Equity Research 11 August 2014

India Banks

Megatrends: Transformational trinity

INDUSTRY UPDATE Asia ex-Japan Banks

We believe the trinity of the UIDAI card (Unique Identification Authority of India card, also known as Aadhaar), mobile banking and the business correspondent (BC) model provide the platforms to achieve total financial inclusion in India. These platforms dramatically reduce the cost of customer servicing, particularly in remote locations, by automating the customer authentication process. Therefore, we think total financial inclusion can be achieved at a manageable cost amounting to less than 0.1% of GDP. Based on our detailed modelling, we estimate these technologies can yield benefits in terms of reduced “leakage” from government schemes (0.2-0.3% of GDP), better tax collections (0.4% of GDP) and better savings behaviour, which could add 0.2% to GDP growth per annum.

NEUTRAL

Lack of identity documentation and transaction costs are key barriers to financial inclusion: India lags emerging market peers and other BRIC countries on most metrics of financial inclusion. Only 35% of India’s adults have a bank account (43% in other developing nations, 61% in other BRIC nations). Poor identity documentation at the account opening stage and ongoing high transaction costs are key barriers to inclusion.

[email protected]

UIDAI (Aadhaar), mobile banking and a BC model dramatically reduce costs: Aadhaar, which is being rapidly rolled out, dramatically simplifies the account opening process by providing identity documentation. Mobile banking and BC mobile ATMs (potentially also Aadhaar based) dramatically lower ongoing transaction costs by automating the customer authentication process. Customer authentication, and associated fraud control, when done manually, requires multiple skilled staff and is consequently expensive. The BC model dramatically cuts costs – both on a per location and on a per account basis. We estimate that in the BC model, the cost per location can be reduced by up to 93% and the cost per account by up to 78% vs. the conventional branch model. Lower costs per location allow the setting up of outlets in remote areas with low density, while a lower cost per account allows reaching out to lower-value customers. Overall cost of financial inclusion manageable; also partly recoverable through additional revenues: We estimate that achieving 100% financial inclusion would involve setting up 0.6m customer service points to service 567m additional accounts in rural and urban areas. Manning and supervising this infra would involve capex of Rs31bn ($0.5bn) and recurring cash opex of Rs77bn ($1.3bn). Put in the context, the recurring service cost is about 0.1% of GDP or ~5 bps of the deposits + loans of the banking system. We estimate that about one-third of the costs can be recovered through additional revenues. Significant economic benefits: We think the benefits of inclusion are significant. Firstly, reduction in government spending related leakages could result in savings amounting to 0.2-0.3% of GDP (annually). Notably these gains are 5x of even the most aggressive estimates of potential losses on account of illegal immigrants receiving these benefits. Secondly, financial inclusion could help move savings away from gold to financial products – which could add up to 0.2% to annual growth. Thirdly, UIDAI can be effectively used to minimize tax evasion through tracking of high-value transactions – potentially another 0.4% of GDP (annually). Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This research report has been prepared in whole or in part by equity research analysts based outside the US who are not registered/qualified as research analysts with FINRA. PLEASE SEE ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 50.

Unchanged Asia Ex-Japan Banks Anish Tawakley +91 22 6719 6016 [email protected] BSIPL, Mumbai Rachna Biyani +91 22 6719 6248 BSIPL, Mumbai Sumit Jain +91 22 6719 6071 [email protected] BSIPL, Mumbai

Barclays | India Banks

EXECUTIVE SUMMARY Lack of identity documentation and transaction costs key barriers to financial inclusion The key constraints to financial inclusion or not having a bank account in India (apart from lack of income) are distance (because of reliance on the high-cost branch model to reach far-flung low-density areas), excessive documentation, higher cost and low literacy rates. This was confirmed by a World Bank study which suggested that the number of respondents citing distance, lack of necessary documentation and “too expensive” as barriers to having a bank account was close to 20% which was higher than for other BRICS economies. More people in rural India cited distance as a major reason (29%). FIGURE 1 India lags developing market peers and other BRIC countries on most metrics of financial inclusion

India

Rest of developing world

Other BRICS Countries

0.00%

10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%

Source: World Bank report on financial inclusion (April 2012). Note: “Rest of developing world” excludes India but includes other BRIC countries and South Asia.

UIDAI (Aadhaar), mobile banking and a BC model dramatically reduce costs Aadhaar dramatically simplifies the account opening (KYC) process by providing identity documentation. Mobile telephone and BC mobile ATMs (potentially also Aadhaar based) dramatically lower ongoing transaction costs by automating the customer authentication process. Customer authentication, and associated fraud control, when done manually requires multiple skilled staff and is consequently expensive. The cost of serving customers using mobile or BCs can be reduced by up to 78% that of the conventional branch-based model. Furthermore, as each “customer service point” is lower in cost it can be established even in remote locations with low volumes. UIDAI has enrolled 640 million Indians as part of the Aadhaar rollout within a span of five years. We think this is extremely impressive. For context, Facebook’s user base scaled up to similar levels in ~7 years. UID now has more enrolments than WhatsApp. Until now, states where the enrolment project received unfettered access have achieved high enrolment rates. With the present government’s support for Aadhaar, we believe the nation-wide 100% enrolment is no longer a pipe dream.

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Barclays | India Banks

FIGURE 2 UID’s ramp-up has been faster than that of Facebook in its initial years

FIGURE 3 In the relatively large states with unfettered access, UIDAI has achieved moderate to high enrolment rates

1,400

UIDAI enrolment rate (%)

1,200 1,000

Rajasthan

800

These states account for 39% of India's population

58%

Tamil Nadu

63%

Madhya Pradesh

61%

600 400

Karnataka

200 0 Year Year Year Year Year Year Year Year Year Year Year 0 1 2 3 4 5 6 7 8 9 10 Facebook

Maharashtra

76%

Andhra Pradesh

UID

Source: Facebook, UID Aadhaar

71%

94% 0%

25%

50%

75%

100%

Source: UIDAI

FIGURE 4 The costs for financial inclusion are manageable, amounting to less than 0.1% of GDP on a recurring cash cost basis Rural India Physical infrastructure

People

One-time capex (Rs)

Kiosks: 25,164 kiosks

33,266 BC supervisors

Kiosks: Rs. 2.8bn

Kiosks: Rs. 3.0bn

Mobile ATMs: 1,35,462

399,190 frontline staff

Mobile ATMs: Rs 10.8bn

Mobile ATMs: Rs 17.1bn

Mobile SMS outlets: 2,38,564

Recurring cash opex per year (Rs)

Mobile SMS outlets: Rs 8.3bn

Mobile SMS outlets: Rs 25.9bn

Total capex: Rs 22.0bn

Total opex: Rs 46.0bn

Urban India Physical infrastructure

People

One-time capex (Rs)

Recurring cash opex per year (Rs)

Mobile ATMs: 71,480

11,493 BC supervisors

Mobile ATMs: Rs 5.7bn

Mobile ATMs: Rs 13.8bn

Mobile SMS outlets: 1,00,913

1,72,393 frontline staff

Mobile SMS outlets: Rs 3.5bn

Mobile SMS outlets: Rs 17.6bn

Total capex: Rs 9.3bn

Total opex: Rs 31.4bn

Source: Barclays Research estimates

Overall the costs of financial inclusion are manageable; they are also partly recoverable through additional revenues Our analysis suggests that the cost of achieving 100% financial inclusion in India is manageable (Rs 31bn in one-time capital expenditure and Rs77bn/year in recurring annual costs). It translates to a one-time setup cost of Rs55/account, and recurring annual cost of Rs137/account. The costs incurred for financial inclusion are also partially recoverable through various charges. The BCs can charge a commission for enabling the government benefits transfer. Customers are willing to pay a small charge for safe and reliable remittance service which can also be captured. And although the No-frills accounts will be low ticket, a small nominal balance maintained can also earn a spread for the BCs. The earnings may not be sizeable – but they contribute in managing the costs of financial inclusion. In addition, the emergence of ‘payment banks’ could further reduce the costs required to help achieve a 100% financial inclusion rate.

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Barclays | India Banks FIGURE 5 The rural branch model for customer servicing is up to 93% more expensive than the BC model in terms of location and up to 78% in terms of cost per account

Circle office

Circle office

Branch (part of overall network not exclusive for BCs)

Dedicated branch Officer

2 - 4 junior staff

BC Supervisor

Kiosk/mobile GPRS/Mobile SMS

Kiosk/mobile GPRS/ Mobile SMS

INR '000, per annum

Rural branch

Rural BCs

Cost per outlet

900 - 1,600

108 - 126

400 - 450

100 - 128

Cost per account

Kiosk/ mobile GPRS/ Mobile SMS

Source: Field discussions, Barclays Research estimates

FIGURE 6 Costs incurred for Financial Inclusion are partially recoverable Amount Government benefits transfer revenues

Rs 44bn (US$0.7bn)

Domestic remittance revenues

Rs 20bn (US$0.3bn)

Spread on balance

Rs 9bn (US$0.2bn)

Total potential savings

Rs 73bn (US$1.2bn)

Rationale 2% of fees can be charged for the total subsidy bill (which is c.2% of the Indian GDP) 2% fee can be charged on the amount remitted. And the Indian remittance market is estimated to be c. Rs. 1 trillion (as per study done by Analysys Mason in 2011. Assumed that the accounts made receive an average subsidy of c.Rs 600 per month and keep a balance on Rs 100 on their account.

Source: Barclays Research estimates

Significant economic benefits Financial inclusion in the true sense will be achieved if access to credit to the rural/urban poor increases. This would potentially lead to conversion of non-productive savings (e.g. gold) into investments. In order to estimate the additional GDP growth it would generate, we assume that a substantial portion of non-productive spending – for example, spending on gold – gets converted into productive investment. When the rural or urban poor get an account opened, it typically leads to a more prudent spending pattern and the possibility of them exploring other products related to savings offered by the bank. 11 August 2014

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Barclays | India Banks

Barclays Research Megatrends Reports This report is one in a series of Megatrends reports published by Barclays India Equity Research team. Please also refer to the previous reports:

• India Capital Goods: Megatrends: Water opportunities bubbling forth, July 2014 - Venugopal Garre, Manish Agarwal and Saurabh Mishra

• India Equity Strategy: Megatrends: India's manufacturing - Exports poised for strong growth, July 2014 – Bhuvnesh Singh, Vijit Jain, Rachna Biyani, Chirag Shah, Venugopal Garre, Manish Agarwal and Saurabh Mishra, Balaji Prasad, Rohit Goel, Sahil Kedia and Ashish Parasrampuria

• India Equity Strategy: Megatrends: Accelerating urbanization in India, March 2014 – Bhuvnesh Singh, Sahil Kedia, Anish Tawakley, Jatin Mamtani, Balaji Prasad, Venugopal Garre, and Saurabh Mishra

• India Capital Goods: Megatrends: Urban transport, March 2014 – Venugopal Garre, Manish Agarwal and Saurabh Mishra

• India Healthcare Trip Takeaways: Views from hospitals resonates with our urbanization theme, March 2014 – Balaji Prasad, Rohit Goel

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Barclays | India Banks

CONTENTS EXECUTIVE SUMMARY .................................................................................... 2 BARCLAYS RESEARCH MEGATRENDS REPORTS...................................... 5 LACK OF IDENTITY DOCUMENTATION AND TRANSACTION COSTS KEY BARRIERS TO FINANCIAL INCLUSION ................................................... 7 India lags its developing market peers in financial inclusion ........................................................... 7 Constraints of distance, excessive documentation and prohibitive costs more pronounced in India ............................................................................................................................................................... 8

TRINITY OF AADHAAR, MOBILE AND BC MODEL PROVIDE THE FOUNDATION FOR ADDRESSING THE INCLUSION GAP .........................10 Tech infrastructure can address barriers to financial access ......................................................... 10 Aadhaar roll-out significantly eases the customer authentication process for banks ............. 11 High tele-density – but low account penetration – makes India ideal for growth of mobile banking ....................................................................................................................................................... 13 Micro ATM-led BC model can leverage Aadhaar, mobile banking to drive inclusion further 16

OVERALL COST OF ACHIEVING INCLUSION MANAGEABLE, POTENTIALLY RECOVERABLE AND LIKELY TO REDUCE IN THE FUTURE21 Cost of achieving 100% financial inclusion is manageable ............................................................ 21 Cost of achieving inclusion potentially recoverable ......................................................................... 23 Risks associated with achieving inclusion relatively modest ......................................................... 25 Emergence of payment banks could give further fillip to financial inclusion initiatives .......... 26

THREE KEY BENEFITS OF INCLUSION: SUBSIDY LEAKAGE REDUCTIONS, RISE IN CREDIT PENETRATION AND REDUCED TAX EVASION ............................................................................................................28 Aadhaar likely to be implemented in three phases........................................................................... 28 Reduction in leakage of government spending results in annual savings worth 0.2-0.3% of GDP.............................................................................................................................................................. 29 In the long term, a better savings behaviour is inculcated in the populace that can add an additional 0.2% to GDP........................................................................................................................... 38 Aadhaar can help minimize tax evasion through tracking of high-value transactions ............ 42

LESSONS FROM OTHER COUNTRIES ...........................................................43 Brazil: A successful bank model effectively leveraging the Business Correspondent ............... 43 Kenya: A telecom company-led model ............................................................................................... 44

APPENDIX ..........................................................................................................45 Technology behind the Aadhaar system ............................................................................................ 45 Types of BC models leveraging Aadhaar or mobile technology .................................................... 47

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Barclays | India Banks

LACK OF IDENTITY DOCUMENTATION AND TRANSACTION COSTS KEY BARRIERS TO FINANCIAL INCLUSION India lags emerging market peers and other BRIC countries on most metrics of financial inclusion. Only 35% of India’s adults have a bank account (43% in other developing nations, 61% in other BRIC nations). Poor identity documentation at the account opening stage and ongoing high transaction costs are key barriers to inclusion.

