Excerpts from a conversation with a person who works as a cleaning staff in Dubai. Actual conversation happened in Hindi.
Me: So how do you save money in India?
Him: I transfer money to my uncle’s bank account. He takes it and gives it to my father. He keeps it.
Me: So, a person keeps the all the money of earning members in your family?
Him: Yeah, and he lends out money at 2% interest to our immediate & extended family members & friends when someone needs it
Me: (My finance mind starts to work) Well, why don’t you open an NRE account? You get 4% interest tax free on savings account and 7.5% on fixed deposit (Thank God, I didn't advise Stocks & Mutual Funds)
Him: Banking doesn’t work for us Sir. Our financial needs are different
Me: Can you explain?
Him: Sometimes for my daughter’s school fees, I need some money urgently. Maybe for some agricultural expenses, I may have some unanticipated need. If I go to banks, they ask for many paperwork. Not at all easy. Not fast.
Me: So, your family based financing model works for you in these situations?
Him: Mostly yes. The lending is not based on my savings. It is based on need
Me: So, how does your family system ensure that the people whom you lend to, return the money back with interest?
Him: Sometimes people make delays in payments. But, no one defaults. We don’t lend to everyone. It is within a circle of extended family & friends in village.
Me: But does this lending business make profit? Lending at 2% won’t make much money.
Him: Sir, this is not done for profit. This is a system to manage our financial needs of everyone in the family with the little money that we save. If everyone puts money in their individual bank accounts, when need comes, no one in the family can raise a huge sum quickly
Me: So, is this how most of the savings are done in your area?
Him: Yes. Wherever these kind of arrangements are not there, commercial money lenders exploit people.
As I sat bank and thought about that, I felt it made eminent sense. Modern banking works on the basis of “individual”. And all economic theories over that are fundamentally based on the concept of maximizing profit. When the capital available with individual is limited, and the needs are very much basic like health, education & food, you cannot really work on the basis of a person-based banking. A collective usage of capital, even though the returns are limited works best to satisfy the needs of an extended group of people, who otherwise might not be eligible for normal bank credit. The extended group factor is another way of ensuring low probability of default as the defaulter will have much more to lose in an extended family setup. As profit maximization on lender’s side is not the objective, he doesn’t jack up the lending rates, doesn’t go after new customers and so on. Probably this is the reason why modern banking is yet to take a strong foothold in rural India. Rural India will get financial inclusion when some business model emerges to tap into this kind of credit functioning. I can think of Co-Operative banking prevalent in some parts of India as a close-by model. But that’s a bit higher on the value chain where the needs addressed are for starting a business, setting up a shop, buying a vehicle etc.. This is a problem where needs are much more basic and the time to raise money is quite limited.
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