Distribution of financial products in India

I. Introduction
Financial products act as an investment avenue and provide the required financial security to the investors based on the risk-return profile of the financial products. In the past, traditional financial products were offered in India through government initiatives by Public Sector Banks (PSBs) (deposit account, credit account), Life Insurance Corporation (LIC), and postal department (recurring deposit, National Saving Certificate, Kisan Vikas Patra). However, in recent years with the advent of liberalization of financial services industry, diverse financial products have been introduced through participation of private and foreign entities in addition to the public sector enterprises. These include products such as debit and credit cards by banks, open-end and closed-end mutual fund schemes (Exchange Traded Funds (ETFs), Index Funds, Systematic Investment Plans (SIP), sector funds, etc.), life and non-life insurance schemes (Unit Linked Investment Plans (ULIPs), pension plans, children education plans, etc.). It further includes shares and debt securities offered by various entities, investments in which are mainly facilitated by the brokerage houses. This has led to rising competition through introduction of innovative and attractive products, regulatory initiatives and growth in the investor base along with increased marketing activities in the financial sector. The increased activities in the financial sector could be reflected in the growth in the aggregate deposits with banks, which has increased from 16% in FY03 to 24% in FY07. The capital markets are also on the growth trajectory where volumes and market capitalization, both have registered growth. The market capitalization1 to GDP ratio has increased from 22% in FY 03 to 82% in FY07 and the turnover (NSE) has registered a CAGR of 26% from FY03 to FY 07. Similarly, activities in the mutual funds have also reflected growth with the Assets Under

Management (AUM) increasing at a CAGR of 33% during the same time period. The number of new mutual fund schemes introduced has risen from 41 in FY01 to a staggering 414 in FY072. Further, in the insurance sector, total life insurance premium collected by all the life insurance companies has grown at CAGR of 23% from FY03 to FY07. Also, the number of new life insurance policies introduced in FY07 stood at 208 as compared to merely 20 in FY013. The introduction of varied products has increased the scope of the financial sector to a very large extent. Even though these products have been targeted towards urban markets as well as rural markets in India, the rural markets have remained largely untapped (See Exhibit 1). This is mainly due to the concentrated distribution activities by some players in the urban markets.

1 2

National Stock Exchange (NSE) Association of Mutual Funds in India (AMFI) 3 Insurance Regulatory and Development Authority (IRDA)

Exhibit 1: DISTRIBUTION OF HOUSEHOLDS BY TYPE OF INVESTMENTS4

Source: SEBI, handbook of statistics, 2006.

Rural households mainly invest in products such as bank deposits, post office savings and LIC policies that involve fewer risks as compared to the relatively risky investments such as mutual funds and bonds as shown in Exhibit 1. Further, the investments in these products have been propelled by higher penetration of these products in rural areas that has been facilitated by growing network of the banks, post offices and LIC branches mostly driven by regulatory policies. The factors responsible for limited distribution networks of other investment products could include lack of willingness from the service providers as well as lack of awareness of the rural households, which is further explained in the note. The concerted efforts of the market players to tap the urban market could have led to saturation of the urban markets. Thus, there could be a requirement to look at the rural markets by the financial service providers in order to maintain the growth in their revenues and increase their market share. This could be supported by the survey of Indian investors published in the Securities Exchange Board of India (SEBI)s Handbook of Statistics, 2006. According to this survey5, the proportion of rural investor households has increased from 3.28% in 1998-99 to 4.22% in 2000-01, whereas the proportion of urban investor households has relatively decreased from 18.34% to 15.2% in the same time period. Moreover, with the rising income levels of the semi-urban and rural population in India and the rapid semi-urbanization observed in rural areas, there exists a strong business case for many financial product vendors to focus on these markets for expanding their market share and customer base. However, the players will have to tackle obstacles for enhancing their penetration levels in the rural market. Such issues are further

4 5

Data sourced from SEBI-NCAER Survey of Indian Investors, June 2000. Data sourced from SEBI-NCAER Survey of Indian Investors, June 2000.

explored in section II of this note. A significant presence of financial products offered by banks and insurance companies has been largely observed in urban and rural markets in India. This presence is mostly driven by certain marketing strategies adopted by these entities which are explained in section III. The regulators (RBI, IRDA, SEBI) also play an important role in directing the distribution process of financial products. Section IV reflects such policy initiatives undertaken by these regulators. Section V reflects innovative marketing strategies that could be adopted by the financial service providers and regulators to reach out to the rural markets and section VI concludes with the implications of the study.

