Financial Inclusion: Issues and Challenges

Author(s): S. Mahendra Dev

Source: Economic and Political Weekly, Vol. 41, No. 41 (Oct. 14-20, 2006), pp. 4310-4313
Published by: Economic and Political Weekly
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I H T Parekh

finance

forum

Financial Inclusion:
and
Issues
Challenges
Financial inclusion is importantfor improvingthe living conditions
of poor farmers, rural non-farmenterprisesand other vulnerable
groups. Financial exclusion, in terms of lack of access to credit
fromformal institutions,is highfor small and marginalfarmers
and some social groups. Apartfrom formal bankinginstitutions,
which should look at inclusion both as a business opportunityand
social responsibility,the role of the self-help group movementand
microfinanceinstitutionsis importantto improvefinancial
inclusion. This requiresnew regulatoryprocedures and
depoliticisationof thefinancial system.
S MAHENDRA DEV

of banksin 1969
he nationalisation

and subsequent developments led

to expansion of the geographical
and functional reach by commercial
banks, regional rural banks (RRBs) and
cooperative credit institutions. Public
policy aimed at "social"and "development
banking" by meeting rural credit needs
and reducing the role of informal sector
credit. It may be noted that despite the vast
expansion, a large number of groups remain excluded from the opportunities and
services provided by the financial sector.
Such excluded groups include small and
marginal farmers, women, unorganised
sector workers including artisans,the selfemployed and pensioners.
P Chidambaram,union finance minister,
indicated in Budget 2006-07 that "out of
the total number of cultivator households
only 27 per cent receive credit from formal
sources and 22 per cent from informal
sources". The minister proposed appointinga committeeon financialinclusion.Based
on this announcement, the government of
India has set up a committee on financial
inclusion under the chairmanship of
C Rangarajanto suggest ways and means
to extend the reach of the financial sector
to cover excluded groups by minimising
the barriers to access financial services.
The Reserve Bank of India (RBI) and
the National Bank for Agriculture and
RuralDevelopment (NABARD) are also
4310

concerned about financial exclusion of

many households.
Against this background, the objective
of this note is to bring out issues and
challenges for reducing financial exclusion. We concentrate here only on a few
selected issues.

Definition of Financial Inclusion

Financial inclusion can be defined as
delivery of banking services at an affordable cost to the vast sections of disadvantaged and low-income groups. In the case
of credit, the proper definition of the
financially excluded would include households who aredenied credit in spite of their
demand. Although credit is the most
important component, financial inclusion
covers various other financial services
such as savings, insurance, payments and
remittancefacilities by the formal financial
system to those who tend to be excluded.1
In the case of credit, many households
are being exploited by moneylenders at
very high interest rates (50 to 60 per cent)
and, therefore, these households should
not be seen as being financially excluded.
It may be true thatRBI is thinking of using
moneylenders as agents. But, the proposal
is yet to materialise. Therefore, financial
inclusion refers to households accessing
institutional credit including commercial
banks,cooperativebanks,RRBs,NABARD
SHG-linkage and other self-help groups,
and credible microfinance institutions.

It is possible thatin orderto fulfil targets

of financial inclusion, more bank accounts
may be opened in the formal system.
However, opening a bank account itself
is not sufficient. Financial inclusion also
refers to making more efforts towards
covering small and marginal farmers
and vulnerable social groups. A broader
definition of inclusion should also focus
not only on credit but also on an increase
in productivity and sustainability of
farmers and other vulnerable groups.

Farmers' Indebtedness
Credit to farmer households is one
of the important elements of financial inclusion. In order to know the extent of
credit inclusion, ideally we should
have dataon thehouseholdswho aredenied
credit in spite of demand. Since we do not
have such readily available data, we use
here farmers' indebtedness as a proxy.
According to the 59th round survey of
NSSO (reportno 498) we have nearly 150
million rural households out of which
around 90 million are farmer households.
At the all India level around49 per cent
of the farmer households were indebted
(col 2 in Table 1). One can say that 51
per cent of the farmer households are financially excluded. These exclusion levels vary from state to state. For example,
it can be concluded that Andhra Pradesh
has the highest percentage of financial
inclusion (82 per cent of farmer households in AP are indebted). On the other
hand, Meghalaya has the lowest percentage of financial inclusion (only 4 per cent
of farmerhouseholds are indebted). These
are misleading figures because the indebtedness here covers loans from both formal
and informal sources.
The percentage of indebted farmer
households by source of loan (cols 3 and
4 in Table 1) shows 56 per cent of indebted
farmer households obtain loans from
formal sources and 64 per cent from
informal sources. The total percentage is

The H T Parekh Finance Forum is

editedand managedby Errol D'Souza,
ShubhashisGangopadhyay,
SubirGqkarn,
Ajay Shah and PraveenMohanty.

