Financial Inclusion – An Assessment of New Modalities and Alternative Models

Introduction

Rapid economic growth in India in the recent years has brought in its wake a number of concerns, which relate to expanding this growth across regions, sectors, and people. The major objective is to ensure inclusive growth by removing the constraints of poor infrastructure, improving economic efficiency and spreading the benefits of growth over a vast population, which has remained outside the purview of this development process. The financial sector in the country has also experienced revolutionary changes but there exist a large number of people whom the financial services revolution has effectively passed by, resulting in financial exclusion of this segment. Financial exclusion, which is generally the outcome of poverty, ignorance and environmental factors, is to a great extent related to supply side issues, i.e. lack of appropriate financial services for those that are excluded by the traditional system of instruments.

Against this backdrop, the article assesses some current initiatives that are attempting to promote greater financial inclusion in the country under various models, ensuring access to mainstream financial services through the provision of appropriate financial products.

The present scene

Financial inclusion, in the sense of extending banking products at an affordable cost to the vast sections of disadvantaged and low income groups, is not new to India. For more than three decades after nationalization of major commercial banks in 1969, Indian banking has shown tremendous growth in volume and outreach resulting in increase in the total number of branches of scheduled commercial banks from 8,321 in the year 1969 to 68,681 as at the end of March 2006 and reduction of the average population per branch office from 64,000 to 16,000 during the same period. Public sector banks were in the forefront of reaching out to sections that were once neglected and designing new, innovative loan products for agriculture and small-scale industries sectors is an outstanding example in this regard.

There are, however, concerns that banks have still not been able to reach a vast segment of the population and provide them with basic banking services. Growth has also not been uniform across all the regions/ States of the country and there still continue to be wide gaps in the availability of banking services in the rural areas. While from the policy angle none of the earlier measures aimed at broad basing their clientele has been withdrawn, the banks might be laying somewhat less emphasis on inclusive practices in view of the thrust on profitability.

The All India Debt and Investment Survey conducted by the National Sample Survey Organization has pointed out that between 1991 and 2002, the share of institutional finance in the outstanding cash dues of rural households decreased by 7 percentage points to 57 per cent, while share of non-institutional sources showed a corresponding increase. The survey also shows that the non-institutional agencies had advanced credit to 15.5 per cent of rural households, while the institutional agencies had financed 13.4 per cent households. Thus, on the whole, only about 29 per cent of the rural households obtained some form of financial assistance. Data published by the Reserve Bank show that the number of loan accounts of small borrowers with credit limit range of Rs.25,000/- or less decreased from 59 million in 1991 to 37 million in 2005, although thereafter it increased to 39 million in 2005.

One of the benchmarks employed to assess the degree of reach of financial services to the population of the country is the quantum of deposit accounts (current and savings) held as a ratio to the adult population. In the Indian context, taking into account the Census of 2001, the ratio of deposit accounts to the total adult population as at the end of March 2004 and 2005 are as under:

[Source : Reserve Bank of India Publications]

* The actual figures could be more taking into account the post-2001 accretion to the population. Together with multiple accounts maintained by the same persons, this could lead to lower coverage ratios.

Within the country also, there is a wide variation across states, from a low ratio of 21 per cent in the case of Nagaland to a somewhat high level of 89 per cent in the case of Kerala, as at the and of March 2004. Although financial exclusion has both absolute and relative connotations, the challenge is to include the segment which stands absolutely excluded.

Modalities of Inclusion

Microfinance and financial inclusion

Provision of micro finance through Self Help Groups (SHGs) since the early nineties through the SHG-Bank linkage Programme and the emergence of Non-Governmental Organizations (NGOs) as facilitators have been major developments in the field of rural finance. The strategy of linking SHGs to banks, initially through savings and later through loan products, has been able to ensure financial inclusion of the hitherto excluded sections of the society to a certain extent. Cumulatively, the number of SHGs linked to banks aggregated over 2.2 million as at the end of March 2006, which translates into an estimated 33 million poor families brought within the fold of formal banking services. It is important to note that about ninety per cent of the groups linked with banks are exclusive women's groups.

There are several micro finance institutions (MFIs) which normally have the organizational form of societies, trusts, cooperatives, non-banking financial companies (NBFCs) and not-for-profit companies set up under Section 25 of the Companies Act, 1956, which supplement the efforts of banks in providing financial services to the poor. The experience of the formal banking system partnering with such MFIs has been quite encouraging in several places.

Role of Lead Banks

The mechanics of financial inclusion would largely depend on the profile of the excluded population, as also the institutional framework available for the purpose. In the context of the multi-agency approach to rural banking in India, financial inclusion could involve several steps and the role of the coordination mechanism in the form of the Lead Bank in the district or the convenor of the State Level Bankers Committee (SLBC) at the state level assumes critical importance. The policy announcement of the Reserve Bank has envisaged an active role for the convener banks of the SLBCs in all states, who have been given the responsibility of reaching 100 per cent financial inclusion in at least one district in their area of operation.

