By Sanjay Behuria,

Microfinance Focus, June 9, 2011: A brand new CWP (Cost and Willingness to Pay) Report by MicroSave says that 70% of financially excluded potential clients are willing to pay for banking services. Will this lead to higher, lower or rational pricing for the end consumer? We will all remember that when similar surveys were published about MF client’s willingness and ability to pay for credit, some companies went overboard leading to the drowning of the whole sector. While survey results are well intended, it is often in danger of resulting in unintended consequences. They need to be analyzed in light of existing perceptions, whether well or ill placed. The real result of the survey will be when intervention is instituted on the basis of the first survey report with a control group and experiment group, and then new results are derived from a new survey of the same hypothesis with both groups. The control group will have no additional inputs from the first survey while the experimental group goes through a financial literacy exercise that explains the 5 W's of financial charges through alternative delivery channels (ADCs). Choice by education - not assumption!

The most oft quoted reason for charging transaction related prices through ADCs is that those who derive benefits from the service must pay for it. Fair argument - but are they the only ones who must pay for the service, do they know why and what they are paying for (adequate disclosure), has there been enough research on the client's desire to pay when they know the cost of transaction versus on assumption of cost of transaction that is supply led? Is the information flow about the transaction fees equitably balanced between user and supplier of services? Are the costs properly apportioned? What details are available in terms of the cost of acquisition of float from financially excluded areas through agent network and through branch network? Do clients pay for services if they have accounts in a loss making branch, if not, why should they be charged for the fees of the agent? It will seem to me that good old banking and intermediation principles are sacrificed in calculating cost of transaction for the financially excluded to keep them excluded - or if they don't specifically pay to get included.

What is financial intermediation?

When a financial institution (FI) collects deposits to lend, it is called financial intermediation. Such FI is regulated under prudential regulation norms by the Central Bank of the country to ensure the safety of the depositor's funds.  The spread between the aggregate cost of deposits and aggregate cost of loans is the revenue of the FI, which pays for its cost of operations and leaves a desired profit for the shareholders - as remuneration for equity and risk. That being so, when can a FI charge additional fees for a transaction? I would surmise, that any transaction or a part of the process of the transaction that does not result in financial intermediation is chargeable, because that is outside the mandate of the FI and is undertaken to benefit the client outside of that mandate. It is like a hospital that does not do pathology tests. They can have it done outside and charge the client or ask the client to get it outside and pay for it outside.

So what transaction results in financial intermediation? I will start an example here of a consumer of tea - the first cup in the morning. When I buy tea (let's say bags for convenience sake), what am I paying for? I am paying for the opportunity cost of land that grows tea, the inputs that went into growing tea, the inputs that went into plucking, processing and transporting tea to the super market, cost of inventory and financing and sundries. I am also paying for the value additions, commissions and taxes that go into making a tea plant to produce my tea bag, including profits on the way to the super market counter. That's it - I don't pay to the producer/supplier for storing that tea in my house, for boiling water to make the tea, for drinking the tea, for disposing the tea bag or anything else. Now transpose that into a financial ADC. When the client makes the first transaction - here the commodity being money, they are not charged. Input costs of setting up a delivery channel, recruiting and training agents and all other costs are deferred until after the first transaction. After that they are charged for clicking a button to find out their balance, to transfer money, to pay for utilities, to pay for services and to draw out their own money. So, in my example, there is no charge for buying the tea, but there is a charge for everything else I do with the tea bags after I have bought it, including not consuming it in a fixed number of days. Unless I am a real tea addict - do you think I will buy and consume tea in the way I do, if those dynamics were to change in the way ADC pricing is currently done?

The key therefore is to exactly map what transactions and activities result in financial intermediation and therefore are locked into the interest rate. Any transaction that is a value addition or is provided as a convenience that does not directly result in financial intermediation or is paid to a third party on behalf of the client may be charged to the client - after disclosure and transparency norms are strictly adhered to. Just because the regulator has permitted us to charge is not sufficient reason to waive the principle of incidence of fees for a financial transaction that results in intermediation.