II. Issues and concerns with distribution in the rural market

There are several issues and concerns related to distributing financial products in rural areas due to which financial service providers have been hesitant towards providing financial services. These issues are examined below: 1. Competition: The competition among various financial product players is getting fierce over the years through the influx of new financial service providers/vendors in the industry. These providers are under continuous pressure to maintain growth in their top lines as well as bottom lines. This has led these companies to concentrate more on the urban areas than the semi-urban and rural areas since semi-urban/rural areas would require either setting up new branches resulting in high capital outlay or setting advanced technologies for providing non-branching facilities as well as providing educational facilities to the rural population. 2. Scale of investment: The funds available for investments among rural households are observed to be lower than the urban household due to lower incomes. According to a survey conducted by NCAER and MAX New York Life in 2005, the average income levels of urban households in India are 85% higher than that of the rural household. Further, rural households could avoid huge investments in risky financial products for longer time period since rural consumption of goods and services are subjected to income irregularities (See 5. Irregularity in payments in the current section). 3. Customers scattered over wide areas: The investors in the rural areas are scattered over a wide geographic area thus creating accessibility problems for the financial service providers/vendors. The providers would have to incur huge costs on setting the required infrastructure (branches and non-branches) for providing financial products among large number of dispersed rural households. Also, the rural investors may not prefer traveling long distances to avail the financial services due to lack of accessibility, awareness, willingness, etc. which are further explored in the note.

4. Rural infrastructure: Many villages in India lack infrastructural facilities like roads, electricity, telecommunications and Internet networks. This creates operational hurdles for players to enter into these markets further discouraging the rural households to reap the benefits provided by the players. 5. Irregularity in payments: Most financial products require regular investments at defined time intervals by the investors. For example, an insurance policy holder has to make a regular premium payment to the insurance company in order to keep the policy active. A majority of rural households are involved in agricultural activities who occasionally fail to make such regular investments since their incomes are largely dependent on vagaries of monsoon. 6. Operational challenges: Companies may face operational challenges such as obtaining relevant documents for verification. Some of the most commonly required documents include a PAN card, ration card, birth certificate, etc. (SEBI)

7. Cultural diversity: Financial service providers find it difficult to penetrate into the rural areas due to the cultural diversity observed in India. Promotion of financial products thus becomes difficult as the sales and marketing personnel are required to understand the local customs, culture and language. Financial service providers/vendors aim at targeting distribution of financial products in rural markets despite several concerns/issues summarized earlier. The providers thus need to identify specific strategies to promote and distribute financial products to the semi-urban and rural households. These strategies are discussed in the following section.

III.

Marketing

approach

adopted

by

major

financial

service

providers/intermediaries
Marketing strategies play a very important role in determining the growth of the financial services industry. Various marketing strategies adopted by the major financial service providers like banks and insurance companies are discussed below. 1. Banks The marketing and distribution strategies of banks are different in urban and rural areas due to diverse demographic and socio-economic nature of these markets. Private banks are mostly concentrated in urban areas due to higher income, better infrastructure, higher investor base and concentration of

commercial activities in the urban areas of the country. The distribution channels used by such banks include bank branches, ATMs, internet banking, phone banking, direct selling agents, call centres, etc. The distribution networks developed by public banks in urban as well as rural areas are a result of policy measures due to which the number of public sector bank branches is higher as compared to private or foreign banks. Private sector banks are also penetrating into the rural areas by using the non-branch delivery systems like the Business Facilitator (BF) model or Business Correspondent (BC) model proposed by RBI in 2006 (See Exhibit 2). Under the BF model, banks utilize the network of intermediaries such as the NGOs, post offices for banking services such as creating awareness and educating on the financial products, collecting and processing information of borrowers, selling banking products and financial services to rural households, etc. The activities in a Business Correspondent model include all those of the BF model and further include disbursing small value credit, etc. Intermediaries under these models have knowledge about the local population and provide feedback about the requirements of the local population (See Exhibit 2). As the local population has trust in these intermediaries it is possible to cross-sell various products. Cross-selling helps in customer retention, reduces customer acquisition costs. It also benefits the customer through fair prices for the products, easier processing and customized products. The usage of such non branching delivery channels has been very less. However, with rising incomes in the semi urban and rural areas, there is further scope for private banks to adopt such non branching delivery models. In addition to the branch and non-branch delivery systems adopted respectively by public and private sector banks, banks also use simple-to-use cash dispensing and collecting machines similar to ATMs which have operating instructions in vernacular languages too. Banks have also initiated credit plus services such as setting up of rural training centres for small enterprises, farmers clubs, knowledge centres, credit counseling centres for educating the semi-urban and rural population with respect to minimizing yield risk and price risk in agriculture. This, further, leads to lower lending rates and lower credit risk.