Illustratively, the convenor of the SLBC has to undertake the following steps for ensuring financial inclusion in the pilot areas in the state:

• Step 1 : Allocation of villages to the banks in the area
• Step 2 : Undertaking village/ household surveys involving banks/ NGOs/ SHGs etc.
• Step 3 : Assessment of the need for financial products
• Step 4 : Preparation of Action Plan in terms of targets for different products , e.g. opening of no-frills accounts, issue of Kisan Credit Cards and General Credit Cards, offering overdraft facilities in no-frills accounts, setting up of SHGs, providing micro-insurance, etc.
• Step 5 : Review and evaluation

Based on experience gained, other areas in the state may be covered in a time bound manner. On a priority basis, the districts covered under the National Rural Employment Guarantee Programme may also be taken up for financial inclusion, in  particular, opening of "no-frills" accounts which would facilitate credit of drafts issued in favour of the beneficiaries, and formation of SHGs to support micro-enterprise-linked livelihoods on a sustainable basis.

Basic "no frills" bank accounts

At the first stage, there is a need for lowering the entry barriers to the banking system and simplifying procedures. Thanks to developments in micro finance, one of the myths held earlier by the banking system that the poor cannot save, has been demolished. Experience has shown that the poor can and do save, may be by way of thrift, and all they need is an appropriate product and access to the banking system. Holding a savings product to a substantial extent reduces financial exclusion. Moreover, the act of saving, however little it may be, reinforces longer-term thinking and a sense of responsibility for one’s future.

Keeping in view the need for the banking system to take urgent steps to bring about financial inclusion in the country, the Reserve Bank of India, in the Mid-Term Review of the Annual Policy for the year 2005-06, exhorted banks to make available a basic banking ‘no frills’ account either with nil or very low balances as well as charges that would make such accounts accessible to vast sections of the population. The nature and number of transactions in such accounts would be restricted and would be made known to customers in advance in a transparent manner. Several banks, both in the public and private sectors, have responded positively to this measure and devised no-frills accounts for the lower income groups.

Although such basic bank accounts are generally considered unprofitable, provision of such deposit accounts has been accepted the world over as a stepping stone to financial inclusion. In a somewhat different way, this requires bank branches to be aware of the surrounding areas in which they work and promotes a more outward-looking, customer-centric model to work alongside their usual profit-driven model. A basic 'no frill' account is just the beginning of a relationship and can pave the way to the customer availing of a variety of savings products and loan products for consumption, housing etc. The account can be used for sanctioning small overdraft facilities and making small value remittances at low cost. The same banking account can also be used by State Governments to provide social security services like health and calamity insurance under various schemes for the disadvantaged. Having such social security cover makes the financing of such persons less risky from the bank’s point of view and they can be financed for various purposes. Further, holders of the no-frills accounts who would be beneficiaries of the Employment Guarantee Scheme of the Government of India, can also be customers of banks over a longer time horizon.

General Credit cards (GCC)

It is almost a cliché that rural credit should adhere to the basic requirements of timeliness, adequacy and hassle-free delivery, apart from taking care of the financial needs of the customer in a wholistic manner, including consumption credit. To address these issues, several 'credit card' schemes have been devised and implemented by banks over the past. Such schemes have the flexibility of use and they fulfill the above requirements to a substantial extent. But all these schemes have so far been activity-specific, i.e. for farmers, artisans etc. The latest in the line is the General Credit Card (GCC) which does not target any specific functional group, but has the potential to address the credit needs of persons with small means having some income-generating activity, without bothering so much about the nature of the activity. Banks have flexibility in fixing the limit based on the assessment of income and cash flow of the entire household. The borrowers are eligible for availment of the credit facilities provided under GCC as per their requirement without any insistence on security and the purpose or end-use of the credit. To provide an incentive to banks for issuing the GCCs, fifty per cent of credit outstanding under GCC up to Rs.25,000 has been made eligible for being treated as indirect agricultural finance under the priority sector lending. While several banks have put in place schemes for issuing GCCs, the progress will have to be accelerated. As done earlier in the case of Kisan Credit Card Scheme, issue of GCC too can be made part of the corporate plans of all banks.

Microinsurance

More than credit, the poor need access to some form of insurance, as they are the most vulnerable to various types of risk to both life and property. They need suitably designed schemes offering health, life or property insurance: limited protection at a somewhat low contribution. It is heartening to know that insurance companies are coming up with schemes aimed at poorer sections of the population and designed to help them cover themselves collectively against risks, the delivery channels being banks, NGOs and SHGs working in rural areas. There is also a possibility of providing some kind of microinsurance to holders of the General Credit Cards, on the lines of the personal accident insurance cover available to Kisan Credit Card holders.

