I am now a part of multiple Whatsapp groups. While most of them are either inactive or a menace, sometimes they have a tendency to toss up a few gems. One of the groups that I am part of is made up of practicing or wannabe financial planners, a legacy of s financial planning workshop that I undertook. One day, one of the members messaged about a slightly old, yet interesting study by RBI about Indian Household Finance. While a lot of research study ends up simply informing me rather than give me too many action points from my scheme of things, it still makes for an interesting read and often sparks ideas. That is how this research ended up finding it’s way into Elementum Money.
What is the Indian Household Finance study?
In July 2017, RBI published the Indian Household Finance study. The main database that they used as source data was National Sample Survey (NSS) Organisation’s All India Debt and Investment Survey (AIDIS) that records asset holdings as at June 2012 for households in India.
The report was pretty pretty long, at 180+ pages. My biggest problem with it though was that I found it pretty repetitive in parts. There were a few points that find their way into multiple sections.
Also, I believe supplementing the secondary data set with some primary research to probe deeper into the findings would have made for a better understanding. It would also have given some good respondent quotes, which as of now find their way into the policy recommendations section.
Another piece that I believe would have helped would be some finer data cuts. For instance, if they are talking about Indians taking a lot of non-institutional debt because they are low on insurance, is there a distinction in the urban and rural areas? There is a point where they talk about livestock too in a generic manner and I am guessing that might not hold true for urban areas. An interesting distinction could also be if there were any households where the head was a female. As the report points out in the end, more data in this direction would help immensely.
7 Main Findings
The report majorly focusses on 7 areas of the household finance landscape. Here’s a quick snapshot (I mean it when I say quick) of those findings.
More physical assets than financial assets
For anyone working in the financial service industry, this is a stark truth of the Indian household. We still like to invest our money where we can see it – like gold and real estate rather than seemingly mythical assets of stocks and mutual funds etc. As per the study, the average Indian household has 77% of it’s wealth in real estate, 11% in gold, 7% in other physical assets like car, furniture, livestock etc with the remaining 5% in financial assets like publicly traded stocks, mutual funds etc.
While this figure of 95% in non-financial assets is quite similar to other developing economies like China and Thailand, it is starkly different from advanced economies like the US where the average household has only 44% of it’s wealth invested in real estate and German households which have a mere 37% invested in real estate.
While in the advanced economies, as households go up on the wealth spectrum they move more towards financial assets, this is not the case in India. One of the reasons predicted is the fact that physical assets allow for easier tax evasion than financial assets, tax evasion being the favourite pursuit of a lot of Indians.
One of the contributing factors to increasing the investment in financial assets is the role of education, in general and not specifically financial education. While an obvious reason might be a better understanding of the need for diversification and the confidence to avail financial products, another indirect reason is believed to be better absorption in the formal economy leading to lesser avenues of tax evasion.
Mortgage penetration low in early years
This I found to be quite a surprising finding. My first job was in the home loans team of a large private bank in India. From my understanding, I thought the age of the borrowers was reducing, atleast when I compared it to my parent’s generation. My conclusion could be a more recent as well as a metro-centred one.
However, the study observes a rising pattern of indebtedness with age, in both secured and unsecured loans. This is different from most other countries where indebtedness follows a hump shaped pattern for households, with the debt amount falling towards the approach of retirement.
In India though, the real estate holdings do not reduce with age and many households also cross retirement with positive debt which they continue to repay. This is probably thanks to the joint-family concept that’s still commonly followed in India with land and debt being transferred across generations.
High Unsecured Debt
Another finding of the study reports that a whopping 56% of the household debt is actually unsecured, probably taken from non-institutional sources like money lenders and intra-family loans. When it comes to non-institutional lending, a split between rural and urban might be helpful considering how a lot of attempts have now been made to ease unsecured lending digitally.
Of the developed economies, US is surprisingly high on unsecured debt, considering the high occurrence of credit card debt that a lot of the citizens seem to notch up just to tide over daily expenses and purchase of consumer durable goods.
Why do households take unsecured loans? Those at the bottom of the pyramid often do so for working capital purposes but tend to depend on high-cost money lenders. However, medical expenses seem to be another big reason for households to borrow in an unsecured manner with 69% of households deal with medical expenses by drawing upon informal sources of funding, 26% of which are loans from moneylenders.
The three main risks which lead to non-institutional borrowing are loss of crops and livestock, major medical emergencies and damage to physical assets due to natural disasters. As the report notes, all these risks are insurable and low levels of penetration is directly correlated to high levels of unsecured and non-institutional debt.
