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.
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.