Submitted by S. Ananth on Thu, 09/15/2011 - 14:57
There is a large latent demand for credit in most parts of India. Building an elaborate credit delivery network/mechanism has been the focus of policy interventions since Independence. The problem of credit availability and credit delivery has been a topic of debate over the past few decades. Due credit needs to be given to the RBI for their long standing attempts to sensitise other financial sector participants, especially banks to their concerns. However measures aimed at improving the credit access by various sections have achieved only a limited success. This limited success has been due a number of reasons foremost among which is the complexity of country and the nature of its economy.
A perceptive RBI report in 2005, Report of the Internal Group to Examine Issues Relating to Rural Credit and Microfinance, pointed out the demand side as well as the supply side perspectives and the causes for the constraints in the rural supply of credit. The supply side perspectives include:
A perceptive RBI report in 2005, Report of the Internal Group to Examine Issues Relating to Rural Credit and Microfinance, pointed out the demand side as well as the supply side perspectives and the causes for the constraints in the rural supply of credit. The supply side perspectives include:
(a) the perception of ‘unbankability’ of borrowers,
(b) small average size of the loan,
(c) problems of distance in servicing customers of banks,
(d) high transaction costs particularly when dealing with innumerable small accounts,
(e) lack of collateral security,
(f) problems related to evaluation and monitoring of cash flows cycles and repayment capacities due to information asymmetry, lack of data base and absence of credit profile of borrowers,
(g) constraints in availability of qualified human resources, (h) lack of banking habits and credit culture,
(j) information-shadow areas and,
(k) inadequacy of extension services crucial to improve the production efficiency of farmers leading to better loan repayments (p.6).
The demand side causes for exclusion included
(a) high transaction costs at the client side,
(b) documentation,
(c) lack of awareness,
(d) lack of social capital,
(e) non-availability of ideal products,
(f) low volumes
(g) hassles related to documentation and procedures in the formal system,
(h) easy availability of timely and doorstep services from moneylenders/informal sources and
(i) prior experience of rejection/indifference of the formal banking system (p.7)1 .
Financial Inclusion
There are a number of definitions for financial inclusion. We lay primacy on the most commonly accepted definition is the one by Rangarajan Committtee or Report of the Committee on Financial Inclusion (2008), and the one provided by Usha Thorat. Rangarajan Committee defines financial inclusion as: “the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost” (p.1)2 while Usha Thorat rightly points out that, financial inclusion is more than micro finance or access to payment systems and there are several dimensions to this including facilitating real sector parameters3 . The UNDP suggests that “inclusion” has to go beyond financial inclusion and should encompass livelihoods, economic and social inclusion. The Centre for Financial Inclusion (Accion International) defines it as a “state in which all people who can use them have access to a full suite of quality financial services, provided at affordable prices, in a convenient manner, and with dignity for the clients. Financial services are delivered by a range of providers, most of them private, and reach everyone who can use them, including disabled, poor, rural, and other excluded populations”4 .
Financial Inclusion is not merely the expansion of micro-credit. Micro-credit is but one component, albeit the largest component in India. Unfortunately, for a number of years, micro-credit has often been the most important pivot around which financial inclusion strategies have been conceived. This has however has begun to change, albeit belatedly. Various issues and challenges (the ground realties) that need to be surmounted if the policy of financial inclusion is to have the desired effects. An attempt has been made to highlight some of the issues that hinder the development of a more inclusive financial system.
In recent years, policy makers are struggling to expand financial inclusion in the country. The President of India, Pratibha Patil, recently pointed out, that only about 45 per cent of Indian population had access to bank accounts, and there was a low ratio of one bank branch for 16,000 people and that “banking coverage of the large population living in six lakh villages in the country was particularly low” while calling for a holistic approach to meet the financial needs of target consumers5 . The need for financial inclusion should be looked at in the context of reported observations by the Deputy Chairman of the Planning Commission, Montek Singh Ahluwalia, that inclusion will be an important part of the Twelfth Five Year Plan6 .
The most recent initiative of the Government of India to expand financial inclusion is Swabhiman. Under the programme, the government has set a target of providing banking facilities in habitations with a population of more than 2000 (as per 2001 census) by March 2012. The banking correspondent model will be used by the banks. This necessitates the banks to cover an additional 73,000 unbanked villages. This does not mean that the banks will provide full fledged banking services, but would instead five major products, which are deemed essential. These products include: savings, micro-credit, remittances micro-pension and micro-insurance. Due credit needs to be given to the government attempts to cajole the banks, especially the public sector banks (herein referred to as PSBs), to expand their inclusionary policies. The PSB were reached more villages than targeted in the financial year 2010-11. It has been pointed out that the PSBs targeted 23,629 under the government’s ambitious financial inclusion plan and reached 26,630 villages7 . It needs to be seen if over the next few years, they expand the bouquet of services they provide to these villages, or if their measures are only due to government directives.
