Financial Inclusion

Financial inclusion in India bogged down by too much concern with regulatory prudence

FICCI last week released a report on the progress of financial inclusion in India titled ” Promoting  Financial Inclusion: Can the Constraints of  Political Economy be  Overcome ? ” . The report finds that the financial inclusion business has not yet come to stay in India and financial institutions responsible for providing financial services  do not yet perceive it as sustainable business.

There is thus a long way  to  go  before  the  target of  covering  55.8  million  excluded households  and  all villages with 2,000 population by 2012 can be achieved, notes the report.

ficci financial inclusion

Financial Inclusion in India – 2011 -2012

The  FICCI  report titled, ‘Promoting  Financial Inclusion: Can the Constraints of  Political Economy   be  Overcome?’  notes  that  the  task  of  increasing  and  maximising  financial inclusion faces major challenges.

These cover a range of issues including:

•      Social  exclusion  of  low  income  families  results  in  illiteracy,  inhibition  and  poor physical  access. It also limits awareness, ability to overcome prejudice about their bank-worthiness and enhances the transaction costs incurred these families for using the financial services available in the country

•      The small value of accounts and transactions expected by the banking system from financially excluded families results in high cost of operations and limits the incentive to serve them

•      The lack of understanding of products and services appropriate to the needs of low income  families results in static approaches like the no frills account where it has become apparent that mere availability is not the issue

•      Limited  experience  with  business  models  suitable  for  small  value  accounts  and doorstep  service delivery results in the slow adoption of mechanisms such as the business correspondent model

Indeed, a significant set of regulatory and promotional efforts have been initiated, which, taken together, could be expected to have a substantive impact on financial inclusion. These include:

•      Big push for the business correspondent model by Banks

•      Mandatory Government to Person (G2P) payments in Banks and Post Office accounts using electronic transfers

•      Rolling out of the concept of a “no frills” account for small value transactions

•      Enabling of the provision of micro-insurance services through facilitating regulation

•      Establishment of funds to finance promotional activities that support the above measures and reinforce the work of microfinance institutions

•      Attempt to revive the cooperative credit system

A number of small steps have also been taken to facilitate inclusion within the existing system such as:

•      Simplified Know Your Customer (KYC) norms and interest rate deregulation for small value accounts

•      An increased emphasis on devising payment systems that address the needs of low income families

•      Small investments but increasing realization of the significance of financial literacy to ensure meaningful financial inclusion and increased emphasis on consumer protection.

Financial Inclusion India Roadmap

A deeper analysis of the roll out of the financial inclusion measures reveals that, in practice, each regulatory and promotional measure has been constrained by overemphasis on prudential aspects by regulators:

•      The BC model met with limited success for four years before the decision to liberalise it was taken. Even today, its future success is yet to be determined given the non-existence of an established replicable business model. Use of the no frills account is minimal despite its linkage to government welfare payments

•      Micro-insurance is yet to be rolled out in a big way outside the limited confines of micro-credit cover

•      The funds allocated to promote financial inclusion are administered within the traditional framework and do not sufficiently emphasise innovation and

•      The cooperative credit system has undergone several rounds of revival and yet its true potential remains to be tapped.

Banks have been advised by the RBI to submit their financial inclusion plans for reaching 72,825  financially  excluded  villages  by  2012  and  to  integrate  these  with  their  normal business  plans. While much has been achieved, as is the norm in any regulatory regime, what has been done by the banks has been the minimum necessary to gain approval (or at any rate regulatory forbearance). Thus significant areas of the rural hinterland of the major states are now reasonably served with banking services.

However, parts of central India, the hill regions and the northeast as well as many of the poorest  areas  of  eastern  India  are  sparsely  banked.  Even  where  banking  services  are available they cater to the needs of the creamy layer of large farmers, traders and, where relevant, production activities.

The engagement of banks with low income families has been essentially in response to directed programmes such as IRDP and, more recently, KCC and No Frills Accounts along with a  plethora of schemes for marginal farmers, youth, micro- enterprises and so on. All are high cost activities and are seen as impositions upon the normal  business of the bank both by staff and (less openly) by managements. Wherever possible,  regulatory  arbitrage, such as the buyout of MFI portfolios by banks in order to boost their priority sector lending, takes place.

The report states that banks do not view financial inclusion activities as profitable and, as a result, the roll out of the schemes is limited in scope and insipid in direction. For reasons of political economy this may not be the official line of bank managements but ultimately it is local  managers  and  staff  who  determine  the  momentum  of  a  rollout.  If  bankers  saw significant potential business in these activities a more dynamic rollout with real momentum would be apparent. Thus, even the untested and unproven business correspondent model remains still born for lack of a business model, being limited largely to technology service providers opening “no frills” accounts that are largely dormant.

The report points out that perhaps the price of prudence in the regulation and promotion of financial services for low income families is substantial welfare foregone. Perhaps this price is substantially higher than the cost likely to be incurred on regulation and supervision of a more dynamic system of inclusion through the formal financial system risk associated with a bolder, more experimental approach.

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