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October 14, 2006

more than 100 (120 per cent) because

farmers take loans from multiple sources.
Approximately, we can say that only 56
per cent of the indebted farmerhouseholds
are financially included as they are getting
loans from formal sources. The shares in
formal and informal sources vary from
state to state. In AP, 54 per cent of the
indebted farmer households obtain loans
from formal and 77 per cent from informal
sources (total is 130 per cent).
Table 1 also gives another distribution
by formal and informal sources (cols 5
and 6). This gives distributionof outstanding loans by sources. The table indicates
that if a farmer's outstanding loan is
Rs 100, around Rs 57.7 is from formal
sources and Rs 42.4 is from informal
sources. These percentages provide
interesting information at the state level.
For example, the percentage of loans from
formal sources in Chhattisgarh,Jharkhand,
Orissa and Uttar Pradesh is more than 60
per cent and higher than that of all India.
On the other hand, only 31 per cent of loan
is obtained from formal sources in Andhra
Pradesh. Therefore, the source of loan is
important for examining the extent of
financial inclusion.
Another issue is the inclusion of credit
for small and marginal farmers. Table 2
shows thatthe shareof formal loan sources
increases with the size of land. At the all
India level, the share of loans from formal
sources varies from 22.6 per cent to 58 per
cent for small and marginal farmers, while
it varies from 65 to 68 per cent for medium
to large farmers. Dependence of small and
marginal farmers on informal sources is
high even in states like Andhra Pradesh,
PunjabandTamil Nadu. Forexample, small
and marginal farmers of AP obtain 73 per
cent to 83 per cent of their loans from
informal sources. This indicates very low
financial inclusion for Andhra Pradesh.
The NSS data also shows that across social
groups, indebtedness through formal
sources is lower for scheduled tribes as
compared to others.
Similarly, there are many financially
excluded households such as unorganised
workers, self-employed, artisansand other
vulnerable groups in both rural and urban
areas.2 Finance for housing is anotherarea
where many poor are excluded.

Supply and Demand Side Issues

It is being increasingly recognised that
addressing financial inclusion requires a
holistic approach addressing both supply
Economic and Political Weekly

anddemandside aspects.Althoughthere
hasbeensignificantexpansionin banking
in the last few decades, there are many
banks,
supplysideproblemsforcommercial
RRBsandcooperativebanks.Someof the
criticismson the trendsin ruralcreditin
the 1990sare:(a) narrowingof thebranch

network in rural areas; (b) fall in creditdeposit ratios in rural areas; (c) disproportionate decline in agriculturecredit to
small and marginalfarmers;(d) worsening
of regional inequalities in rural banking
-steepest decline in credit-deposit ratio
in eastern and north-eastern states; and

Table 1: Percentage of Indebted Farming Households by All Sources of Loans,

by Source of Loan and Distribution of Outstanding Loans by Source, 2003
State

Percentage of Indebted
Percentage of
FarmerHouseholds
IndebtedFarming
Householdsin Total
by Source of Loan
RuralHouseholds
Formal
Informal
(AllSources)
4
2
3

AndhraPradesh
ArunachalPradesh
Assam
Bihar
Chhattisgarh
Gujarat
Haryana
HimachalPradesh
Jammuand Kashmir
Jharkhand
Karnataka
Kerala
MadhyaPradesh
Maharashtra
Manipur
Meghalaya
Mizoram
Nagaland
Orissa
Punjab
Rajasthan
Sikkim
TamilNadu
Tripura
UttarPradesh
Uttaranchal
West Bengal
Groupof UTs
All India

54
14
15
23
66
63
76
57
9
44
57
96
64
92
6
2
33
20
68
58
38
18
59
46
47
65
51
42
56

82
6
18
33
40
52
53
33
32
21
62
64
51
55
25
4
24
37
48
65
52
39
75
49
40
7
50
51
49

