CITYZEN. In informal insurance and savings, we trust

Much has been said and done in recent years to get the poor into systems of formal finance. Committees have been set up, recommendations implemented, and ‘no frills’ accounts launched in their millions. Underlying this effort has been a steadfast official belief that the challenge is essentially one of providing the poor access to formal financial systems; once banks and other official institutions are available the poor would flock towards them. In reality, the informal systems are proving to be much more resilient. Indeed, the poor in our cities, despite having banks all around them, often prefer to function within informal systems of finance.

This preference has a lot to do with informal systems being much more sensitive to the conditions the poor actually face in the city. A major challenge in the city — particularly for those who migrate from great distances —– is the uncertainty built into the entire exercise. They are often functioning in an environment that provides them very little support. The very nature of some of their work, such as construction labour, limits the number of years they can work. There is thus considerable pressure to save as much as their limited wages will allow.

At the same time they are exposed to considerable risk. An accident at work can be ruinous both in terms of their health and their earning capacity. In cities like Bengaluru that emphasise expensive upper end private healthcare over government hospitals, even an otherwise manageable health challenge can be financially devastating for the poor.

The official response of the twin challenges of savings and risk is usually to provide financial products for both. There are financial products designed to meet the need of the poor to save, and there are insurance products. And the poor are expected to divide their severely limited resources between the two products. This is a choice that even the non-poor often find difficult to make. An investment in insurance may be a necessity but if nothing untoward happens you would be better off saving that money and earning interest.

The informal sector understands this dilemma very well. It recognises the need of the poor to have a mechanism that allows them to save with the option of converting it to insurance if and when an unexpected expenditure arises. The product the informal sector provides to address this need goes by different names in different Indian cities. It involves a group of people pooling their savings, say, every month for a period of ten months. Individuals can bid every month for the amount that is pooled in the month. This provides a kind of instant insurance premium; those who do not need the money that month can treat their contribution as a saving and the amount the others have bid as interest.

This system relies heavily on trust. Those who are given the responsibility of keeping the pooled contributions are trusted not to disappear and provide the money at short notice. And for those who do not face an emergency the returns can be quite high, particularly in times of great uncertainty. When unexpected events hit a larger number of workers it would increase the number of people willing to bid to take the entire amount pooled in, say, that month. This would increase the returns for those who do not face that event.

There have expectedly been efforts to formalise this system, as in the creation of chit funds. But the very size of these larger formal chit funds takes away some of the advantages of the local informal products. The chit fund agency is usually a distant and largely unknown entity which cannot generate the same levels of trust as the informal group. And the record of some large chit funds does not generate confidence either. Large formal institutions cannot also always provide support immediately, say, for a medical emergency in the middle of the night.

In this battle for trust the formal financial sector has other constraints as well. Its search for efficiency can take it further away from the poor. The accelerated process of digitisation has many advantages, including providing round-the-clock services, but it cannot replace the trust in someone you know. This preference for some elements of the informal is by no means an Indian peculiarity. China for one also has a resilient informal sector. In fact, informal financial systems are also used by their industry. But while the Chinese tend to believe that what cannot be changed must be accepted, Indians, in official circles at least, prefer to insist that there is nothing that is not in their power to change.

The writer is a professor at the School of Social Science, National Institute of Advanced Studies, Bengaluru