Issues in Expanding Financial Inclusion
The nuances of implementing financial inclusion are more complex with different dynamics seemingly at work. Convincing formal institutions, especially in the banking sector is more difficult. It is pertinent to note that without the participation of the banking sector, financial inclusion may be difficult to achieve. The importance and role of the banks should be seen in the context of the overwhelming capital deficiency in a country like India.
Despite years of growth in the formal banking sector, they have not been able to expand their service or product portfolios. Any field study indicates that there is a clear urge to borrow from the banks on the part of the borrowers and a fond hope that at least in future the banks will lend to the poorer sections. This is not to claim that only the poor access non-formal sources of credit. It is common for Small and Medium Enterprises survive mostly on accessing non-formal sources of credit.
Any attempt at expanding financial inclusion will have to acknowledge that there important factors that inhibit the development of a more inclusive financial system is possible only with the active participation of the banking system. However, since the reforms of 1991, the banking system is oriented to the stock markets with their emphasis on short-term profits. This often forces the banks to look at various opportunities through a short-term cost-benefit analysis. Such practices have over the past two decades been detrimental to the health of the banking sector and importantly will serve as a major obstacle to the growth of a more inclusive financial system.
Four important factors that the banks will have to deal with include:
(1) The viability gap that arises due to the fact that the cost of servicing the cost of providing these services (or ‘social’ or ‘holding costs’) involves. In an era when the banking sector is concerned as much as profitability and growth, it is unlikely that the banks will be willing to go make a substantial departure from their current practices, without an implicit or explicit subsidy from the government.
(2) Recovery, especially in the rural areas will be an issue and unless the institutional framework is more efficient, it may not be an attractive business proposition. The social dynamics of a village compound the risks for a large institution such as a bank.
(3) Financial inclusion for the banks is a miniscule part of the portfolio in the present juncture and compared to their growth rates possible in other sectors. Therefore, this segment (financial inclusion) is unlikely to be a focus area in the near future. Credit to the excluded sectors or even deposits mobilised from the poor invariably consists of only a small part of the overall portfolio of the banks. This is unlikely to change in the near future. Hence, for the banks, which have an obsession for growth, it is difficult to make a substantial shift from current policy that would accommodate financially inclusive policies beyond a point. Banks like most of the formal institutions are not willing to spend inordinate amounts of time and resources in order to create a market. Historically, the large formal financial institutions have found it more convenient to move into a market that has been assiduously built and nurtured by either the smaller companies or by informal players.
(4) Banks (at least till now) view financial inclusion through the prism of existing business opportunities and often in comparison to other business segments. Banks need to view FI as being akin to creating and nurturing a new market segment rather than as one that readily exists. FI is invariably a long-drawn out process requiring large scale investments over the years to bear fruit to the banking sector in terms of profitability.
The above obstacles to financial inclusion may mean that the banks will be looking to the government to subsidise their activities in the sphere of financial inclusion. This subsidy is often expected to be in the form of costs that need to be incurred, especially those related to the technology infrastructure.
FI requires banks to customise their products and services in order to suit the requirements of the poor. As Usha Thorat succinctly points out “financial inclusion should be led by understanding the needs of the customer rather than achieving targets. In rural areas banks should reach out rather than expect playing a numbers game. A well planned strategy should focus on customising products for transactions, remittances, savings, loans and insurance. Improving financial literacy and credit counselling in fact should precede delivery of financial products. In fact a localized approach would require banks to rethink their policy on having uniform products for the entire country ....”8
Interestingly, the unwillingness of the banks to expand their financial inclusion portfolio has provided a business opportunity that has been quickly filled by the microfinance companies. The MFIs provide ‘filler loans’ (as a senior banker called it) with few questions about the end-use of funds invariably helped them. In contrast, the banking sector operates, rightly, with more stringent conditions. The existence of a clearly discernible formal structure, in the MF organisation helped the banks to lend it is convenient (business proposition wise) to deal with a few companies rather than millions of customers dispersed in remote areas. Unless these complex issues are solved, a paradigm shift in financial inclusion may remain elusive.
It is in the above context that one needs to approach the financial inclusion and the role of Aadhaar. Financial Inclusion requires large investments in the form of the need to establish a wide network of agents/branches in order to serve a large number of small volume transactions. The costs for the financial service providers include the cost of opening the accounts (KYC norms, etc), infrastructure costs, staffing costs and importantly, the cost of funds. Aadhaar has the benefit of reducing the costs related to KYC norms as the RBI has now accepted the Aadhaar number as the equivalent of KYC. This eliminates the need for banks to undertake the need for verification in order to meet the KYC obligations. Aadhaar has the additional advantage of portability in case customers move to different places, apart from being the number to which they can flag various transactions.