Percentage Distribution
of OutstandingLoan
by Sources
Formal
5

77
103
88
84
56
49
50
65
94
60
55
40
66
30
99
97
67
79
46
70
81
89
67
55
70
44
73
71
64

31.4
26.9
37.5
41.7
72.4
69.5
67.6
65.3
67.6
64.1
68.9
82.3
56.9
83.8
18.2
6.0
77.3
68.8
74.8
47.9
34.2
57.8
53.4
79.7
60.3
76.1
58.0
59.0
57.7

Informal
6
68.5
73.1
62.6
58.5
27.7
30.5
32.5
34.7
32.3
35.9
31.2
17.6
43.0
16.2
81.9
94.0
22.6
31.1
25.1
52.1
65.8
42.2
46.5
20.3
39.7
23.9
42.1
41.0
42.4

Note: Formaland Informalis morethan 100 per cent because farmersborrowfrommultiplesources.

Source: CalculatedfromNSSO (2005).
Table 2: Percentage Distribution of Outstanding Loans by Formal and Informal Source
across Size Classes of Land in Selected States, 2003
<0.01

0.0 I0.40

Size Class of LandOwned

0.401.012.0 I4.011.00
2.00
4.00
10.00

16.9
36.5
58.3
64.7
24.8
19.1
22.6

19.3
20.8
83.2
62.4
29.2
37.4
43.3

25.1
47.0
80.2
77.1
65.6
46.0
52.8

26.6
66.1
78.8
72.1
49.1
61.5
57.6

41.5
63.4
83.8
88.4
61.2
65.2
65.1

48.6
19.6
88.7
96.9
47.5
74.3
68.8

49.5
70.1
91.1
13.2
30.1
82.9
67.6

31.4
39.2
83.8
74.8
47.9
53.4
57.7

83.2
63.5
41.6
35.4
75.2
80.9
77.4

80.9
79.2
16.8
37.5
71.0
62.5
56.7

75.0
53.0
19.8
22.8
34.5
53.9
47.2

73.4
33.8
21.1
27.9
50.9
38.6
42.4

58.4
36.6
16.2
11.7
38.8
34.7
34.0

51.4
80.4
11.3
3.2
52.4
25.7
31.2

50.5
29.9
8.9
86.8
70.0
17.2
32.8

68.5
58.5
16.2
25.1
52.1
46.5
42.3

State

Formalsources
AP
Bihar
Maharashtra
Orissa
Punjab
TamilNadu
All India
Informalsources
AP
Bihar
Maharashtra
Orissa
Punjab
TamilNadu
All India

10.00+ AllSizes

Source: CalculatedfromNSSO (2005).

October 14, 2006

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4311

(e) crippling of the RRBs.3 Political interference including loan waivers and writeoffs also resulted in unviability and sickness in some of the formal rural credit
institutions.
One issue is whether we need separate
institutions for promoting financial inclusion. Existing formal institutions may be
sufficient for this purpose. It is true that
commercialbankshave theirown problems
such as manpower shortage, an unfavourable attitude towards rural services, infrastructureand technology problems in rural
areas, etc. Ruralbanking has to be friendly
to small and marginal farmers and other
vulnerablegroups.It requiresa specific type
of organisationalethos, cultureand attitude
[Rangarajan2005]. The cadre of officers in
ruralbranches has to develop this attitude
and promote financial inclusion of low
income groupstreatingit both as a business
opportunityas well as social responsibility.
There is a need to address the supply side
problems in commercial banks, RRBs and
cooperative banks. As the last year's union
budgetadmits,"thecooperativebanks,with
few exceptions, are in shambles". This
institutionhasto be revived as many farmers
are dependent on the credit from these
banks. The Vaidyanathan Committee's
recommendationsmay be helpful to revive
cooperative sector.
So far we have been discussing mainly
the issues relating to credit. Savings, insurance and other financial services are
also important.NSS datashows thataround
88 per cent of rural households in 2002
reportedone or the other form of financial
assets under "deposits" which include
deposit accounts with banks, government,
certificates, post office deposit accounts,
private deposits, insurance policy and
cash in hand.However, it may be noted that
only 6.82 crore households out of a total
of 19.9 crore households (around 36 per
cent) availed of banking services to have
a deposit account in 2001. Therefore, there
is a lot of scope for business opportunities
for banks to include deposit-excluded
households.
The poor face many individual and
covariate risks such as droughts, floods,
cyclones, fires, theft, pest attacks, sharp
falls in prices, health problems, accident,
death of a family member, etc. They need
some kind of insurance to cope with these
risks. The supply of insurancemechanisms
has increased in the last decade. With the
opening up of insurance to the private
sector,the pricingof insuranceservices will
see some changes. Too much under-pricing
4312

