R B I –  Report of the Household Finance Committee: Some fun with your assets and liabilities as compared to the developed countries 

When my nephews and nieces, all well placed in life, when we got together recently, were involved in a heated exchange of the assets and liabilities position of an individual of India with other countries like the West, South East or other developed countries like China, I just happened to find the report submitted by Mr Tarun Ramadorai from Imperial College, London who headed a committee as named in the title of this essay. Yes, you should read the report and also understand myriad pie charts, graphs and other forms of comparison among Indian assets and liabilities on account of an average Indian with one from the advanced and emerging markets.

The report appears as under:

 www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=877 

After reading the report, please do send your suggestions to cgmicdbr@rbi.org.in by E mail or by letter to CGM-in-Charge, Department of Banking Regulation, Reserve Bank of India, Central Office, Shaheed Bhagat Singh Marg, Mumbai-400 001 on or before September 15, 2017.

To motivate you to read the report, I took the pains to pen below the major findings of the committee by the way of executive summary along with some explanation by myself. You must read the original report and enjoy the fruits of the labor of the committee. Those appear under quote” — “are from the report but I have also expressed my views.

Now direct to the executive summary from the report:   

Executive summary:

1. ” A large fraction of the wealth of Indian households is in the form of physical assets (in particular, gold and real estate). This is unusual in the international context, and especially unusual for younger households, and for households in the bottom 40% of the wealth distribution, i.e., those with the lowest amounts of gross assets.” It is no wonder that Tamilnadu exhibits thousands of tolas of gold being stolen from the houses of teachers, retired bankers, senior retired bureaucrats, highly qualified professionals like lawyers, chartered accountants, or management consultants and most of them uninsured.

 2.” Despite the high holdings of real estate, mortgage penetration is low early in life, and subsequently rises as households age. This is also at variance with Indian households’ counterparts in other countries, where debt has a characteristically hump-shaped pattern over the lifecycle. Indian households tend to borrow later in life and are more likely to reach retirement age with positive debt balances, which is a source of risk given that they are no longer earning income during these years.

a) We note that 1. and 2. above are clearly connected. Social arrangements in which household’s bequest housing wealth to future generations and in turn receive support during retirement are an underlying determinant of these patterns. Such traditional approaches to household financial management have likely evolved over time as a rational response to prevailing economic conditions. We note, however, that these traditional structures are increasingly under pressure from shifting demographic patterns, social norms, and changing economic conditions, introducing risks to economic well-being especially as households age.”

3.  The Indian household finance landscape is distinctive through the near total absence of pension wealth. Pension accounts and investment-linked life insurance products exist, but they are only used frequently by households located in a small group of states, while in most other states, the contribution of pensions wealth to household wealth is negligible.” (It is not surprising since we did not have pension as a product and unions in banks initially went table to table to discourage it. I was one of the first in my bank to opt for it but struggled hard with the bank to get even 10% of employees to sign for the pension. But later on, after I took VRS from the bank, the unions went on strike to opt again for pension.

4. We document high levels of unsecured debt, and perhaps more importantly, debt taken from non-institutional sources such as moneylenders. Such debt generates high costs for Indian households, and as we document later in the report, is likely to lead to households becoming trapped in a long cycle of interest repayments. We note that this phenomenon has been well-documented over the decades, but nevertheless remains stubbornly persistent.” (Please request your nationalized bank where you have a regular bank to give some advance for any emergency requirement. Till recently, those banks even took a long breathe to even finance against gold. Well, the money lender smilingly lends the money at an exorbitant cost which attracts the poor to fall into their trap.)

5. There are low levels of insurance penetration (life and non-life) despite numerous sources of risk such as rainfall (leading to income shocks in largely agrarian segments of the population), health shocks, and catastrophes such as floods or cyclones.” (Why blame the rural poor or agriculturist? Just now, the current Prime Minister brought a new crop insurance scheme where substantial premium is paid by the central government but insure for the full amount. The banks need to step up their efforts to emphasize this fact to agricultural borrowers or agricultural customers though they need not avail any loans. Will they?)

