India Has Built the Rails — Will Passengers Climb Aboard?

I wrote recently about four key drivers of change in financial inclusion: technology/distribution, open ecosystems, policy/regulation and data. These are, of course, all supply-side factors and leave aside the most important driver of all: consumer demand. I was reminded of the importance of the demand side repeatedly while in India last week.

India has put in place virtually all of the supply-side factors that should make low-cost financial services available for all. The JAM Trinity — comprising a unique Jan Dhan basic account, Aadhaar ID linked to biometric data, and Mobile connectivity — is in place for most of the country, even for those using feature phones. A combination of public and private banks have built an open, interoperable payment system that works at very low cost and is directly accessible to anyone with a bank account and a mobile phone. And both federal and state governments are promoting adoption by channeling government subsidies through bank accounts. The recent demonetization drive that took the old 500 and 1,000 rupee notes suddenly out of circulation has given the less-cash agenda an extra boost.

But the big question in the story right now is the customer. Low-income, mass-market customers are not as familiar with the world of mobile apps and digital finance as the sophisticated urban dwellers of Mumbai and Bangalore. The India experiment relies heavily on the economy moving from cash to digital payments. However, business models for the various financial service providers that will be needed to support the acceptance architecture for a digital economy are still uncertain. Only one payment bank so far has taken advantage of new government regulations designed to expand access to financial services and officially launched, although others are expected to come on line in the next two months. On the plus side, some of the new players appear to be thinking ahead and pursuing digital-heavy strategies, acquiring merchants and promoting frictionless P2P digital payments rather than relying heavily on expensive cash-in cash-out networks. This may help avoid pricing models that incentivize cash over digital payments, which has been a challenge in East Africa.

India has built the rails, but are the trains and the passengers ready to climb aboard and use them? For digital finance to reach all Indians, it will require a huge change in consumer behavior, and at present, it is unclear how this will come about.

We know from other markets the often overlooked importance of distribution in making mobile financial services a success. In Kenya, agents were incredibly important to educating customers about the new service and assisting them with their first transactions, building awareness and a comfort level with the technology that eventually led to habitual usage. But that habitual usage still made pretty heavy use of a familiar technology: cash. And the leap from cash to fully digital may be bigger than anticipated. We can imagine that some transition period where customers can continue to convert digital to cash and back to digital again may be required. But it is not clear if new players in India will be sufficiently incentivized to build out cash-in, cash-out networks, knowing they are costly to support and transaction revenues will be slim. There will be challenges in shifting consumer behavior, as well as the familiar challenges of managing liquidity across the distribution network.

We met with a commercial bank that has big plans for the mass market and is investing heavily to build out the agent infrastructure to serve it, including in rural areas. But the biometric and card-capable machines that underpin their business correspondent network cost $300 apiece, a high fixed cost that will be challenging to recover. And we must not underestimate the difficulty of building habitual use in the low-income segment; one payment bank licensee told us about the challenges of supporting the delivery of monthly pension payments to elderly villagers. One recipient came to the agent with just a SIM card, no phone. The agent had to put his SIM into a phone, check the balance and then dispense the cash from his pension payment. And this had to be repeated every month. While this may not be the case for every user of the system, there will be a segment of customers that may not be able to tap into their funds on their own, even with a bank account. Agents will therefore be a critical intermediate step in moving from cash to digital payments.

India has put in place a policy framework for wider financial inclusion with technology-driven public infrastructure and utility pricing to encourage financial services providers to reach citizens with a range of services. The long-term future is very clear in everyone’s minds — a digital system in which all Indians can hold funds in an account and easily transact with one another digitally. The big question in the story is how we will get from an economy where cash is a primary means of transacting to one where citizens are comfortable transacting completely digitally. The key to making the shift to digital is customer uptake. In the near to medium term, this is likely to require a deep distribution network, banks that are sufficiently incentivized to build the cash-in cash-out network and a merchant ecosystem that will build a bridge to the digital future. Those agents and merchants will be fundamental to supporting customers in the transition, and currently, the business models to support the costs of building such networks are by some reports extremely challenging.

The next year will be telling in how adoption of digital financial services in India unfolds. Shocks to the system like demonetization can help push the digital agenda, but they are strong medicine. It remains unclear how this will affect consumers’ experiences and whether it will encourage habitual use. The fundamental building blocks of distribution networks with viable business models and consumer adoption of digital payments will be the true test for whether India can fulfill the promise that it holds for radically changing the face of financial services for all Indians.