Banks as Drivers of Financial Inclusion

Team members:

Pramod Athani
Ashutosh Mishra
Chaitali D. Patil
Kavita Sengar
Nitesh Aggarwal
 Table of Contents

1. Introduction 03
2. Financial inclusion 04
3. Financial exclusion 05
4. Who are excluded 05
5. Why are they excluded 06
6. Rationale behind financial inclusion 07
7. Challenges to financial inclusion 08
8. Role of Banks in financial inclusion 09
9. public sector banks 09
10. private sector banks 09
11. Micro finance institutions 10
12. Committee on financial inclusion 11
13. Role of information and communication technologies in financial inclusion 12
14. Conclusion 13
15. References 14
Introduction:

Former UN Secretary-General Kofi Annan said

“The stark reality is that most poor people in the world still lack access to sustainable financial
services, whether it is savings, credit or insurance. The great challenge before us is to address the
constraints that exclude people from full participation in the financial sector. Together, we can and
must build inclusive financial sectors that help people improve their lives.”

India has huge rural population that is economically underdeveloped, this makes financial
inclusion indispensable. Banks especially public sector banks have a huge role in meeting this
challenge.
Financial Inclusion
We have all heard of the terms like inclusive growth, financial inclusion, and equitable distribution of
income, but what exactly these terms mean and why are they important to us as a rapidly developing
country. In this paper, we make a modest attempt to understand these, specifically, financial inclusion
and the role of banks if any in this regard.

What is financial inclusion?

Dr. C. Rangarajan committee on financial inclusion defines it as:

"Financial inclusion may be defined as the process of ensuring access to financial services and timely
and adequate credit where needed by vulnerable groups such as weaker sections and low income
groups at an affordable cost."

The financial services include the entire range - savings, loans, insurance, credit, payments etc. The
financial system has to provide its function of transferring resources from surplus to deficit units but
both deficit and surplus units are those with low incomes, poor background etc. By providing these
services, the aim is to help them come out of poverty. So far, the focus has only been on delivering
credit i.e., microcredit and has been quite successful (barring the recent controversies relating to MFIs
which we discuss later in this paper). Similar success has to be seen in other aspect of finance as well.
Financial Exclusion

Financial exclusion refers to the lack of accessibility to financial products and services by various
groups of people due to a variety of reasons.

Who Are Excluded:

In India we observe that a number of groups are outside the financial net. We note the following
categories of people who are either partially or completely outside the financial network. This is not the
exhaustive list.

Farmers: an unbelievably large number of rural small farmers are still outside the
institutionalized financial network. These farmers still depend on the village money lenders who charge
stratospheric interest rates.

Village non-farmers: Rural people who are not engaged in the farming activity but are engaged
in other activities such as trading and other vocations are also outside the institutionalized financial
network.

Urban and semi urban wage laborers: These are often illiterate, daily wage earners who lack
the knowledge of banking and other financial products and services.

Urban and semi urban people: Many people in the urban and especially semi-urban areas lack
the access to the financial products and services form institutionalized financial players and rely on the
informal actors, which leads to a number of undesirable situations.

Minority community members: People from the religious minorities are also found to be
lacking access to the financial products and services for various reasons.
Why Are They Excluded

Here we try to point out some of the reasons why these categories of people are excluded from the
financial network.

High cost: High cost has been percieved as major barrier in the financial inclusion of the rural
and urban poor people. For example, to open a savings account one needs a minimum of Rs. 500
typically. This may deter a number of people from opening such accounts. It is said that good
banking/saavings habits begin with a savings account.

Attitudinal aspects: Many of these categories of underbanked or unbanked people are not
comfortable in using formal financial services. Reasons range from lack of good savings habit and a
feeling of intimidation in understanding the language, various documents, terms and conditions etc.

Lack of physical access: Many villages are so farflung and sparsely populated that formal
financial institutions find it difficult to set up operations. Hence these people never encounter the
institutional players.

Lack of awareness: Many people lack the awareness of the various financial products and
services. i.e., they are not financially literate. This is also one of the major reasons why people do not
transact with the financial institutions

Illiteracy: A significant part of our county's population is still illiterate, which along with a
number of other things acts as barrier in financial inclusion.

Infrastructure issues: setting up infrastructure for serving these poorer section of society is
difficult and costly, hence many institutionalized players shy away from it

Nonfeasibility: Operations in sparsely populated areas, where the volume of transactions is not
very high is a major problem.

