Spotlight

New Delhi, 30 September 2015

Financial Inclusion

KEY DRIVER TO INCLUSIVE GROWTH

By Moin Qazi

The hype over the RBI cutting the repo rate to boost economy and markets notwithstanding, the Modi government’s highly ambitious financial inclusion plan--the Pradhan Mantri Dhan Yojana (PMDY) seems to have lost its sheen after the initial euphoria. Under the government diktat the banks worked at a frenzied pace to chase targets and opened a record number of accounts. But the very objective of opening these accounts has been lost as the majority of these have not seen any transactions.

The extent of financial exclusion remains staggering. Out of 600,000 villages in the country, only about 30,000 have a commercial bank branch. Till recently, more than 50% of India’s population did not have any bank account and more than half of the total farmer households did not seek credit from either institutional or non-institutional sources of any kind..

Access to finance is critical for a country’s development - it is as much a part of a country’s basic infrastructure as access to roads, or electricity, or the Internet. Ample evidence indicates that economies with deeper financial sectors and well-functioning financial systems perform better. Moreover, access to finance is an important contributor to inclusive development. Poor households in particular need access to a broad range of financial services — savings, insurance, money transfers, and credit — in order to smooth consumption, build assets, absorb shocks and manage risks associated with irregular and unpredictable income. Without access to good formal services, the poor must rely on the less reliable and often far more expensive informal sector. A growing body of evidence confirms that gaining access to finance has a positive impact on household welfare.

India serves as an ideal case study with over 60% of the adult population operating outside of formal financial services, according to the World Bank. India has 600,000 villages, of which only 74,000 have access to banks. Financial inclusion efforts by the government focus on trying to increase the number of brick-and-mortar banks, creating a massive network of banking correspondents to target rural areas, and installing more ATM branches – one within 15 minutes walking distance of every Indian by January 2016.

A growing body of evidence confirms that gaining access to finance has a positive impact on household welfare. However, the financial services usually available to the poor are limited in terms of cost, risk, and convenience, requiring the poor to, on occasion, tap into other assets, such as livestock, building materials, and ‘cash under the mattress’, when the need arises. Cash under the mattress can be stolen or lose value as a result of inflation. A cow cannot be divided and sold in parcels to meet small cash needs. Certain types of credit, particularly those from moneylenders, are extremely expensive. Rotating savings and credit clubs (the international variant of the Indian bishi) are risky and don’t allow much flexibility in loan amount or in timing of deposits and loans. Deposit accounts of formal financial institutions require minimum amounts and may have inflexible withdrawal rules. Loans from these institutions have collateral requirements that exclude many poor borrowers.

The prevailing view in financial inclusion literature is that people in developing countries resort to informal services because they have no other option. While their irregular and low income, and often distant location, makes low-income adults in emerging markets unviable clients for formal providers, the majority of them prove to be regular users of multiple financial services. They often prefer informal services due to the enhanced value that locally delivered financial services provide that formal services cannot.

Financial inclusion is delivery of banking services at an affordable cost to the vast sections of disadvantaged and low income groups. Unrestrained access to public goods and services is the sine qua non of an open and efficient society. As banking services are in the nature of public good, it is essential that availability of banking and payment services to the entire population without discrimination is the prime objective of the public policy. By financial inclusion we mean the provision of affordable financial services, viz., access to payments and remittance facilities, savings, loans and insurance services by the formal financial system to those who tend to be excluded. In the policy framework for development of the formal financial system in India, there is always an emphasis on the need for financial inclusion and covering more and more of the excluded population by the formal financial system.

There are five factors which reflect the need of financial inclusion in rural India. These are:

Inability to access financial services; Lack of access to safe and formal saving avenues like banks; Lack of credit products in which investment can be made; Lack of remittance products which makes money transfer a cumbersome affair; Lack of insurance products which makes risk management a distant dream for poor.

Financial inclusion enables poor people to save and to responsibly borrow—allowing them to build their assets, to invest in education and entrepreneurial ventures and to improve their livelihoods. Poor people save, borrow, and make payments throughout their lives, but to use these services to their full potential, to protect their families and improve their lives, they need products well suited to their needs. Bringing this about requires attention to human and institutional issues, such as quality of access, affordability of products, sustainability for the provider of these services, and outreach to the most excluded populations.

Financial inclusion should not end with just opening accounts. The customer must make this account his financial diary and conduct transactions which can grow into a credit history. Or else all these accounts would remain deadweight. What needs to be done is to make more and more of these accounts actually transactional, and actively transactional. Once in a way the subsidy also comes in, so that’s the first set of transactions. But after that, what is important is getting the customers used to the habit of saving, getting them to use formal channels for the remittance of money and then, through the way the money comes into the account, building some kind of credit analytics and making small loans and micro insurance available to them.

The real challenge is to encourage poor people to actively use a variety of formal banking services (including savings, credit and remittance) so that their dependence on costly informal channels such as moneylenders is greatly reduced. What is needed is a holistic framework and infrastructure support focused on four core dimensions of universal financial inclusion – affordable products; viable and reliable delivery models; diverse customer needs; and multilingual financial education programmes.----INFA