India lags its developing market peers in financial inclusion India lags even some of its South Asian peers like Bangladesh and Sri Lanka on most metrics of financial inclusion. Data from the World Bank suggests that only 35% of India’s adults have a bank account versus 61% penetration in other BRIC countries and 43% in other developing countries. FIGURE 7 India lags developing market peers and other BRIC countries on most metrics of financial inclusion

India

Rest of developing world

Other BRICS Countries

0.00%

10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%

Source: World Bank report on financial inclusion (April 2012). Note: “Rest of developing world” excludes India but includes other BRIC countries and South Asia.

Sri Lanka’s bank account penetration at 69% is almost double that of India, and Bangladesh’s at 39% was also ahead. In terms of adults who have saved at a formal institution the proportion was 12% for India versus 28% for Sri Lanka and 17% for Bangladesh. India lagged on the borrowing front as well, given only 11% had borrowed from a formal financial institution, versus 23% for Sri Lanka and 18% for Bangladesh. An estimate from the Reserve Bank of India (RBI) suggests that close to 90% of small businesses have no links with formal financial institutions while the bank credit to GDP ratio in the country as a whole is a modest 70%. In a large state such as Bihar, it is even lower at a mere 16%.

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Barclays | India Banks

FIGURE 8 India lags Sri Lanka and Bangladesh on all metrics of financial inclusion Afghanistan Pakistan Nepal India Bangladesh Sri Lanka 0%

10%

20%

30%

Adults who borrowed from a FFI

40%

50%

60%

Adults who saved at a FFI

70%

80%

Adults with an account at FFI

Source: World Bank report on financial inclusion (April 2012). Note: FFI = “Formal financial institution”.

The lack of financial inclusion within India is more pronounced in rural India where the percentage of adults with bank accounts is just 33% versus 41% for urban India. FIGURE 9 Lack of financial inclusion is more pronounced in rural India

Overall

Urban

Rural

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

% of adults with a financial account Source: World Bank report on financial inclusion (April 2012)

Constraints of distance, excessive documentation and prohibitive costs more pronounced in India The key constraints in financial inclusion or not having a bank account in India (apart from lack of income) are distance (because of reliance on the high-cost branch model to reach far-flung low-density areas), excessive documentation, higher cost and low literacy rates. This was confirmed by a World Bank study which suggested that the number of respondents citing distance, lack of necessary documentation and too expensive as barriers to having a bank account was close to 20% which was higher than for other BRICS economies. More people in rural India cited distance as a major reason (29%). The World Bank study cited low income as the most commonly reported reason for not having a formal account. This was cited by 63% of unbanked adults and the only one 11 August 2014

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Barclays | India Banks reported by 25% (multiple responses were permitted) as per a World Bank study done by Demirguc-Kunt and Klapper in 2012. While this was cited as a reason by 69% of the respondents in “lower middle income countries” it is not the only reason for lack of financial inclusion in India. This is evident from the fact that countries like Angola (39%), Bangladesh (40%), Kenya (42%) and Sri Lanka (69%) in spite of being in the “lower middle income group” have been able to do better than India on account penetration. In India the most commonly cited reason for not having a bank account after “not enough money” was a family member already having an account. This was cited by 41% of the sample group and by 46 percent of unbanked female respondents, suggesting higher than usual incidence of indirect usage by woman. Addressing this indirect usage at a low cost can empower women, especially in rural India. FIGURE 10 Low income, family member’s account and high account-related expense are the top reasons for low account penetration

70

UIDAI can address these 3  reasons,  and  to some extent  the "low income" constraint

60 50 40 30 20 10 0 Religious Reasons

Lack of Trust

Excessive Documentation (KYC etc) India

Distance

Too expensive

Family member already has account

Low income Constraint

Other BRIC Economies

Source: World Bank, Demirguc-Kunt and Klapper 2012

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Barclays | India Banks

TRINITY OF AADHAAR, MOBILE AND BC MODEL PROVIDE THE FOUNDATION FOR ADDRESSING THE INCLUSION GAP Aadhaar dramatically simplifies the account opening (KYC) process by providing identity documentation. Mobile telephone and BC mobile ATMs (potentially also Aadhaar based) dramatically lower ongoing transaction costs by automating the customer authentication process. Customer authentication, and associated fraud control, when done manually requires multiple skilled staff and is consequently expensive. The cost of serving customers using mobile or BCs can be reduced by 78% than that of the conventional branch based model. Furthermore, as each “customer service point” costs lower, it can be established even in remote locations with low volumes.

Tech infrastructure can address barriers to financial access We assess how we think each of the major barriers to financial access can be offset by the technology infrastructure which is in the process of being set up in India. Lack of necessary documentation: This gets addressed through a unique identification number for each individual that will suffice for Know Your Customer (KYC) requirements in formal financial institutions. Banks in India are required to follow customer identification procedures while opening new accounts, to reduce the risk of fraud and money laundering. The strong authentication that the UID will offer can remove the need for such individual KYC by banks for basic, no-frills accounts. Apart from significantly reducing the documentation for the poor to get a bank account, it will, over time, bring down the KYC costs for banks. Lack of proximity or distance as a constraint: An Aadhaar Enabled Payments System (AEPS) leveraging a BC micro ATM network integrated with Aadhaar Authentication would mitigate the need to travel long distances for hitherto financially excluded customers. Remote verification of identity would enable local agencies, including self-help groups and small retail shops equipped with mobile bank devices, to act as BCs. This addresses one of the major constraints for the rural poor in financial access. Prohibitive transaction cost: A significant portion of technology-related costs is driven by “cost of proving identity” and “cost of travelling a large distance to access account”. A visit to the bank for the poor often means significant travel and associated expenses, and the loss of a day’s wages. This makes access to a distant branch expensive for a rural customer. However, as pointed out earlier, Aadhaar Enabled Payments System (AEPS) leveraging a BC micro ATM network integrated with Aadhaar Authentication would mitigate the need to travel long distances. Not enough money: Direct transfer of subsidies and electronic benefit transfers through UID would reduce leakage that increase cash flows and partly address the “low income constraint” as well. Also, greater financial inclusion can over time mean that rural India gets easier access to credit, unleashing the entrepreneurial energy at the bottom of the pyramid. Our study suggests that technology platforms that include UID Aadhaar, mobile banking, and micro ATMs can help lower the cost of financial inclusion for banks. For example, banks can leverage the UID enrolment process and infrastructure to acquire customers and open UID-enabled Bank Accounts (UEBAs). Aadhaar eases the KYC and the customer authentication process for the banks.

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Barclays | India Banks

Aadhaar roll-out significantly eases the customer authentication process for banks Rapid rollout of Aadhaar in states where the program was given unfettered access is a positive sign. With the present government’s support for Aadhaar, we believe the goal of 100% nation-wide enrolment is no longer a pipe dream. The Unique Identification Authority of India (UIDAI) embarked on an ambitious programme in 2009 to assign a unique identification number to every Indian resident. This involves storage of an Indian resident’s data and biometric information. UIDAI has issued unique identification numbers (Aadhaar) which are linked to a person’s demographic and biometric information. Aadhaar is a unique 12-digit number issued after biometric (iris and fingerprint) and demographic de-duplication. Its mandatory fields include the name, age/date of birth, gender and address of the resident apart from the biometric information and a photograph. This number only guarantees identification and does not bestow any rights or benefits. The rationale for Aadhaar is to address the problems with the existing “identity databases” in India which suffer from duplicate/ghost beneficiaries. The key is to ensure integrity of data from the beginning, check each new entry against the existing database and de-duplicate the same. FIGURE 11 Aadhaar is a unique 12-digit identification number for residents of India

Source: UIDAI Aadhaar

UIDAI has enrolled 640 million Indians as part of the Aadhaar rollout within a span of five years. We think this is extremely impressive. For context, Facebook’s user base scaled up to similar levels in ~7 years. UID now has more enrolments now than WhatsApp. Aadhaar was initially given a mandate to enrol 100 million people, which was subsequently revised to 200m, and then 600m – 50% of the national population (the remaining 50% to be done by the National Population Register or NPR). This has already been achieved as targeted in 2014. Five large states – Maharashtra, Andhra Pradesh, Tamil Nadu, Madhya Pradesh and Karnataka – account for ~50% of the total Aadhaar cards issued, and have seen high registration rates.

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Barclays | India Banks

FIGURE 12 UID’s ramp-up has been faster than that of Facebook in its initial years 1,400 1,200 1,000 800 600 400 200 0 Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Facebook

Year 7

Year 8

Year 9 Year 10

UID

Source: Facebook, UID Aadhaar

In February 2014, the Cabinet Committee on Unique Identification Authority of India (CC UIDAI) allowed UIDAI to conduct enrolments in states where enrolment was being done by the Registrar General of India (RGI) – the key states include Uttar Pradesh, Bihar, Chhattisgarh, Uttarakhand, West Bengal, Odisha and Tamil Nadu. Earlier the enrolment in these states was done by the Registrar General of India under the National Population Register project, while UIDAI was enrolling in 18 states and Union territories. Until now, states where the enrolment project received unfettered access have achieved high enrolment rates. Key large states – mainly Uttar Pradesh, Bihar, Chhattisgarh and Uttarakhand – only recently (Feb 2014) allowed UIDAI to begin enrolments (so far, enrolment was done by the Registrar General of India under the National Population Register project). Dramatic progress is expected in the next few years on this front. Hence we expect the ramp-up in total enrolments to sustain its pace over the next few years. FIGURE 13 In the relatively large states with unfettered access, UIDAI has achieved moderate to high enrolment rates

FIGURE 14 Key states, which recently allowed UIDAI to begin enrolments, still have a relatively low enrolment rate

UIDAI enrolment rate (%) Rajasthan

These states account for 39% of India's population

58%

Tamil Nadu

63%

Madhya Pradesh

61%

Karnataka

71%

Maharashtra

25%

50%

75%

8%

Chhattisgarh

13%

Uttar Pradesh

15%

Uttarakhand

These states account for 44% of India's population

26% 44%

Odisha 94%

0%

Bihar

West Bengal

76%

Andhra Pradesh

Source: UIDAI

UIDAI enrolment rate (%)

47%

Gujarat

100%

52% 0%

25%

50%

75%

100%

Source: UIDAI

In July 2014, the newly elected NDA (National Democratic Alliance) government at the centre gave a vote of confidence to the UIDAI program, and sought the speedy rollout of the Direct Benefits Transfer (DBT) scheme. This move indicates that the program is likely to continue to get support from the central government going forward.

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Barclays | India Banks

High tele-density – but low account penetration – makes India ideal for growth of mobile banking Mobile banking can be transformational in developing countries with limited infrastructure, and low access to formal financial institutions – especially in rural areas – but a relatively high tele-density. Mobile phones scores highly in terms of their reach (leading telecom companies together have close to 1.5 million outlets in India) and cost (cost of a transaction through mobile is ~2% of branch banking) when it comes to banking or payments, even though they may not score that well on ease of use. Mobile payments have taken off in African countries like Kenya where, after five years, 86% of households have a mobile money account and 60% of Kenyan GDP flows through mobile systems. Kenya’s account penetration has risen significantly over the past decade. The share of the population using more than one financial service has risen from 19% in 2006 to 46% in 2013. This has been largely due to the pickup in mobile financial services – the most widely used type of financial service in Kenya. The launch of the M-PESA program in Kenya – which successfully enrolled several users to use mobile technology for electronic transfers – in March 2007, has been a key trigger for the rise in penetration. This service is still fairly nascent, and offers significant upside in terms of financial penetration in Kenya (as the gap between tele-density and account penetration remains fairly high). FIGURE 15 The significant difference between tele-density and account penetration makes India ideal for mobile banking Country

Account penetration in formal financial institution

Tele-density

Difference 38%

India

35%

73%

Kenya

42%

78%

36%

Uganda

20%

52%

32%

Bangladesh

40%

60%

20%

Congo

9%

25%

16%

Sri Lanka

69%

100%

31%

Source: Barclays, CIA estimates

FIGURE 16 Financial services penetration in Kenya has improved significantly… %

Kenya - population using > 1 financial service (%) 46

50

M-PESA penetration in Kenya (%)

90

82

80

70

60 50

30

44

40

19

30 20

10

10

0

0

2006

2013

Source: Global Savings Forum (‘Expanding Customers’ Financial Options Through Mobile Payment Systems’ – November 2010), Barclays Research

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%

70

40

20

FIGURE 17 …driven by the rise in penetration of the M-PESA program

2008

2009

2013

Source: Global Savings Forum (‘Expanding Customers’ Financial Options Through Mobile Payment Systems’ – November 2010), Barclays Research

13

Barclays | India Banks Rapid growth in the Indian mobile industry has meant that India has 886 million subscribers split into a 41% tele-density in rural India (versus 33% adult account penetration) and complete penetration (more than 100% owing to multiple phones) in urban India (this compares to account penetration in formal financial institution of 41% for urban India). Mobile banking can be a big driver of financial inclusion both for rural India and the urban poor segment (especially the migrant population) given that the mobile can be used for transactions and there is no need to get any other device or card. While there are ~17 million users of mobile banking at this point, we believe the potential it offers to achieve the objective of financial inclusion is significant. While the RBI came out with guidelines for mobile banking and payment transactions in 2005-2006, it really took off in India after the introduction of Immediate Payment Service (IMPS) in November 2010 by National Payments Corporation of India (NPCI). IMPS are an instant 24x7, interbank electronic funds transfer service through mobile phones. Over the past decade, the system has evolved from basic services such as information alerts to sophisticated ones like money transfers. Mobile banking particularly addresses the needs of the urban poor who still incur high charges while remitting money through informal channels (60% of the remittances are through informal channels, as per a study by NABARD-GTX in 2009) as a safe, convenient and low-cost means of sending money back home. We also include a case study of Eko Finance which as a master Business Correspondent of various banks leverages mobile banking to help urban migrant remit money to their native villages/towns. FIGURE 18 Mobiles are at an introductory stage in the Indian banking and payment channels

Source: Deloitte report on “M-banking and M-payments: The Next Frontier”, 2013

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Barclays | India Banks FIGURE 19 Mobile banking has evolved rapidly in India

Source: Deloitte report on “M-banking and M-payments: The Next Frontier”, 2013; Barclays Research

There are three models of mobile banking prevalent in India.

