This post is written by Sanjay Behuria, Independent Strategy Coach and Consultant.
A cost and willingness to pay report by Microsave says that 70% of financially excluded potential clients are willing to pay for banking services. Will this lead to higher, lower or rational pricing for the end consumer? We will all remember that when similar surveys were published about microfinance clients’ willingness and ability to pay for credit, some companies went overboard, leading to the drowning of the whole sector. While survey results are well intended, it is often in danger of resulting in unintended consequences. They need to be analyzed in light of existing perceptions, whether well or ill placed. The real result of the survey will be when intervention is instituted on the basis of the first survey report with a control group and experiment group, and then new results are derived from a new survey of the same hypothesis with both groups. The control group will have no additional inputs from the first survey while the experimental group goes through a financial literacy exercise that explains the 5 W’s of financial charges through alternative delivery channels (ADCs). Choice by education – not assumption!
The most oft quoted reason for charging transaction related prices through ADCs is that those who derive benefits from the service must pay for it. Fair argument – but are they the only ones who must pay for the service, do they know why and what they are paying for (adequate disclosure), has there been enough research on the client’s desire to pay when they know the cost of transaction versus on assumption of cost of transaction that is supply led? Is the information flow about the transaction fees equitably balanced between user and supplier of services? Are the costs properly apportioned? What details are available in terms of the cost of acquisition of float from financially excluded areas through agent network and through branch network? Do clients pay for services if they have accounts in a loss making branch, if not, why should they be charged for the fees of the agent? It seems to me that good old banking and intermediation principles are sacrificed in calculating the cost of transactions for the financially excluded to keep them excluded – or if they don’t specifically pay to get included.
What is financial intermediation? When a financial institution (FI) collects deposits to lend, it is called financial intermediation. Such FIs are regulated under prudential regulation norms by the Central Bank of the country to ensure the safety of the depositor’s funds. The spread between the aggregate cost of deposits and aggregate cost of loans is the revenue of the FI, which pays for its cost of operations and leaves a desired profit for the shareholders – as remuneration for equity and risk. That being so, when can a FI charge additional fees for a transaction? I would surmise, that any transaction or a part of the process of the transaction that does not result in financial intermediation is chargeable, because that is outside the mandate of the FI and is undertaken to benefit the client outside of that mandate. It is like a hospital that does not do pathology tests. They can have it done outside and charge the client or ask the client to get it outside and pay for it outside.
So which transaction results in financial intermediation? I will start an example here of a consumer of tea – the first cup in the morning. When I buy tea (let’s say bags for convenience sake), what am I paying for? I am paying for the opportunity cost of land that grows tea, the inputs that went into growing tea, the inputs that went into plucking, processing and transporting tea to the super market, cost of inventory and financing and sundries. I am also paying for the value additions, commissions and taxes that go into making a tea plant to produce my tea bag, including profits on the way to the super market counter. That’s it – I don’t pay to the producer/supplier for storing that tea in my house, for boiling water to make the tea, for drinking the tea, for disposing the tea bag or anything else. Now transpose that into a financial ADC. When the client makes the first transaction – here the commodity being money – they are not charged. Input costs of setting up a delivery channel, recruiting and training agents and all other costs are deferred until after the first transaction. After that they are charged for clicking a button to find out their balance, to transfer money, to pay for utilities, to pay for services and to draw out their own money. So, in my example, there is no charge for buying the tea, but there is a charge for everything else I do with the tea bags after I have bought it, including not consuming it in a fixed number of days. Unless I am a real tea addict – do you think I will buy and consume tea in the way I do, if those dynamics were to change in the way ADC pricing is currently done?
The key, therefore, is to exactly map which transactions and activities result in financial intermediation and therefore are locked into the interest rate. Any transaction that is a value addition or is provided as a convenience that does not directly result in financial intermediation or is paid to a third party on behalf of the client may be charged to the client – after disclosure and transparency norms are strictly adhered to. Just because the regulator has permitted us to charge is not sufficient reason to waive the principle of incidence of fees for a financial transaction that results in intermediation.
How are all financial transaction prices locked in? All deposit taking FIs have a balance sheet which shows customer liabilities and assets. Their liabilities are categorized as demand and time liabilities. Demand liabilities are those which do not have fixed duration and therefore can leave the system next day. Not much use to the bank to lend it away and face liquidity problems and therefore banks pay no or minimal interest depending on the trend study of how long such demand deposits stay with them and can therefore be utilized without concomitant liquidity problems. The time deposits are matched or deliberately mismatched on the asset side to get a spread and take care of liquidity problems – balancing risk with income. The FIs actually make more money in their demand side of the transactions than the time side of it – demand liabilities are the cheapest and demand assets are the priciest – compare current account with overdrafts and credit cards. Therefore to charge any fees on these transactions is a double charge to the client and laced with profit motive for the FI rather than providing service and being adequately compensated for that service.
The FI is meant to provide service at its location. Any service outside the location is an added cost to the service provider and may be charged to the customer. This is similar to transacting in another branch of the same bank. The ADC is not a branch office but an extension of the branch office. There could be a fixed fee for transacting at the ADC counter, which is aggregate of all its costs. However, the customer may be given a choice to pay a fee and transact at the ADC counter or make a visit to the branch and pay no fee. Once this choice is given, demand and supply forces will step in to keep the fees at a reasonable and affordable level. Currently fees are charged on a cost to FI for running the agent network – which is like picking up the stick at the wrong end. Why does the FI have to pass on the cost of ADC to the customer when it bears the cost of opening a branch in its own books through asset liability management? Does the FI use the ADC for its business for the customer only, or does it also have other reasons – a country’s social and economic policy, its own social responsibility, branding and marketing value, and asset and liability portfolio, for example. Currently, it seems that all the advantages that the FI get from ADC are accrued to the FI, while the disadvantages are passed on to the customer.
In part 2, we will discuss which services a financial institution can and cannot charge for, and why they should use alternative delivery channels.