of these schemes by the government may

not be sustainable for both the public and
private sectors.
On the demand side, some of the constraining factors for financial inclusion in
ruralandurbanareasarelow productivityand
risk and vulnerabilityof small andmarginal
farmers, low skill and poor market linkages for ruralnon-farmand urbanworkers.
vulnerability to risk for rural landless and
urbanpoor, inadequateawareness and low
financial literacy. In order to improve
demand, the suitability of existing financial products for the farmers/poormust be
assessed. For example, the ruralpoor do not
even have a safe place to keep theirsavings,
let alone thinking about the demand for
credit. Suitable mechanisms have to be
explored for addressing the risks faced by
farmers and other poor, risks such as
weather, price, yields, technology, etc.
Moreover, financial instruments have to
be developed in such a way that they
promote economically viable activities.
The financial institutions have to educate
the poor and vulnerable by giving wide
publicity to their financial instruments,
e g, no frills bank accounts.

Role of Self-Help Groups

The RBI recognised the problem of
financial exclusion in the annual policy
statement in 2005 and since then has initiated several policies aimed at promoting
financialinclusion of especially pensioners,
the self-employed and those employed in
the unorganised sector.4 Some of these
include "no frills" banking accounts, a
simplified general purpose credit card
(GCC), introduction of a pilot project for
100 per cent financial inclusion, etc.
NABARD has also taken several initiatives that have significantly contributedto
financial inclusion. The self-help group
(SHG)-bank linkage programme of
NABARD is an innovative programme.It
started as a pilot programme in 1992.
We now have 22 lakh SHGs under this
programme, comprising more than three
crore poor households who are accessing
credit throughcommercial and cooperative
banks. Every year six lakh SHGs are
added. The programme is no longer
confined to southern states. The nonsouthern states have 46 per cent of the
groups. Thus, the SHG movement is now
a national movement.
There have been several institutional
innovations in financial services by
including civil society. Followed by the

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success of SHG-bank linkage programme

and the Bangladesh Gramin Bank model,
many of the NGOs have taken to financial
intermediation by adopting innovative
delivery approaches. Following the RBI
guidelines in 2000, commercial banks
including RRBs have been providing
funds to microfinance institutions (MFIs)
for on-lending to poor clients. Though
initially only a handful of NGOs were into
financial intermediationusing a variety of
delivery methods, their numbers have
increased considerably. A large majority
of MFIs operate on much smaller scales
with clients, with the latternumberranging
from 500 to 1500 per MFI. However, a few
non-banking financial company (NBFC)
MFIshaveanoutreachof morethanone lakh.
MFIs have been playing an important
role in substituting moneylenders and
reducing the burden on formal financial
institutions.5 The competition created
in the form of developing several nonbankingfinancial institutions in ruralareas
and the SHG movement has also reduced
the interest rates in the informal credit
market.6
With the objective of ensuring greater
financial inclusion and increasing the
outreachof the banking sector, banks have
been allowed to use the services of NGOs,
self-help groups, MFIs and other civil
society organisations as intermediaries in
providing financial and banking services
through the use of business facilitator and
correspondent models. Provisions for this
kind of financial intermediation have
opened new and diverse avenues to address
the issue of financial inclusion by banks.
NABARD also has some other initiatives
like thejoint liability group approach,Rytu
Mitra Groups in AP.
One can also learnlessons from successful experiences in andoutside India.Within
India, we have good and successful practices for credit like the Kudumbasree
programme in Kerala and the Velugu
(IndiraKrantiPadhakam)SHG programme
in Andhra Pradesh. We also have good
practices in SEWA (health) and BASIX
(livelihoods) for insurance, while the
Pondicherrypilot projectoffers lessons for
bank accounts. We can also learn from the
successful practices in countries like
Bangladesh, Thailand, Indonesia, Mexico
and Brazil.
There are some issues, which have to be
sorted out regarding the SHG movement
and MFIs. Some of these are: Are the
SHGs really self-help groups or are
they receiving lot of subsidies from the
Economic and Political Weekly

government or donors? What will happen

if the subsidies are removed? Are the
interest rates of 24 per cent to 36 per cent
charged by MFIs justified? What types of
terms and conditions are needed for better
functioning of MFIs?