• Account-based model: This model requires a bank account which can be operated using a mobile phone. One can make interbank transfers and cash withdrawals within certain transaction limits (essentially, in a cash withdrawal transaction, the mobile phone number acts as an ATM card). These applications can either be downloaded or installed on the SIM card of a handset. This model basically uses a mobile phone to provide services available through internet banking along with specific payment services linked to the bank account.

• No-frills account (open): This model is the most helpful when it comes to financial inclusion as an organization with a strong distribution footprint ties up with banks to offer pre-paid services through mobiles. Under this service banks are responsible for the customer KYC. The maximum amount per transaction is limited to Rs50,000. Cash withdrawals can be made at the agent outlets (which are traditionally Business Correspondents or BCs of the banks). This service offers transactions across banks, merchants and billers through use of payment processors like Visa and Mastercard.

• Prepaid wallet (semi-closed): This service is offered by telecom companies through a “semi-closed loop” instrument (i.e. redeemable at a group of clearly identified merchant locations/establishments which contract specifically with the issuer to accept the payment instrument), which uses mobile phones. The example of this is Oxicash. In this model no cash-out is allowed and a maximum balance of Rs50,000 with full KYC and up to Rs10,000 for utility payments with no KYC is allowed. This can also be very helpful for financial inclusion given that one doesn’t need a bank account at all to avail oneself of this service.

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Barclays | India Banks FIGURE 20 Three distinct models of mobile banking are prevalent in India Mobile Banking

Mobile wallet- Open

Mobile wallet- Semiclosed

Operators

59 banks in India

Vodafone Mpesa, Airtel Money. Aircel Mobile Money

Oxicash, Money on Mobile etc

Involvement of Bank

Yes

Led by banks

No involvement

Documentation

Full KYC

Full KYC

No KYC

Balance

Linked to bank account

Loaded pre-paid amount

Loaded pre-paid amount

Interest

4% pa interest on savings account

No interest

No interest

Cash Withdrawals

Bank ATM

Agents, Retailers (BC's), and ATM's Not allowed yet, but being piloted

Money Transfer

Payment options

Transaction Limits Payment and transfer Time

Person to Person (P2P) transfer from wallet to wallet, wallet to bank account and bank account to wallet Utilities, mobile recharge, DTH, Utilities, mobile recharge, DTH, movie and travel tickets, school fees, movie and travel tickets, school point of sale fees, point of sale Single- INR5000-INR1000; Day Banks allowed by RBI to decide the INR10000-INR25000, Month limits INR25000-INR50000 Instant and round the clock through Instant and round the clock through IMPS IMPS Person to Person (P2P) transfer to bank account or mobile wallet

Person to Person (P2P) transfer from wallet to wallet, wallet to bank account and bank account to wallet Utilities, mobile recharge, DTH, movie and travel tickets, school fees, point of sale Single- INR5000-INR1000; Day INR10000-INR25000, Month INR25000-INR50001 Instant and round the clock through IMPS

Source: Outlook, Barclays Research

According to a study by Deloitte entitled “M-banking and M-payments: The Next Frontier” (2013), transaction value through Immediate Payment Service (IMPS) has increased rapidly from Rs260mn in September 2012 to Rs7bn in July 2013 and the number of transactions has also increased 7x from 93,715 per month in September 2012 to ~701,110 per month in July 2013.

Micro ATM-led BC model can leverage Aadhaar, mobile banking to drive inclusion further Banks have traditionally relied on a branch-led model which involves multiple skilled people to minimize fraud. The requirement of multiple skilled people partly stems from separate people to authenticate and process transactions. The branch-led model therefore entails a higher investment which makes it unviable to reach people in far-flung rural areas or cater to customers with low transaction values. However, the advent of a unique ID in the form of an Aadhaar number, a portable proof of identity which can authenticate a customer on the basis of biometrics, will give an additional impetus towards a lower-cost Business Correspondent model, and also help suitably manage credit risks. Additionally, the high penetration rate of mobile phones will also help in reaching the last mile through mobile banking which leverages the distribution network of the mobile networks. The recent RBI norm permitting non-deposit taking NBFCs (non-banking finance companies) to act as BCs – as well as the removal of stipulations regarding the distance criteria for catchment area – should further provide impetus to the BC model. Technology really is the backbone which will drive further penetration through the BC model. BC uses a fingerprint scanner-cum-identifier, a micro ATM/mobile and a printer to process the payments. Micro ATM/mobiles are connected to the central server of the bank thus enabling connectivity between the BC and the bank, even in remote locations. The beneficiaries can use their UID number or mobile number for identification and authentication. The BC carries cash physically for making payments to the beneficiary. Thus in effect, each BC carries a pocket ATM to the village in which it operates. BCs can use different methods for authentication and validation of customers/beneficiaries. They can 11 August 2014

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Barclays | India Banks either rely on mobile banking (m-PIN) or micro ATMs which in turn use biometrics/PIN that the Aadhaar-based solution provides. This technology has been utilized to develop the Aadhaar-enabled payment system (AePS), which essentially allows an Aadhaar card holder to carry out a financial transaction on a micro ATM provided by the BC. AePS was launched in July 2011 with signups from several banks, and is being piloted in Jharkhand state. AePS also comprises bank card payment services, including RuPay card by NPCI and Visa card. BCs are now also allowed to perform e-KYC (electronic ‘Know Your Customer’) on behalf of the bank. Three large banks – Axis, HDFC Bank and SBI – have already launched the eKYC facility in select branches, with plans to scale up penetration over time. In fact, eKYC is accepted as a valid KYC by all financial regulators, and hence, products. This should further help with a wider rollout of the BC model. FIGURE 21 Schematic of a transaction through a BC

Source: Unique Identification Authority of India, Planning Commission, April 2010

FIGURE 22 Banks are starting to offer the eKYC capability in branches as well as through BCs Bank

eKYC capability

Axis Bank

Launched eKYC for account openings by BCs in rural areas, with aim of opening 100,000 accounts over three months (October 2013) Tied up with NPCI (National Payments Corp of India) to introduce eKYC procedures in branches (December 2013)

HDFC Bank SBI

Launched eKYC in branches, with phased rollout planned over time (April 2014)

Source: Company data, Barclays Research

In this backdrop banks have started to look beyond the traditional approach of branch banking and increased their focus on the Business Correspondent (BC) model to cater to customers in rural India. Account penetration in rural India at 33% is lower than the urban India average of 41% (source: World Bank data). Heightened focus on the BC model which is a more viable model to service low-density villages has meant that the number of villages covered by banks has increased from 11% at the end of March 2010 to 45% at the end of March 2013. This was largely driven by a 6.5x increase in BC branches between March 2010 and March 2013. 11 August 2014

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Barclays | India Banks FIGURE 23 Proportion of villages covered has gone up, driven by a heightened focus on the BC model

50% 40% 30% 20% 10% 0%

300000 200000 100000 0 FY09‐10

FY10‐11

FY11‐12

FY12‐13

Villages  serviced by conventional Branches

Village serviced by Business Correspondents (BC's)

Other Modes

% of villages covered (RHS)

Source: RBI, 2014

Why is the BC model more viable than the bricks-and-mortar branch model? Historically cash transactions could only be carried out at bank branches where multiple bank employees would verify the identity of the account holder. The advent of mobile payments, smart cards and now the UID authentication process has meant that these transactions can be automated. Therefore, they can now be more reliably executed by low skilled, low cost, outsourced agents (called Business Correspondents or BCs). They work closer to the customer which means that the customer’s cost of travelling to transact in a “bricks-and-mortar” branch goes down. The cost of a rural branch is such that for recovering the operating expenses, it has to cover 20,000 households which is difficult given that the catchment area for a rural branch in most cases doesn’t exceed 2,500 households. The legal relationship between the BC and the bank is that of an Agent and Principal bound by a legally enforceable contract. The BC, in turn, employs CSPs (customer service points) who are sub-agents of the banks. The BC gets compensated by the bank for services rendered which is shared with the CSP and the technology provider.

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Barclays | India Banks

FIGURE 24 Rural branch cost structure not sustainable below a certain density threshold Operating costs

Fully staffed

Lightly staffed

Officer

1

1

Other employees

4

1

Cost of officer - Rs m per year

0.5

0.5

Cost of other employees- Rs m per year

0.2

0.2

Other cost

0.3

0.2

Officer's cost

0.5

0.5

Other employees cost

0.8

0.2

Other cost

0.3

0.2

Total cost of outlet

1.6

0.9

4,000

2,000

Number of accounts Source: Bank Interview, Barclays Research estimates

FIGURE 25 BC model costs 1/4th – 1/3rd per account as compared to a dedicated branch Operating costs, '000

Kiosk

Mobile GPRS

Mobile GPRS

BC supervisor

156

156

156

Support staff

75

75

75

Other costs

100

100

100

Cost of supervision

331

331

331

Number of CSPs supervised

12

12

12

Supervision cost per CSP

28

28

28

Cost of BC

60

60

60

Other cash cost

33

39

21

Direct frontline cost

93

99

81

Total cost per CSP

120

126

108

Source: Bank Interview, Barclays Research estimates

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Barclays | India Banks

FIGURE 26 The rural branch model for customer servicing is up to 93% more expensive than the BC model in terms of location and up to 78% in terms of cost per account

Circle office

Circle office

Branch (part of overall network not exclusive for BCs)

Dedicated branch Officer

Junior staff

BC Supervisor

Kiosk/mobile GPRS/Mobile SMS

Kiosk/mobile GPRS/ Mobile SMS

INR '000, per annum

Rural branch

Rural BCs

Cost per outlet

900 - 1,600

108 - 126

400 - 450

100 - 128

Cost per account

Kiosk/ mobile GPRS/ Mobile SMS

Source: Field discussions, Barclays estimates

FIGURE 27 And the costs incurred for financial inclusion include a one-time capex charge of Rs 22bn and recurring cash opex of Rs 46bn Rural India Physical infrastructure

People

One-time capex (Rs)

Kiosks: 25,164 kiosks

33,266 BC supervisors

Kiosks: Rs. 2.8bn

Kiosks: Rs. 3.0bn

Mobile ATMs: 1,35,462

399,190 frontline staff

Mobile ATMs: Rs 10.8bn

Mobile ATMs: Rs 17.1bn

Mobile SMS outlets: 2,38,564

Recurring cash opex per year (Rs)

Mobile SMS outlets: Rs 8.3bn

Mobile SMS outlets: Rs 25.9bn

Total capex: Rs 22.0bn

Total capex: Rs 46.0bn

Urban India Physical infrastructure

People

One-time capex (Rs)

Recurring cash opex per year (Rs)

Mobile ATMs: 71,480

11,493 BC supervisors

Mobile ATMs: Rs 5.7bn

Mobile ATMs: Rs 13.8bn

Mobile SMS outlets: 1,00,913

1,72,393 frontline staff

Mobile SMS outlets: Rs 3.5bn

Mobile SMS outlets: Rs 17.6bn

Total capex: Rs 9.3bn

Total capex: Rs 31.4bn

Source: Barclays Research estimates

Brazil – where account penetration in a Formal Financial Institution (FFI) is 56% – has had a high degree of success with the BC model. The BCs in Brazil effectively acted as good transactions points (payments, withdrawals, and deposits accounted for over 95 per cent of the transactions volume).

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Barclays | India Banks

OVERALL COST OF ACHIEVING INCLUSION MANAGEABLE, POTENTIALLY RECOVERABLE AND LIKELY TO REDUCE IN THE FUTURE Our analysis suggests that the cost of achieving 100% financial inclusion in India is manageable (Rs31bn in one-time capital expenditure and Rs77bn/year in recurring annual costs). It is ~0.1% of GDP which in perspective is equivalent to a ~ 5 bps burden on loan and deposits. In our view, this cost is also potentially recoverable. It translates to a one-time setup cost of Rs55/account, and recurring annual cost of Rs137/account, on our estimates, which is recoverable through fee generation from a combination of charges. In addition, the emergence of ‘payment banks’ could further reduce the costs required to help achieve a 100% financial inclusion rate.

