Big Trouble with Small Savings at India's Sahara

I recently came across a news story from India that I think offers both a couple of cautionary points for regulators regarding deposits, and a few questions for bankers and microfinance practitioners who are thinking about how to expand savings opportunities to more poor households.

First, stick with me while I give a brief rundown of the story. It centers on Sahara India Financial Corp., a non-bank financial institution in India, with more than 42 million depositors. (By comparison, the State Bank of India, the country's largest lender, has 100 million customers). Sahara India Financial is a key property in the empire of Subrata Roy, a magnate whose group holdings are estimated to be worth US$10 billion. Sahara's savings business accomplishes such a reach in large part through its army of hundreds of thousands of agents who go door-to-door in largely rural and poor areas collecting as little as one rupee (about two U.S. cents) per day from its clients to apply to savings plans they hold with Sahara. A number of the products offered by Sahara are commitment savings plans that lock-up client deposits for many months or years, offering them their deposits, plus interest, back at the end of the time period. The appeal of commitment savings plans, which are popular in a number of developing countries, is that it commits people to save, thus enforcing savings discipline. (For a review of commitment savings products in developing countries, see this paper by researchers Nava Ashraf et. al.)

However, the Reserve Bank of India, the country's central bank, earlier this month ordered Sahara to stop taking deposits, charging the firm with putting the savings of depositors at risk in several ways. For one thing, the RBI said Sahara failed to invest a portion of its US$4.3 billion of deposits in required low-risk investments. (Sahara is required to invest all deposits in low-risk investments, such as treasury bonds). Also, the central bank charged Sahara with taking advantage of its customers - many of whom are illiterate - by cutting interest payments whenever they fell behind on installments. (Many depositors receive only one percent interest a year on their savings, according to a Wall Street Journal article). Thus, given that inflation in India has recently been running at more than 11%, many Sahara depositors appear to be paying a significant sum for having the firm hold their money for them). Moreover, the firm often keeps records of millions of deposits in "tattered paper notebooks," according to another Wall Street Journal article. In recent days, the central bank softened its stance and told Sahara that it can continue taking deposits, but only those that mature before June 30, 2011. This will effectively halt Sahara's savings plan business, according to a third story in the Wall Street Journal.

What struck me about Sahara was the massive scale of its outreach and modest size of deposits it typically collects. On the surface, by extending savings products to poor households likely passed over by banks, Sahara seems to be providing a useful service - enabling households to set aside money now that can be used later for investment or other purposes. However, in the end, it appears that Sahara treated its customers unfairly, and its business practices may have run the risk of destabilizing India's financial system.

As such, Sahara's case presents a couple cautionary points about regulating savings:

• Regulators must regard ensuring the safety of deposits in financial institutions as of paramount importance. The failure - or even a perception of the potential failure - of a financial institution can cause it to collapse and erode trust households have in the entire financial system. Regulators must closely monitor institutions and, ideally, introduce some sort of deposit insurance, such as the Federal Deposit Insurance Corporation (FDIC) in the United States, which insures the first US$100,000 per depositor per bank.
• Governments have an important role to play in promoting financial literacy and requiring financial institutions to explain in a clear, concise manner features of financial products. Also, it is critical that consumers (both literate and illiterate) can understand the concept of interest rates, and, more generally, the value proposition presented by various financial products (such as Sahara's commitment savings plans).

At the same time, Sahara's story raises a few questions that may be useful for bankers and microfinance practitioners to reflect upon with an eye toward figuring out how to give more people around the world the "luxury" of a low-cost savings account:

• What is the value proposition that Sahara's tens-of-millions of customers saw in the company's savings products? My guess is that, for many, Sahara was the only game in town. Setting this aside, I would also guess that the convenience of an agent coming by regularly to collect a modest sum of money was attractive, in part because it enforced savings discipline. Moreover, even if there was a bank relatively close by, Sahara's customers may have felt more comfortable conducting transactions with an agent than with bank teller. (Research has shown that some poor people can be intimidated by banks, i.e. feeling they must dress-up to be treated fairly). Also, it appears that Sahara required little (perhaps too little) personal information from clients (as opposed to banks in some countries that require individuals to present a number of supporting documents - some of which individuals may not have - just to open an account).
• How can banks make mobilizing small savings into a viable business? I find it hard to believe that, if no corners are cut, Sahara's business model is sustainable. This is because, even in a low-wage country like India, it is very expensive to go door-to-door to collect very small deposits. Operational expenses of such an outreach would be difficult for the financial institution to recoup by investing in low-risk (and thus likely low-yield) investments. Can a financial institution ever run a successful small-scale deposit collection operation that has the reach of Sahara (without exploiting their customers, or receiving subsidies from governments or donors)? A "yes" answer will likely depend on advances in technology, such as the ability to make deposits at retail outlets like pharmacies using point-of-sale (POS) banking terminals. But it may be worthwhile to think more boldly. One (admittedly dreamy) idea that jumps to mind is emulating an advertising-supported business model that Google has had so much success with by placing ads on the front of passbooks (or the shirts of deposit collectors, as my colleague Ellen Seidman suggested).

I don't want to extrapolate too much from the case of one financial institution in one country. Indeed, I believe there is a political component to Sahara's case that I don't have insights on. Yet, if nothing else, it may be interesting for someone to pick apart the details of Sahara's savings mobilization business model and see if there are any lessons that can be extracted and applied in a safe, legal, and socially responsible way by financial institutions in India and further afield.