PART ANALYSIS OF CHAPTER NO 3 : BROADENING ACCESS TO FINANCE (From the Study Report titled, “A...

Era Business School PGDM 12’14 Batch

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Group Members: Richa Dev, Manoj Kajla, Pawan Kumar & Col Ajay K Raina, SM

ASSIGNMENT : FMS

PART ANALYSIS OF CHAPTER NO 3 : BROADENING ACCESS TO FINANCE (From the Study Report titled, “A Hundred Small Steps”)

Submitted to: Prof RA Chopra By: Group No 2/PGDM 12‟14

1- What is it?

1.1 Document The publication, “A Hundred Small Steps”, is factually a Report on Financial Sector Reforms by a Committee that had been constituted by Planning Commission of India with an aim of outlining a comprehensive agenda for the evolution of the financial sector indicating especially the priorities and sequencing decisions which the decision makers must keep in mind during the long drawn process of decision making. Given its mandate through a government order, the Committee had been headed by present Governor of RBI, Sh. Raghuram G Rajan (then Professor, Graduate School of Business, University of Chicago) and comprised of some of the very well-known names from the industry.

1.2 Mandate The study by the Committee was bound by certain important terms of references and same have been reproduced below:-

(a) To identify the emerging challenges in meeting the financing needs of the Indian economy in the coming decade and to identify real sector reforms that would allow those needs to be more easily met by the financial sector. (b) To examine the performance of various segments of the financial sector and identify changes that will allow it to meet the needs of the real sector. (c) To identify changes in the regulatory and the supervisory infrastructure that can better allow the financial sector to play its role, while ensuring that risks are contained; and (d) To identify changes in other areas of the economy—including in the conduct of monetary and fiscal policy, and the operation of the legal system and the educational system—that could help the financial sector function more effectively.

1.3 Layout The publication is laid out in eight chapters with the first chapter giving out Executive Summary of the whole document, including gist of 35 proposals as made by the Committee over next seven chapters. Running into well over 200 pages, the Report covers a canvas covered over three years, ie between 2007 (when the Committee was constituted) and 2009 when the Report was published in the present form.

1.4 Relevance Today, we are in a different decade as also in a different Five Year Plan and yet the study Report holds relevance in the sense that it throws open certain issues that may be analysed by the students of a PG course in Management to understand not only the macro-level thinking that goes into formulation of such important documents but also the timelines


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that get involved in decisions at macro-level (after all, not many of the proposals, despite their absolute relevance have been implemented till date). At the same time, a study of the Report would also help a reader (read student) understand what Report has to say about „re-introduction‟ of earlier ideas during any fresh policy formulation process.

1.5 Scope Our group (Group No 2) has been tasked with analysis of Chapter No 3, titled, “Broadening Access to Finance” and to that extent, whatever follows hereafter, would relate to that very chapter in particular with some relevant pointers to other chapters in general.

2 – What is it About?

2.1 About the Chapter The ibid chapter is all about different aspects (like need, importance, pitfalls, suggested methodology and such like issues) as these pertain to the process of inclusion and holistic coverage of masses as far as financial inclusion is concerned. At the very outset, the Report has been quick to point out that certain steps have already been taken by the government in this direction even though the whole issue needs to be looked at differently and there is a definite need to have a paradigm shift in this regard. Very deliberately and through use of common sense as well as hard logic, the Report has tried to highlight the fact that mere expansion of credit coverage does not and should not qualify to be called or seen as financial inclusion. The Report meticulously highlights the fact that instead of a credit centric myopic approach towards the financial coverage and inclusion, it is not only pertinent but also utmost important to look at such an inclusion in terms such as payments services, savings products, insurance products, and inflation-protected pensions. It would only be when such an all-inclusive approach is taken by the policy makers that this aspect of the financial sector reform will eventually get addressed. It is understood that no matter what policies and decisions regarding financial sector reforms are taken, if the masses at the grassroots levels are left out of the implementation framework, no good would come to our economy as a whole. The ever increasing poor-rich (and not urban-rural, as the Report highlights) divide does not augur well for the nation and such a trend needs to be effectively curbed. The Report, as it moves along, keeps referring to certain steps that have already been taken or measures that have already been instituted but without any real effect on the situation on ground. The Report, through various proposals and suggestions, spells out the possibility of providing financial coverage to as many as 90% of the households in the country provided certain steps are taken and such aims are set. The Report re-visits some of the steps that have been taken through decades after independence, especially the nationalisation of banks and creation of priority sector lending, but laments the fact that the approach that was centred around opening up of more and more branches, setting up of rural banks and cooperatives, and setting targets for wider inclusion and such like ways, has shown mixed results and whatever results have been forthcoming, have hit the state of diminishing returns. The Report, therefore, justifies the thought process that feels that unless some radical steps are taken the system will remain ineffective and only partially successful.


