My perspective on the Mor Committee report

The report is one of its kind as it covers the entire financial services space, most of the suggestions have been backed up with data and lot of innovative suggestions have been made to further financial inclusion.

One the positive side, there are both broad design/system related recommendations as well as specific operational suggestions. It is best to start with the overarching design issues as they set the framework of the report. It is heartening to note the two critical changes in policy enunciated by the committee viz a) channel agnosticism and b) flexibility to incorporate future technological changes. I feel these are very positive recommendations as our policy has prevaricated between one model over another in its quest for inclusion, not realizing the relative strengths of each model. If the future policy takes into account this aspect, much of the work on creation of a facilitating environment is half done. Banks, Rural banks, Cooperatives, NBFCs, MNOs, Post offices all have to be harnessed to realize the goal. The second recommended policy change flows out it; if the policy has to support all efficient channels, it has to be flexible, accommodative and open to incorporate innovations as they appear. The third big picture issue dealt by the committee relates to policy bias against consumption finance and focus on production finance. Practitioners like me have been arguing that a 15-­‐20 thousand loan goes in the poor household’s war chest to meet financial requirements as they come and to demand that it must be used for production purposes is to ignore ground reality. Moreover, to say that education related expense or expenses on sanitation is not productive use is as arbitrary as anything.

Having listed the bigger policy shifts, the report also suggests a slew of long overdue specific recommendations. The following para narrates these measures and I must qualify that this is by no means an exhaustive list but what appeals to me.

1. Simplified KYC for small value accounts – This was long overdue as insistence on current address proof does not make much sense. Identity proof supported by biometrics is enough to have a bank account.
2. NBFCs as BCs – Another long overdue measure as the arguments against it based on competition and co-­‐mingling of funds can be countered by allowing such BCs to operate in unbanked areas and use of CBS technology. It is a win-­‐win proposition for clients, banks and NBFC-­‐MFIs as NBFCs will be able to offer both credit and savings and banks can build a deposit base from unbanked areas.
3. BC interoperability – Interoperability will not only allow a smooth payment facility for clients but also make the BCs viable. In the absence of it, bank specific BCs compete for a limited pie making each other unviable.
4. Interest subvention to be given to farmers – A very positive suggestion as subvention through banks not only gives the impression of subsidy in banking but also adds to the work of banks. However, there is a caveat in this – it assumes each beneficiary has a bank account, which is not the case. As such, in all probability, it will have to wait for universal inclusion.
5. Activity based refinance not institution based – This recommendation combined with the suggestion of risk based refinance will help the rural sector as institutions like NBFCs and Consumer credit companies can tap into refinance and expand their lending.
6. Equity investment in complementary infrastructure such as weather stations and warehouses to be reckoned as priority sector lending (PSL) with a multiplier of four. If accepted, it will help the rural sector in building risk mitigation infrastructure and also give banks a new window for meeting their PSL targets.
7. Concept of Adjusted PSL – a novel concept as it takes into account sector difficulty as well as current level of inclusion and will incentivize banks to lend to the neglected sectors and regions.
8. Reckoning PSL compliance every quarter in place of annual compliance will help avoid bunching of sanctions and make PSL an on going focus of banks.
9. Subscription to bonds of NBFCs to be counted as PSL-­‐ the logic of allowing wholesale lending to such institutions as PSL and disallowing subscription to bonds was always dodgy and this anomaly has been corrected.
10. Differential provisioning norms based on sector.
11. Focus on consumer protection – for the first time, the committee has laid out a detailed action plan for consumer protection and is timely considering the global concern on mis-­‐selling.
12. Monitoring mechanism – it is a welcome move that the committee has laid out a comprehensive mechanism including indicators for monitoring progress against set targets.

It is evident that the report has a host of positive recommendations, but from my experience as a practitioner and a researcher, I also see many concerns. These concerns suffer from the limitation of being based on my own experience and knowledge. On the issues side also, I follow the similar presentation style of first dealing with bigger issues and then with the specifics.

The inclusion targets set by the committee to be achieved by Jan 1, 2016 strike as being optimistic and a bit away from the real sector realities. While the idea of having a payments point within fifteen minutes of walking distance and universal bank account is based on the premise of Aadhar linked e-­‐accounts and using the architecture of 8.25 lakh merchant establishments plus adding others like mobile rechargers and around 0.2 million BCs and as such has been backed up by a roadmap [debatable], the vision of enabling access to credit and risk mitigation products has not been backed by any such roadmap. Agreed that some specific measures like adjusted PSL norms and enabling equity investments in risk mitigation infrastructure will add to the availability, but a specific action plan is missing. On the savings and payments side, while linking Aadhar account with automatic bank account is a good idea, it needs to be debated whether there is demand for it. Barring a few countries like Canada, Australia and NZ wherein 99% of the adult population has a bank account, nowhere there is universal inclusion. To assume that in a country where 80%

live below $2 a day, everybody wants a bank account is a bit out of sync with the reality. There are also practical issues associated with it as it is not clear what happens to the 55 million Aadhar cards issued till date and whether banks have the bandwidth to absorb this surge in account numbers. The concept of payment banks is related to this and a key concern relates to the viability of these banks plus allowing one sided inclusion focused on liabilities to one class of institutions and leaving the asset side of inclusion to national banks that too Public sector banks. India Post, which already does the function of envisaged payments bank is surprisingly not mentioned. I believe converting India Post as a payments bank and strengthening it along with strengthening BC network can solve the problem of payments access to a significant extent and obviate the need to create new institutions in an already complex landscape.

