Half a Nation! - Financial Inclusion Lessons for India

Key Words – Financial Inclusion, Mircrofinance, Customization, Poverty Alleviation Programmes, Technology

Abstract

Today India may boast of 7-8 percent GDP growth but still 50 percent of the population lives below the international poverty line. The economic success of India is a representation of less than half the nation. Imagine the growth possible if the other half is integrated into the mainstream economy. Financial inclusion is the key for this. This study was conducted during May-July 2011 at the Reserve Bank of India, Chandigarh, India. Financial inclusion in India is very poor with 51.4 percent of 89.3 million farmer households being excluded from any source of credit. A cross-country comparison of India with Sri Lanka, Bangladesh, France, Indonesia and Philippines has been conducted. A door-to-door survey was carried out in three relatively prosperous villages in Panchkula district of Haryana, a state where officially the financial inclusion programme has largely been successful. Results show that although most households have a bank account, these are hardly used. Thus the financial inclusion policy, where successfully implemented has addressed access; however comprehensive financial inclusion, including access to services like credit, savings, insurance, pension plans, has not been achieved. Thus right from the policy level the aim should be “usage” with better implementation and not mere “access.” A different approach for India has been suggested for tackling this problem.

Introduction

According to Dr. C. Rangarajan, 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. More than half the world’s adult population, that is an approximate 2.5 billion adults do not use any form of formal financial service. 2.2 billion of these adults live in Africa, Asia, Latin America, and the Middle East. National Sample Survey Organisation data reveal that 45.9 million farmer households in India (51.4%), of the total 89.3 million households do not access credit.¹

Why financial inclusion?

Financial inclusion is extremely crucial for poverty reduction and equitable growth, especially for the developing nations. Today development in most developing countries is a result of the contribution of the economically top few percent of the population. Through financial inclusion it is possible, over a period of time, to transform these economically deprived people into a large section of society that actively contributes to the economic development. This further leads to a snowball effect. With financial inclusion, banks gain business. For example, in India 49.5 million farm households can be included financially. Financial inclusion and electronic mode of payment can be used to check pilferage of funds to a large extent. Finally, financial inclusion opens up access to a large market, which creates opportunities for global market players and foreign investment, increasing employment in developing countries.

Thus, it is important to understand that the purpose of financial inclusion in India is the integration of the financially excluded into the mainstream banking system, thus providing them a platform for empowerment out of their state of economic and financial deprivation. In India, financial inclusion is being carried out under the Reserve Bank of India through the “Lead Bank.” A lead bank is identified for every state and is mandated to cover all villages, with a population of 5000 or more, with a bank branch within 5 km., within the stipulated time period. A brief analysis of financial inclusion strategies in different countries has been conducted with special emphasis on factors of Indian relevance.

France - Although it is a statutory right to have a bank account in France and 99 percent of the households have a bank account, people find it difficult to use the financial services.² Often customers do not possess a clear understanding of banking system, deterring the use of various banking services and the repayment of credit. Banks often seek to limit their risks and costs and may charge as fees from the client. This scenario of misunderstanding and insecurity prevents people from utilizing banking services.³ The narrow perception of financial inclusion to merely the ability to access to a bank account presents a rather skewed view of the problem. Mere access doesn’t allow the presumption of successful usage.

Thus, from the Indian context, it is a must to remember that the huge financial inclusion discourse of the current time must not be only limited to opening up of a bank account or a bank branch in the vicinity of the village. Further, it must be noted that fear and insecurity towards the banking process is prevalent in the Indian society to a large extent. Thus schemes must concentrate on awareness and the ability of usage as much as on mere access.

Indonesia - After a poorly performing subsidized credit program called BIMAS in 1880s, Indonesia’s government rural bank, Bank Rakyat Indonesia(BRI), implemented a new model called the BRI Unit Desa System. This involved simple branches offering savings and microenterprise credit to the self-employed across the country. A profitable scheme, BRI’s Unit Desa System, now serves tens of millions of clients.⁴ A case study on the BRI branches and village units (unit desa) identifies the following factors contributing to the success of the BRI:⁵

Thus, this case highlights the importance of proper customization of the program to the particular case, innovation according to the environment and sustainability of the program. Every program should incorporate a mechanism to check or at least minimise political interference thus ensuring transparency in the system.