In this practice, India is not a homoegenous land mass with vital state-level differences. A poor state like Bihar has nearly all it’s loan as an unsecured debt with almost all of it from non-institutional sources. On the other hand, those numbers are much lower in a state like Goa.
Low insurance penetration
Another fact, well acknowledged in India is the abysmally low levels of insurance penetration amongst the populace. The most often stated reason from the 2015 wave of Finscope study, indicated by 50% of the population for not availing insurance is affordability while 16% indicated a lack of awareness. Some likely reasons stated by the study were high transaction costs, a lack of understanding of the details of the products, and the distribution channel.
The authors of the study also report that the problem of explaining the gains of holding a health insurance policy to a healthy individual are amplified by unfamiliarity and mistrust of formal financial institutions. Inability to pay upfront premium could be another reason, as cited by affordability being a barrier.
Here again, there is quite a variation in the adoption of life insurance among state. States like Maharashtra, Karnataka and Tamil Nadu have visibly higher levels of life insurance participation, while others like Madhya Pradesh and Chhattisgarh exhibit a much lower participation.
Absence of pension wealth
The fact that retirement accounts form no or a negligible part of the Indian household assets is not at all surprising. Not only has it been concluded in multiple studies but it’s also an instinctive result. For decades, most Indians have been employed with government employers and the comfort of a fixed pension after retirement. If not a government pension, for a lot of Indians, their kids were often an obvious retirement plan. However, with the government stopping the practice of pension since 2005 and increasingly nuclear families, planning for retirement is now a necessity.
Australian households end up allocating 23% of their household wealth towards retirement accounts with UK households allocating 25%.
Indian households keep accumulating financial and physical assets with age, not displaying a typical hump shaped pattern as seen in other countries. Reverse mortgage, where households are able to utilise their physical real estate assets to generate liquid income over the years is an unheard of concept in India so far.
The report puts in an unintentionally witty aspect that a lot of Indians end up implementing reverse mortgage through their kids. They benefit from the care monetary support given by the kids in their old age with the promise of bequeathing the property to them post death. However, as put in by the report, in the next 15 years, the elderly population is expected to grow by 75%. If the trend of negligible retirement savings continues, this section could be increasingly vulnerable in their time of need.
Dual Role of Gold
We are all pretty aware of the important role gold occupies in the Indian psyche – be it as a solid asset or even as a marker of social standing in important events. Even when we consider household finance, the second highest allocation or 11% of it is done to gold.
More importantly, 7.6% of the debt is through gold loans, which is a product unique to the Indian market. In the bank branch that I sit in, there is a counter for gold loans close by. There is a steady stream of people who come to use gold as a collateral value. So, not only is gold treated as an investment asset but it is also looked at as a physical collateral against which liquidity can be borrowed if the need ever arose.
Yet again, we see differences in state wise details. Any guesses for the state displaying the most love for the yellow metal with a high fraction as assets and 40% of debt through it? Yup, it is indeed Tamil Nadu.
Financial goals center around life events like wedding
While goal based investing is still nascent in India, as a culture we have often delayed gratification to save for some life goals. Turns out, even today wedding remains the top priority for which money is saved for years together.
The most stark number was how lower income groups wished to save on an average 117% of their annual income towards a wedding while the number kept falling, reaching a mere 15% of the annual income at the top quintile of income. It would be interesting to have a data slice to see if the amounts varied on the basis of whether the wedding was for a boy or a girl. The still-prevalent social evil of dowry would be doing much to tip the scales on the basis of gender.
It is a sad truth that weddings and the social marking they seem to portray, attracts a lion’s share of a household’s savings. It can only be hoped that the needle starts tipping to more value adding and enriching aspects like education.
Some insights behind this behaviour
Considering the Indian market is quite unique in a lot of ways, the committee also
Lack of trust
Trust in financial institutions is still a rarity. In fact, respondents who claimed not to trust financial instiutions shoed a far higher probability of staying invested in physical, tangible assets like gold. Such physical assets also gave them a feeling of unrestricted control unlike financial products like banks with minimum balance or even mutual funds with exit loads.
Cumbersome processes and paper work
A lot of respondents also associated big financial institutions with cumbersome processes and long winded paper work. This feeling is directly co-related to them availing non-institutional debt especially in times of dire need like a medical emergency.
Lack of unstructured financial advice
Let’s face it, financial products can be complex and need some time and effort for an understanding. Also, a lot of behvioral handicaps tend to creep in while managing one’s own finances. Hence, the need for financial advice is quite pertinent. However, the landscape of financial advice in India is not only sparse but also unstructured. We have enough degrees to create an alphabet soup yet which one should customers go to for advice on the whole, is anyone’s guess. In fact, when customers took advice outside the friends and family circle, the probability of their participation in life insurance was higher.