6. There is a strong negative correlation between participation in insurance and the incidence of non-institutional source debt, suggesting that households are dealing with risks through high-cost borrowing ex-post as opposed to insuring against such risks ex-ante. We find that this is a costly approach for households, as high interest payments on informal debt impose substantially greater costs on Indian households relative to the (counterfactual) policy of purchasing actuarially fair insurance.

a. This is an important observation, since it suggests that efforts to reduce informal lending will likely fail in an environment in which households are not sufficiently well-insured against risks.

b. We note that some of these risks could be mitigated through strengthening the public provision of health and social welfare services. We also observe that this finding could arise from tight constraints on household budgets which do not permit them to take on insurance ex-ante; or as a consequence of adverse selection, moral hazard, or other issues causing premiums in the insurance market to become unaffordable for households.

Next, we attempt to evaluate the implications of these features of Indian household balance sheets in response to point ii) on the ToR. We also attempt to evaluate the size of any gains from counterfactual policies that households might pursue, and conclude (in this partial equilibrium exercise) that Indian households can potentially realize significant benefits from several changes to their balance sheets. In particular, we find that:

  1. If the current patterns of allocation are maintained, demographic projections indicate that there will be significant additional pressure on the demand for assets such as gold and real estate in the coming decades.
  2. Over the coming decade and a half, the elderly cohort is expected to grow by 75 percent. Only a small fraction of this cohort has saved in private pension plans. Moreover, a large segment of the population of households in all age cohorts has not actively taken steps to insure adequate financial coverage during retirement. The need to finance adequate consumption during retirement is therefore a looming issue, and when combined with the low penetration of insurance, households appear particularly vulnerable to adverse shocks later in life.
  3. Indian households can benefit greatly by re-allocating assets towards financial markets and away from gold. If households in the middle third of the gold holdings distribution re-allocated a quarter of their existing gold holdings to financial assets, on average, they could earn an amount equivalent to 0.8% of their annual income per year (on an ongoing flow basis). Expressed differently, the wealth gain in real present value terms accruing from this shift would be sufficient to move these households roughly 1 percentage point (pp) up the current Indian wealth distribution. For households that hold more substantial amounts of gold, i.e., those in the top third of the cross-sectional distribution, the ongoing annual income gain from re-allocating a quarter of their gold holdings to financial assets is 3.4%, which when capitalized, translates into a upwards movement of roughly 5 pp along the Indian wealth distribution. These projected gains are almost always above zero, even when we account for volatility which may lead to different realizations of returns on gold and financial assets.
  4. For the median Indian household, shifting from non-institutional debt to institutional debt can lead to gains equivalent to between 1.9%–4.2% of annual income on an ongoing basis, or equivalently when capitalized, to upward moves along the current Indian wealth distribution of 2.5 pp–5.5 pp. These gains are almost always above zero in the cross-section of all households, regardless of the reason that the debt was incurred (medical costs, or financing business operations), and regardless of whether the debt is secured by collateral or unsecured. We also note that these numbers are quite conservative, as we accept self-reported “friends and family” interest rates as zero, despite the fact that there is likely significant non-monetary compensation demanded for the provision of such informal credit.
  5. By avoiding the interest burden of emergency credit associated with medical costs, the median Indian household can gain 0.4%–1.2% of annual income on an ongoing basis, or equivalently, move up the Indian wealth distribution between 0.4 pp–1.6 pp. Households could avoid such costs if they were able to access strengthened public health services or if they were able to purchase actuarially fair insurance ex-ante that exactly covered the ex-post debt principal incurred in order to finance future emergency (such as health) expenditure.”

