Gauging household income key for microfinance clients

Source: This post is based on the article “Gauging household income key for microfinance clients” published in The Hindu on 2nd September 2021.

Syllabus: GS3– Mobilization of Resources, Growth, Development

Relevance: Credit growth, Micro-Finance

Synopsis: An accurate assessment of household-level incomes would avoid instances of over-indebtedness and ensure the long-term stability of the ecosystem.

Introduction

Recently released, Consultative Document on Regulation of Microfinance in June 2021, shows that the microfinance movement in India is set to receive momentum.

Following the Malegam Committee Report, the current Consultative Document on Regulation of Microfinance looks to reassess the priorities of the microfinance sector.

What are some key recommendations?

First, some of the key regulatory changes proposed in the document take household income as a critical variable for loan assessment.

Second, the definition of microfinance itself is proposed to mean collateral-free loans to households with annual household incomes of up to ₹1,25,000 and ₹2,00,000 for rural and urban areas respectively.

Third, it suggested all Regulated Entities to have a board-approved policy for household income assessment. It caps loan repayment for all outstanding loans of the household at 50% of household income.

Why measuring household income is complex?

First, with a high degree of informality in our economy, income tends to be unpredictable in time and volatile in volume.

Second, Low-Income Households (LIHs), who form the customer base for Microfinance Institutions (MFIs) have seasonal and volatile income flows. For instance, households with migrant workers who migrate to the city for certain months of the year see an income peak during those months.

Third, the highs are also contrasted by lows during certain lean seasons when remunerative work is unavailable, such as drought and during the growing season. There have been attempts to understand their inflows by measuring their expenditure. But, due to rotational debts, expenditure also does not truly reflect the household’s income.

Fourth, for most LIHs, their expenditure on income-related activity is not separate from their personal expenses. It is difficult to separate the household’s personal expenses from their occupational pursuits.

How household income can be measured?

Structured survey-based approach: It could be used by Financial Service Providers (FSPs) to assess a household’s expenses, debt position and income from various sources of occupation. However, attention must be paid while designing such a questionnaire so that it captures seasonality and volatility in cash flows.

Template-based approach: It could be used wherein FSPs could create various templates for different categories of households (as per location, occupation type, family characteristics, etc.).

Household templates could be defined based on publicly available data sets that contain State/district-level information about household cash flows and occupation types. These templates could then be used to gauge the household income of a client matching a particular template.

Centralised database: FSPs could collect and maintain household income data through a centralised database. This would allow for uniformity in data collection across all FSPs.

Technology Service providers could play a crucial role in this exercise and create customised digital architecture for FSPs depending on their specific needs. Creating new technology to document and analyse cash flows of LIHs would facilitate innovation in the standard microcredit contracts through customised repayment schedule and risk-based pricing, depending on a household’s cash flows.