Lack of financial literacy
While nothing to be proud of, this is one aspect, where we Indians are not alone. Financial literacy, including basic concepts like compound interest and the reducing balance loans is something most households are unaware of. The problem is that a lot of them are also unaware what they are unaware of. With this lack, comes the habit of continuing the way old practices of handling household finances, which may or may not be best suited for their needs.
Considering the report is commissioned by RBI, it ended with quite a few interesting policy recommendations. I thought of listing down the ones that I found pretty interesting:
While, I personally do not believe annuities are a very efficient product considering the kind of costs they incorporate and the returns they end up providing, they still make up for an easy product for people to understand. The committee believes that annuities, which are still an under penetrated proportion of the Indian insurance business (17% total investment) could serve as a good pension product post retirement.
In this regard, the government is providing benefits to NPS annuity schemes. The committee also proposed more transparency in the Indian annuity market as well a more focused regulatory mechanism to serve it’s needs.
There were quite a few good suggestions on the insurance front. I will mention two most interesting aspects from the recommendations.
Insurance can be a difficult product to understand in the first instance, and lack of awareness is a major barrier in adoption. The committee recommended two solutions in this case – one, a large scale campaign on the lines of Mutual Fund Sahi Hai (Mutual Funds are the right way) to create awareness and two, clear, comprehensive communication at the point of sales.
While the first one would require an industry body like IRDA to jump in, for the second one, there might be some process shifts required. Most of the times, the distributors do have enough knowledge considering they have stringent certifications to show for it. However, a process change might be warranted for better communication between the seller and the buyer here.
The second aspect was the insight that households under estimate the harm caused by lapsation of policy to future claims and benefits. The report then goes on to state how industry commissions are lopsided with distributors getting commissions only at the time of sale and no incentive whatsoever for renewal. Maybe, insurance providers need incentives on the lines of the way SEBI now has a trail-only model for Mutual Fund distributors.
Ever noticed how so many Indian women are emotional when it comes to gold, with it being a sign of inter generational wealth transfer? In the report, the committee recommends an option of inter generational transfer through gold bonds. Personally, as a woman who has experienced and worn this wealth transfer, I am not sure there is a substitute for it.
Another aspect observed is the physical tangibility of gold as an asset. In that regard, the committee proposed that the sovereign gold bonds have an added physical redemption feature, allowing them to be exchanged for gold if so desired. This I thought was a smart idea. Just the possibility would mean much more peace of mind.
To deal with tax evasion through investment in gold, the committee also recommended mandatory PAN card requirement for all gold purchases at jeweler shops. Of the India that I know, this might be a utopian idea.
The committee makes a lot of recommendations in this area and I found a lot of them quite vital.
The committee recommended a uniform financial advisor “licence number” to replace the multiple degrees floating around. The uniform licence number would also imply a uniform regulation for the advisors, through a Self Regulated Organisation. In this regard, I for one, really believe in the CFP model widely adopted in the US where most advisors vow to be fiduciaries, implying that they would act in the interest of the client.
To aid the transparency of fiduciaries in the advisory model, the committee recommends that there is a clear communication of the compensation structure to the household availing of advice.
Another great idea was that of information being available about financial advisors online. The idea is also that their client should be able to rate their services, thereby providing a robust database for anyone looking to avail financial advice.
The committee put forth the opinion that technology could be a huge enabler in making personal finance customizable and scalable for Indians. In this regard, they propose that apart from mutual funds, after the right checks and balances, more digital distribution was the way forward. Personally, in that regard, as we go deeper into the hinterland, we might then need vernacular versions of such distribution arms as well.
The committee also proposed that the government initiative of DigiLocker should be extended to banks, brokers and insurance companies which could then issue documentation and deliver it directly to the customer’s DigiLocker. In this regard, I believe we would need to build more on the trust before we can expect adoption of this service.
The committee also believed that with digitization and e-KYC, the process to switch between financial service providers could be made seamless and esier for households.
Phew! Yes, another long post. But, then if the original report itself is so long, it is bound to have such interesting nuggets that hopefully give an idea into the varied financial landscape that is India. For me, the biggest takeaway was the fact that India is at the cusp of major changes when it comes to household finance. Here’s hoping Elementum Money can make a positive contribution in that development, even if it is a drop in the ocean.
Do you identify yourself with a typical Indian household? Or do you believe you are better planned? Let me know in the comments below.