Why financial inclusion has not taken off

Since Independence, several attempts have been made towards financial inclusion of the poor, particularly in rural areas. The initiatives include the cooperative movement, followed by priority sector lending, lead bank scheme, service area approach, creation of National Bank for Agriculture and Rural development, introduction of regional rural banks/ local area banks, microfinance, kisan credit cards, business correspondence and finally Pradhan Mantri Jan-Dhan Yojana.

All these initiatives are supply driven — supply of banking services to the poor people at their doorstep. However, it is time to introspect as to why these programmes have not been effective in improving economic conditions of the poor people.

Availability of finance is a means to an end, but not an end in itself. The ultimate objective is to provide a constant source of income to the poor so that they will demand financial services. If banks do not wish to penetrate into remote rural areas, other service providers could surely do so, provided there is a genuine demand for it. Supply-driven financial inclusion does not work.

The outcome of earlier financial inclusion programmes has been much below expectations. According to NSSO reports, the share of institutional credit to farmers declined from a peak of 69.4 per cent in 1991 to 56 per cent in 2012. Farmers’ dependence on non-institutional credit has gone up from 30.6 per cent in 1991 to 44 per cent in 2012. The availability of finance is a necessary, but not sufficient condition for poverty reduction. Many high cost financial inclusion initiatives have not enthused rural households.

According to the 70th Round of National Sample Survey, among the institutional agencies, the share of commercial banks’ lending to agriculture was the highest at 25.1 per cent, followed by co-operatives at 24.8 per cent in 2012 due to their low cost.

Self-help groups contributed only 2.2 per cent of total institutional credit. Micro finance institutions (MFIs) continue to charge poor borrowers 24-34 per cent, close to the usurious interest rates charged by village money lenders.

In order to provide banking services at reasonable costs to the poor people, the business correspondents model was introduced in 2006. Being technology driven, the BC model played a critical role in opening large number of Jan-Dhan accounts during the recent period, but was unable to provide basic banking services to them for several reasons.

The RBI has nudged banks to open a brick and mortar branch in every village with a population of 2,000 or more. However, according to the 2011 Census, 96 per cent of Indian villages have a population of less than 1,000. Can the BC model be able to provide basic banking services to large segment of population living in small villages?

The BC model is akin to the agency model followed by insurance companies and pension funds. Out-sourcing of financial services through agents for a commission has been somewhat successful in case of other financial services, as the agents get a constant flow of income.

The compensation in the case of the BC model is awfully inadequate compared to the services expected from them. Banks’ lending activities through BCs are negligible. The activities of BCs are typically limited to opening new deposit accounts for a commission. The opportunity of opening new deposit accounts is quickly exhausted, particularly after the success of Jan-Dhan Account scheme.

BCs are expected to provide small withdrawal and deposit facilities besides remittance service to all deposit holders. He is all in one — a clerk, cashier, branch manager, financial adviser and agent for rural digitization. He goes to the base branch and settles all deposit and withdrawals. BCs either neglect these activities, or are not in a position to do justice to them due to the sheer workload.

Some BCs do agency functions for mutual funds, LIC, or sell small savings instruments as they get a fair amount of commission. Hence, it is natural for them to ignore basic banking activities that are less lucrative. Handling cash is also risky, particularly where the base branch is far away. BCs have limited overdraft facility that may not be sufficient for daily requirement of the account holders.

Let us take the case of how BCs can work for a village with a population of 2,000 — for which there is a brick and mortar branch with at least three or four staff. Assuming an average family size of five in such villages, there might be 400 families who can potentially open bank accounts. A brick and mortar branch in a village of 2,000 population may have at least 400 deposit accounts if each family opens only one account. Assuming that some families have more than one account, such deposit accounts may go up to, say 800.

For a BC to provide basic banking services effectively, deposit accounts should not exceed 500. Even ultra-small branches, where an officer from a base branch occasionally visits the rural area, are not working well where deposit accounts are more than 800.

The commission-based BC model is not working well for the banking system, unlike for other financial services. All ultra-small branches with a BC model with more than 1,000 accounts may be immediately converted into brick and mortar branches. Alternatively, for every 1,000 Jan-Dhan accounts in a locality, there should be a physical branch. Accounts from multiple banks may be shifted to the bank ready to open a brick and mortar branch to serve 1,000 such account holders. This exercise can be undertaken by the State-Level Bankers’ Committee.

The Government should pool all resources under several rural development schemes and provide a scheme-based permanent source of income through gainful employment to the rural people. Although, schemes may vary from state-to-state based on availability of natural resources, non-farm activities like construction of roads, electrification, warehousing, healthcare, irrigation would provide a constant source of income and make the financial inclusion truly demand-driven.

The writer is former Principal Adviser and Head of the Monetary Policy Department, RBI

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