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Looking back, the Report tries to bring in a change in the focus by stating a few hard facts about the myopic view associated with credit expansion in isolation, overlooking the need for the poor to have vulnerability reducing instruments, limited focus on sectors and not segments till now and so on and so forth. The Report also tries to identify the possible reasons for such a dismal state of affairs by bringing up the following issues to the fore:-

(a) Rural branches are seen as a burden rather than an opportunity by the increasingly profit-oriented public sector. (b) The priority sector norms are now so broad in coverage; banks migrate towards the bankable within the priority sector rather than the excluded. (c) The mandated low interest rates, in an area where risks are high, do not impress banks. The corruption that gets associated in such a scenario, defeats the whole exercise. (d) The Committee recognises, however, that a greater commercial viability cannot be truly achieved for all sections of the poor, and therefore some kind of mandated coverage will always be required. The key is to move the primary strategy towards innovation and commercial viability, with more carefully targeted mandates seen as filling the gaps, rather than having broad mandates as the central instrument as is the current practice.

(e) The rich-poor divide has replaced the conventional rural-urban divide in access to financial services, as measured by the distribution of savings accounts. (f) The poor have no more access in the richly branched urban areas than in the rural areas.

3 – Why is it Important?

3.1 In Few Words The importance of the Report can be realised by having a look at the summary of certain very important points, as enumerated below (brief explanations of these points would then follow):- (a) Pragmatic recognition of needs of poor.

(b) A balanced assessment of existing strategy that has been adopted for a perceived view of inclusion till now. (c) A proposed strategy to have a more balanced, much more holistic and a meaningful inclusion of those who matter the most. As can be seen in the above summary, the Report appears to ‘know the way‟ and is

not only willing to „show the way‟ but also „go the way’! That is where the real importance of the Report lies. In the following paragraphs, we would briefly see the details of each one of the ibid points.


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3.2 Need Recognition for Poor The Committee, with well researched data to back up its claims, has pointed to the fact that India‟s poor, many of who work as agricultural and unskilled/semi-skilled wage labourers, micro-entrepreneurs and low-salaried worker, are largely excluded from the formal financial system and, thus, too large a proportion of the poor lie outside the formal banking system. While trying to highlight the fact that the rich-poor divide has replaced the conventional rural-urban divide in access to financial services, the Committee has cited another fact that rich, irrespective of their rural or urban landings, will always get bank access while poor masses, both in rural and urban India, are denied the same. The divide, therefore, is not along rural-urban but along rich-poor lines. A matter of concern to the study group is the extent to which the poor use financial services, but sourced from the informal rather than the formal financial system. The Committee goes on to spell out needs of those deprived of any institutionalised financial inclusion and highlights the fact that such needs can no longer be ignored. The needs, in brief, are as under:-

(a) Savings. In the lowest income quartile, the most preferred savings instruments were bank savings accounts though only 50 per cent of those with savings had bank accounts. Life insurance and informal savings schemes like self-help groups and microfinance institutions were the other preferred instruments. Over 20 per cent of respondents in the lowest income quartile held savings in chit funds and self-help groups/microfinance. Over 50 per cent of the clients saving with SHGs/microfinance institutions were agricultural wage labourers and self-employed farmers, while 30 per cent of chit fund members belonged to this category. Therefore, the poor have largely missed out on the boom in the equity markets for a number of reasons, including a high priority on security and liquidity, and perhaps a limited understanding of the economic effects of inflation on savings. Worse, the tax on bank deposits has increased the gap in returns between bank savings and equity. (b) Insurance. The participation of low-income groups in life insurance, the second most preferred savings instrument after bank savings deposits, is still very limited. As low as 14% of lowest quartile population is covered by insurance and that too inadequately. The policy lapse rate is also the highest amongst the poor. (c) Credit. Well about 70% of the poor borrow predominantly from informal sources, especially moneylenders and relatives/friends. Nearly 90 per cent of Survey respondents in this quartile relied on informal sources for credit. The high dependence on informal sources, in turn, implies that bulk of the borrowing by the very poor is at very high interest rates that go as high as 36% as a routine. As a result, large segments of India‟s poor households continue to be shut out of mainstream finance. More worrying, according to some measures, access is actually declining.