Financial Inclusion
There are a number of definitions for financial inclusion. We lay primacy on the most commonly accepted definition is the one by Rangarajan Committtee or Report of the Committee on Financial Inclusion (2008), and the one provided by Usha Thorat. Rangarajan Committee defines financial inclusion as: “the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost” (p.1)2 while Usha Thorat rightly points out that, financial inclusion is more than micro finance or access to payment systems and there are several dimensions to this including facilitating real sector parameters3 . The UNDP suggests that “inclusion” has to go beyond financial inclusion and should encompass livelihoods, economic and social inclusion. The Centre for Financial Inclusion (Accion International) defines it as a “state in which all people who can use them have access to a full suite of quality financial services, provided at affordable prices, in a convenient manner, and with dignity for the clients. Financial services are delivered by a range of providers, most of them private, and reach everyone who can use them, including disabled, poor, rural, and other excluded populations”4 .
Financial Inclusion is not merely the expansion of micro-credit. Micro-credit is but one component, albeit the largest component in India. Unfortunately, for a number of years, micro-credit has often been the most important pivot around which financial inclusion strategies have been conceived. This has however has begun to change, albeit belatedly. Various issues and challenges (the ground realties) that need to be surmounted if the policy of financial inclusion is to have the desired effects. An attempt has been made to highlight some of the issues that hinder the development of a more inclusive financial system.
In recent years, policy makers are struggling to expand financial inclusion in the country. The President of India, Pratibha Patil, recently pointed out, that only about 45 per cent of Indian population had access to bank accounts, and there was a low ratio of one bank branch for 16,000 people and that “banking coverage of the large population living in six lakh villages in the country was particularly low” while calling for a holistic approach to meet the financial needs of target consumers5 . The need for financial inclusion should be looked at in the context of reported observations by the Deputy Chairman of the Planning Commission, Montek Singh Ahluwalia, that inclusion will be an important part of the Twelfth Five Year Plan6 .
The most recent initiative of the Government of India to expand financial inclusion is Swabhiman. Under the programme, the government has set a target of providing banking facilities in habitations with a population of more than 2000 (as per 2001 census) by March 2012. The banking correspondent model will be used by the banks. This necessitates the banks to cover an additional 73,000 unbanked villages. This does not mean that the banks will provide full fledged banking services, but would instead five major products, which are deemed essential. These products include: savings, micro-credit, remittances micro-pension and micro-insurance. Due credit needs to be given to the government attempts to cajole the banks, especially the public sector banks (herein referred to as PSBs), to expand their inclusionary policies. The PSB were reached more villages than targeted in the financial year 2010-11. It has been pointed out that the PSBs targeted 23,629 under the government’s ambitious financial inclusion plan and reached 26,630 villages7 . It needs to be seen if over the next few years, they expand the bouquet of services they provide to these villages, or if their measures are only due to government directives.
Issues in Expanding Financial Inclusion
The nuances of implementing financial inclusion are more complex with different dynamics seemingly at work. Convincing formal institutions, especially in the banking sector is more difficult. It is pertinent to note that without the participation of the banking sector, financial inclusion may be difficult to achieve. The importance and role of the banks should be seen in the context of the overwhelming capital deficiency in a country like India.
Despite years of growth in the formal banking sector, they have not been able to expand their service or product portfolios. Any field study indicates that there is a clear urge to borrow from the banks on the part of the borrowers and a fond hope that at least in future the banks will lend to the poorer sections. This is not to claim that only the poor access non-formal sources of credit. It is common for Small and Medium Enterprises survive mostly on accessing non-formal sources of credit.
Any attempt at expanding financial inclusion will have to acknowledge that there important factors that inhibit the development of a more inclusive financial system is possible only with the active participation of the banking system. However, since the reforms of 1991, the banking system is oriented to the stock markets with their emphasis on short-term profits. This often forces the banks to look at various opportunities through a short-term cost-benefit analysis. Such practices have over the past two decades been detrimental to the health of the banking sector and importantly will serve as a major obstacle to the growth of a more inclusive financial system.
Four important factors that the banks will have to deal with include:
(1) The viability gap that arises due to the fact that the cost of servicing the cost of providing these services (or ‘social’ or ‘holding costs’) involves. In an era when the banking sector is concerned as much as profitability and growth, it is unlikely that the banks will be willing to go make a substantial departure from their current practices, without an implicit or explicit subsidy from the government.
(2) Recovery, especially in the rural areas will be an issue and unless the institutional framework is more efficient, it may not be an attractive business proposition. The social dynamics of a village compound the risks for a large institution such as a bank.