Philippines – The Philippines, an island nation, has 71 dialects, 80 provinces, 17 regions, 41,960 Barangays. The Philippines has followed a diverse approach with respect to financial inclusion.⁶ It has encouraged many institutions like small local banks, NGOs, and specialized microfinance banks. Thus, although local initiatives of social entrepreneurs and varied social groups contribute, the government plays a sound, supportive, regulatory role.⁷ Interestingly the Philippines doesn’t have one national policy on financial inclusion. Although key aspects are given in the National Strategy on Microfinance, various government schemes in the area of financial inclusion undertake initiatives related to their respective jurisdiction and legal mandate.⁸ The Economist Intelligence Unit has ranked the Philippines second in the world in its “Global microscope on the microfinance business environment 2010,” which rates countries according to their microfinance regulatory and market infrastructure. The Philippines is a leader in mobile money and related regulation.⁹ Mobile network operators or other non-bank entities licensed as “electronic money issuers” must abide by set standards and guidelines. Now there are 8 million users of e-money and 28,000 cash-in/cash-out agents nationwide.¹⁰

Similarly in India there is huge diversity in terms of geography, culture, religion, and language. Thus, the approach has to be customized according to the people of the region and brought under a standard regulatory framework. Technology can be effectively leveraged to provide last mile coverage.

Sri Lanka - According to a 2009 GTZ study on financial inclusion in Sri Lanka about 82.5 percent of households have access to financial institutions. The National Development Trust Fund is the biggest wholesale lender for microfinance institutions in Sri Lanka.Poverty Alleviation Microfinance Projects (PAMP I and II) were started to establish a sustainable microcredit delivery system for the poor. Further, The Hatton National Bank (HNB) in Sri Lanka uses the concept of the Barefoot Banker to set up a number of village-level schemes to distribute loans. Loans up to LKR 15,000 (USD 165) can be approved without formal collateral. Over 600,000 students have been a part of the saving system through HNB’s network of 200 student banking units, and the bank holds savings deposits up to nearly USD 40 million from these students. In addition, National Saving’s Bank’s youth savings program reached nearly 390,000 youth with a total savings of LKR 3.4 billion (USD 30 million) by the end of 2005.¹¹

Despite many drawbacks, Sri Lanka is doing relatively much better in the field of financial inclusion. This may be due to many factors. Due to lesser incidence of poverty (about 15%), microfinance becomes more viable. In India programs may be modelled as “poverty alleviation microfinance programmes.” Literacy rate is about 92 percent. A better literacy rate can be linked to better awareness of financial services and an open mindset towards using them. In India, impetus to financial literacy is a must, along with financial inclusion. Women are actively involved in the economy. During 2003-2007 of the estimated worker contracts abroad, on average, 65 percent have been females. Around 80 percent of exports have been dependent largely on the fortunes of the garment industry in which over 90 percent of employees are women.¹² Financial policy in India should be designed to specifically empower women. The network of schools is quite wide in India and can be harnessed as a tool for propagating financial literacy and usage of services. The youth form a major chunk of the Indian population, and inculcating in them financial habits can be a crucial step for the future. Similarly, post offices can also be used for the purpose of financial inclusion.

Grameen Bank, Bangladesh has its own products and services, targeting criteria, system of credit delivery, and recovery. Its underlying philosophy is that credit is a fundamental right. Grameen Bank is a trust-based bank, which offers loans without any collateral. It has very clientele friendly and flexible credit delivery and recovery mechanism. As of September 2008, Grameen has 40,016 centers, 98,038 groups, and about 7.6 million members. Ninety-seven percent of its members are women. Grameen has mobilized more than US$ 826 million as deposits including US$ 373 from non-members (Sept. 2008). The deposit as a percentage of outstanding loans is 136 percent. The interest rate charged on loans by the Grameen Bank is lower than the rate of interest fixed for the government-run microcredit programs. Yet the Grameen Bank has earned a profit in every year except 1983, 1991, and 1992. The bank has a decentralized system, and it follows a participatory approach. At the same time the entire system is made transparent by strict monitoring through a strong Management Information System (MIS). It also has a strong internal audit system.¹³ Thus in the case of financial inclusion the objective of poverty reduction should be made crystal clear. Special strategies must be made to effectively target the poorest.

Financial Inclusion in India

The status of financial inclusion is quite poor in India. India has 2.4 percent of the world’s geographical area and 16 percent of its population. Within the vast Indian population there are many types of people who speak a number of languages, come from varied cultures, and have diverse mindsets. There are many social distinctions between people on the basis of minority groups, caste, and religion. There are many parts of India (like Jammu & Kashmir, North Eastern States, and Naxalite regions) that are politically unstable. A majority of the population lives in rural areas. Due to low literacy levels the awareness level of most people regarding financial services is abysmally poor. All these factors call for a specialized policy.