Exhibit 2: Distribution channels - Banks

2. Insurance The insurance sector can be classified into life insurance companies and non-life insurance companies. Non-life insurance companies utilize distribution channels such as direct mail, direct sales force, insurance agents, agreements with the corporates, banks, real-estate companies, etc. However, in lifeinsurance companies; distribution is mainly through agents, as the personal interaction is necessary for persuading the customer. As on March 31, 2006, there are approximately 20,000 Urban Career Agents and 47,000 Rural Career Agents in LIC. However, the insurance sector remains highly untapped in the rural market. According to the World Bank-NCAER Rural Finance Access Survey 2003, over 82% of the rural households in India had no insurance cover. Nevertheless, most of the players have realized the potential of the rural market and have taken proactive initiatives to tap the market. Some of the initiatives taken by the insurance companies are as below: 1. Insurance companies are offering small premium term insurance products to the rural sector to increase sale of insurance policies in rural areas.

2. Most of the life insurance companies are selling group insurance schemes to meet their social sector obligations and cover maximum lives under the social sector. 3. Micro Finance Institutions (MFIs) are an important distribution channel for many insurance companies. MFIs lend to Self Help Groups (SHGs) in the rural areas. Many insurance companies are selling group term insurance policy to the members of the SHG who have collectively taken credit from the MFI. The SHGs willingly buy such insurance policies because it acts as cost effective collateral for them to avail credit from the MFIs or other financial institutions. 4. The private players are also tying up with public sector banks, co-operative bank and the Regional Rural Banks (RRBs) to penetrate into the rural market. The large rural customer base and wide branch network of these banks offer an effective distribution channel to the insurance companies, thereby promoting bancassurance . 5. A few insurance companies have also tied up with consumer goods companies like HLL, ITC, etc. which have a well set-up distribution network. For example, ICICI has entered into an agreement with e-choupals, the web based marketing platform of ITC, to market and distribute its insurance products to the rural households. Along with the major financial services providers, regulators also have an important role in promoting financial products in rural areas.
6

IV. Initiatives taken by the regulators

Indian financial sector is mainly regulated by three regulators the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and the Insurance Regulatory & Development Authority (IRDA). These regulators have initiated certain policy and regulations to facilitate smooth distribution of financial products and services through financial service providers/ vendors (public, private and foreign companies) in rural areas. These regulations aim at creating awareness of specific financial products in rural areas as well as the overall development of the financial services industry. 1. Life insurance policies and Insurance Regulatory and Development Authority (IRDA) The IRDA initiated reforms in the insurance sector in 2000-01 that included allowing private and foreign insurance companies to participate in the urban and rural areas along with the public sector institutions. Further, it was made mandatory for new players to maintain a minimum proportion of life insurance policies sold in the rural areas thereby necessitating setting up of distribution networks in the rural areas (See Table 1). This regulation has thus facilitated access to financial products in rural areas.

Insurance products offered through banks.

Table 1: Obligation of life insurers to social and rural sector Social sector Year of operation (Number of lives covered) 1 2 3 4 5 6+
Source: IRDA Note: As per the census definition, a rural area is one with a total population of less than 5,000, with a population density of less than 400 per square kilometer, and where more than 25 per cent of the male working population is engaged in agricultural pursuits. Social sector includes economically vulnerable sections of the population, such as agricultural labourers, road construction workers, fishermen, artisans and physically challenged self-employed individuals.

