Putting wealth management at the centre of micro finance

By Suyash Rai, Sona Varma and Bindu Ananth

Let’s talk about ‘Shanta’ -- a standard rural micro finance customer. She is a woman in her late-20s and manages a household of young children, elderly dependents and her spouse. She has plenty of economic entrepreneurialism that results in incomes from agriculture, dairy and labour.

Her income is adequate, but there are many claims on her money. Children falling sick, school fees, a relative’s marriage, neighbours taking a loan, and so on.

Add to this the fact that her income is extremely volatile -- rain failure in particular years results in total crop failure; labour opportunities disappear due to economic cycles; or, more commonly, a health shock results in inability to work and earn money.

Cash for her household therefore is a leaking bucket. There are days (far too many) in the year when there is simply not enough.

Enter a micro finance institution (MFI). It makes an important difference to Shanta’s life by letting her take a loan when there is not enough money, providing some element of a safety net. This allows her to manage cash mismatches in ways that are superior to taking usurious loans from moneylenders, selling assets like gold or buffaloes, or pulling her daughter out of school!

The growth of micro finance in India has been unambiguously important for millions of poor households in the country. However, much more can and should be done.

Need for wealth management

Shanta’s financial life can be seen as a combination of certain exposure to time (income today, income tomorrow, expenses the day after, and so on) and uncertain exposure to shocks such failure of the monsoon, or ill-health.

Her financial wealth can be seen as a combination of assets that she currently owns (jewellery, cows, goats, etc) and the present value of her future income computed by using a risk-adjusted discount rate.

How do we give Shanta the full range of financial services and wealth management by a financial services provider so that she is able to both manage her family’s consumption needs on a day-to-day basis and fully utilise her skills and assets to increase her wealth?

The need for such wealth management support is universal; it is even more important for low-income households. Low resource levels imply that while mistakes are expensive for everyone, it is far more so for poor households that juggle many balls for survival.

Wealth management is a notion that transcends product-centric thinking and outreach. It asks the question: How can I, as a financial services provider, steadily increase the wealth of my customers over a period of time using finance and financial advice as my only tools?

There is a need for providers to think innovatively about understanding customer needs, what products/services to make available, and the design of these products/services.

Like their middle-income counterparts, low-income households need to move resources across time and space, in a manner that meets their needs for finance smoothly over a lifetime. They require the full suite of financial services -- savings, credit, risk mitigation, and insurance, remittances -– to meet their needs.

One critical aspect is the range of services that are available; the other is the manner in which they are customised to the needs of a particular household.

Finance is very unlike a physical product in its potential for customisation and its malleability. Liquidity can be provided either through savings or loans, with or without collateral. A loan can involve weekly repayment or bullet repayment; a loan when combined with rainfall insurance can provide a ‘payment skip’ when the monsoon fails; a remittance inflow can be swept instantaneously as an account balance into a money market mutual fund.

Very little justice has been done to this aspect of finance in existing work. We like to think of finance as playing the role of a noise-cancelling headphone that responds precisely to noises in the environment and cancels them out instantaneously, giving the listener a smooth and high-quality listening experience.

Similarly, we can give households a smooth and growing income stream, cancelling out revenue and expense ‘noises’ in their daily life using certain financial tools.

The front-line officer in an MFI is a crucial piece of the wealth management puzzle. She is the person who interfaces with the client and has visibility in both directions: products and services of the provider, and needs of the customer.

To a significant extent, decisions taken by a household are informed by its knowledge of what services it has access to, and its understanding of how these options can be best used. The need, therefore, is to expand the options and to supplement this enhanced choice set with sound advice to the household.

If access to finance is to be looked at through the prism of wealth management, financial judgment and advice has to be integrated with the products. The relevant analogy is that of a doctor who diagnoses the patient’s condition based on manifest symptoms and then applies his judgment to recommend a particular course of treatment (he does not merely offer a generic list of medicines). 

There is an important role for expertise on the part of the financial services provider. Investment in training front-line officers acquires tremendous importance.

Continuing with the doctor analogy, if it is obvious that no single pill works well for all patients, why should it be any different with finance? Insurance, for example, is almost mandatory for an individual who is in the prime earning age bracket and the sole breadwinner of the family. But the relevance is less obvious for an individual who is elderly and depends on savings and children’s income.

Similarly, a household with high dependence on seasonal cash flows from agriculture, for instance, might experience severe stress in taking a loan that requires weekly repayments due to the mismatch between inflow and outflow. Financial services providers cannot wish this heterogeneity away if they want to be true to wealth management.

Need for adaptation

We believe that local financial institutions such as MFIs are well suited to play this wealth management role if they can adapt their operating models over a period of time.

Although the current models of micro finance have grown at a rapid pace, they fall short in the wealth management dimension as discussed here. Some MFIs have started exploring expanding their product suite, but nowhere is the entire set of financial services being offered.

There are regulatory and other barriers that restrict MFIs from providing the entire range of financial services. For example, most MFIs cannot offer savings products, and rightly so given their typically fragile capital base and strongly local character. But they can provide savings through the business correspondent model, by associating with larger commercial banks or as agents of mutual funds.

Similarly, MFIs can enter into innovative tie-ups to provide other financial services such as remittances, insurance, and pensions.

Some current processes would need to be changed to effect this transition. For example, most MFI loan officers travel to where their clients are located for disbursement and repayment of loans; they spend a lot of time travelling and processing.

While this may have its benefits -- bringing banking services to the client’s doorstep -- it also limits the client’s exposure to the range of products and options available, and the amount of quality time spent with the service provider.

The wealth management approach of providing financial services entails continuous contact with the front-line officer. There is also a strong case for branch-based models that give customers a sense of permanence as the provider is part of the community fabric rather than an ‘outsider’. Managers should spend most of their time understanding the needs of clients, in terms of the dynamics of their livelihoods.

Since such advice is customised, there has to be a deep understanding of the household, supported by appropriate analytical tools. One analytical tool, for instance, is household typologies based on risk profiles (heavy dependence on wage incomes, high volatility of cash flows due to rainfall risks) matched with financial portfolios (combination of savings, loans and insurance).

It’s on the basis of this knowledge that managers are in a position to offer sound advice. To save time doing routine activities, they can use technology to reduce the time spent on processing and back-end operations.

Therefore, institutions offering services should make investments in technology, product development, analysis, and training client-facing managers.

From an incentives perspective, there is a conflict between incentivising frontline officers on sales/disbursement targets and providing customised advice to households, because for many households taking a loan may be a bad idea.

Incentivising officers on the basis of the impact on the customer’s wealth would align the organisation’s goal with the officer’s actions, even though measuring such an impact would be challenging.

Horizontal versus vertical growth

Most MFIs are growing horizontally across geographies, with a single product. This, again, is not ideal as the wealth management perspective calls for institutions that are embedded within the community and growing vertically rather than horizontally. It means they should be serving a limited set of clients in a more complete way, rather than be spread across a large number of clients across geographies. This, in some ways, ties the fate of the institution with that of the financial wellbeing of clients in the given geography.

This paradigm of wealth management, coupled with a sound institutional architecture that ensures sustainable delivery of services, can go a long way in unlocking the true potential of financial services providers, including MFIs.

Such complete access to financial services could enhance capital accumulation at the household level. Appropriate risk management tools like insurance and savings buffers would also lead people to specialise in what they do best.

All these are important pathways between access to finance and income increases, and we have an unprecedented opportunity to make this happen in India with the growth of the micro finance movement.

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