Panchkula village case study - As an estimation of the ground reality of the financial inclusion status, a door-to-door in-depth interview-based survey on bank usage was conducted in 3 villages (Kidarpur, Nandpur, Jallah - consisting of 205 households) of district Panchkula of Haryana.

Methodology – A questionnaire was designed and filled out based on the interviews conducted with the people. One household was taken as one unit. Important questions included whether anyone in the household had a bank account, frequency of usage of banking services, types of financial services availed, and problems faces with the banking system. The respective bank account number was also noted for authentication. Out of the 205 households in these 3 villages, responses could be recorded from 178 households. The questionnaire response and the interviews were conducted in the local language, Hindi.

Characteristics of sample space – These three villages were economically better off. More than 90 percent of the households have an average annual income between Rs. 10,000 and Rs. 50,000. Most of them are farming households. This survey was conducted on a rather small sample set of the population and therefore no blatant generalization would be inappropriate. However detailed personal interviews were conducted during the survey process. It can safely be used as an approximate indicator of the people’s attitude towards the banking system.
Results - Of these all households had a bank account. However usage was very low: 38.2 Percent (68 households) had not made even a single transaction in the past six months or since the opening of the bank account, whichever was lesser; 25.8 percent (46 households) had made one transaction; 19.6 percent (35 households) had made two transactions; 10.1 percent (18 households) had made three transactions; and only 6.1 percent (11 households) had made more than 3 transactions in the same time period. Interestingly, the majority of the people have used only the saving deposit facility of the bank. Only a few odd households had ever used credit or some other facility of the bank. The main hurdle in the usage of the banking services was cited as the excessive paper formalities related in the process. Among the secondary reasons were poor awareness among the people and distance of the branch of the bank. Also it must be noted that people had many doubts and suspicions towards the banking institutions. Many people were even hesitant to provide information and to that extent there is a possibility of error.

Discussion - From this ground-interaction with the people, it is evident that the current strategy of financial inclusion is inadequate. It’s primary focus lies on the opening of a bank account and to that extent it is even successful. Although that is the first step, it must be accompanied with foresight and action to enable the masses to actual benefit from the entire scheme.

Problems with the current system - Currently the Reserve Bank of India is following a large-scale programme for financial inclusion. At the same time, many government departments are undertaking various PAPs like the Swarna Jayanti Gram Swarozgar Yojana (SJGSY), Jawahar Gram Samridhi Yojana, Employment Assurance Scheme etc. Despite these giant initiatives, targets are left unmet, and poverty level is too high with respect to the enormous funding pumped into PAPs. On the other hand, the financial inclusion campaign remains incomplete. Currently the sole stress is laid on opening of a bank account. Actual usage and activity of the account are very limited. Many accounts lie dormant. Awareness about other facilities of the bank is very low. Banking schemes are not very poor-centric, and many people have lots of inhibitions while approaching the bank. This defeats the very objective of financial inclusion and mobilizing the below-poverty line families.
The banks find it a burden to open branches in rural areas, as they may not be economically viable. People also have a fear of the banking system and prefer the informal sector. Further policy is made at the central level, and unilateral policy orientation is adopted for a country as diverse as India. Finally a lot of funds, designated for public welfare, are diverted into the black market.

Based upon the analysis of financial inclusion strategies adopted by other countries and the insights gained through the field survey, a different approach to financial inclusion in India has been suggested here. The aim behind this approach is to

A Different Approach

An approach with certain vital modifications has been presented here. It is a basic conceptual presentation here and can be further developed.

The entire financial inclusion framework and policy should be integrated with poverty alleviation programmes (PAP). Both these campaigns should be brought under one integrated policy framework for effective poverty alleviation and financial inclusion as an aspect of it.
Today financial inclusion in India is carried out under the guidance of the RBI, through the lead bank scheme. Most banks are hesitant to open branches in remote areas. People are also not very open to the idea of formal sector banking. Along with opening of a bank account, it is essential to enable capital formation. This integration is important to enable actual usage-based financial inclusion and not the mere opening of a bank account. Along with the integration of these two aspects, an overhauling of the PAP is needed.