Minimum business requirement for life insurance companies (% of total number of policies) 7 9 12 14 16 18

5000 7000 10000 15000 20000 25000

2. Building bank networks in rural areas RBI has undertaken several initiatives to increase bank networks in rural areas which are summarized below: 1. From 2006 onwards, RBI approved setting new branches condition to 50% of such branches being opened in unbanked areas. 2. In 2006, Rural Regional Banks (RRBs) were allowed to market mutual fund units based on the approval from their Board of Directors. These RRBs, can enter into distribution agreements with private or foreign mutual fund houses for marketing their schemes based on the terms and conditions specified by the RBI. 3. Minimal Credit/Deposit Facilities through financial inclusion in rural areas Financial inclusion is a process of providing basic banking services at an affordable cost to the vast sections of deprived and low income groups. According to a study provided to the World Bank and OECD, access to financial services can lead to favorable economic growth (Claessens, 2005). However, access to these services is subjected to factors such as financial literacy, income levels and financial assets held among urban and rural households, which are inconsistent especially across rural households. In India, with approximately less than half of the population (48%) having access to financial

services (Sri Lanka 59%, Malaysia 60%, Korea 63%) it becomes necessary to prioritize financial inclusion to promote economic growth. In 1998, RBI promoted financial inclusion through the introduction of Kisan Credit Cards (KCCs) provided by the PSBs. However, in recent years, the process of financial inclusion has been gradually extended by RBI wherein all banks are advised to align their policies and strategies accordingly. Some of the initiatives undertaken by RBI for promoting financial inclusion include: 1. Introduction of a No Frills Basic Bank Account

2. Simplified general purpose credit card with a revolving credit limit of Rs.25000 for rural households 3. In 2006, RBI made it mandatory to open at least half of new branches in unbanked areas. 4. Under the Union Budget for 2007-08, the finance minister has also announced creation of Financial Inclusion Fund and Financial Inclusion Technology Development Fund for managing the costs of development, promotional and technology interventions. 4. Promoting financial literacy in rural areas Literacy rates in rural areas are comparatively lower than urban areas. According to Census 2001, all India literacy rate is 64.8% of which the literacy rate among urban population is 79.9% whereas for the rural population it is 58.7%. The demand for financial products mainly depends upon the investor awareness which further depends upon the literacy levels of the rural investors. Financial literacy enables investors to make an informed investment decision. In India, financial literacy gains even more importance as the literacy rate in the country is low and a large section of population is out of reach of formal financial set-up. Regulators thus play an important role to create awareness among investors through financial literacy. This also includes providing awareness among the investors about the financial products. Regulators initiatives include the following: 1) In the Mid-tem review of the Annual Policy for the year 2007-08, RBI proposed a scheme for Financial Literacy and Counseling Centres (FLCC). The objective of the scheme is to provide free financial literacy and credit counseling in rural and urban areas. 2) RBI has also launched a financial information web-site in Hindi, English and 12 regional languages that aims at teaching basics of banking, central banking and finance. 3) Public sector banks could act as an important channel through which financial literacy could be generated in rural areas as they possess network and reach in the areas.

V. Way forward
In order to tap the rural and the semi-urban markets for distributing financial products certain steps have to be taken by both, the players and the regulators. 1. Creating awareness about different financial products Regulators like RBI and IRDA have taken steps to promote financial literacy but further efforts are required from both the regulators and players in the financial industry to increase awareness among the rural investors. Financial education for the rural investors should focus on their financial needs and the products catering to such needs. For example, the population involved in agricultural activities should be educated about insurance of agricultural implements, crop insurance, etc. This would not only increase the depth of the market for the financial products but also facilitate the financial inclusion in India. 2. Customize/repackage the financial products The marketing/promotion approach to be taken for rural population should be different as compared to their urban counterparts. This is due to the major differences in perception of financial products of the rural population. For example, rural households prefer saving-oriented life insurance policies which could fulfill their long term goals like the costs of a daughters marriage as opposed to their urban counterparts for whom tax consideration is a major influential factor for purchasing a life insurance policy. Thus there is need to understand the perception of the rural households and design innovative products to cater to their needs. 3. Explore new distribution channels Financial service providers should explore new distribution channels or tie up with intermediaries like the MFIs or other social groups. They can bank on the network and established operations of these institutions as against opening up of new branches that involve higher infrastructure costs, staff expenses, etc. The development of the MFI model in India would be critical for the distribution of financial products. 4. Credit bureaus Risk assessment of the households in the semi-urban and rural areas is one of the major hurdles for companies offering financial products in the rural areas. Credit bureaus or credit information companies could be instrumental in filling this information gap and would help small investors to access various financial products at fair prices. This step would also boost the confidence of the players who are looking at the semi-urban and rural households as their potential customers.