Cost of achieving 100% financial inclusion is manageable Our analysis suggests that the cost of achieving 100% financial inclusion is manageable. We estimate conservatively that the cost of giving financial access through no-frills accounts to ~396m rural Indians and 172m urban Indians (above the age of 15 and presently unbanked) would be Rs31bn in one-time capital expenditure and Rs77bn in recurring annual costs. To put it in perspective, the recurring cost is a mere ~4% of the total profit (and ~1.5% of the net interest income) of the banking sector in 2013. FIGURE 28 Cost of achieving 100% financial inclusion – Rs31bn in one-time capex and Rs77bn/year in cash opex Financial Inclusion Capex: Rs 31.2bn Opex: Rs 77.4bn Rural Capex:Rs 22.0bn Opex:Rs 46.0bn Rs. bn Total Capex

Kiosk 2.8

Mobile ATM 10.8

Mobile SMS

Urban Capex: Rs 9.3bn Opex:Rs 31.4bn Mobile Mobile ATM SMS

8.3

5.7

3.5

Total Supervisory opex

0.7

3.7

6.6

2.4

3.4

Total frontline opex

2.3

13.4

19.3

11.4

14.2

No. of accounts, m

30.2

162.6

202.8

85.8

85.8

Source: Citi Foundation – Sa-dhan report, Barclays Research estimates

FIGURE 29 Share of the total cash opex cost for financial inclusion by different mediums Urban mobile SMS 23%

Rural kiosk 4%

Rural mobile ATM 22%

FIGURE 30 Share of number of frontline staff as required by different mediums Urban mobile SMS 18%

Rural kiosk 4% Rural mobile ATM 24%

Urban mobile ATM 12%

Urban mobile ATM 18% Rural mobile SMS 33% Source: Barclays Research estimates

11 August 2014

Rural mobile SMS 42% Source: Barclays Research estimates

21

Barclays | India Banks FIGURE 31 Financial inclusion would entail creating 396m accounts for the rural population, which would take Rs22bn in one-time capex and Rs46bn in recurring expenses Rural India Key metrics Total rural population, m Unbanked population, m Kiosk costing Capex per kiosk, Rs '000 Cash expenses per kiosk, Rs '000 Salaries paid per kiosk, Rs '000

Numbers 831 396 111 33 88

Total cost per kiosk, Rs '000 Accounts serviced Opex cost per account Maximum number of accounts created, m Mobile Micro ATM costing Capex per mobile Micro ATM, Rs '000 Cash expenses per mobile Micro ATM, Rs '000 Salaries paid per mobile GPRS, Rs '000

231 1,200 100 30.2

Total cost per kiosk, Rs '000 Accounts serviced Opex cost per account Maximum number of accounts created, m Mobile SMS costing Capex per mobile SMS, Rs '000 Cash expenses per mobile GPRS, Rs '000 Salaries paid per mobile GPRS, Rs '000

206 1,200 105 162.6

Total cost per kiosk, Rs '000 Accounts serviced Opex cost per account Maximum number of accounts created, m

143 850 128 202.8

80 39 88

35 21 88

Rationale Assuming 29% are under 15 and 33% already have bank accounts Includes UPS, Biometric unit, laptop etc. Further details in Figure 53. Includes rent, maintenance etc. Further details in Figure 53. Includes Rs60,000 p.a. paid to the operator, Rs740,000 paid to BC and his support staff to manage 12 CSPs Based on discussions with players in the field Caters to villages with population >10,000 Includes Biometric unit, GPRS mobile etc. Further details in Figure 54. Includes fuel, maintenance etc. Further details in Figure 54. Includes Rs60,000 p.a. paid to the operator, Rs740,000 paid to BC and his support staff to manage 12 CSPs Based on discussions with players in the field Caters to villages with population 100 - 2,000 Includes mobile cost, printer etc. Further details in Figure 55. Includes insurance, connectivity charges etc. Further details in Figure 55. Includes Rs60,000 p.a. paid to the operator, Rs740,000 paid to BC and his support staff to manage 12 CSPs Based on discussions with players in the field Caters to villages with populations of 2,000 - 10,000

Source: Barclays Research estimates

FIGURE 32 Financial Inclusion would entail creating 172m accounts for the urban population, which would take Rs9bn in one-time capex and Rs31bn in recurring expenses Urban India Key metrics Total urban population, m Unbanked population, m GPRS mobile costing Capex per mobile GPRS, Rs '000 Cash expenses per mobile GPRS, Rs '000 Salaries paid per mobile GPRS, Rs '000 Total cost per kiosk, Rs '000 Accounts serviced Opex cost per account Maximum number of accounts created, m Mobile SMS costing Capex per mobile SMS, Rs '000 Cash expenses per mobile GPRS, Rs '000

Numbers 410 172 80 39 154 273 1,200 161 85.8 35 21

Salaries paid per mobile GPRS, Rs '000

154

Total cost per kiosk, Rs '000 Accounts serviced Opex cost per account Maximum number of accounts created, m

210 850 206 85.8

Rationale Assuming 29% are under 15 and 33% already have bank accounts Includes Biometric unit, GPRS mobile etc. Further details in Figure 56. Includes fuel, maintenance etc. Further details in Figure 56. Includes Rs60,000 p.a. paid to the operator, Rs740,000 paid to BC and his support staff to manage 12 CSPs Based on discussion with players in the field Services roughly half the urban population Includes mobile cost, printer etc. Further details in Figure 57. Includes insurance, connectivity charges etc. Further details in Figure 57. Includes Rs60,000 p.a. paid to the operator, Rs740,000 paid to BC and his support staff to manage 12 CSPs Based on discussions with players in the field Caters to villages with populations of 2,000 - 10,000

Source: Barclays Research estimates

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Barclays | India Banks

Cost of achieving inclusion potentially recoverable In our view, financial inclusion will also create material revenue opportunities as direct benefit transfer (of government schemes) is implemented and domestic remittances segment are routed through the banking channel. We estimate that annual revenues from this segment could be Rs73bn ($1bn). There is strong evidence to suggest that customers, even poorer ones, are willing to pay for effective remittance services. FIGURE 33 Costs incurred for financial inclusion are partially recoverable Amount Government benefits transfer revenues

Rs 44bn (US$0.7bn)

Domestic remittance revenues

Rs 20bn (US$0.3bn)

Spread on balance

Rs 9bn (US$0.2bn)

Total potential savings

Rs 73bn (US$1.2bn)

Rationale 2% of fees can be charged for the total subsidy bill (which is c.2% of the Indian GDP) 2% fee can be charged on the amount remitted. And the Indian remittance market is estimated to be c. Rs. 1 trillion (as per study done by Analysys Mason in 2011. Assumed that the accounts made receive an average subsidy of c.Rs 600 per month and keep a balance on Rs 100 on their account.

Source: Barclays Research estimates

Revenues earned through Government benefits transfer The subsidy disbursement as per the prevailing system leads to sizeable leakages which can be prevented, thus saving the government roughly 0.2–0.3% of GDP (as will be discussed later in detail). Routing direct benefits from the government through these NFAs would enable a better means of subsidy penetration.

Domestic remittance revenues The remittance market in India is estimated to be worth around Rs1tn currently, as per a study done by Analysys Mason in 2011 with 80% directed towards rural India. This is broadly in line with the ~10% of the GDP which was suggested as an estimate in a study by Dr Deshingkar et al. The lack of convenient access to financial services to an estimated 100 million domestic migrant workers – the majority of whom are from low-income households – is a critical component of financial inclusion. Banks and mobile companies have an opportunity to serve this segment (this is currently being serviced by informal channels). The informal sector accounts for ~70% of domestic remittances in India (as against 25% in China), based on estimates by an IIM Bangalore paper in 2011. The annual fee potential for financial institutions if we assume a 1.5%-2% fee (lower than the 3%-6% charged by the informal channels and India Postal Department charge of ~5% for a money order) ranges between Rs18bn and Rs24bn. According to a paper by NABARD GIZ in June 2011, migrants value the security and speed of money transfers highest. Banks meet all these criteria, but migrants still rely on informal transfer methods. This may be due to inconvenience related to banking services (e.g., travelling and waiting time), KYC norms, and a low degree of financial literacy and capability. UIDAI Aadhaar again addresses some of these concerns given that it would ease the KYC aspect and an Aadhaar-enabled payment gateway along with the BC model would ease the travelling and distance constraints. In fact, a Memorandum of Understanding (MoU) was signed between the Unique Identification Authority of India (UIDAI) and the National Coalition of Organisations for 11 August 2014

23

Barclays | India Banks Security of Migrant Workers in July 2010 to ensure a process for identity certification of migrant workers. The coalition represents 20 Civil Society Organizations (CSOs) serving migrant workers and communities. Additionally, the National Payments Corporation of India (NPCI), the umbrella organization of all retail payments system in India, joined hands with the Unique Identification Authority of India (UIDAI) to launch “Aadhaar based Remittance Service (ABRS)” at the end of 2013. This service will leverage NPCIs’ real time payment platform and facilitate money transfers from one Aadhaar number to another, or from Aadhaar number to accounts and vice versa. It would also be possible to transfer money from an Aadhaar number to the mobile number of the beneficiary customer. This would help lay the foundation for money transfers on a 24x7 basis in a simplified format. FIGURE 34 There exist different modes of remittances, with varied sets of benefits

Source: NABARD 2011

The incremental benefits of an Aadhaar-based remittance system, in our view, would be:

• User convenience: No need to remember/make multiple inputs for initiating financial transactions, just input the one number i.e. AADHAAR.

• Brings transparency to financial transactions • Expedites the process of electronification of retail payments • Expands the reach of financial inclusion More recently, Bank of India launched a domestic remittance service called ‘Instant money transfer (IMT)’ that allows card-less cash withdrawal from select ATMs. The IMT allows a customer to send money to a receiver by using just the receiver’s mobile number through the bank’s ATM or using a retail Internet banking facility. The receiver may withdraw money from designated BoI ATMs without using a debit card. The receiver would receive partial details for cash withdrawal on his/her mobile phone, and the rest of the details from the customer (the receiver would need details from both sources in order to complete the transaction). With this facility, a beneficiary can withdraw up to Rs25,000 through an IMT transaction on a monthly basis while the per transaction limit is set at Rs10,000. The sender would be charged an IMT fee of Rs25 for every IMT transaction he or she issues to a receiver or beneficiary.

Spread on balances Maintaining an account (even a “no-frills” one) is a strong incentive to inculcate a culture of saving. Thus, even if an individual were to maintain a nominal balance of Rs100 on his account, the bank stands to earn a 4% spread on that amount. It may not amount to much – but it contributes to partially recovering the costs incurred. 11 August 2014

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Barclays | India Banks

Evidence suggest customers are willing to pay for service Our analysis shows that the recurring costs are potentially recoverable. Assuming that the bank can generate income from float, deposit/withdrawal charges, remittance fees and account maintenance charges, an average account (assuming an average balance of Rs1,000) can potentially generate annual revenue of Rs80-90/account – we estimate this is sufficient to covers the recurring costs involved in achieving financial inclusion. Our discussion with the largest Business Correspondent of SBI, Zero Mass Foundation (ZMF) highlighted that the BC viability increased after September 2009 when RBI allowed BC’s to charge customers (and banks to share some of the revenues) a reasonable amount subject to their respective board approvals. While private banks’ BCs have started charging customers even in rural India, the BCs of PSU banks typically charge the urban customer only (even though all PSU banks have the requisite board approval). We highlight the typical charges that a customer service point (CSP) levies on the customer at the last mile:

• Opening of No Frills Accounts (NFA) of banks: The account opening charges for NFAs is close to Rs25 for rural areas (only in the case of BCs of private sector banks) and Rs100 for urban areas. Of the amount collected from the client, 25% is retained by the bank. CSPs get 40% of the remaining amount while the rest goes to the BCs.

• Maintenance of NFA: The maintenance charge for an NFA is in the range of Rs4 per annum. Of the amount collected from the client, 25% is retained by the bank. The CSP gets 40% of the remaining amount while the rest goes to the BC.

• Deposit services for NFA: The cash deposit charge is in the range of 0.25% on average, with the minimum being Rs1 and upper limit fixed at Rs6. Of the amount collected from the client, 25% is retained by the bank. The CSP gets 40% of the remaining amount, with the rest going to the BC.

• Withdrawal services for NFA: The cash withdrawal charge is in the range of 0.5% on average, with the minimum being Rs2 and upper limit fixed at Rs12. Of the amount collected from the client, 25% is retained by the bank. The CSP gets 40% of the remaining amount, while the rest goes to the BC. In the financial models it is assumed that the CSP gets Rs1per withdrawal transaction.

• Remittance services for NFA: The remittance charge is close to 2% on average, with the minimum being Rs25 and upper limit fixed at Rs100. Of the amount collected from the client, 25% is retained by the bank. The CSP gets 40% of the remaining amount; the rest goes to the BC.

• The CSPs also facilitate provision of credit to an NFA holder on which they get 1% on the sourcing of the loan and 1% on recovery of the instalments.

• Additionally, the CSPs can get commission on selling insurance, bill payment and act as the last mile for pension schemes and direct benefit transfer schemes like MGNREGA.

Risks associated with achieving inclusion relatively modest Furthermore, the key risks associated with achieving financial inclusion are also modest, in our view. We believe that a very stringent KYC approach within the context of preventing fraud, money laundering or terrorism ends up excluding a vast population at the bottom of the pyramid from the financial system. A balanced approach of a more lenient KYC system along with dynamic risk management can ensure that the objective of financial inclusion is met, without exposing the banks to unwarranted risks. UIDAI Aadhaar with its biometric database linked to the banking system can ensure more robust and dynamic risk management which relies on pattern recognition of transactions 11 August 2014

25

Barclays | India Banks (similar to the ones used by credit card companies). In fact, the Nachiket Mor Report on “Comprehensive Financial Services for Small Businesses and Low Income Households” advocates that while the RBI should require a strong Proof of Identity (POI) for each and every customer and a documentary proof of one national address but waive the requirement of documentary proof for the current address, for the purpose of opening a full-service bank account. It should enjoin banks to carry out careful tracking of usage and transactions patterns to ascertain the risk levels of the customer and take necessary action based upon risk-based surveillance processes developed internally by each bank. FIGURE 35 Risk management approach should move to relatively easier KYC, but more dynamic risk management Stringent KYC

Dynamic Risk Management

Results in Exclusion of a large section More likely to achieve the goal of financial but filters out the illegal activities like inclusion but also the risk of including money laundering etc fraudsters in the financial system

Active risk management additionally identifies suspicious transactions

Passive Risk Management

Relatively easier KYC

Tracking unusual transaction patterns can filter out the illegal customers

Results in Exclusion of a large section but filters out the illegal activities like More likely to achieve the goal of financial money laundering etc at the account inclusion but also the risk of including opening stage itself fraudsters in the financial system

Limited detection of fraudsters once they are in the system

Limited detection of fraudsters once they are in the system

Source: Barclays Research

Emergence of payment banks could give further fillip to financial inclusion initiatives A key constraint in financial inclusion is a lack of a payments system which covers the geographical breadth of India, in a reliable and cost efficient manner. While India’s high mobile penetration can be leveraged to address this need, mobile operators currently are forced to tie up with banks to provide a cash-out facility (from either an ATM, branch or a retailer which is part of the bank’s BC network). In this context, the recently released draft RBI guidelines on payment banks (July 2014) could give an additional impetus to the objective of financial access. Payment banks would allow the customer the option of deposits and payments but not offer any credit. A Payment bank may or may not pay interest on the account/wallet that it provides. It can actually be an independent payment bank which holds a combination of CRR and SLR with the Central Bank with the need to partner with a sponsor bank (nested banks) where it maintains an escrow account. RBI’s recent payment bank related guidelines mainly specify the eligibility criteria for contenders, allowing several kinds of entities to apply for a license (these include nonbanking finance companies, corporate BCs, mobile telephone companies, supermarket chains, real sector cooperatives and public sector entities). Furthermore, the regulator has allowed a range of banking activities through payment banks – including acceptance of demand deposits, payment and remittance services, internet banking and functioning as a BC of other banks. We think this bodes well for the future setup of payment banks, and subsequent fillip to the financial inclusion initiative.

