The Hindu Business Line : Financial inclusion and inclusive development

Financial inclusion is the delivery of financial/banking facilities to all people in a fair, transparent and equitable manner at an affordable cost.

Indian Bank launched the `National Pilot Project for Financial Inclusion in the Union Territory of Puduchery' on December 30, 2005. Financial inclusion is the delivery of banking facilities/financial services to all people in a fair, transparent and equitable manner at an affordable cost.

The purpose of this effort is to give a saving bank passbook to all those who do not possess one in Puduchery by December 30, 2006. The Indian Bank's project should be seen in the context of the Union Government constituting a 10-member committee under the Chairmanship of Dr C. Rangarajan, Chairman of the Economic Advisory Council to the Prime Minister, to submit a report on `Financial Inclusion.'

One of the important terms of reference of the committee is "to identify the barriers confronted by vulnerable groups in accessing credit and financial services, including demand, supply and institutional constraints."

Who are excluded?

As on March 2005, there were 70,324 total bank branches in India. Of this, 32,115 were rural branches and the balance 38,209 were in urban/semi-urban areas. The rate of increase in the number of bank branches in India during 1991-2005 in urban and rural areas was 3.5 and 0.6 respectively; that is, the outreach of banks in rural areas is declining.

A branch per 16,000 people is the All-India population bank intensity and this differs across States. Only 30 per cent of the rural people have a bank account; the rural people get only 9.2 per cent of the total credit lent out by scheduled commercial banks.

According to NSS data (Indebtedness of Farmer Households — 2003), 46 per cent of the outstanding debts of farmers is sourced from the unorganised financial system.

The lending to the small and tiny sector also less falls short of the mandated 10 per cent of the net bank credit. The lending to SSI sector was only 9.4 per cent of net bank credit, and includes the indirect lending as well. Indeed, lack of credit for working capital is often cited as a major reason for the sickness in the SSI sector.

Priority sector lending

Traditionally, the agriculturalists, particularly small and marginal farmers, the rural and urban poor, SSI and tiny sectors do not get access to adequate credit at affordable rates. Scheduled commercial banks are mandated to lend at least 40 per cent of their net bank credit at concessional rates to the priority sector comprising agriculturalists (18 per cent), SSI (10 per cent) and other small borrowers from various sectors.

As a result, the credit to priority sector increased from 14 per cent in 1969 to 37.7 per cent in 1991 of the net bank credit.

During this period, the non-performing assets (NPAs) of banks also increased. As a result, through out 1990s, several changes were brought vis-à-vis priority sector lending including deregulation of interest rates above Rs 2 lakh.

Of the 18 per cent credit allocated for agricultural sector, the banks can make indirect lending up to 4.5 per cent to input providers, subscription to bonds of National Bank for Agriculture and Rural Development (Nabard) etc. Regional Rural banks are allowed to fix interest rates and to move unviable rural branches to semi-urban areas. The priority sector included new borrowers such as professionals, software industries, leasing and hire purchase companies and a few more.

In the calculation of NPA of farm loans, the interest overdue time period was reduced from two years to two seasons of the crops for which the loan is taken. This has effectively reduces the interest overdue to 12 months; it will increase the priority sector NPA substantially.

These reforms increased the effective rate of borrowing for customers in the priority sector. The high cost of borrowing and the adverse market conditions reduced bank profitability and increased the priority sector NPA; and banks shied away from lending to the priority sector.

In the reform era, the Statutory Liquidity Ratio and the Cash Reserve Ratios have been progressively reduced, to give larger scope for lending activities of the commercial banks. Nevertheless, bank investments in approved securities have always remained higher than the minimum norm.

Process of exclusion

The inadequate priority sector lending clearly shows that the people working (or owning a small asset) in the agricultural and tiny sectors are really excluded from the organised financial system. The functioning of that part of the economy is poor, which is getting alienated in the market economy with little support from the State. Hence the financial exclusion.

The declining contribution from the agricultural sector to GDP reduces the per capita income of the rural population and leads to iniquitous income distribution. The average size is declining; and the proportion of the small and marginal farmers and landless agricultural labourers is rising. In the urban centres, the unorganised sector is expanding and with it the marginalisation of labour. These labourers do not have a sustainable security net. Globalisation has also affected the sustainability of small and tiny industrial sectors.

Process of inclusion

The poor man's economy does not make him a credit-worthy customer of the bank but the poor man needs credit as much for his/her business as to meet contingencies such as medicare. As such, economic development should primarily include the agricultural, small/tiny sectors. This should enable the poor to earn and save, and should give them the opportunity to get regular employment, which, in turn, will automatically lead them to the bank as credit-worthy borrowers. Thus financial inclusion needs inclusive development.

Notwithstanding the economic exclusion, an inclusive financial system will be immensely beneficial in the context of increasing transfer payments being made by both the Union and State governments such as pension for aged, freedom fighters, and financial assistance to widows, destitute, pregnant women, girl children in poor families to pursue education, dole for unemployed youth, etc. There are chances for leakages in these programmes. Financial inclusion will ensure that the transfer payments reach the identified beneficiaries in full. Further, this should largely reduce the cost of making transfer payments. Therefore, inclusive financial system should go hand in hand with inclusive development.

(The authors are academicians and can be contacted at sri_ni@vsnl.net or srsethu@hotmail.com)