How is all financial transaction prices locked in? All deposit taking FIs have a balance sheet which shows customer liabilities and assets. Their liabilities are categorized as demand and time liabilities. Demand liabilities are those which do not have fixed duration and therefore can leave the system next day. Not much use to the bank to lend it away and face liquidity problems and therefore banks pay no or minimal interest depending on the trend study of how long such demand deposits stay with them and can therefore be utilized without concomitant liquidity problems. The time deposits are matched or deliberately mismatched on the asset side to get a spread and take care of liquidity problems - balancing risk with income. The FIs actually make more money in their demand side of the transactions than the time side of it - demand liabilities are the cheapest and demand assets are the priciest – compare current account with overdrafts and credit cards. Therefore to charge any fees on these transactions is a double charge to the client and laced with profit motive for the FI rather than providing service and being adequately compensated for that service.

The FI is meant to provide service at its location. Any service outside the location is an added cost to the service provider and may be charged to the customer. This is similar to transacting in another branch of the same bank. The ADC is not a branch office but an extension of the branch office. There could be a fixed fee for transacting at the ADC counter, which is aggregate of all its costs. However, the customer may be given a choice to pay a fee and transact at the ADC counter or make a visit to the branch and pay no fee. Once this choice is given, demand and supply forces will step in to keep the fees at a reasonable and affordable level. Currently fees are charged on a cost to FI for running the agent network - which is like picking up the stick at the wrong end. Why does the FI have to pass on the cost of ADC to the customer when it bears the cost of opening a branch in its own books through asset liability management? Does the FI use the ADC for its business for the customer only, or it also has other reasons - country's social and economic policy, its own social responsibility, branding and marketing value, and asset and liability portfolio. Currently, it seems that all the advantages that the FI get from ADC are accrued to the FI, while the disadvantages are passed on to the customer.

What other services do FIs provide that they can charge for?

Statement of account - They normally provide a fixed number of free statements as per contract, if the customer wants more than that they have to pay for it. Any postage and incidental charge incurred is also charged to the customer.

Prepaid - pay on demand services - Any remittance is pre-paid whether they are Bank draft, Banker's check, Money transfer and Wire transfer, Checks for collection or pressing a button transfer. Since these funds are not deposits and are not a part of financial intermediation, the banks can charge service charges and incidental expenses for these. In the electronic age a cash transaction is possible away from the parent branch and fees can be charged for this - as this is not mandatory for the FI and they have incurred additional establishment costs as a convenience to the client. However, if an internet transfer within the same network is not chargeable, a cell phone transfer must receive the same status.

ATM and internet banking charges - these are not chargeable services as the Banks put them up for their own convenience - though camouflaged as customer convenience. FI's save on expensive floor space and human resources (tellers) when clients transact away from branch premises. Client's actually do the work of the employee and not get paid for it!

Any transfers that require an intermediation of a payment network will incur fees as banks have to pay this fee to be a member of the network or are charged on pay-per-use basis.

Providing service outside official premises (at door) is chargeable as this is an additional convenience for the customer - but customer must have a choice to transact in the branch for free or away from the branch for a fee.

What services can FIs not charge for?

Customer registration/opening of account - This is done for the purpose of intermediation and cannot be charged. The customer has a right to decline. It is a part of the Bank's process - the customer will be pretty happy to have an account without filling in an application form or getting a loan without it being processed. This is like charging a customer a fee for entering the super market and an exit fee for having entered the super market and not purchased an item. The entire benefit of customer registration accrues to the FI - the customer account is the very reason for its existence, and yet the client pays for it! Any incidental expenses like stamp duty, legal charges and opinions or any other expense which is to be paid out by the FI to an external agency may be charged to the customer. Definitely not for printing cost of the form in which customer data is captured. This expense is part of the operations cost of the FI and already captured in its interest spread.