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Barclays | India Banks We think the RBI is more likely to give these “specialized bank licenses” to corporates, as it eliminates the risk of directing credit to related corporate entities. We highlight two transformational ideas which we believe can change the payment landscape in the country.

• A payment bank licence to India Post whose excellent distribution network in rural India along with the Aadhaar-based biometric authentication could be leveraged to offer a more efficient, low cost and reliable payment system.

• The set-up of white label business correspondents (BCs) (akin to white label ATMs) which are flexible around cash-in and cash-out through multiple payment entities.

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Barclays | India Banks

THREE KEY BENEFITS OF INCLUSION: SUBSIDY LEAKAGE REDUCTIONS, RISE IN CREDIT PENETRATION AND REDUCED TAX EVASION In our view, the benefits of increased financial inclusion are significant. Firstly, the reduction in government spending related to leakages could result in savings amounting to 0.2-0.3% of GDP (annually), we estimate. Secondly, the long-term social benefits of inclusion – driven by a rise in credit penetration helping to reduce poverty levels – could translate to an additional 0.2% of GDP. Thirdly, UIDAI can be effectively used to minimize tax evasion through tracking of high value transactions – potentially another 0.4% of GDP.

Aadhaar likely to be implemented in three phases We envisage a phased implementation of Aadhaar and in each phase it will likely be integrated with additional service delivery platforms starting with the various subsidy/benefit transfers by the government. Over time, we expect that Aadhaar would be made mandatory for various income segments to achieve the multiple objectives related to financial inclusion, reduction in leakages of subsidies/benefits and better targeting of subsidies and reducing tax evasion.

• In Phase 1, UIDIAI Aadhaar can help the cause of financial inclusion by virtue of being a valid KYC document in most banks, providing an Aadhaar-enabled payment gateway for direct benefit transfers and remittances and bringing banking to the doorsteps through technology enabled Business Correspondents. It would not be mandatory but there would be a “pull factor from the unbanked population” to register for the card.

• In Phase 2 we also expect that UIDAI Aadhaar would be made mandatory for anybody availing themselves of subsidies/benefits from the government. This would mean people across income segments that derive any benefits from the government will have to get an Aadhaar number. This will help in reducing leakage in the various subsidies /benefits that these segments receive from the government in the form of food security through PDS, kerosene/LPG, fertilizer, MNREGS, education, healthcare, housing, etc. UID Aadhaar will only address the leakage accruing from ghost beneficiaries (by having a unique identity), under-payment (by direct payment through Aadhaar-enabled payment gateway to the beneficiary’s account) and misreporting (attendance record captured by Aadhaar authentication) in schemes like MNREGS, etc.

• In Phase 3, the focus would be more on the “middle class and above” segment. Apart from the card being made mandatory, we advocate linking it to bank accounts and the PAN cards for each resident. This will help in eliminating duplicate and bogus PAN cards, and also help in better targeting of subsidies/benefits by using appropriate income cut-offs. Most importantly, linkage of bank accounts and PAN to the Aadhaar card can help curb the parallel economy by reducing tax evasion in India which is estimated to be ~20% of Indian GDP.

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Barclays | India Banks FIGURE 36 We envisage a three-phase architecture for UIDAI Aadhaar

Note: Empowerment line cutoff is Rs6,700/month for a family of 5 (per capita of Rs1,336), as estimated by McKinsey, while the poverty line cutoff is Rs4,370 for a family of 5 (per capita Rs874/month). Source: UIDAI, Barclays Research

We also believe that once Aadhaar penetration reaches close to 100%:

• The health records of individuals can be linked to Aadhaar and that the database can be leveraged to ensure better health insurance coverage.

• It can also be used to improve or monitor attendance of school teachers and students or monitor attendance of doctors and staff in government hospitals to improve the quality of education and healthcare in the country.

• It can also be leveraged to achieve the government’s goals related to energy efficiency. This can be achieved by linking households’ electricity, LPG connections to Aadhaar and incentivise households towards optimum energy usage.

• A database with the education and vocational record of the population can be linked to Aadhaar and can be used to design re-skilling programmes or better design of employment schemes.

Reduction in leakage of government spending results in annual savings worth 0.2-0.3% of GDP By eliminating duplication and ghost recipients, Aadhaar can dramatically reduce leakages in the subsidy and benefits expenditure of the government. This can result in annual savings of US$5bn (0.2-0.3% of GDP), on our estimates. It is important to note that these gains are significantly higher than the most aggressive estimates of the losses that could occur on account of illegal immigrants receiving these benefits (we estimate an overall increase of less than 3% in the subsidy bill due to potential leakage to “illegal immigrants”). In fact, in our view, Aadhaar could act as a powerful tool to track and eliminate subsidy leakage to “illegal immigrants” in the future. In the long run, it is likely to prove to be a useful means of intercepting illegal subsidy transfers and eliminating the same.

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Barclays | India Banks FIGURE 37 Potential benefits from leakage control in various schemes are significant Aadhaar benefits for the financially excluded/bottom of the pyramid

Potential savings Comments (USD mn)

Savings from preventing leakage to ghost beneficiaries and ineligible recipients in PDS system (including kerosene)

1,866

Savings from preventing leakage to ghost beneficiaries, commercial entities in LPG

660

Savings from using biometric authentication to control misrepresentation of man hours, over-invoicing and extraction by intermediaries of wage payment to the actual beneficiary in MNREGS

517

Savings in education (Sarva Shiksha Abhiyan)

498

Savings in Indira Awaas Yojana

228

Savings in other schemes pertaining to scholarships, pensions, accredited social health activists (ASHA), Janani Suraksha Yojana (JSY) and Integrated Child Development (ICDS) Savings from preventing leakage to ghost beneficiaries, ineligible recipients of power subsidies (mainly for agriculture) Total

190

556

Assumes 12.5% cost savings in the total subsidy bill for foodgrain subsidy (excluding back-end infrastructure) and 8.3% of total kerosene subsidy bill Assumes that Aadhaar will result in benefits of ~10% through reduced diversion from household to commercial inline Assumes 12% benefit due to Aadhaar (7% due to musterroll automation and 5% due to direct wage payment to the Aadhaar-linked bank accounts of the beneficiaries). We apply this benefit only to the ‘wage component’ of MNREGS expenditure 10% savings in the mid-day meal scheme, books and uniforms and 10% from controlling teacher absenteeism 10% savings accruing from controlling fake or ghost beneficiaries Assumes that Aadhaar’s direct benefit transfer can reduce leakage owing to fake and ghost beneficiaries by ~7% 10% savings accruing from controlling fake or ghost beneficiaries

4,515

Source: Barclays Research estimates

FIGURE 38 Potential leakage of subsidies to “illegal immigrants” if they get an Aadhaar card is small, by our reckoning

Scheme Food Subsidy

2013-2014 (USD million)

Estimated number of people availing/ impacted by the scheme (million)

Estimated increase owing to 20 million illegal immigrants, i.e. 4 million households (USD million)

16,250

813

400

MGNREGS

4,311

360

165

LPG subsidy to around 140 m connections/households Kerosene Subsidy

6,600

140

189

5,047

140

144

Indira Awaas Yojana

2,278

10

0

Education

4,951

197

146

Other Schemes

2,708

680

80

Estimate of total benefits leakage owing to illegal immigrants availing these schemes if they get the Aadhaar card

848

Comment 75% of the rural population and 50% of the urban likely to access this; have assumed that the entire population of illegal immigrants avail themselves of this. ~360m people at 5 people per household benefit from it. We assume that illegal immigrants are split in the ratio of the rural/urban population split of India Proportionate increase assuming4m illegal immigrant households. Proportionate increase assuming 4m illegal immigrant households. Two million dwellings funded at Rs45,000 per house per annum. This implies around 10m individuals benefitted. This is out of a 680m people who can be classified as below the middle class in India. We apply a similar ratio to the illegal immigrant population. Assume that education benefits are accessed by children below 14 years who are ~29% of the population within the segment below the middle class in India. Assume that these benefits accrue to people below the middle class in India and split it proportionately amongst the illegal immigrants Hence, the total subsidy bill increase will be around 3%, and the potential rewards from leakage control are more than 4x this amount. Furthermore, a lot of illegal immigrants may already be availing themselves of this scheme.

Source: Barclays Research estimates

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Barclays | India Banks We estimate that UID Aadhaar’s direct transfer of benefits and subsidies, assuming they are fully ramped up in the next five years, could reduce leakage in the system to the tune of Rs317bn ($5bn) annually. These benefits would accrue from its ability to prevent leakage in subsidies through the Public Distribution System (PDS) where we capture the impact of the “food security bill”, LPG and Kerosene and also benefit schemes that include MNREGA, Indira Awaas Yojana and others in the healthcare and education sector. In our analysis, we have not projected any benefits from leakage control in the fertilizer and electricity-related subsidies, where the implementation of direct subsidy transfers would be relatively more challenging. FIGURE 39 Subsidy bill in India has grown significantly since 2007-2008 3000.00

2.8% 2.6%

2500.00

2.4% 2.2%

2000.00

2.0%

1500.00

1.8% 1.6%

1000.00

1.4%

500.00

1.2% 1.0%

Subsidies in INR bn

2012-13

2011-12

2010-11

2009-10

2008-09

2007-08

2006-07

2005-06

2004-05

2003-04

2002-03

2001-02

2000-01

1999-00

1998-99

1997-98

1996-97

1995-96

1994-95

1993-94

1992-93

1991-92

1990-91

1989-90

1988-89

1987-88

1986-87

1985-86

1984-85

1983-84

1982-83

1981-82

0.00

Subsidies as % of GDP

Source: RBI, Barclays Research

There are significant leakages across the value chain in the implementation of these schemes. The key sources of leakage are:

• Ghost beneficiaries: This is the practice of availing oneself of schemes like MNREGS, scholarships for the underprivileged, or cylinder subsidy for non-existent beneficiaries, which typically accrues to a middle man. A process which makes it compulsory for beneficiaries to authenticate their Aadhaar number through biometrics can eliminate this problem.

• Underpayment: In a scenario where benefits are not transferred directly into the beneficiary account, leakage could happen if the intermediary only partially pays the concerned person in cash. This could easily be addressed through the direct benefit transfer via an Aadhaar-enabled payment gateway.

• Multiple cards: In some cases the beneficiary avails himself/herself of the benefits more times than he or she is supposed to by getting multiple cards. This is typically true for PDS, where households get multiple ration cards, and could also be addressed through a biometric-based authentication process to de-duplicate such databases

• Shadow ownership: This is where people avail themselves of a benefit that they are not entitled to by virtue of misrepresenting their identity. Again, this problem would be easily solved through an Aadhaar-based biometric authentication system.

• Misreporting: This is when intermediaries indicate inflated amounts due to beneficiaries by tinkering with attendance or number of hours worked, which is especially true for MGNREGS. This can also be addressed by recording attendance and number of hours worked through a biometric-based system. 11 August 2014

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• Incorrect classification: Wrong classification of a person in a category where he is actually not entitled to particular benefits. Currently cannot be solved by Aadhaar-based biometrics but if the PAN card and return information get linked to Aadhaar then it would be possible to address this as well.

• Wastage, leakage and theft: Valid in the case of food or medicines owing to poor warehousing facilities or security. Cannot be addressed by Aadhaar-based biometric. FIGURE 40 Potential net benefit of Rs300bn ($5.0bn) from Aadhaar ramp from curbing leakage in direct transfers and subsidies 400 350 300 250 200 150 100 50 0

Total Benefits

Aadhar Costs

Source: Barclays Research estimates, NIPFP

We estimate that a significant share of the annual $5bn benefits would accrue from curbing the leakage in the PDS (the channel through which the food security bill will be implemented, it also captures the kerosene subsidy). FIGURE 41 We estimate that a significant share of the annual benefits will accrue from reducing leakage in PDS system

350 300 250 200 150 100 50 0

MNREGS

PDS

LPG Subsidy

Education

IAY

Other Schemes

Source: Barclays Research estimates

While we assume that integration of Aadhaar with various schemes would be gradual and would be fully ramped up by 2018-2019.