(3) Financial inclusion for the banks is a miniscule part of the portfolio in the present juncture and compared to their growth rates possible in other sectors. Therefore, this segment (financial inclusion) is unlikely to be a focus area in the near future. Credit to the excluded sectors or even deposits mobilised from the poor invariably consists of only a small part of the overall portfolio of the banks. This is unlikely to change in the near future. Hence, for the banks, which have an obsession for growth, it is difficult to make a substantial shift from current policy that would accommodate financially inclusive policies beyond a point. Banks like most of the formal institutions are not willing to spend inordinate amounts of time and resources in order to create a market. Historically, the large formal financial institutions have found it more convenient to move into a market that has been assiduously built and nurtured by either the smaller companies or by informal players.
(4) Banks (at least till now) view financial inclusion through the prism of existing business opportunities and often in comparison to other business segments. Banks need to view FI as being akin to creating and nurturing a new market segment rather than as one that readily exists. FI is invariably a long-drawn out process requiring large scale investments over the years to bear fruit to the banking sector in terms of profitability.
The above obstacles to financial inclusion may mean that the banks will be looking to the government to subsidise their activities in the sphere of financial inclusion. This subsidy is often expected to be in the form of costs that need to be incurred, especially those related to the technology infrastructure.
FI requires banks to customise their products and services in order to suit the requirements of the poor. As Usha Thorat succinctly points out “financial inclusion should be led by understanding the needs of the customer rather than achieving targets. In rural areas banks should reach out rather than expect playing a numbers game. A well planned strategy should focus on customising products for transactions, remittances, savings, loans and insurance. Improving financial literacy and credit counselling in fact should precede delivery of financial products. In fact a localized approach would require banks to rethink their policy on having uniform products for the entire country ....”8
Interestingly, the unwillingness of the banks to expand their financial inclusion portfolio has provided a business opportunity that has been quickly filled by the microfinance companies. The MFIs provide ‘filler loans’ (as a senior banker called it) with few questions about the end-use of funds invariably helped them. In contrast, the banking sector operates, rightly, with more stringent conditions. The existence of a clearly discernible formal structure, in the MF organisation helped the banks to lend it is convenient (business proposition wise) to deal with a few companies rather than millions of customers dispersed in remote areas. Unless these complex issues are solved, a paradigm shift in financial inclusion may remain elusive.
It is in the above context that one needs to approach the financial inclusion and the role of Aadhaar. Financial Inclusion requires large investments in the form of the need to establish a wide network of agents/branches in order to serve a large number of small volume transactions. The costs for the financial service providers include the cost of opening the accounts (KYC norms, etc), infrastructure costs, staffing costs and importantly, the cost of funds. Aadhaar has the benefit of reducing the costs related to KYC norms as the RBI has now accepted the Aadhaar number as the equivalent of KYC. This eliminates the need for banks to undertake the need for verification in order to meet the KYC obligations. Aadhaar has the additional advantage of portability in case customers move to different places, apart from being the number to which they can flag various transactions.
1 http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/65111.pdf (Website last visited 20 June 2011).
2 http://www.nabard.org/pdf/report_financial/Full%20Report.pdf
3 “Micro Finance to Financial Inclusion and Responsible Finance-A Paradigm Shift”, Speech Delivered at Financial Inclusion Policymakers Forum, Malaysia (http://www.bnm.gov.my/index.php?ch=263&pg=848&ac=878 – Website Accessed on 18 May 2011).
4 http://www.centerforfinancialinclusion.org/Document.Doc?id=778
5 “Inclusive Economy needs strong banking sector: Pratibha Patil”, The Hindu, 24 December 2010, p.19.
6 http://www.inclusion.in/index.php?option=com_content&view=article&id=536...
7 “Public Sector Banks reach out to more villages in 2010-11”, Businessline, Hyderabad Edition, 21 May 2011, p.6
8 http://www.bis.org/review/r061107e.pdf
2 http://www.nabard.org/pdf/report_financial/Full%20Report.pdf
3 “Micro Finance to Financial Inclusion and Responsible Finance-A Paradigm Shift”, Speech Delivered at Financial Inclusion Policymakers Forum, Malaysia (http://www.bnm.gov.my/index.php?ch=263&pg=848&ac=878 – Website Accessed on 18 May 2011).
4 http://www.centerforfinancialinclusion.org/Document.Doc?id=778
5 “Inclusive Economy needs strong banking sector: Pratibha Patil”, The Hindu, 24 December 2010, p.19.
6 http://www.inclusion.in/index.php?option=com_content&view=article&id=536...
7 “Public Sector Banks reach out to more villages in 2010-11”, Businessline, Hyderabad Edition, 21 May 2011, p.6
8 http://www.bis.org/review/r061107e.pdf