Even though, some of the action points related to availability of deposits and payments services need to be debated, the thrust of the report on this cannot be debated. However, I find similar road map missing for credit and risk mitigation products. What is more disturbing is that even the existing thrust on credit is sought to be diluted through measures like phased elimination of rural branching norms and support to agent model being followed by the private sector banks – it is a known fact that banks find it difficult to outsource credit function to agents. Other measures that will dilute the PSL by private banks relate to encouraging securitisations and making subscription to bonds of NBFCs as eligible items for PSL calculation. While it will ease the liquidity position of NBFCs, the systems are not developed enough to monitor the end use of NBFCs individual loan accounts. Excessive dependence on securitization model has already given rise to some becoming originate to distribute NBFCs greatly enhancing the risk as the underlying field risk remains with the NBFCs. All this has been argued on the premise of unsuitability of bank branches to financial inclusion but the question is whether with technology, work rationalization and systems overhaul can the concept of branches not be made profitable? This is big leap of faith and in one stroke takes away the efforts being made through RRBs and Cooperatives. The report does have a section for these banks but the real issue of political interference and bearing the burnt of populist schemes being behind their performance is side stepped by saying they are prone to “local capture”. I believe that FI policy in India particularly aimed at credit inclusion has to ride on a revamped Coop and RRB structure. Leaving them where they are with some minor suggested changes in governance is ignoring the sunk cost and leads to formation of new untested experiments/institutions like Wholesale banks and NBFCs graduating as banks. On the credit side, also surprising is the omission of ~6 million SHGs, while NBFC-­‐MFIs with 2 million clients have a prominent place in the report.

I feel that instead of creating new institutions like wholesale banks and new structures like merchant establishments acting as payment points, the issue of inclusion can be dealt with following changes in the existing system

• Making India Post a payments bank
• Strengthen BCs through interoperability and non-­‐financial services (suggested by the committee)
• Removal of State Govt ownership in Cooperative banks
• Conversion of PACS as BCs – will add 1 lakh BCs that already have existing relationships in the area
• Removal of State Govt ownership in RRBs and making them subsidiaries of mainstream national banks. These can take the place of suggested subsidiaries.
• Allow MNOs with safeguards like an escrow account to handle remittances
• National banks (PSU and Private) to use technology and work rationalization to make their rural branch network profitable.

We need to leverage on the existing institutions. Having known the NBFC sector, I am afraid that allowing NBFCs in their present form to become banks is fraught with systemic stability issues. Easing their liquidity issues through suggested measures like refinance, ECBs and bonds and allowing them to become BC more than adequately harnesses their efficiency. Not sure when RRBs are said to strain the supervisory capacity, will not NBFCs turned banks, wholesale banks and payments banks add to the woes of supervision.

Coming to some specific areas of concern, the following merit reconsideration

• White label BCs with access to payments and settlement system – Though the idea is appealing, I see two issues with it. One relates to mis-­‐selling as the BC might sell products, which are more remunerative to him, rather than to the client and the related issue of what happens to the existing nested BCs?
• Nested vs Open BCs – The report argues that in case of nested BCs, there is a possibility of risk transfer to the sponsor bank in case it becomes big. I feel in a nested scenario, sponsor bank can still absorb the loss but in case of independent BCs, even the backstopping is not there. Supervision will be another challenge as they will deal with deposits.
• Adjusted PSL norms – I find it difficult to accept that current level of achievement under PSL is considered to be the utmost banks can do as the multiplier is derived from current level of achievement. For ex. If banks are currently achieving 75% of direct agriculture, Rs 1 lent for agriculture will be counted as 1.25. Similarly, the impact of sector and inclusion based multipliers needs to be seen and would have been good if the report had worked out March 2013 PSL achievement based on the new norms. If that would result in exceeding the PSL to cross 50% of ANBC, the suggested APSL only window dresses the under achievement to make it look impressive.
• SRO for NBFC-­‐MFIs: I feel considering the Indian scenario this is not a good idea, it’s time has come and gone. Making a body, which derives its 100% funding from members and plays the role of lobbyist for its members as SRO has serious conflict of interest and credibility issues.
• RIDF not as PSL – The arguments given for it relate to State Governments ability to raise funds on its own. It ignores the more important aspect of bringing project discipline, efficient use of funds and monitoring expertise provided by NABARD. The impact of it is visible in rural countryside. This seems more paradoxical, when securitizations of MFI portfolios and bonds issue by them are suggested to be PSL. I feel this is a case of replacing a more deserving asset class under PSL with a more risk prone and opaque asset class.

Summing up, I feel the committee has done an excellent job of presenting the pressing issues in inclusion like the low credit to GDP ratio and presenting the contours of a flexible yet risk conscious policy framework and backing it up with innovative suggestions like adjusted PSL, white label BCs and Aadhar linked e-­‐ bank accounts. However, I would have liked a detailed plan for credit and risk products coupled with leveraging on existing institutions before creating new ones.