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Major savings to accrue from improving the efficiency of the Public Distribution System (PDS) The Public Distribution System (PDS) in India consists of around 4.77 lakh shops to distribute food grains at a subsidised price. The PDS mandated it to cover ~165 million households (75% of the rural and 50% of the urban households in India) post the National Food Security Act which was passed in 2013. We estimate that the total food subsidy bill will shoot up to around Rs1.3tn in 2014-2015 (was ~Rs975bn in 2013-2014) out of which we assume that 75% pertains to consumer subsidies while the remainder is attributable to back-end costs. There are various leakage estimates in the PDS but a study by a Planning Commission member Professor Abhijit Sen which used NSSO consumer expenditure data from the PDS which was compared to the state-wise food offtake. It indicated leakage of around 42.8% in 2008-2009 (it was 54.8% in 2004-205 as per the study). A government of India study in 2005 indicated 58% leakage out of which 16.67% was attributed to “ghost beneficiaries”. Key sources of leakage:

• Ghost/non-existent beneficiaries or having duplicates: This problem can be addressed by Aadhaar. A National Advisory Council study highlighted a case of a person in Faridabad district of Haryana who was found to possess more than 500 ration cards, something that could easily have been identified if the person could access the benefits only on the basis of Aadhaar-enabled biometric authentication.

• Wrong classification, i.e. issuance of ration cards to ineligible families: McKinsey & Company’s 2011 paper on e-payment highlighted that the Andhra Pradesh state government had issued 18 million ration cards in 2009 although it estimated six to seven million BPL (i.e. below the poverty line) families. Some of the mismatch is due to differences between the centre and state governments in defining the eligibility criteria. Linking the UIDAI Aadhaar card to the PAN card and increasing the PAN card coverage itself could partly solve this problem going forward. We have for our analysis assumed that UIDAI Aadhaar can result in costs savings of the order of 12.5% of the total subsidy bill (excluding back-end infrastructure). This is in line with the study done by National Institute of Public Finance and Policy in Nov 2012. While a report by NCAER in 2005 indicated leakage of around 38% in the kerosene subsidy, we assume that only 8.3% is the amount of leakage that can be attributed to ghost or duplicate beneficiaries and can therefore be addressed by UIDAI Aadhaar. The kerosene subsidy, which was ~Rs294bn in 2013-2014, also gets distributed through the PDS network in India.

Significant savings to accrue from reduced kerosene subsidy – case study of a direct transfer pilot in Alwar district In Rajasthan, the state government initiated a pilot project in December 2011 following directives of the central government to bring about a transition to cash-based subsidy delivery. The pilot was conducted in the Kotkasim block of Alwar district. A total of 25,843 ration cards existed in the block, including 22,114 APL cards, 2,627 BPL cards and 1,082 AAY cards. Kerosene was being sold to these consumers at INR15.25 (US$0.3) per litre. After implementation of the scheme in December 2011, the retail price was increased to INR44.25 (US$0.86) per litre. The difference between the two was credited into the bank account of the consumer. A total of 15,020 zero-balance, no-frills bank accounts were opened (as of February 2012) for consumers of PDS kerosene. Before initiation of the scheme, awareness campaigns were conducted over a period of two months. Initially, people refused to participate in the program even when they were told that 11 August 2014

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Barclays | India Banks they would receive one month’s subsidy in advance (Telegraph, 2012). However, when the district collector obtained permission from the state government to deposit three months’ worth of the subsidy in advance, a large number of people became amenable to participating. A sum of INR263 (US$5.14) was deposited into bank accounts of households with no LPG connections and INR175 (US$3.42) in the accounts of those with a SBC. Interestingly, even though kerosene is primarily used for lighting, the provision of kerosene subsidy has been linked to LPG connections. Moreover, since the transfers are being made in advance, they are not linked to the time of purchase or the amount of kerosene lifted. Results from the Kotkasim block in Alwar district indicated that the purchase of kerosene reduced drastically from 82,000 litres (KL) in November 2011 to 18 KL in December 2011 (79 per cent), 23 KL in January 2012 and 13 KL in February 2012. (Alwar, 2012) This could be due to a combination of reduction in diversion of PDS kerosene and reduction in the purchase of kerosene by households. An annual saving of INR46.6 crore (US$9.10 million) was expected, assuming conservative savings of 60 per cent of kerosene.

Aadhaar can significantly improve the efficacy of the LPG subsidy • The India government subsidises the LPG cylinder rates for household consumption which is not the case for commercial use. This leads to leakage/diversion of LPG cylinders from household to commercial usage. We estimate that the total LPG bill for the government would have been about Rs396bn. The government imposed a cap of 6 cylinders per household in September 2012 which was increased to 9 in January 2013 and 12 in January 2014. This was implemented after recommendations from the Task Force on Direct Transfer of Subsidies on Kerosene, LPG and Fertiliser (Nilekani, 2011).

• Additionally, the transfer of LPG subsidies through a direct benefit transfer system was started in 289 districts (in a phased manner) starting June 2013. As part of this exercise, 300 banks seeded 63.2 million bank accounts to enable the direct transfer of LPG subsidy. This is to authenticate individuals who are using LPG cylinders. This was implemented to minimise the leakage and diversion of cylinders meant for household consumption. While the Aadhaar-linked direct subsidy payment for LPG was suspended in January 2014 to sort out some teething issues related to beneficiaries who don’t have linked bank accounts, we view this as a short-term blip.

• The committee appointed to analyse the scheme strongly recommended implementation of the scheme. Overall, the committee was of the opinion that the scheme was a very efficient way to disburse subsidies. In particular, the committee was of the opinion that the scheme ensures that the actual customer gets the subsidy benefit, reduces the misuse (as the incentive for diversion is eliminated), and improves the availability of LPG for ‘genuine’ consumers.

• There were also a few challenges in implementation, mainly: 1) difficulties in obtaining Aadhaar in districts where its penetration was low; 2) getting Aadhaar seeding done in bank accounts and LPG database; and 3) getting customer grievances resolved on account of systemic challenges.

• The key mitigation measures recommended by the committee were: 1) establishing a ‘single window’ for grievance redressal, with back-end support by three entities – OMCs (oil marketing companies), NPCI and UIDAI; 2) ‘parking’ of subsidy while the consumer becomes eligible to receive it; 3) having a pre-launch preparatory period (of three months) during which there should be extensive enrolment, seeding of Aadhaar in the LPG/bank database; 4) holding UIDAI accountable for monitoring and generating Aadhaar for all enrolment agencies; and 5) defining and ensuring minimum service 11 August 2014

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Barclays | India Banks levels for various business processes (e.g. enrolment, delivery, etc) which are part of the transfer scheme. FIGURE 42 Flow of payment of LPG subsidy through Aadhaar

Source: UID Aadhaar

• We have assumed that Aadhaar will result in a benefit of ~10% in terms of reduced diversion from household to commercial usage, in line with the assumptions of the National Institute of Public Finance and Policy paper in November 2012.

• The former Union Minister for petroleum and natural gas Mr Veerapa Moily had indicated the importance of Aadhaar-based Direct Benefit Transfer for LPG (DBTL) and suggested that currently out of the 150 million gas connections around 50 million (or 33%) are fake connections.

• Over the long term we believe that if the Aadhaar database gets linked to the PAN card database this would ensure better targeting of the LPG subsidy as the government can implement income cut-offs to ensure that only the really needy segment gets the LPG subsidy.

Significant benefits under MGNREGS We highlight that UIDAI Aadhaar’s biometric authentication along with direct benefit transfers through Aadhaar-enabled payments can reduce leakage which is the main source of inefficiency in the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS). A study by McKinsey & Company in Nov 2010 entitled “The benefits of epayments to Indian society” indicated that misrepresentation of man-hours in the muster log is a prevalent practice, with the recording of an inaccurate number of workers or work days. Studies have shown that workers had allowed their job cards to be used for recording fictitious work, against which payments had been made. Over-invoicing for works programmes is another misuse of the NREGS. An NCAER study in 2009 “Evaluating Performance of NREGA”, highlighted leakage of almost Rs40m in the purchase of materials for 18 village panchayats. The study by McKinsey & Company indicated four sources of leakage in the MNREGS:

• Misrepresenting man-hours in the muster-log to record higher workdays either through non-existent workers (i.e. recording workers who have not reported to work) or inaccurate work days (i.e. recording higher work days that for the number of workers 11 August 2014

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Barclays | India Banks who have reported for work). An audit conducted by the Centre for Planning, Monitoring and Evaluation in 19 districts of Orissa during 2007-2008 (CPME, August 2008) found that muster rolls had 8.6% ghost beneficiaries, 23.1% ghost person days and only 61% of the claimed wage payments had actually been received by workers.

• Extraction during withdrawal of funds by beneficiary. • Leakage due to over-invoicing of works, payments made against fictitious works, or extraction from vendors/contractors.

• Transaction-related costs which include the one incurred by the state administration in preparing pay orders and writing cheques for release of payments, by the beneficiary to receive payments (travel cost and notional wage loss), by payment intermediaries for processing and releasing payments. While the McKinsey study estimates a 15% leakage in wage payments because of exaggeration of workers and attendance owing to lack of authentication, we assume a 12% benefit due to Aadhaar (7% due to muster-roll automation and 5% due to direct wage payment to the Aadhaar-linked bank accounts of the beneficiaries). We apply this benefit only to the “wage component” of the MNREGS expenditure. We do not assume that Aadhaar can control leakage of material or extraction from vendors and contractors. FIGURE 43 There exist significant inefficiencies in MNREGS

Source: McKinsey, “The benefits of e-payments to Indian Society,” Nov 2010

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Aadhaar can improve the efficiency of the government spending on education (‘Sarva Shiksha Abhiyan’) In terms of primary education the government has two major programmes:

• The Sarva Shiksha Abhiyan (SSA) where the government funds the schooling facilities, teacher’s salaries, textbooks and uniforms for children.

• The Midday Meal Programme (MDP) which focuses on the nutritional requirements of the enrolled students through provision of cooked meals. The benefits under these schemes are based on enrolment data provided by each state which is prone to inflated numbers on account of under-age enrolments, nominal enrolment of children who do not actually attend school, double enrolment of children who attend private schools, and fake enrolment of ghost beneficiaries. A paper by Kumar and Rustagi (2010) observes that the reasons for these inflated numbers are the pressure to report universal enrolment, the opportunity to get additional allocations of food and other materials that can be siphoned out, and sometimes even the need to retain a teacher’s post. This results in wasteful expenditure, leakages, and sub-optimal intended outcomes due to this misreporting of number of students. Aadhaar’s biometric authentication could help in monitoring the enrolment and attendance of students as well as teachers Teacher absenteeism is also a major problem in Sarva Shiksha Abhiyan which again can be addressed by biometric-based authentication. A government of India report in 2009 highlighted that in Madhya Pradesh two-thirds of the teachers did not attend schools, in Uttar Pradesh 20% of the teacher were absent, in Bihar 25% of the teachers were absent, while in 14 other states teacher attendance rates were between 75% and 85%.

• We have assumed that Aadhaar will reduce leakage by 10% in the Midday Meal scheme (in line with the NIFPP paper we assume that 85% of the costs are related to number of students while the rest are fixed administrative costs), books, and uniforms owing to accurate reporting of students (versus ghost beneficiaries earlier).

• In case of teacher absenteeism we also assume a benefit of 10% which can either be cost based, with the government weeding out or adjusting salary as per attendance for teachers, or outcome based, that is improved education quality received by the students as teachers perform their jobs better.

• We apply these benefits to the Rs214bn spent on Sarva Shiksha Abhiyan (split between Rs188.3bn on teachers’ salaries, Rs13.3bn on books and Rs13bn on uniforms) and 85% of the total Midday Meal expenditure of Rs82.3bn.

Aadhaar can reduce leakage in the Indira Awaas Yojana (IAY) programme The Indira Awaas Yojana (IAY) programme aims to address the rural housing shortage of ~40 million by the end of the 12th year plan (2012-2017). This scheme provides monetary assistance for housing to specific categories of people below the poverty line in rural India to construct or upgrade their houses. The categories include SC/ST (at least 60% of the allocation), minorities, freed bonded labourers, disabled persons, widows/divorced women, family members of military and paramilitary killed in action. The construction assistance provided was increased from Rs45,000 to Rs70,000 per unit in plain areas, and from Rs48,500 to Rs75,000 per unit in hilly areas (FY14). This meant that the budgeted amount for FY14 increased from Rs81bn to Rs137bn. The disbursement currently is done through banks and post offices. According to a report by IFMR in 20092010, nearly 32% of the funds spent for IAY were actually illegally diverted. They specifically indicated that Rs8bn was siphoned off to personal deposits and current accounts between 11 August 2014

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Barclays | India Banks 1997 and 2002. Individual officers in multiple offices were accused or found guilty of stealing funds. There was extensive misreporting of houses constructed suggesting extensive leakage of IAY funds. Funds were reported as spent on over 20,000 houses which were found to be non-existent or half-completed between 1997 and 2002, with more than 14,000 of these in Orissa and West Bengal. Funding was provided to ineligible beneficiaries, sometimes on the recommendation of powerful political leaders (CAG 2003). News reports suggest even more extensive corruption in certain places, such as Bihar where allegedly less than 8% of the 64,000 reported houses in Araria district were actually built, even though the entire allotment was disbursed. While Aadhaar cannot address the problem of wrong classification of beneficiaries it can certainly eliminate problems like fake or ghost beneficiaries by Aadhaar-based direct transfers to beneficiary accounts or cases of the same beneficiary availing himself or herself of the benefit twice. FIGURE 44 Only 40-60% of government spending on various schemes reaches the eventual target 70% 60% 50% 40% 30% 20% 10% 0% Food

MNREGA

Education

Fuel

Health, Family welfare, drinking water and sanitation

Source: National Sample Survey Office; government fiscal statistics, McKinsey Global institute 2014

The analysis assumes that only 10% of the leakage in Indira Awaas Yojana can be curbed be direct benefit transfers through Aadhaar. The analysis also includes five other schemes pertaining to Scholarships, Pensions, Accredited Social Health Activists (ASHA), Janani Suraksha Yojana (JSY) and Integrated Child Development Centres (ICDS) on which we expect a total expenditure of ~Rs152bn per annum. We assume that Aadhaar’s direct benefit transfer can reduce leakage owing to fake and ghost beneficiaries by around 7%. Our assumptions around leakage that we believe can be curtailed by the UID are a fraction of the actual leakage estimated in some of these schemes.