Financial education

One of the major hindrances in the way of delivery of financial services to the poor is the lack of basic knowledge and lack of awareness of the products and services available. In fact, education is a great facilitator. The delivery of financial education would include (i) increasing knowledge of financial matters, (ii) developing understanding of financial products and (iii) building skills in financial management

One of the pioneers in promoting the concept of financial inclusion, the United Kingdom, has established a Financial Inclusion Task Force, which has emphasized 'access to free face-to-face money advice' as an important component of financial inclusion, apart from access to banking and access to affordable credit. A Financial Inclusion Fund has also been established there to promote financial inclusion.

 Poverty is a well-known problem in most developing countries. But what is needed is development of mechanisms that ensure that poverty is not exacerbated by lack of access to financial services. People need information and advice when they get into debt. Such information and guidance can best be delivered by appropriate mechanisms and if such effective mechanisms are put in place, they in turn would reinforce the demand for credit.

Some banks have on their own take steps to provide such education, as in the case of the Debt Counselling Cells recently set up by some banks. However, any large scale delivery of financial education has to leverage on the presence of other agencies, such as private entities, non-governmental organizations, civil society organizations, outlets of the corporate sector etc., apart from Government initiatives. The use of information technology (IT) offers a lot of promise in providing financial literacy and education and experience in several parts of the country through the use of kiosks, mobile vans, etc. has shown to what extent IT can be leveraged to provide information on various products and services, production processes and markets for the products. While provision of connectivity for facilitating communication services in rural areas is still an issue, recent developments in wireless technology holds out a lot of promise for evolving an IT-based information dissemination system.

Mode of delivery of services

For the financial sector, the mode of delivery of services is as important as the nature of services to be delivered, as it has several implications for the institutions. It is generally agreed that any delivery of financial services should take into account the issues associated with (i) outreach, (ii) impact and (iii) sustainability of the programme.

Outreach

In India, we have developed a vast network of the banking system in the rural sector and this has prompted us to adopt a bank-centric approach in the delivery of financial services, be it through targeted lending to priority sector and weaker sections, Government-sponsored poverty alleviation programmes or linkage of Self Help Groups, in every aspect leveraging the reach of the banking system in the country.

However, it is also true that one of the major factors affecting this outreach is the cost of expanding the branch network and increasing the number of people manning a branch. The relatively high transaction cost of dealing with a number of small accounts also negatively impacts further expansion. When the focus is only on cost reduction and profit maximization, banks naturally shy away from areas and activities, which are cost-intensive, low yielding and fraught with uncertainties. In such a scenario, it becomes difficult for banks to cover more and more customers located in far-flung areas all by themselves. Hence, there is a need for alternative models of delivery.

Alternative model - Use of intermediaries

On the basis of recommendations made by an Internal Group of Reserve Bank of India on Rural Credit and Micro Finance (Khan Committee), banks have been permitted in January 2006 to use intermediaries such as Non-Governmental Organisations/ Self Help Groups (NGOs/ SHGs), Micro Finance Institutions (MFIs), other Civil Society Organisations (CSOs) and private entities including outlets of the corporates in the rural sector in providing banking and financial services through the use of 'Business Facilitators' and 'Business Correspondents'. This can lead to provision of services and products – savings, credit, insurance - at the doorstep of the customer in both rural and urban areas.

Advantages of the alternative model

• Choice of intermediaries

While the NGOs/ MFIs and various other formal and informal organizations would be the automatic choice of banks for appointment as Business Facilitator/ Correspondents, other private agencies working in the rural sector can be used for the purpose. This could include the kiosks, e-choupals and the retail chains being established in rural areas by several corporates. The regulations also permit individuals to be appointed as 'Business Facilitators', who would provide support services without handling cash.

• Cost issues

This is the most important advantage of this model. The use of intermediaries in services delivery through the Business Facilitaror/ Correspondent models can help banks in reducing their cost. Studies have shown that the all-inclusive cost of delivery of small amounts of loans up to Rs 25,000 directly by banks comes to above 20 per cent of the loan amount and the cost would be proportionately higher in the case of smaller loan amounts. In one study reported by the Institute for Financial Management and Research (IFMR), Chennai, it is observed that the intermediary (here an MFI) has the cost advantage in delivery of small value loans – while the cost for banks for loans up to Rs 10,000 is reported as 33.1 per cent, that for the MFI is 22.7 per cent. A bank can, therefore, address the cost issue to certain extent if it provides the service through an intermediary in the form of Business Facilitator or Correspondent. Of course, the actual costs would depend on the nature of the intermediary, its efficiency of operations and the methodology adopted by it to reach out to the customers.

