Debit cards, mobile banking and the dynamic inconsistency problem

As part of its total financial inclusion (TFI) and other programs to expand the reach of formal banking to cover the poor, central and state governments in India have been encouraging the issuance of debit cards along with bank accounts. It is also proposed to deliver many direct cash transfers like pensions and scholarships to beneficiaries through debit cards.

Taking access to credit one step forward, it has also been proposed to deliver cash through mobile phones in various mobile banking models under discussion. Accordingly, people can use their cell phones as a mobile personal ATM, from which they can easily transfer cash for various purchases.

While it is true that debit cards would enhance the ease of access to banking services, especially in urban areas, there is growing evidence from the research of behavioural economists that highlights attention on the cognitive biases thrown up by such easy access.

Behavioural economists have found that people, especially poor people, exhibit dynamically inconsistent preferences, wherein they attach a higher value to the present than any future time, "a preference for one that arrives sooner rather than later". Such hyperbolic discounting models of human behaviour show very high discount rates for the immediate against a very low one for distant time horizons.

The commonest manifestation of such time inconsistent preferences is the self-control problem. This relates to a variety of topics including procrastination, addiction, efforts at weight loss, sending children to school, deferring consumption, and saving for retirement. In this framework, extensive research done over the past decade on savings among the poor point to self-control problems that plague people's savings and consumption decisions. They have found that people succumb to the choice of spending on immediate needs and demands than saving for the future though they had originally planned to save for a future need (like child's education or building a house).

Accordingly, behavioural economists have advocated use of commitment savings products and default savings options that lock in savings and increase the cost of withdrawl so as to overcome the inconsistency in inter-temporal preferences. By the same argument, facilitating easy access to bank accounts works towards amplifying their preference for the immediate and against the future.

In the circumstances, access to banking services through a debit card (or mobile phone) enables people to withdraw their savings easily from the nearest ATM center, without having to physically visit and endure the formalities of withdrawing the money from a regular branch. In a scenario where customers have a simple no-frills account and easy access to ATM centers, the debit cards (and mobile phone banking) may end up exacerbating the self-control problem and encourage people to withdraw available money for immediate consumption than future needs. Ironically enough, the relative illiquidity of a savings bank account may be preferable to the liquidity of a debit card (or mobile phone account)!

In other words, technologies like debit cards and mobile phones come up against a trade-off problem. On the one hand, they enable easier access to formal credit mechanism. On the other, they also run the risk of feeding into people's self-control problems, which has the potential to lower their savings appetite while exacerbating their consumption urges. Therefore, while embracing such interventions that facilitate easier access to formal credit mechanisms, it is important to strike the appropriate balance.