In the long term, a better savings behaviour is inculcated in the populace that can add an additional 0.2% to GDP Financial inclusion in the true sense will be achieved if access to credit to the rural/urban poor increases. This would potentially lead to conversion of non-productive savings (e.g. gold) into investments. In order to estimate the additional GDP growth it would generate, we assume that a substantial portion of non-productive spending – for example, spending on gold – gets converted into productive investment. A simple analysis indicates that this would likely add an additional 0.2% to GDP. We derive this using the following logic: spending on gold in India currently accounts for about 2% of GDP. Assuming that about half of this (i.e. 1% of GDP) gets converted into investments, the impact on GDP growth would be about 0.2% (using the formula: GDP growth = Investment rate/ICOR, i.e. incremental capital output ratio). For the purpose of this analysis, we have used an ICOR of 4.5 – the average ICOR for India in the FY1995-2011 period. 11 August 2014

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FIGURE 45 Annual spend on gold in India accounts for 2-2.5% of GDP

%

FIGURE 46 Re-directing a portion of gold spending towards productive investments could result in additional 0.2% of GDP Item

Gold spending in India (% of GDP)

3.0

Gold spending in India (% of GDP)

2.5 2.0 1.5 1.0

2011

Source: World Gold Council, Barclays Research

2012

2.0-2.5

1.0

Incremental Capital Output Ratio (ICOR)

4.5

Hence, incremental GDP growth (ppt) 2010

Comments

Rise in investment rate, if 50% of gold spending directed towards 'productive' investments (ppt)

0.5 0.0 2009

Value

2013

Average value for FY1995-FY2011

Using the formula: GDP growth = 0.22 Investment rate / ICOR

Source: Barclays Research estimates

The number of individuals saving in India at 22% of the total number of adults is lower than the 35% reported in Brazil, China, Russia, and South Africa and also lower than some of its South Asian peers like Sri Lanka (28% of adults save) and Bangladesh where 16.6% of the adults save in one form or the other. More importantly, slightly less than half of the savers actually saved in formal financial institutions versus 80% of the savers in the case of BRICS economies. When the rural or urban poor get an account opened, it typically leads to a more prudent spending pattern and the possibility of them exploring other products related to savings offered by the bank. According to a World Bank study there is empirical evidence that indicates “the set of individuals having a formal account” are four times as likely to save as likely to report having saved using any method as those without an account (with 46% of account holders reporting having saved, and 10 percent of non-account-holders doing so). The case study based on our interaction with the urban poor is illustrative of the impact of opening a bank account on savings. Sarita (name changed) is a maid in with an urban middle class family in Mumbai. She hails from a small village around 10 km away from Simdega in Jharkhand. While she has worked for close to 10 years in Kolkota and Gujarat, she did not save anything partly because she never opened a bank account either in the city or in Simdega. Opening the account in Simdega was not exactly convenient given the distance and the effort involved, while in the city proving her identity or giving a residence proof was tough. The only identity card she has is a “voter ID” which has an address that indicates a village which is different from her actual village. She in the absence of a bank account inevitably spent most of the money or lent it to her friends who in most cases did not return it back. The family that she was working with in Mumbai asked her to start saving money in a bank as then she can keep her cash safely, earn more interest. Her “voter ID” was initially not accepted as the proof of identity in the bank but when the family she was working with gave a letter confirming that she stays in their apartment, her account was opened. There was a marked change in her spending pattern once she realized the benefits of savings. Since then has she has deposited a minimum of INR3,000/month and not made a single withdrawal. She will clearly with this savings profile become progressively more profitable for the bank and also avail herself of credit at some stage.

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Barclays | India Banks If she had a UID Aadhaar card she could have opened the bank account earlier without requiring help from her employer as that would have sufficed as a “single proof of identity and address”. A similar case study of the rural poor: Savitha lived about 40 kms away from Chennai in the rural village S. V. Chataram. She had a successful goat rearing business. Previously she had tried other livelihood options but those turned out unlucky for her. The crisis in her life began two years ago when her husband was diagnosed with cancer. She ran from pillar to post to gather a corpus of Rs50,000 ($1,000) for his treatment. Later on she came to know about the Chief Minister’s Health Insurance Scheme that allows families like her to get funds up to about $2,000 for lifestyle diseases. She availed the same at a premier hospital in Chennai and, to her dismay, the insurance amount dried up quickly. Subsequently, unexpected events forced her to mortgage her house in order to obtain a fresh loan of Rs1.6 lakhs ($3,200) at 3% interest per month from a local pawn broker. She and her son could manage to pay only the interest while the principal amount remained unpaid. At the time of our interview, Savitha’s husband’s treatment was yet to be complete and hence it was getting increasingly difficult for them to survive. A single family member’s sickness pushed the entire family into a quagmire of impoverishment. This, and other similar stories, raises questions about the type of products that can protect households like that of Savitha’s from falling into a perpetual debt trap. The long-term impact of financial inclusion can also be estimated using a different approach – estimating the positive impact of higher penetration on poverty reduction, and hence estimating the additional income from the same. A study “Do rural Banks Matter? Experiments from the Indian Social Banking Experiment” by Robin Burgess and Rohini Pande indicates that significant rural branch expansion between 1977-1990 in India increased the per capita output in rural India, especially small-scale manufacturing and services and resulted in a poverty reduction. Furthermore, a study by World Bank (Patrick Honohan, 2004) highlighted that a 10 percentage point increase in the private credit-to-GDP ratio reduces the percentage of population in poverty by 2.5-3 percentage points. Hence, if we assume an increase in private credit/GDP ratio by 10 percentage points over the next ten years (i.e. a percentage point every year) it would mean that 42 million Indians would be moved out of poverty in a 10-year period. As per our estimates, this would result in incremental annual income of 0.2% of the GDP (this estimate is similar in magnitude to our earlier estimate which was derived using the capital productivity approach). FIGURE 47 Poverty reduction by 3 percentage points – driven by a rise in credit penetration – could result in additional income of c0.2% of GDP, on our estimates

Item India's population (million)

Reduction in % of people below poverty line (ppt)

Hence, additional number of people moved out of poverty Income level cutoff for poverty (Rs / annum) Hence, additional income (Rs billion) Additional income (as % of FY24E GDP)

Number (FY24E estimate) 1,406

3%

42 16,270

Comments Assuming population growth rate of 1.4% per annum (FY14-FY24E) Assuming that 10% rise in credit penetration reduces poverty level by 3ppt Assuming 5% growth per annum

343 0.21%

Source: Barclays Research estimates

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Social benefits include higher formal sector access, cheaper remittance solutions and easier credit availability Access to a formal bank account to a person who historically has been financially excluded from the formal banking system can reduce the cost of transactions for the poor, increase his/her ability to save and earn interest and gives him/her access to inexpensive credit, reducing his/her dependence on the informal system of money lending. The overall economy benefits owing to a combination of more efficient remittance solutions and increase in credit penetration.

Opening a formal bank account will mean lower transaction costs for the hitherto unbanked population The first step in financial inclusion is increasing account penetration. Having an account which can be accessed easily either through a branch network or a BC can reduce the cost of transactions for the poor. We look at a case study on a person classified as rural poor (source: UIDAI Aadhaar). The present challenges in financial access are well-illustrated in the case of Ram, who lives in the village Atariya in Bundelkhand. To collect the MGNREGS wages deposited into his bank account, Ram must walk for an hour and a half to the village of Kakarwaha, six kilometres away. Three buses everyday ply from Kakarwaha to Badagaon, 14 kms away, where the nearest bank branch is based. Ram can collect his wages only on the Thursday of each week—the bank has divided the days among the surrounding villages so as to manage the workload. MGNREGS beneficiaries must reach the branch before closing time at 2:30 pm, else come again the following week. The bus fare for Ram costs Rs.10, and the moneylender gets a cut of his wages. The costs Ram pays in order to collect the Rs.500 in wages due to him are substantial. He incurs the loss of a day’s wage, the cost of the bus fare, and additional interest charged by the moneylender. In all, Ram incurs a cost of more than 20% of the benefit, in his efforts to collect the benefit payment. However life for Ram of Atariya village can change in a post UIDAI Aadhaar world. The universal micropayment infrastructure will allow him to easily collect his MGNREGS payment, without travel and the loss of a day’s wages. Here, Ram will have already registered for a UID number and received it along with a UID-enabled Bank Account (UEBA).The MGNREGS process will work as before, with the muster rolls travelling from the Panchayat level, to the block level, all the way to the state. However, unlike the previous scenario, where a cheque may be issued, an electronic payment is made directly to Ram’s account. If Ram has a mobile phone, he receives an SMS when his pay is credited to his account.

Case study of an innovative mobile based remittance solution – Eko Finance Some innovative financial services facilitators/providers have focussed on the “bottom of the pyramid” segment which has limited access to formal financial services. A case in point is Eko which is a growing mobile money network of over 3 million customers, 3000 agents, 10 billers, 5 MFIs and 4 Banks for banking, payment and money transfer services. Eko allows low-wage immigrants workers in the Indian urban areas to remit money to their homes using their mobile phone and is increasingly offering other value-added services like “savings solutions” or “insurance” to its customers. Eko has processed over 30 million transactions with a total value of over US$1.2bn since its inception in 2007, and leverages technology to enable its customers to do a secure financial transaction on any mobile phone be it a smart phone or a feature phone in the last 6 years. 11 August 2014

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Barclays | India Banks Eko’s technology allows any mobile phone, including ultra low-cost phones, to do secure financial transactions without installing any app on the phone or SIM. They have achieved this by building what they suggest is the world’s most usable and universal ‘strong’ twofactor authentication solution (i.e. which requires the presentation of two ‘independent’ authentication factors for full verification) and a user interface that works across all mobile phones. This universal user experience has helped them to build a P2P (peer-to-peer) network for payments and transfers. Operationally, Eko works as a “Business Correspondent” as defined by the Reserve Bank of India. As a National Business Correspondent (BC), they provide the technology platform to link financial institutions with low-income customers via mobile phones as well as agents known as Customer Service Points (CSPs). The CSPs are existing small retail shops enabled by Eko to extend financial services to walk-in customers, including opening of bank accounts, deposits, withdrawals and money transfers. They also partner with institutions to offer payment, cash collection and disbursal services. Geographically, Eko is present in Delhi-NCR, Mumbai, Hyderabad, Bihar, Uttar Pradesh, Haryana and Punjab. Eko has partnered with State Bank of India, the largest bank in India; ICICI Bank, the largest private sector bank in India; as well as YES Bank and IndusInd Bank.

Aadhaar can help minimize tax evasion through tracking of high-value transactions Aadhaar can also be used to eliminate duplication in tax identities (PAN numbers) and track high value transactions. This could help address tax evasion which we estimate at US$7bn (0.4% of GDP) annually. FIGURE 48 Potential benefits from leakage control in various schemes and reduction in tax evasion are significant Aadhaar benefits from targeting the financially included segment

Potential savings (USD mn)

Better tax enforcement

7,365

Reducing subsidies with better income segment targeting Total

100

Comments Assumed that size of the shadow economy in India is 20%, and is likely to reduce to 18% (world average is 16%) due to Aadhaar becoming mandatory for high-value transactions Estimated based on TERI paper

7,465

Source: Barclays Research estimates

FIGURE 49 Informal economy in India is significantly large relative to other regions 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 25 OECD countries

162 countries worldwide 1999

2003

India

116 developing countries

2007

Source: World Bank, March 2012: “The Shadow Economy and Work in the Shadow: What do We (Not) Know?” by Friedrich Schneider

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LESSONS FROM OTHER COUNTRIES Countries around the world have focussed on attaining higher levels of financial inclusion considering that it clearly can help achieve social and economic equality and improve the plight of the population at the bottom of the pyramid. Some countries like Brazil (with a BC-led model) and Kenya (with a telecom-led model) have made rapid strides in the objective of financial inclusion. We think India can learn from the experiences of these countries as it works towards the objective of a significantly higher rate of financial inclusion.

Brazil: A successful bank model effectively leveraging the Business Correspondent The financial inclusion programme in Brazil gained momentum in 2000-2010 (after its start in the mid-1990s) after agents of the banks were permitted by the Central Bank of Brazil to offer services like deposits, withdrawals and transfers apart from bill payments consultation, mobile phone top-ups, sourcing of loans and credit cards, collection of repayments, international transfers, etc. Brazil mostly used existing retailers as an agent whose primary or sole activity consisted of “banking or related financial services” only to minimize fraud. Banks as principal were responsible for the quality and reliability of the service. Banks had to ensure that the agents complied with all the legal and regulatory norms. Brazil now has a network of more than 100,000 agents servicing the remote corners of the country. The Business Correspondent (BC) model gave a significant impetus to financial inclusion as the number of bank accounts doubled between 2000 and 2008, of which 50% of the accounts have remained active and operative. The Central Bank of Brazil provides regulatory oversight to minimize operational risk. The Brazilian Banking Correspondent Model is driven by retailers. Services are provided through point of sale devices installed with the merchants, which can permit financial transactions in real time or near real time. However, the experience of Brazil may not be able to be replicated exactly in India given the population of Brazil is almost one-sixth that of India. The BC outlets in Brazil focus primarily on transaction and payment services, which include invoice payments, collection of service and payment orders, disbursal of government benefits and pensions, pre-paid mobile topups. Other banking services such as making deposits and withdrawals from savings accounts are comparably less compared to bill payment services.

Key lessons from the Brazilian model • The Central Bank of Brazil was highly successful in creating an enabling environment for the BC model to flourish. Therefore, Central Banks have a key role in BC model propagation.

• To reduce the operational risk, the Central Bank has been experimenting with incremental changes in regulation, one at a time and moving forward.