Lack trained manpower: Studies have found that there is a lack of well trained workforce to
operate in such areas. For example the banks lack adequately trained workforce to work in rural bank
branches which will instill confidence in their rural customers and make for a pleasurable experience.

Lack of required technology: Formal institutional players lack the required information and
communication technology to operate cost effectively to serve these class of customers.
Rationale Behind Financial Inclusion

Banks and other financial institutions play an important role in the economy of a country. They
are recognized as a factor of growth and production. These institutions are primarily responsible in the
efficient allocation of finance capital in the economy. Most advanced market based economies of the
west have a well developed financial sector. The recent financial crisis only underscores the centrality
of these institutions albeit in a negative light.
Research has shown that financial literacy and participation in various financial institutions
helps in making people financially responsible. Hence without adequate understanding and
particiapation, a large portion of the population is missing out on the fruits of the economic growth of
the country. If left untackled, we risk unequal distribution of wealth, and as a consequence a number of
social challenges.
Challenges In Financial Inclusion

In India, institutionalized financial players face a number of issues, because of which financial
inclusion has not been achieved. Some of them are discussed below:

Large area: India has a large area, with over five lakh villages that more often than not poorly
connected by roads, setting up branches in these places is infeasible. Hence a considerable polulation is
left out of the net.

Cost of small value transactions: Rural people and urban and semi-urban workers typically
transact in small amounts. The cost of these small value transactions is considerably high. Without the
use of modern technology and better business models, this would remain a major problem.

Weak delivery model: A number of banks and other instiotions have a weak delivery model
that lacks the effectiveness in delivering products and services.

Unsuitable Products: Banks and other instituins do not have produccts and services that are
well suited for their prospective customers. This lack of fit between the customers needs and the banks
offerings make the financial inclusion that much more difficult.

Civil unrest and violent movements: Maoist movement and other sub-nationalist movements
in North eastern part of India have for long been a barrier in opening of these institutions.
Role of Banks In Financial Inclusion

Banks, specifically commercial banks, have a huge role in the financial inclusion. It is said that
the habit of savings and investments begins with the savings account. Towards this end banks have a
role in bringing the underbanked and nonbanked people into the financial network. Banks can also
vitally help these sections of the society by providing timely credit which will help these people in
engaging in economically productive edevours.
Having examined the challenges to the financial inclusion, our team feels that the onus lies on
the government and the Reserve Bank of India to push the banks and other financial institions to take
steps in this regard.

Public sector banks:

Since the government is a majority stakeholder in public sector banks, it can direct these banks
into these areas. Given the size of these banks, they can make a significant impact in this regard.

Private sector banks:

Government and RBI have hinted to the private banks that those who are found lax on the
financial inclusion will be dealt with stearnly (see references). Private banks once nudged into this area
are likely to find innovative business models to keep up with the bottom line pressures.
Micro Finance Institutions

We have seen a phenomenal growth of operations in the micro finance institutions. Combined with an
innovative business model, the MFIs have managed to scale their small value lending to a very high
level. This has been seen by some, as almost a panecea that would eradicate poverty in the rural areas.
However, this group is sceptical of such a view owing to the recent revelations of their practices
especially in the state of Andhra Pradesh.
We believe firstly, that the for profit MFIs have their own dynamic and are driven by bottom
line pressures which sometimes manifests itself in their business practices. We have come across the
news of more than one MFI using coercive methods for loan recoveries. Practices such as threatening,
social ostracizing, forceful recoveries have led to suicides.
Second, the lack of transperency in the effective interest rates charged by these MFIs is making
the matters worse. Some of the villagers claim, and these seem to be credible, that the effective interest
rates charged by these MFIs can go upto 42% per annum. Clearly these are usurious and regulators
must ensure that MFIs clearly specify the interest charged by them.
Third, there is a considerable lack of financial literacy, which in this case sadly manifests itself
as cyclic debts. That is laons taken to pay off previous loans. There is a need to educate the people
about the advantages and risks involved in these financical products and services.
Fourth, till now the regulators especially the RBI has not taken firm punitive action even though
there have been several cases of maltreatment of villagers by the MFIs.

Our group is of the view that the commercial banks especially public sector banks should take
their job seriously and use some of the innovative models that MFIs have used. It is also our view
regulating the for profit MFIs would be difficult at most owing to their political power, and in the
absence of effective regulation, we would be replacing the village money lender with the corporate
MFIs with all their negative effects.
Committee On Financial Inclusion

Government of India constituted a Committee to enhance financial inclusion in India on 22 June 2006.
The Committee presented its report in January 2008. The report has analyzed financial inclusion in
detail.

