'Slumdogs and Negative Lists'

Ramesh Ramanathan from livemint:

As the film Slumdog Millionaire graphically depicts in an early scene, the plight of the urban poor can be sickeningly sad. Unfortunately, policymakers believe that the challenges of poverty are still in rural India, and the market finds urban India’s burgeoning middle class too attractive to pay attention to the urban poor.

I want to focus on a practice in the banking industry—relatively unknown outside the sector—that I believe can cause enormous damage to the lives of the urban poor: negative lists in credit appraisals. A negative list is a list of areas of a city that a bank has identified where residents would not qualify for credit approval, just by virtue of the location.

This is a relatively new development in India. Historically, banks relied on customer relationships and on-the-ground assessments by local staff to make credit decisions. However, a more rule-based approach to the credit approval process, de-emphasizing individual judgement and focusing on credit scores is now being practised, led apparently by some foreign banks and private sector banks (and possibly some public sector banks as well). Such a process can—while delivering many risk management benefits and scale economies—create an insidious form of systemic discrimination against the poor.

The data on negative lists is very hard to come by, given that much of this is proprietary within each bank, and no formal paper trail can really be established. However, the urban microfinance organization that I am involved with has stitched together some sketchy information for Bangalore, and the results are troubling:

There are a total of 153 negative list areas, spread across 43 pin codes accounting for about 40% of the total pin codes in the city.
These are common to many banks since they use common local agents.
A qualitative analysis of the negative list areas indicates high overlap with the low-income and slum areas of the city.
Factors that apparently go into the definition of the negative list include crime statistics.

To put it bluntly, negative lists are discriminatory. Consider the implications.

Lack of access to formal credit can have damaging consequences—on a personal level, it can drive people into debt traps from informal sources who can charge interest rates up to 10% a day. On a larger level, though, the consequences are even more destructive. As formal funds get sucked out of these areas, commerce gets bogged down, the entire neighbourhood deteriorates, driving a downward spiral of economic decay where the whole community—residents, traders, labourers— become dependent on an informal ecosystem of financial support to keep them afloat. This is the breeding ground for the mafia and criminal networks.

I’m not trying to sensationalize the problem. The US had a practice similar to our negative lists, called “redlining”, where areas of a city that were poor or dominated by blacks were credit-quarantined. Consider this quote from a book titled When Work Disappears—The World of the New Urban Poor by William Julius Wilson, professor of social policy at Harvard, “Redlining paralysed the housing market, lowered property values and further encouraged landlord abandonment. Abandoned buildings would serve as havens for drug dealing and other illegal activity.”

I don’t believe there is a sinister motive behind negative lists—just a natural evolution of seemingly logical business rules to ensure a systems-based process for low-risk credit growth in banks. This is especially true given that we don’t have reliable information on individuals, and credit history data is just beginning to get systematically compiled and shared. Unfortunately, we don’t always understand the downstream consequences of our actions.

Given the seriousness of the negative list issue, it needs to be stopped. This is not going to happen with corrective action from market forces—it will require policymakers to enact legislation to set the right framework, and then enormous patience, persistence and creativity to ensure compliance.

A bit of comparative history is useful. When the redlining practice in the US became public in the 1960s, there was enormous pressure for several years to get corrective policies. The Fair Housing Act of 1968 and the Community Reinvestment Act of 1977 were seminal pieces of legislation that addressed redlining discrimination.

We need to initiate a similar process here in India. First of all, RBI needs to formally confirm the existence of the practice of negative lists. The onus is then on RBI and the ministry of finance to establish the necessary regulatory checks to protect against this.

Discriminating on the basis of location means not giving people an equal shot at improving their lives. In this sense, these people are doubly damned: first by their birth into a poor household— what Warren Buffett evocatively calls the “ovarian lottery”—and second, by our systematic biases in denying opportunities to them. If India is to be a country where we want to embrace the power of the market, we need to ensure that the rules of the game are fair: that is, everyone gets equal opportunity to fulfil their full economic potential.