While integrating financial inclusion with PAP, banking needs to be made more user-friendly and specific for poor customers. Looking within the Swarnjayanti Gram Swarozgar Yojana, studies show that only one-eighth of the beneficiaries belonged to below poverty line, while for the Grameen Bank programme only 4.2 percent were outside the targeted population. According to Prof. Muhammad Yunus, a financial system for the poor should bring the disadvantaged people within the folds of some organizational format, which they can understand and can find socio-political and economic strength in it through mutual support. It should create opportunities for self-employment and income for the poor and be cost-effective, sustainable, need-based, and flexible.¹⁴

Under this integration, all public welfare payments may be made via a bank account. This is being done with respect to National Rural Employment Guarantee Act (NREGA), however the extent of coverage is very low. Although there are some standalone initiatives like the pension e-payment system in Jharkhand and the electronic crediting of payments by the Punjab Foodgrain Corp to the bank accounts of Punjab farmers, there is no holistic change in the pipeline. According to a 2010 McKinsey study, Inclusive Growth and Financial Security,¹⁵ a complete electronic mode payment system would directly benefit the nation by Rs 1 lakh crore. The largest benefit would accrue to the welfare schemes to the tune of 82 percent of total savings. The cost of the required infrastructure is estimated between Rs 60,000 crore and Rs 70,000 crore. This cost would be recovered in the very first year of operation, with expected benefits estimated at Rs 1,00,000 crore.¹⁶

During 2001-07 in Jammu and Kashmir, out of the total 71,639 sponsored cases, banks sanctioned loans in favor of 34,616 cases and the amount was released in only 30,107 cases (42%). Lack of co-ordination between banks and the implementing agencies also widens the gap of financial exclusion. Due to illiteracy, the borrowers are not able to complete the formalities in time. In a survey of SHG leaders of Jammu and Kashmi, it was observed that 27 percent of the respondents found the procedures time consuming, 23 percent of the respondents mentioned that the government officials were not much interested in the programme, and 16 percent mentioned that officials indulge in bribery.¹⁷ If PAP and financial inclusion are brought under the same umbrella, then bank loans can be facilitated through RBI directives, which the banks are mandated to follow.

It may be argued that many of these measures are in place. However the point here is that currently there is a huge PAP agenda followed by the Government and an equally large financial inclusion agenda being followed by the RBI. Both of these should be aligned together and made a matter of unilateral policy.

Financial literacy is as important as financial inclusion. Without knowledge of the scheme, people often feel hesitant to approach the banking institutions. There is a fear that they might be charged extra or be unnecessarily harassed. Therefore, it is essential for the people to be made aware of the nuances of the programmes. The Reserve Bank of India is vigorously concentrating on the expansion of the banking network into rural India. However, this must be accompanied by awareness generation regarding the user-friendly nature of the banking services. This may be accomplished by providing a financial literacy mandate to the leading bank. Incorporation of basic financial principles into the grade-10 curriculum may prove to be more effective. NGOs and other civil society institutions can be identified for particular areas and be used as a platform for awareness generation. Adequate stress should be laid on the spread of education as such. Academic curriculum must be made relevant as per the needs of the targeted audience.

No one strategy can be applied for the whole of India. Inadequate room for ground-level customization often leads to poor targeting of various schemes; as a result, banks become hesitant to provide credit.

The requirements, attitude, acceptance level, empowerment, and poverty levels of the people should be gauged. Accordingly, an appropriate approach should be selected and implemented. This may be branch banking, mobile banking, bank correspondent model, smart card model, public-private partnership etc. If the approach is too radical, then approval may be sought by the state-level body. Instead of a national policy that is formulated at the centre, only a very broad policy should be made at the centre. The finer implementation strategy should be finalized at the state division or district level, keeping in mind local socio-economic factors. Application of the same strategy for Punjab, Mizoram, and Tamil Nadu is inherently bound to be unsuccessful. The targets and regulatory framework should be made by the central authority, as has been successfully done in the Philippines.

Further along with customization, enough leverage must be allowed for direct people’s participation at the cutting edge level. This is essential for the scheme to adapt to the people’s precise needs. This measure could increase transparency and bring down corruption, as is seen in the working of the Grameen Bank. A simple example here is of the Public Distribution System in India. The food grain is supplied once in a fortnight and recently the quota of food grain has been increased to 20 kgs. The very poor do not have the purchasing power to buy such large quantity of food grains at a time. This has resulted in many not availing the PDS and the unutilized food grain being diverted to the open market.¹⁸

In a country as wide and varied as India, technology can be effectively used to reach out to far-away areas. For example The Corporation Bank has provided customers with Smart Cards, which act as an e-purse and e-passbook and holds multiple customer accounts. The bank has opened branchless banking units in Karnataka, Andhra Pradesh, Kerala, Gujarat, Haryana, and Tamil Nadu.¹⁹

Despite different models and methods for different areas, the model should have strict performance evaluation.

