Goal-Directed Savings: A Financial Product Hiding In Plain Sight

One of the most frequently used incentives to make consumers buy a product or a service is credit. It takes several forms, it can be a ‘pay later’  loan or  ‘zero down’ equal monthly installment loan.

While loans help the consumer who doesn’t have a lump sum in hand to make a purchase, an equally compelling product that provides the same benefit is goal-directed savings.

A well designed goal-directed savings product can not only be more beneficial for the consumer, but it can also draw a lot more consumers to purchase a product or service.

Loans, while available in several forms and from a multitude of providers, are not available to everyone. An essential requirement to have access to loan is a good credit score. A credit score is a number that indicates the likelihood of the borrower repaying the loan. For obvious reasons, lenders check the credit score carefully before deciding to offer a loan.

The process for granting a loan usually works like this (simplified):

• Lender checks borrower’s CIBIL score if they have one
• The borrower submits evidence of regular paycheck. These are usually bank statements that show evidence of regular deposits or pay slips
• Lender determines the eligibility of the borrower using their risk models and sanctions a certain loan amount at a certain interest rate

But what determines a good credit score? Here-in lies a problem, and an opportunity.

While the organised financial instruments in India are rapidly expanding and ever greater number of people now have access to banking and loans, obtaining a good credit score is nearly always dependent on having a regular, predictable, income.

The process becomes a lot harder when the borrower has an income stream that is not regular.

What Is Irregular Income And Why Does It Matter?

Let’s consider two individuals, One who makes a regular income of INR 1000/ week (for approximately INR 4K/month) and another who on an average makes INR 5K in a month. But this earner does not get an income every single month. She might get INR 3K some months, INR 6K- INR 8K other months and zero in some down months. The average, however, is INR 5K/month.

The first person with a regular income is in a vastly superior position to avail of loans. The regular income, even if in an unorganized sector, serves as a powerful signal for creditworthiness. The second person, despite having a larger average income, will typically need to move to unorganized sources for loans – money lenders or family/friends’ network. Such a source will be at a significantly higher cost to the borrower.

The reason from the standpoint of a bank is understandable; the ability to repay a loan is directly dependent on future reliable income streams (for non-asset backed loans). And a history of regular incomes is a lot easier for a bank to use as indicative of future income potential, which in turn reduces the loan risk.

Banks like predictable patterns. Irregular income streams do not provide any such pattern and hence are considered high risk.

Irregular incomes are fairly commonplace in the lower end of the economic pyramid. An independent shopkeeper who sells certain kinds of items that have high seasonality would have irregular income. Contract daily wage earners, such as construction workers, who get projects for a few months with periods of unemployment before the beginning of the next project begins are another. In fact, in the unorganized sector, regular incomes might very well be the exception than the rule.

An irregular income is easy to spot – the bank statements of the borrower will not show similar deposit amounts coming in at regular intervals.

So how can some with irregular incomes get access to lump sum cash to make purchases?

The answer is goal-directed or special purpose savings.

Loans and savings are more similar than one might think. A loan consists of a getting a lump sum amount upfront and then the consumer paying for it in smaller installments spaced out over time. Directed savings consist of making small installment savings spaced out over time and then get a lump sum at the end of it.  In both cases, a lump sum amount is available for use.

Loan provides lump sum amount before  installment based repayment

Savings provide lump sum amount after installment based savings

In goal-directed savings, the consumer puts away savings in bite-sized amounts at regular intervals. This might be difficult during periods of low income but helps in creating a habit of regular savings. When the desired level of savings is achieved, she is able to purchase high-ticket goods and services.

Savings Bank Vs Goal-Directed Savings

Don’t regular savings accounts in banks provide this feature already? Yes, but not really. Savings bank accounts suffer from low usage in these cases for a number of reasons:

• Complexity and costs: The process of opening and operating such accounts is complex and expensive with minimum balance requirements, different service levels, assorted fees etc.
• Generic, not use case driven: Savings accounts are also too generic, and not tailored to specific use cases of consumers. The money set aside for a mobile phone purchase, school fees and healthcare needs is all pooled into one undifferentiated sum. Saving regularly is difficult for most people.  And without clear visibility towards how much progress they have made towards their saving target, it becomes even more difficult. Goal-directed savings help here.
• Low returns: Savings accounts offer low interest rates, but goal directed savings can provide a significantly higher return on savings by passing on discounts from ecosystem service providers to the consumer

Combining a friction-less savings instrument, with an ecosystem tie up for specific use cases to motivate savings, can make for a compelling savings instrument.

Predictable and convenient access to lump sum amounts is key to financial security. Goal-directed savings is the most direct, effective and inclusive way to obtain access to such amounts – its a product whose time has come.