CFI has initiated a mission called National Rural Financial Inclusion plan. It has set targets to
increase FI in the country across regions and across institutions (banks, rural regional banks etc). It has
suggested measures to address supply and demand constraints in increasing financial inclusion.

The measures to address supply constraints aim to provide finance (via banks, microfinance
etc). Demand constraints imply that despite the supply people do not come forward because of number
of factors.

The report says:

It is widely recognized in economic literature that there are at least five different types of capital -
physical (roads, buildings, plant and machinery, infrastructure), natural (land, water, forests, livestock,
weather), human (nutrition, health, education, skills, competencies), social (kinship groups,
associations, trust, norms, institutions) and financial.
One of the causes as well as consequences of poverty and backwardness is inadequate access to all
these forms of capital. Thus to look at financial inclusion in an isolated way is problematic.

The interim report was presented before the Budget of 2007-08. The Finance Minister in the Budget
decided to implement, immediately, two recommendations. The first was to establish a Financial
Inclusion Fund with NABARD for meeting the cost of developmental and promotional interventions.

The second was to establish a Financial Inclusion Technology Fund to meet the costs of technology
adoption. The overall corpus for each fund was Rs.500 crore, with initial funding to be contributed by
the Central Government, RBI and NABARD.

In the 2008-09-budget statement, the Finance Minister proposed two more measures: one to add at
least 250 rural household accounts every year at each of their rural and semi-urban branches of
commercial banks (including regional rural banks) and two, to allow individuals such as retired bank
officers, ex-servicemen etc to be appointed as business facilitator or business correspondent or credit
counselor.
The Role Of Information And Communication Technology In
Financial Inclusion

This group is of the strong opinion that the solution to the problem of Financial Inclusion in
India is IT. The existing infrastructure framework should be made effective use of to speed up the
financial inclusion.

Postal Network: The government should consider tying up with private banks to deliver
financial solutions to the un-banked, using its extensive postal network. The synergistic outreach of the
existing postal system supplemented by banking functions is the answer to the challenges posed by
rural markets. India has one of the world’s largest postal systems with its branches in the remotest
areas. The people can easily connect with the postman this can be used to provide financial cover to the
excluded masses and gradually full-fledged banking services may be extended.

Mobile Banking: The transaction costs can be radically reduced even in remote locations
through M-banking. Digital Divide could be exacerbated at a lower level. The costs, ease of access for
the consumers and the profitability of providers will ultimately decide the level of wireless penetration.

Ubiquitous Technology: Rural banking must deliver an easy user experience which requires a
ubiquitous technology with an innovative Geographical User Interface (GUI).
Conclusion
Financial Inclusion is needed for rural and downtrodden masses that are the future growth
engine of the economy. One cannot undermine the need to include the economically underprivileged in
the mainstream banking sector. The role of various technology tools and associated technologies in
providing financial solutions to the unbanked is also substantial. Rural ATMs, plastic cards (like smart
cards, biometric cards, etc.) and mobile payment technologies do have the ability to engage the
unbanked sections. The public sector banks have a social duty to engage in this drive. Financial literacy
and engagement can indeed be achieved if time bound effectively monitored programmes are
undertaken.
References:

1. “Public sector banks step up financial inclusion drive” The Hindu Business Line
http://www.thehindubusinessline.com/2010/09/24/stories/2010092451760600.htm
2. “Private banks lax on financial inclusion may lose Govt biz” The Hindu Business Line
http://www.blonnet.com/2010/02/04/stories/2010020451230600.htm
3. “RBI banks on technology to drive financial inclusion” The Hindu Business Line
http://www.blonnet.com/2010/01/12/stories/2010011251391700.htm
4. “Financial Empowerment of Rural Indian Households” http://skoch.in/fir/Financial%20Inclusion
%20and%20Empowerment%20of%20Indian%20Rural%20Households.pdf
5. "Financial Access For All Still Miles to Go” http://skoch.in/fir/Financial%20Access%20For
%20All%20Still%20Miles%20To%20Go.pdf
6. “Half the world is unbanked” Financial Access Initiative
http://financialaccess.org/sites/default/files/110109%20HalfUnbanked_0.pdf
7. “Financial Inclusion: An Introspection K G K Subba Rao” Economic and Political Weekly
Jan 13-19 2007