Can bank account-based payments boost savings?

The Finance Ministry plans to focus on mobilising savings in the next phase of PMJDY, the financial inclusion scheme. This column presents results from an experiment in Chhattisgarh, which tests whether the method of payment of wages and other transfers affects household finances. It finds that people that are paid through their bank account save more than those that are paid in cash.

The financial landscape is changing drastically in India. In 2006, the Reserve Bank of India (RBI) introduced the Business Correspondents (BC) model¹ (RBI, 2006), and in 2014, the Government announced the financial inclusion scheme, Pradhan Mantri Jan Dhan Yojana (PMJDY)². According to official estimates, 115 million bank accounts were opened under PMJDY by January 2015. In parallel, over 730 million people have received a unique identification number, or Aadhaar³ (Unique Identification Authority of India (UIDAI), 2015). By linking the bank account number to Aadhaar, social welfare payments can be transferred directly to the accounts of beneficiaries at a low cost.

Politicians mainly focus on the potential public administration gains. Making direct transfers to biometrically-protected bank accounts is expected to improve the targeting of beneficiaries and reduce leakages. Muralidharan et al. (2014) provide compelling evidence of this hypothesis. They introduced biometrically-authenticated social welfare payments in randomly selected sub-districts (treated group) in Andhra Pradesh, and compared outcomes with sub-districts that did not have this system (control group). After two years, the share of this type of payments in treated sub-districts had reached around 50%. Although incompletely implemented, the impact is already remarkable. Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) workers get paid 10 days sooner, and receive 24% higher incomes than beneficiaries in control sub-districts. Overall, it is estimated that the new system reduces MNREGA leakage by more than 10 percentage points in treated areas.

Method of wage payment and savings behaviour

In a recent paper, we contribute to this discussion by focusing on the finances of the recipients, rather than on public administration gains (Somville and Vandewalle 2015). We hypothesise that being paid through a bank account instead of in cash can change savings behaviour, especially in a developing economy like India where most transactions are handled in cash. When paid through an account, the money is saved ‘by default’, while payments in cash is money ready to be spent. We know from other contexts that the, ‘default option’ is a strong predictor of human behaviour⁴. When faced with a choice, people may defer action and do nothing. The default option – what happens when we do not make an active choice – then prevails. We therefore expect the move towards account-based payments to trigger changes in households’ finances.

We tested this hypothesis in collaboration with ‘Basix Sub-K’, an NGO (non governmental organisation) that is a BC for various banks. BCs are intermediaries who provide financial and banking services on behalf of a bank. Their main responsibilities are selecting one shop owner per village to become the local banker, training the person, and providing the necessary equipment - a mobile phone, a fingerprint recognition device and a receipt machine, which are interconnected through Bluetooth. The BC also pays the local banker, helps wherever needed, and provides customer services to the clients.

In the autumn of 2013, we sampled 442 villagers in 17 villages located in three districts of Chhattisgarh. All of these villagers either had a bank account, or were assisted in opening one. Following a baseline survey, we organised a practical information session for all the participants. We showed them how to deposit and withdraw money, and demonstrated the importance of the fingerprint recognition tool to protect their account. From February till May 2014, we hired a centrally-located room in each village, where we interviewed the participants on a weekly basis for a total of 7-13 weeks. We gathered detailed information on the evolution of the various earnings and expenditures of the household members over the past seven days. The respondents received Rs. 150 at the end of each interview, which is approximately the daily wage rate for labour under MNREGA⁵. We randomly allocated the respondents to being paid through a bank account (constituting the treatment group) or in cash (constituting control group). They were free to deposit or withdraw any amount they wanted, the transaction costs were negligible, and bank services were available at their doorstep. The only cost was the couple of minutes it took to perform a transaction.

Individuals paid through bank accounts save more

This simple change in the payment method led to a tremendous difference in savings and consumption patterns.

First, we find that being paid through a bank account instead of in cash increased the account balance by around 110% (or almost Rs. 420) after three months of weekly payments. This can be seen in Figure 1 below. The interviews started in week 1 and ended in week 13. On average, the account balance of the people who were paid through their account increased much quicker than that of the respondents who were paid in cash.

Figure 1. Average bank-account balance of treated vs. control group

Second, the effects are long lasting: five months after the last weekly payment, the average account balance of the treated was still twice that of the control group.

Third, the villagers who were paid in cash did not save more in the form of other assets, such as cash at home or with savings groups, than the ones paid through their account. Hence, the intervention had a net positive impact on the total savings of respondents paid through their bank account.

Fourth, the villagers who were paid in cash spent Rs. 402 more on regular consumption (such as rice, vegetables, fuels and soap) than the people paid through their accounts - an increase that is remarkably similar to the increase in the savings of villagers paid through accounts.

Finally, the effects are uniform across different categories - the intervention had similar effects on men and women, and on old and new account holders.

Our results are consistent with the ‘default option’ effect. The typical behaviour in the control group is to procrastinate on deposits, and to spend the money instead. On the other hand, the treated group procrastinates on withdrawals, hence saving the money ‘by default’. This leads to an endurance of the default option, and therefore, a difference in the average account balance across the two groups.

We also test whether paying individuals through accounts can inculcate in them a habit to save money through that account. After a break of seven weeks, we tweaked the original design. We did interviews for four extra weeks, but paid everyone (both treated and control group) in cash. We explicitly told them that the use of the accounts is the same, but that they have to make deposits themselves if they want to save money through the account. During those weeks, the change in the account balance was the same for both groups. The account balance of the treated remained twice that of the control group, but this difference was created during the original experiment itself (when the treated were paid through their account). Furthermore, the treated and control groups no longer differed in their consumption patterns. These findings imply that there were no habit formation effects in terms of savings and consumption.

Our experiment introduces a new argument in the financial inclusion and public transfer discussion. The way people receive their wages and other payments can largely affect households’ finances. The marginal savings rate is high in our experiment - people received a total of Rs. 1,500 on average, out of which the treated group saved almost one third more than the control group. An important question for future research is how savings and consumption would be affected if the entire income of households is paid through accounts instead of in cash.

Notes:

Business Correspondents (BCs) are essentially ‘last-mile banking agents’ appointed by banks. These local bank representatives take banking to the doorstep of people in remote areas across the country. They are the link between the customer and the nearest banking outlet and undertake routine transactions such as collection of deposits, payments, cash withdrawal, recovery of loans etc.
PMDJY seeks to provide universal access to basic banking services by 2018. Besides bank accounts (at least one per household), the scheme will provide debit cards, overdraft, credit and insurance facilities.
Unique Identification Authority of India (UIDAI) captures the biometric identity – ten finger prints, iris and photograph – of Indian residents and issues a 12-digit individual identification number called Aadhaar. Aadhaar serves as a proof of identity and address anywhere in the country.
Some well-known examples include the expression of end-of-life treatment preferences (Kressel and Chapman 2007), organ donation decisions (Johnson and Goldstein 2003, Abadie and Gay 2006), and the enrolment to savings plans in the US (Madrian and Shea 2001).
When we started the weekly interviews in February 2014, the MNREGA wage rate was Rs. 146 per day. In March 2014, it increased to Rs. 157 per day.