt coming from formal sources.

The percentage of households with institutional credit increases for households holding higher value of assets. Moreover, the percentage of households with institutional credit across all asset-holding classes is higher in rural areas compared to urban areas. The same trends were seen in 2013.

One potential reason could be the relative lack of collateralizable assets among low-income and urban households. The report finds that the percentage of households who own a land in the lowest asset-holding class is approximately 35 percent for rural households, and less than 1 percent for urban households. Additionally, while more than 90 percent of rural households own a land in other asset-class groups, less than 20 percent and approximately 55 percent of urban households in the third and fourth asset-holding class, respectively, own a land.

The difficulties with lending to the poor due to lack of collateral has also been highlighted as an important constraint by Nobel laureates Abhijit Banerjee and Esther Duflo in their book Poor Economics. With microcredit constituting only 5 percent of total household debt, there remains a scope for product and process innovation in facilitating access to unsecured credit. Interestingly, the percentage of households with non-institutional credit remains roughly in the same range for all asset-class groups, suggesting that lack of collateral may not be a binding constraint for non-institutional credit.

Non-Institutional Debt And Credit Gaps

A sizeable proportion of non-institutional debt mainly comprising professional moneylenders, family, and friends provide interest free loans. The AIDIS, 2019 report finds that while the interest rate for a majority of non-institutional loan ranges between 20-25 percent, one in every five informal loans in rural areas, and one in every three informal loans in urban areas, are interest-free.

The report also finds that informal debt is primarily used for financing regular household expenditure (~30 percent), and out-of-pocket medical expenditure (~10 percent), both in rural and urban areas. Close to 20 percent of informal debt is also used for financing housing improvement expenditures, 22 percent for financing farm enterprises in rural areas, and 13 percent for financing non-farm enterprises in urban areas.

These findings indicate that informal sources of finance are able to offer flexible and customised access to credit in contrast to formal sources of credit. Not only is the need for collateral not binding, the terms and conditions too are suitable enough to cater to a variety of needs.

Two areas where there seems to be a glaring product gap is the availability of formal credit to fund emergency medical expenses as well as enterprise financing, most of which are household-based micro-enterprises.

(With inputs from Rakshith S Ponnathpur)

Misha Sharma is Practice Head-Household Finance, Dvara Research.

Views are personal and do not represent the stand of this publication.