10

5. Obligatory targets Regulators in the financial market can impose targets on players in the industry to achieve certain level of penetration in the rural areas. For example, a mutual fund should be required to spend certain amount of its profits on generating financial literacy or investor education campaigns. This would boost the efforts on the part of the financial players to initiate financial education campaigns and develop or design products for the rural households. 6. Leveraging on technology A well developed technological system in financial services companies could reduce cost of transactions and processing of applications. The companies distributing financial products by using MFI network in rural areas can control their own operations by leveraging on advanced technological devices like the smart card readers. Through the use of technology, one-time development of a database of customers can be facilitated, which can help adding products in the same database and promoting distribution of all financial products under one roof. Other benefits of technology include growth and sustenance of customers, enhancement in productivity levels of the employees. Financial inclusion in India would lead to enormous volumes and enhanced customer base which requires a robust technology.

VI. Conclusion
Variety of financial products like mutual funds, insurance, shares, debentures, derivative instruments, etc are available in India. However, the reach of these products is very limited and the features of many of these products are very basic in nature. Further development and innovation in these products would be faster if they are accessed by all classes of investors in urban as well as rural areas. The thrust lies mainly on the distribution of financial products to deepen the market for such products and improvements in the product design itself. The responsibility of ensuring these improvements vests with all the stakeholders in the financial services industry.

11

REFERENCES SEBI (2006), Handbook of Statistics on the Indian Securities Market 2006, Securities Exchange Board of India. Accessed at http://www.sebi.gov.in/Index.jsp?contentDisp=Section&sec_id=3 on April 15, 2008. Census (2001), accessed at http://www.censusindia.gov.in/Census_Data_2001/India_at_glance/rural.aspx on April 15, 2008. India Stats (2008), accessed at http://www.indiastat.com/default.asp on April 15, 2008. Watson Wyatt Worldwide (2008), Asia-Pacific Insurance Review. Accessed at http://www.watsonwyatt.com/asia-pacific/pubs/apinsurance/showarticle.asp?ArticleID=16410 on April 15, 2008. NCAER (2008), Study of Services to Depositors and Small Borrowers in Rural and Semi-Urban AreasVolume-I. Accessed at http://www.ncaer.org/downloads/Reports/Services-to-Depositors_RBI-Vol_I.pdf on April 15, 2008. EPW (2005), Expanding Access to Financial Services- Where Do we go from Here? Accessed at http://www.epw.org.in/epw/user/userindex.jsp# on April 15, 2008. RBI (2007), Mid - Term Review of the Annual Policy 2007-08. Accessed at http://rbi.org.in/scripts/NotificationUser.aspx?Id=3908&Mode=0 on April 15, 2008. Sa-Dhan (2005), Annual Report 2004-05. Accessed at http://www.sadhan.net/Adls/Microfinance/AR/Annual_Report_Final_2004-2005.pdf on April 15, 2008. RBI (2006), Financial Inclusion by Extension of Banking Services - Use of Business Facilitators and Correspondents. Accessed at http://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=2718 on April 15, 2008. FindArticles (2001), Emergence of Flexible Distribution Channels for Financial Products: Electronic Banking as Competitive Strategy for Banks in India. Accessed at http://findarticles.com/p/articles/mi_qa4012/is_200107/ai_n8957497/print on April 15, 2008. RBI Notification (2006), Marketing of Mutual Fund Units RRBs. Accessed at http://rbidocs.rbi.org.in/rdocs/notification/PDFs/70491.pdf on April 15, 2008. RBI (2007), Financial Sector Policies for growth and employment Accessed at http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/81252.pdf on April 15, 2008. Census (2001), accessed at http://www.censusindia.gov.in/Census_Data_2001/India_at_glance/literates1.aspx on April 15, 2008. SSRN (2005), Access to Financial Services: A Review of the Issues and Public Policy Objectives. Accessed at http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID744644_code427206.pdf?abstractid=744644&mirid=1 on April 15, 2008 RBI (2006), Financial Inclusion for Sustainable Development: Role of IT and Intermediaries. Accessed at http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/73715.pdf on April 15, 2008.

12