The Real Barriers to Saving and Investing in India: Case of Low-Income Households (LIHs)

Imagine you have extra money and want to save it for the future. Would you put it in a bank, or would you rather stuff cash under the mattress for a rainy day or perhaps invest in a local savings group? For millions of low-income households (LIHs), the riskier options are not just hypotheticals but reality.

A country cannot achieve equitable economic development if a large population remains excluded from the formal financial system. Access to savings and investments is not just about accumulating wealth, it is about being prepared for unexpected events like job loss or medical emergencies and affording education (poverty and inequality-reducing investments).

Despite efforts to overturn history and increase access to financial services, why do LIHS still shy away from formal savings and investment products? Let’s dive into the barriers with a bit of economic detective work.

Access vs Usage

When it comes to financial inclusion, the struggle is twofold:

i) Can’t access financial services (supply side)

ii) Do not trust or want to use them (demand side)

India has had big wins in expanding financial access. Bank account ownership, the first step towards saving and investing in financial institutions, rose from 35% to 77% between 2011 and 2021, largely due to initiatives such as the Pradhan Mantri Jan Dhan Yojana (PMJDY) and the Business Correspondents (BCs) model. However, the progress is unevenly distributed across states, specifically in rural and semi-urban areas. Historically, financial institutions have refrained from entering villages with smaller populations due to the limited profitability when catering to sparsely populated areas and LIHs.

As a result, residents in these areas must travel long distances to access banking services. Travel and the procedures to open a bank account can equate to nearly a full day’s earnings for poor households. The opportunity cost of missing out on a day’s wage to open a bank account is not an ideal financial strategy.

Trust Issues and other complications

Even when access is available, usage remains a challenge. In 2021, 35% of the accounts possessed by LIHs remained inactive, or almost 1 in 3 accounts did not make a deposit or withdrawal over the past year. PMJDY scheme, for all its success, encountered a 1 in 5 inoperative ratio in 2024, with the rate larger for women. Where does the usage gap stem from:

• One-size-fits-none products: Traditional savings and investment products are not suited for the situation of LIHs. When the paycheck is as unpredictable as the monsoon season (climate change, ugh), regular commitments to a fixed deposit or pension are not suitable. No wonder, LIHs tend to save and invest through informal methods such as chit-funds and Self-Help Groups (SHGs) that often charge high interest rates.

  
  

• Transaction costs are a Killer: Even when banks are physically accessible, complicated terms and conditions and cumbersome procedures (e.g., Know Your Customer (KYC) process, extensive paperwork, etc.) deter households from engaging in formal financial services. Even with the expansion of digital banking, only 38% of households are digitally literate (most likely LIHs), which prevents LIHs from fully transitioning to formal platforms. The deadly trio of thick paperwork, travel time and digital literacy gaps makes the effort not worth the payoff.

  
  

• Trust, or the lack thereof: Negative past experiences, hidden fees or the perception of financial institutions being unreliable and exploitative have left a sour taste. Moreover, financial literacy remains low for LIHs. When these households are not aware of the effect of compounding, one of the many benefits of the financial products, why would they save and invest in them?

  
  

• Behavioural Quirks: Firstly, LIHs often prioritize immediate needs over future benefits, leading to suboptimal long-term financial decisions. Additionally, market-linked products such as mutual funds can also feel like gambling without adequate information and trust in the product and institution. As a result, LIHs tend to invest in familiar assets, such as gold and real estate, which cannot be converted to cash for payments easily. Unfortunately, evidence on behavioural factors that affect financial decision-making remains limited.

  
  

• Gendered Dimension: Considering the norms surrounding women's behaviour, unequal division of labour and roles in the household (also discussed in my previous blog post), women are less likely to access as well as use financial services. They simply have limited opportunities to use financial products regularly. As cited in a case study by MicroSave Consulting,

Damini does not experience a regular cash flow. Whenever she receives cash gifts from her relatives, she prefers to keep it at home for future use. Banks intimidate her and she prefers to avoid them.

How can we break the barriers?

• Enhancing Service Delivery: While the BC model has been instrumental in extending banking services to remote areas, it faces implementation challenges in certain areas, including low remuneration, inadequate training and high attrition rates. Better incentives, training and support for BCs to ensure reliable last mile service delivery can increase interest and take-up of formal savings and investment products. Encouragement of female BCs has proved to increase the likelihood of women engaging with financial services.

• Regulatory Reforms: RBI can aid in reducing documentation requirements and streamlining KYC requirements to lower costs and time barriers to access accounts. Moreover, information sharing by banks, microfinance institutions, and fintechs can enhance the efficiency of service and reduce costs.

  Ultimately, how can the trust deficit be reduced?  This can take the form of fast-tracking grievance-redressal systems and mandating transparent regulation. For example, regulators could specify a set of unsuitable products that cannot be offered to households below a certain income threshold, preventing exploitative practices.

• Product Innovation: Products with features such as depositing of funds without penalty for missed payments can be gamechangers. A successful model is digital gold savings, which allows users to buy digital gold, a culturally preferred asset, which can be redeemed to buy jewellery, cash or avail loans, while remaining linked to the formal financial system.

• Behavioural Interventions: SMS reminders, financial education programmes (led by local champions in local languages), and default options such as depositing cash transfers or loans into bank accounts have promoted savings. For example, a pilot study making LIHs promise savings led to 73% engaging with the savings product and 17% achieving their financial goals. Simple modifications to the design of the product can encourage the take-up of formal savings products.

India has made significant strides in financial inclusion, yet there is a wide mismatch between owning a bank account and actually using it, let alone other savings and investment products. By tackling structural barriers and designing flexible products and measures to build institutional trust, we can help low-income households build a financial safety net.

The challenge now is aligning financial institutions' interests with those of the low-income household. Perhaps a debate for my next blog post. However, the goal remains clear: to create a financial ecosystem in India that caters to the needs of its diverse population, fostering resilience for individuals and the nation alike.