Productivity of Small Farmers

and Other Vulnerable Groups
Ultimately, financial inclusion will be
successful only if the productivity of the
small and marginal farmers, rural nonfarm enterprises and other vulnerable
groups is sustained with viable economic
activities. We have to recognise thatfinancial inclusion for farmers cannot be sustained by the banking system alone as there
is a need for other measures like public
investment in irrigation, research and
extension, infrastructure in rural areas,
proper seeds and fertilisers, a good marketing system for better price. etc. Small
and marginal farmers face many risks in
cultivation. Financialinclusion should take
into account the risk elements experienced
by farmers while framing policies. Banks
should provide credit plus services to the
farmers and the ruralnon-farm sector. The
agricultural officers must provide "farm
advisory" services thatwill help in making
agriculture an integrated activity with
appropriate backward and forward linkages [Rangarajan 2005]. Rural banking
has to be restructured so that credit will
be supplemented with farm and non-farm
advisory services.

Conclusion
The purpose of this note is to flag the
importance of financial inclusion in improving the living conditions of poor
farmers, rural non-farm enterprises and
other vulnerable groups ariddiscuss a few
importantissues and challenges. It does not
cover all the issues due to space constraints.
The concept of financial inclusion covers
wider financial services such as credit,
savings, insurance,etc. We have noted that
financial exclusion in terms of access to
credit from formal institutions is high for
small andmarginalfarmersandsome social
groups. For example, even in a state like
AndhraPradesh, 73 per cent to 83 per cent
of outstanding loan for small and marginal
farmers is from informal sources such as
moneylenders and traders. Supply and
demand problems have to be solved with
appropriatepolicies. Banks should look at
financial inclusion both as a business

opportunity and as a social responsibility.

Apartfrom formal banking institutions,the
role of the self-help group movement and
MFIs is important to improve financial
inclusion of people. However, some
regulatory proceduresfor MFIs may have
to be evolved by having consultations with
MFIs, consumers and the government.
Depoliticisation of the financial system
is needed for maintaining the viability
of formal financial institutions. The risk
elements of small and marginal farmers
and other vulnerable groups have to be
taken into account in framing policies
for financial inclusion. For improving
the productivity of small and marginal
farmers and improving the skills of rural
non-farmworkers,the bankingsystem may
have to undertake credit plus advisory
services. [lr1
Email: profmahendra@yahoo.co.in

Notes
[These are the personal views of the author.]
1 Formoreon thedefinitionof financialinclusion
see Thorat (2006).
2 On household indebtedness see NSS report
no 501, All IndiaDebt andInvestmentSurvey
published in 2005.
3 More on this see Shetty (2003) and articles in
Ramachandranand Swaminathan(2004).
4 More on the initiatives of RBI on financial
inclusion, see Usha Thorat (2006).
5 On the approachof RBI on micro finance, see
Reddy (2005).
6 See Mahajan(2004).

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Finance, Governmentof India.
Mahajan,Vijay (2004): 'Deregulatingthe Rural
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NSSO (2005):Indebtednessof FarmerHouseholds
2003, NSS Reportno 498, CentralStatistical
Organisation,Governmentof India.
Ramachandran,V K and M Swaminathan(2005):
Financial Liberalisationand Rural Credit in
India, Tulika Publications,New Delhi.
Rangarajan, C (2005): 'Agricultural Credit:
Reaching the MarginalisedFarmers',lecture
delivered at the Bankers' conference
(BANCON) 2005, Kolkata, November 12.
Reddy, Y V (2005): 'Micro Finance: Reserve
Bank's Approach', RBI Bulletin, September.
Shetty, S L (2003): 'CreditFlows to RuralPoor',
mimeo, EPW ResearchFoundation,Mumbai.
Thorat,Y S P (2006): 'IndianBanking:Shaping
an Economic PowerHouse', lecturedelivered
atBankingConclave2006 organisedby FICCI
at Kolkata, July 31.
Thorat, Usha (2006): 'Financial Inclusion and
MillenniumDevelopmentGoals',RBIBulletin,
February.

October 14, 2006

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4313