• The Brazilian model is not strictly able to be replicated in India as revenues from the model are driven by bill payments and remittances and India’s demographic profile differs from Brazil’s.

• Given a choice, the agency network tends to converge on urban and operationally convenient areas and might concentrate on profitable products and transactions.

• Existing retail and other distribution networks can be used successfully in the urban segment for BC operations.

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Kenya: A telecom company-led model Kenya has pursued a telecom-led model for inclusion since it amended its Banking Act in 2009 to create a provision for use of agents to carry out banking activities. The guidelines issued by the Central Bank of Kenya allowed for-profit organizations, limited liability partnerships, and individuals etc to be employed as agents. The Kenyan success with mobile money is driven by technological innovation and a relatively benign/supportive regulatory environment. The launch of mobile money M-PESA by a mobile service provider in 2007, with along with participation from banks, made a significant contribution both to the financial sector and financial inclusion. This money transfer service was initially started by a micro-finance company to help collect repayments but was taken over by Safaricom, which is a Telkom Kenya-Vodafone affiliate. This opened a new channel for delivering financial services, enabling customers to perform a range of transactions such as account opening, making deposits, loan repayments, making payments to other parties, and so on, thus creating a seamless interface of microfinance institutions, commercial banks and telecom service providers. This enabled the integration of the mobile money system with the core banking system (CBS) of the banks, which enabled transfers between mobile phone virtual accounts and traditional bank accounts. M-PESA – the mobile-phone based money transfer service of Safaricom – with 8.8 million customers and 15,200 agents, is one the most successful mobile banking models in the emerging markets. A subscriber of Safaricom has to register with a new SIM which has the application loaded on it. The customer has to create a PIN for the security of his account. M-PESA allows cashin and cash-out via retailers of Safaricom and other related retailers. The money collected by Safaricom (which it converts to e-cash) is transferred to an escrow account with a bank. The money which is loaded on the mobile can be sent to any recipient including those who are not be registered M-PESA. The final recipient can keep it as a balance on his mobile or can withdraw it as cash from any associated retailer, after paying a commission. The final recipient can be a company or person selling goods or services. The Central Bank of Kenya’s support for Mobile Banking is also a result of the limited presence of the formal banking system in the country. M-PESA does not pay any interest on deposits to its account holders, and doesn’t offer any loans. It is largely a payment mechanism. The arrangement in Kenya, however, entails higher operational risk than a bank-led model. The Kenyan model is not fully able to be replicated in India as it is a telecom company-led model, while India is pursuing a bank-led model. In our view:

• The model in Kenya is fraught with many operational risks which have the potential to derail the system.

• The banking infrastructure in Kenya and India are not comparable. India, therefore, may not have the same incentives to adopt a telecom-led model.

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APPENDIX Technology behind the Aadhaar system Technology systems will have a major role across the UIDAI infrastructure. The Aadhaar database will be stored on a central server. Enrolment of residents will be computerised, and information exchange between Registrars and the CIDR will take place over a network. Authentication of residents will be online. The Authority will also put systems in place for the security and safety of information. FIGURE 50 UID Aadhaar Application Architecture

Source: UID Aadhaar

Overview of applications hosted in CIDR The application hosted by Central ID depository (CIDR) can be broadly categorised into two:

• Core applications: In the core category UIDAI will have enrolment and authentication applications services.

• Supporting applications: This category consists of applications required for administration, analytics, reporting, fraud detection interfaces to Logistics Provider and Contact Centre and the portal.

Biometric Solution The Biometric Solution Provider (BSP) will design, supply, install, configure, commission, maintain and support biometric components of the UIDAI System. In CIDR, there can be up to three BSPs operating simultaneously. Two biometric components are utilised in the UIDAI System. The biometric components are:

• Automated Biometric Identification Subsystem (ABIS): ABIS will be used in the Enrolment Server as a part of the multi-modal biometric de-duplication solution. In the early release, ABIS will also be used in the Authentication Server for verification. The ABIS will maintain its own database of proprietary fingerprint and iris image templates for de-duplication (and face templates at the discretion of the vendor), and must be able to respond to verification requests accompanied by fingerprint and/or iris images, as well as ISO/IEC 19794-2:2005 format fingerprint minutiae files. Vendors will work with

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Barclays | India Banks UIDAI to provide further specification within ISO/IEC 19794-2:2005 to promote interoperability with future verification clients.

• Multimodal Software Development Kit (SDKs): SDKs will be used in the enrolment client, manual check (for duplicates), authentication server (for later releases) and the analytics module. The SDK may contain signal detection, quality analysis, image selection, image fusion, segmentation, image pre-processing, feature extraction and comparison score generation for fingerprint, iris and face modalities. The biometric solution components used in the UIDAI system are:

• Multi-modal de-duplication in the enrolment server • Verification subsystem within the authentication server • Enrolment client • Manual checks and exception handling Considering the expected size of the de-duplication task, the UID Enrolment server will utilize multi-modal de-duplication: multiple modalities such a fingerprint and iris images will be used for de-duplication. Facial photographs can be provided if the vendor wants to use them for de-duplication. While certain demographical information is also provided, UIDAI provides no assurance of its accuracy. Demographic information shall not be used for filtering during the de-duplication process, but this capability shall be preserved for potential implementation in later phases of the UIDAI program. FIGURE 51 UID de-duplication - system architecture

Source: UID Aadhaar

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FIGURE 52 UID Aadhaar applications

Source: UID Aadhaar

Types of BC models leveraging Aadhaar or mobile technology There exist varied BC models leveraging technology platforms like Aadhaar, or mobile technology. These differ in terms of capital costs and maintenance costs which are suitable for different demographic or geographical settings. A basic kiosk model for villages with large populations (>10,000 population): Our analysis indicates that a basic kiosk model is viable for villages with population >10,000. We estimate that a kiosk can service ~1,200 accounts on an average. We think that a kiosk can manage this many as if the government direct benefits were to be routed through the CSP operated NFAs, then the account activity will improve.

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FIGURE 53 Capital expenditure and maintenance costs of a basic kiosk (assuming 1,200 accounts) are manageable Kiosk Model in rural India Capital Costs in Kiosk Model

Cost

Laptop

30,000

Biometric Unit

8,000

UPS/Printer

22,000

Furnishing

20,000

Data Card

2,000

Telephone deposit

1,000

Training

8,000

Working Capital

20,000

Total

111,000

Operational Costs in Kiosk Model

Annual Costs

Rent

6,000

Maintenance of Hardware/Admin

6,000

Connectivity charges

10,000

Cost of Insurance

4,800

Electricity

6,000

Total

32,800

Source: Sa-Dhan, Citi Foundation, Barclays Research estimates

Biometric GPRS model (with a motorbike) to access multiple low density villages: Our analysis for the biometric GPRS-based model where a bike is used to increase access suggests that it can feasibly reach villages with population between 100 to 2,000 cost effectively. We think they too can satisfactorily service only ~1,200 accounts as government benefits will improve account activity. FIGURE 54 Capital expenditure and maintenance costs of a biometric device with a bike (targeting more than 5 low density villages) are manageable Biometric mobile shop Capital Costs

Cost

Biometric GPRS mobile plus blue tooth enabled hand held printer

15,000

Security Deposit

25,000

Motor Bike

40,000

Total

80,000

Operational Costs Fuel Expenditure Maintenance of Hardware/Admin Connectivity charges Cost of insurance Total

Annual Costs 18,000 6,000 10,000 4,800 38,800

Source: Sa-Dhan, Citi Foundation, Barclays Research estimates

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Barclays | India Banks Mobile SMS shop in an existing retail outlet: This model requires investment in a basic mobile phone leveraging on the USSD (Unstructured Supplementary Service Data) technology. Additionally, the retailer needs to place a deposit with the mobile company which provides connectivity. In this model we have assumed that the shop also sells other articles such as mobile phone SIMs, in addition to acting as a customer service point (CSP) for a BC. FIGURE 55 Capital expenditure and maintenance costs of a Mobile SMS shop in an existing retail outlet are manageable Mobile SMS Model Capital Costs

Cost

Mobile Cost

5,000

Printer/Note counter

5,000

Security deposit

25,000

Total

35,000

Operational Costs Operational Costs Connectivity charges Cost of Insurance Total

Annual Costs 6,000 10,000 4,800 20,800

Source: Sa-Dhan, Citi Foundation, Barclays Research estimates

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ANALYST(S) CERTIFICATION(S): I, Anish Tawakley, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

IMPORTANT DISCLOSURES CONTINUED Barclays Research is a part of the Corporate and Investment Banking division of Barclays Bank PLC and its affiliates (collectively and each individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 14th Floor, New York, NY 10019 or refer to http://publicresearch.barclays.com or call 212-526-1072. The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by investment banking activities. Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with FINRA. These analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’s account. Analysts regularly conduct site visits to view the material operations of covered companies, but Barclays policy prohibits them from accepting payment or reimbursement by any covered company of their travel expenses for such visits. In order to access Barclays Statement regarding Research Dissemination Policies and Procedures, please refer to https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html. In order to access Barclays Research Conflict Management Policy Statement, please refer to: http://group.barclays.com/corporates-and-institutions/research/research-policy. The Corporate and Investment Banking division of Barclays produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

Risk Disclosure(s) Master limited partnerships (MLPs) are pass-through entities structured as publicly listed partnerships. For tax purposes, distributions to MLP unit holders may be treated as a return of principal. Investors should consult their own tax advisors before investing in MLP units. Guide to the Barclays Fundamental Equity Research Rating System: Our coverage analysts use a relative rating system in which they rate stocks as Overweight, Equal Weight or Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry (the "industry coverage universe"). In addition to the stock rating, we provide industry views which rate the outlook for the industry coverage universe as Positive, Neutral or Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone. Stock Rating Overweight - The stock is expected to outperform the unweighted expected total return of the industry coverage universe over a 12-month investment horizon. Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the industry coverage universe over a 12month investment horizon. Underweight - The stock is expected to underperform the unweighted expected total return of the industry coverage universe over a 12-month investment horizon. Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where the Corporate and Investment Banking Division of Barclays is acting in an advisory capacity in a merger or strategic transaction involving the company. Industry View Positive - industry coverage universe fundamentals/valuations are improving. Neutral - industry coverage universe fundamentals/valuations are steady, neither improving nor deteriorating. Negative - industry coverage universe fundamentals/valuations are deteriorating. Below is the list of companies that constitute the "industry coverage universe": Asia ex-Japan Banks Agricultural Bank of China Limited (1288.HK)

Axis Bank (AXBK.NS)

Bank Mandiri (BMRI.JK)

Bank Negara Indonesia (BBNI.JK)

Bank of Baroda (BOB.NS)

Bank of China (Hong Kong) Ltd. (2388.HK)

Bank of China Limited (3988.HK)

Bank of Communications Co., Ltd. (3328.HK)

Bank of East Asia Ltd. (0023.HK)

Bank of India (BOI.NS)

Bank Rakyat Indonesia (BBRI.JK)

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IMPORTANT DISCLOSURES CONTINUED Bank Tabungan Negara (BBTN.JK)

BS Financial Group (138930.KS)

China CITIC Bank Corporation (0998.HK)

China Construction Bank Corp. (0939.HK)

China Merchants Bank Co., Ltd. (3968.HK) China Minsheng Banking Corp., Ltd. (1988.HK)

Chongqing Rural Commercial Bank (3618.HK)

CTBC Financial Holding (2891.TW)

Dah Sing Banking Group Ltd. (2356.HK)

Dah Sing Financial Holdings Ltd. (0440.HK)

DBS Group Holdings, Ltd. (DBSM.SI)

DGB Financial Group (139130.KS)

E.Sun Financial Holding (2884.TW)

Federal Bank (FED.NS)

First Financial Holding (2892.TW)

Hana Financial Group (086790.KS)

Hang Seng Bank Ltd. (0011.HK)

HDFC Bank (HDBK.NS)

HSBC Holdings PLC (0005.HK)

ICICI Bank (ICBK.NS)

Indusind Bank (INBK.NS)

Industrial & Commercial Bank of China Ltd. (1398.HK) Industrial Bank of Korea (024110.KS)

ING Vysya Bank (VYSA.NS)

KB Financial Group (105560.KS)

Kotak Mahindra Bank Ltd. (KTKM.NS)

Mega Financial Holding (2886.TW)

OCBC Group (OCBC.SI)

Punjab National Bank (PNBK.NS)

Shinhan Financial Group (055550.KS)

SinoPac Financial Holdings (2890.TW)

Standard Chartered PLC (2888.HK)

State Bank of India (SBI.NS)

UOB Group (UOBH.SI)

Woori Finance Holdings (053000.KS)

Yes Bank (YESB.NS)

Distribution of Ratings: Barclays Equity Research has 2578 companies under coverage. 45% have been assigned an Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 55% of companies with this rating are investment banking clients of the Firm. 39% have been assigned an Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 46% of companies with this rating are investment banking clients of the Firm. 14% have been assigned an Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 42% of companies with this rating are investment banking clients of the Firm. Guide to the Barclays Research Price Target: Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock will trade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's price target over the same 12-month period. Barclays offices involved in the production of equity research: London Barclays Bank PLC (Barclays, London) New York Barclays Capital Inc. (BCI, New York) Tokyo Barclays Securities Japan Limited (BSJL, Tokyo) São Paulo Banco Barclays S.A. (BBSA, São Paulo) Hong Kong Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong) Toronto Barclays Capital Canada Inc. (BCCI, Toronto) Johannesburg Absa Bank Limited (Absa, Johannesburg) Mexico City Barclays Bank Mexico, S.A. (BBMX, Mexico City) Taiwan Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan) Seoul Barclays Capital Securities Limited (BCSL, Seoul) Mumbai Barclays Securities (India) Private Limited (BSIPL, Mumbai) Singapore Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore) 11 August 2014

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US08-000001

India Banks: Megatrends: Transformational trinity -

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