Cash deposit - A cash deposit when made into an account whether deposit or loan is a part of financial intermediation - it is the basic business of a bank and cannot be declined or charged.  The bank has a right to pay differential rates of interest for size and volume of deposits depending on how the funds can be utilized. So instead of charging a fee on deposit, they may reduce the interest paid or even have threshold levels for paying any interest - for example; interest may be paid only if the money stays for 30 days or more. Deposits can be hybrid of a current and savings account or notice deposit to be able to make such flexible interest payable arrangements.

Electronic deposit - Similarly for an electronic deposit, if the bank pays any fees to the payment or electronic network, such fees maybe charged to the customer. There cannot be a fee for the deposit transaction itself. Interest may be paid as per cash deposit to take care of non-utilization of the demand liabilities.

Cash withdrawal - a cash withdrawal is customer's money back to them and no customer likes to receive less money than what their statement shows. This is probably the biggest drag for populating transactions at ADCs and what I call picking up the stick at the wrong end. Charging customers for returning their own money, which the bank used for its intermediation purposes to earn revenues is like stealing from the customers pocket. This could be the one big reason why transactions are not picking up at the ADC. What can be argued is that the charge is for the door delivery of cash outside the branch premises. Again fair comment - but here the customer must have a choice to pay for the door delivery or draw for free from the parent branch or an ATM.

Then why should an FI have ADCs?

First, the government will beat them with the right end of the stick. Apart from that, it is a part of their business to have accounts and build their portfolio. Smallness of accounts has nothing to do with the business side of assets and liabilities. Banks have high cost employees in the areas of Treasury, Liabilities and Assets to take care of rationalized interest pricing issues to work towards making ADCs profitable. If the solution is to simply transfer the cost to the client, then there is no reason to have specialists - the MIS can do that. The Banks have to take long term views similar to when they open a new branch. Most bank branches do not become profitable until after 3 years and there are many which continue to be in losses for ever - sometimes internal transfer pricing mechanism is used to camouflage this - for which the engineer that does the re-engineering ends up with a fat salary for juggling the numbers through complex mathematical exercises. Do they charge loss making branch customers for transactions?

The main reason FIs are looking to charge customer's fees for transactions through ADC is because they have to make an immediate payment to the agent network for providing this service. In their internal accounting and transfer pricing, they do not know how to reflect this. Accounting and financial policies of Banks do not mandate a transaction related expense outflow unless it is compensated by a matching inflow from somewhere. This is because they have two independent heads of income - interest and fee. The mismatch working through ADCs is that they are making a fee related expense for an interest related income. To obviate this glaring discrepancy in their financials they are insisting on matching fee expenses with fee income - and the 'poor' client is paying for this. Statistics worldwide has proven that an agent makes between $100-$200 per month and an aggregator makes another $100per agent as its facilitator. Against this the bank saves infrastructure cost and employee cost. Most bank employees - the lowest cadre makes about $500 per month. How will the books of the bank look if they allocated salary of one staff to the aggregator per agent -- and accounted the fees as salary instead of commission? If this was to be accepted, the banks will probably stop charging fees for transactions - because they will not know where to put a fee income against which there is no fee expense - probably in sundry deposits and earn the wrath of the auditors.

In conclusion, fees for ADCs need not be charged to customers, just because the Central Bank mandates it, or that survey results show that customers are willing to pay for it. Fees can be only charged when it is justifiable, equitable, and transparent and has full disclosure. FIs whose reason for existence is financial intermediation, can only make revenues through judicious use of their assets and liabilities. Fee income is mandated for providing related services which does not result in intermediation. The same principle should apply to transactions through ADCs. It is hoped that such a change will lead to increase in volumes and transactions through ADCs and make branchless banking viable; otherwise this has the risk of being a statistical exercise to meet Millennium Development Goals.

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About the Author:
Sanjay Behuria is an independent Branchless Banking and Access to Finance Consultant and the opinions expressed in this article are solely that of the author.