For maximization of outcome specific targets in terms of the exact number of people who should have started using financial services should be given instead of vague and general targets like opening up of a branch. Periodic reports must be required to contain the account activity details and proof.

The second factor is Responsibility. When institutions involved with financial inclusion fail to perform, benefits that these institutions derive from the larger economic system, and the RBI should be put at stake. Clear penalties should be given in case of non-performance, with proper media coverage. Good performance appreciation should be ensured through the media. The reports of the performance should be made public and easily accessible.

Through India’s developmental history, the most ideal plans have been brought up; however their implementation has been faulty. Comptroller and Auditor General of India has been consistently criticizing the government for alleged misappropriation of funds and rampant corruption in the NREGA and other government initiatives. At the end of the 2006-07 financial year, out of an allocation of Rs 12,074 crores, only Rs 8,823 crores were spent for NREGA. For the year 2007-08, the CAG report observed that while the government had allocated more that Rs 51,000 crore to NGOs for implementing welfare schemes, there are no concrete records as to the usage of this huge sum of money.²⁰
Thus the check mechanism incorporated in this approach is the most important aspect. With the advent of Internet banking and core banking, RBI can maintain a nationwide database of all bank accounts and the activity therein. This would require a very powerful server and software, which may be difficult to initially acquire and install but is definitely possible. Software can be created for tracking all bank transactions and systematically documenting them. Thus, whenever the centre makes an allocation of funds or state government a special counter shall be created for that particular allocation. Thereon, all transactions made out of that account would be recorded. The software will make a user-friendly and readable format of these transactions. This money can thus be tracked down till the end recipient. Thus, any pilferage of funds can be easily detected with the name and details of the functionary involved at the particular level where the pilferage has taken place. The system can be designed to strike a warning message in case it detects pilferage of funds to some personal account or some illicit cash withdrawal. The lowest level disbursing authority will be required to provide the account numbers to which the final funds have been provided. The audit authorities, like the CAG, can automatically cross-verify these accounts through the software.

This will curb corruption. Through this system usage-based performance evaluation can be conducted. This information of the software should be made public. Also information regarding the people involved in the disbursement of funds can be made public, thus invoking direct public accountability for the taxpayers’ money. This will prevent major corruption in the implementation of the government schemes. They will work more efficiently, lifting people out of poverty, enabling them to make use of financial services. Thus integrating them with the mainstream economy.

Financial inclusion in India and other developing countries is a relatively new area of research. Economic potential of a large part of the population can be unlocked through financial inclusion and this kind of research can have far reaching consequences for the lives of many people. Similar evaluation of current financial-inclusion strategies of other countries can be conducted.

This is a conceptual model and can be further developed to provide a more practical orientation. It can be refined, based on a wider empirical survey, which may yield interesting findings. A cross-country comparison of financial inclusion based on empirical data can be accomplished for better application across countries. It can also be linked to theoretical principles of economic development.

CONCLUSION

Today, while India may record a GDP growth rate of over 8 percent, about fifty percent of the Indian population lives below one dollar a day. Less than half of India’s population is a part of India’s economic growth story. Therefore it is easy to imagine the growth possible if the bulk of the Indian population starts contributing substantially to the Indian economy. Without effective financial inclusion, income disparities in India are actually increasing with economic growth. Thus financial inclusion is very crucial.

The fundamental aim of financial inclusion is the integration of below poverty line people into the mainstream economy. Today the access-based financial inclusion policy is not meeting the aim of effective usage. Financial inclusion is a necessary step in ensuring large-scale economic development. A different approach to financial inclusion policy has been presented here with the following aspects:

Some aspects covered in this approach are being carried out partially in some areas. The idea behind presenting these five points together is to layout an approach to financial inclusion. A holistic approach and policy orientation with each of these five ideas integrated together can form an effective policy for financial inclusion. Although difficult to implement, this approach may prove to be much more effective.

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¹¹ IFC. Deposit Assesment in Sri Lanka, May 2011, International Finance Corporation available at http://www.ifc.org/ifcext/globalfm.nsf/AttachmentsByTitle/Desposit+Assessment-SriLanka/$FILE/Desposit+Assessment-SriLanka.pdf on 19.01.2012

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Half a Nation! - Financial Inclusion Lessons for India

Nazuk Kumar Indian Institute of Technology, Delhi

Abstract

Introduction

Why financial inclusion?

Financial Inclusion in India

A Different Approach

CONCLUSION

Nazuk Kumar
Indian Institute of Technology, Delhi