• Harnessing local knowledge

The banking sector, which has a problem in expanding its outreach beyond a certain point, now has the opportunity to take the advantage of the local knowledge of these persons/ agencies in providing financial services in hitherto unreached remote areas. They can support institutions and organisations that can deliver real services as also conceive and implement capacity building initiatives.

• Technology in intermediation

Many of the NGOs/ other intermediaries are quite technology savvy and use various products to reduce cost of operations. Partnership with these organizations would provide the banks an opportunity to look at technology-based solutions and low cost delivery mechanisms that will reduce transaction cost of such services with the volumes required to make such a model sustainable. Use of IT-enabled products and services at the bank and the intermediary level (in the form of simputers, personal digital assistants etc.) have proved to be useful in providing low-cost intermediation, at the same time addressing the issues of speedy accounting of the transactions at the bank level.

 Other issues

While the amount of compensation to be paid to the intermediaries by the banks would vary from case to case and also would depend on the nature of service provided, there is a need for uniformity in the method of application of compensations to avoid any problems in future as also to clearly address the issue of costs to the customer. 

 Most of the innovations in financial services have taken place as a response to customer perception of cost and margin factors and risk management. In catering to the poor, banks may have to look for composite products including both savings and loans components and having appropriate linkage with insurance so as to make it a package.

 Impact

Any policy or programme for delivering financial support services to the poor aims at improving their standard of living and helping them to cross the poverty barrier. The impact of such programmes has to be judged with reference to its success in this regard, achieved  through asset creation with credit combined with appropriate hand-holding and linkage facilities. In this, the role of domain-specific knowledge providers such as extension agencies in the farm sector, technical training institutes in the non-farm sector and rural development and self employment training institutes set up by many banks, is important, as proper utilization of credit is possible only with a sound knowledge of viable practices and alternatives available at the ground level.

 Sustainability

Any economic activity undertaken with the help of credit has to be self-sustaining. Further, the institutions providing these credit facilities should also be able to sustain their activities. This needs appropriate designing and pricing of the products and appropriate delivery methods which should, inter alia, address the cost issues, as any outreach expansion and provision of financial services to the poor has cost implications for the institutions.

 Local level banking institutions

The Regional Rural Banks  (RRBs) which are currently undergoing a process of consolidation aimed at improving their operational viability, are among the most suited institutions to bring about financial inclusion in the rural sector, as they have a wide network of branches spread over far-flung areas of the country and have over the years acquired the expertise in dealing with the people of small means. It is with this objective that the Reserve Bank had specifically advised RRBs in December 2005 to offer small overdraft facilities in the no-frills accounts. While several issues need to be addressed in strengthening this sector, it is no doubt that an appropriately constructed model with the RRBs at the center stage will go a long way in furthering linkage with the disadvantaged and provide financial inclusion.

 Similarly, there are several cooperative banks which are running well and several primary cooperative societies (PACS) in the country which are functional. They provide additional outlets for the banking sector. Wherever such banks/ societies exist, they can be identified and entrusted with the job of providing saving/ credit facilities to the financially excluded people. There may be a case for these local level banking institutions acting as intermediaries for larger commercial banks, in a manner that will lead to a win-win situation for both.

 Special needs of disadvantaged areas

In a move to speed up financial inclusion in the North-Eastern Region of the country, the Committee on Financial Sector Plan for North-Eastern Region (Chairperson: Smt. Usha Thorat, Deputy Governor, RBI) in its report submitted in July 2006, has recommended that the commercial banks should prepare a roadmap so that the branches in this region can give banking access to 50 new households every month for the next four years with a deposit account, with option to the households of opening such accounts as “no frills” accounts. The report has emphasized that the focus should be on proactively connecting banks to the people, rather than waiting for walk-in-customers and has underlined the need for adequate publicity with a view to promoting financial literacy among the people. The suggestions would merit application elsewhere also.

Conclusion

In fact, there is a need for banks to redesign their business strategies to incorporate specific plans to promote financial inclusion of the low-income groups treating it not only as a corporate social responsibility, but also as a business opportunity. The business opportunity lies in exploiting the low margins-high volumes situation at the 'bottom of the pyramid' and seen in this context, financial inclusion would not only be socially desirable, but also would make a lot of economic sense. To quote noted economist Prof. C.H. Hanumantha Rao, "Considering the prevailing socio-economic structure and the nature of our polity, the challenges for achieving more inclusive growth are much greater than for stepping up the GDP growth rate". Financial inclusion opens the possibilities of other types of inclusion and coupled with appropriate policies, has the potential to lead to overall inclusive growth of the society.

Prepared by Shri R. N. DASH  Deputy General Manager & Member of Faculty in the College of Agricultural Banking (CAB), Reserve Bank of India, Pune. The views expressed in this article are personal.