Discussion on above matter:

My views/suggestions: How many nationalized banks or private banks offer financial advice on insurance, housing loan/housing insurance on household goods and house, consultation on mutual funds, procedure to evolve financial goals based on practical basis rather than fanciful ideas and assumptions, planning for emergency loans, information of financial markets like share market, debenture market, bonds/their valuation or the latest introduction of investment in ETF on navratnas of the public sector? Unless the nationalized banks or private sector banks do consider even a bank clerk or a lower level government functionary or equivalent persons as the real customer and work out solutions at a nominal cost, we are not on target in amalgamating our country with developed or emerging markets which are ahead of us in all parameter pertaining to the study.

Just for fun, I have given below an instance quoted in the study regarding the financial advice received by a middle-class person:

  • The availability of resources and the sources of debt are very different across Indian states.
  • Some states (e.g., Maharashtra, Karnataka and Tamil Nadu) have high levels of life insurance participation, while in others (e.g. Madhya Pradesh and Chhattisgarh) participation is very low.
  • In states such as Tamil Nadu, households store a high fraction of their wealth in gold, and also have more than 40% of their total debt in the form of gold loans.
  • We find that the events that have had the largest financial impact on the family during the 2 years prior to the survey date are the loss of crops or livestock due to bad weather, medical emergencies associated with hospitalization, and damage to properties, farm equipment or other business capital, due to a natural disaster. Cumulatively, these events account for the major financial losses in more than 60% of cases.
  • The next three sources in order of financial vulnerability concern reductions of the income-generating capacity of the household, due to job loss, an increase in the costs of agricultural inputs, or a deterioration in overall market conditions. Cumulatively, they account for the major financial losses of around 25% of households.
  • Finally, life events such as theft/burglary, family separation, or the death of the main income earner are also important sources of financial risk, which may affect a considerable part of the population, but their overall financial impact seems to be much smaller than the other sources discussed above.
  • We estimate financial gains for three scenarios: a shift of resources of 25% of gold holdings to financial assets, a replacement of non-institutional with institutional debt, and a shift to full coverage of medical costs through health insurance.
  • Households can earn substantial ongoing income gains from these movements. When capitalised, the real present value gain from re-allocating to financial wealth from gold translates into average movements up the Indian wealth distribution of between 0.2 and 4.9 percentage points (pp).
  • Households shifting from non-institutional to institutional debt can move between 2.5 pp and 5.5 pp up the wealth distribution.
  • Households can move up between 0.4 pp and 1.6 pp by taking on insurance to avoid the burden of emergency credit associated with medical costs.

Financial advice

  • In this table, we report the shares of the population that obtain financial advice from different sources. The source of the data for India is the Financial Inclusion Insights Survey, Wave 3 (2015). We calculate population averages using frequency weights, as reported by the surveying institution.
What or who do you depend the most for a financial advice?
Spouse 40.5%
Myself only 30.4%
Friends, family, and neighbors’ 25.1%
Bank/financial institution 1.4%
Informal savings/lending groups 0.2%
Radio 0.1%
TV 0.1%
Religious institutes 0.1%
Insurance company 0.1%
Other 2.3%

(It is surprising that spouse is more knowledgeable than any bank/financial institution regarding financial advice. This has resulted in miniscule percentage of our population in investing in financial products. I am sure, we all have heard that only 2-3% in Indian population avail insurance products while nearly 60%-70% population in the west think of the financial products even for a new born baby.)

Conclusion

Yes, the intention of paraphrasing an interesting study of R B I – Report of the Household Finance Committee, is to provoke you to give time to some serious study made by RBI to make us on a par with the investing/borrowing people of the West/Emerging countries and make our life a better and comfortable one. When will we think of pension, investment in all financial products and move away from the typical poverty always projected by the socialist minded film producers? Moreover, even availing borrowing products to improve our living is a worthy one but within our capacity to return the capital and resultant interest. Let us not totally live in the past but use the best financial advice available in the world to improve our lives.

Please do read the original report of RBI and submit your suggestions directly to them.  

Reference

www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=877

The original report is available with the above web site with hundreds of graphs/pie charts and other modern examples to provoke our brain.

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