3.3 Strategy in Vogue The Report identifies the real basis of the existing strategy for inclusion. As the Report has analysed, the strategy relied primarily on the following pincers:-

(i) Expanding branching into rural areas; (ii) Setting up special purpose government sponsored institutions (such as regional rural banks and cooperatives); and (iii) Setting targets for credit to broad categories of the excluded.


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The inefficacy of opening more and more branches has already been highlighted in

the analysis. Unfortunately, however, the rural branches have not been profitable, and there is little interest among private and public sector banks in opening new branches there. The issue with staff from urban backgrounds getting posted to such branches and then decision making resting with head offices that are located in faraway cities, together, have led to downfall of the system. Thus, the predominant lender to the poor is still the moneylender, in part because he is flexible, does not need documentation, is prompt, and can respond to his client‟s emergency needs very well. Further, the loan assessment and monitoring in the cooperative movement in India has been much more lax, in part because of the easy availability of refinance from outside, and because of limited control exercised by those whose funds are being employed. Dilution in priority sector norms also contributed to a reduced focus on underserved segments. The bulk of increase in credit to agriculture was accounted for by increase in indirect finance to agriculture, which includes activities that can be considered commercially viable. There is a delicate balance in setting priority sector norms and eligible categories. High priority requirements and narrow eligible categories targeted at those who truly do not have access could lead to greater access to credit, but could reduce bank profitability considerably. Essentially, banks would be making transfers to the needy; a role better played by the government and that is where the problem lies as far as this policy is concerned. The experimentation with risk mitigation through National Agricultural Insurance Scheme (NAIS) for farmers has led to a situation wherein premium inflows have been far exceeded by insurance outflows, primarily because of some really unrealistic parameters. The highly subsidized nature of this insurance has distorted farmers‟ views on what the true price of insurance should be, and discouraged private initiatives to provide crop insurance. Subsidized livestock insurance schemes have had a similar effect. Insurance against agricultural price fluctuation has been hampered, as small farmers are unable to exercise hedging options that are available to larger farmers.

To summarise the existing strategy, the study Report is of the conclusion that the

past strategy for inclusion had mixed results. While the public sector did create a rural network, that network did not bring enough of the poor into the formal system, and the rural network weighs on public sector bank profitability. The cooperative system is in serious financial difficulty. Narrowly defined priority sector norms can force banks to lend, but again by impairing profitability. The focus on increasing credit in the absence of appropriate products for risk mitigation led to over-indebtedness among the poor. As the financial sector becomes more competitive, and as banking privileges get eroded, it will become more difficult and unwise to compromise bank profitability by mandating that banks take on the burden of financing inclusion. Instead, the approach has to be to make inclusion more profitable.

3.4 A Fresh Approach to Strategy Formulation Based on the facts analysed and certain comparisons made with better strategies being followed elsewhere, the Committee is of the view that any comprehensive and sustainable response to addressing issues of financial inclusion must necessarily factor in the role of the market. This is because efficiency, innovation and cost-effectiveness are key to serving the financial needs of the poor. The financial sector does not ignore the poor because of biases, but because the transaction costs in serving them are high. Initiatives that reduce these costs will allow service providers to begin thinking of financial services for the poor as a business opportunity and not as an act of charity. Also, any new strategy for


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increasing access to financial services will require the creation of a vibrant ecosystem that supports financial inclusion. In the backdrop of the above, the Committee has identified six major areas that need certain changes (both in approach and functioning) to make the dream of financial inclusion a reality. The areas and the proposed changes have been enumerated below:-

(a) Overall Organisational Structure. It is important that the organizational architecture supports and creates institutions that can reach the poor. The Committee recommends a two-pronged approach—first, to facilitate the creation of small finance banks, and second, to strengthen the linkages between large and small financial institutions. The Committee believes that notwithstanding the checkered history of small banks in India, a strong emphasis on good quality lending, low cost structures, effective governance and management, and tight prudential norms, could make small banks very useful to provide financial services to the poor. The Committee recommends, therefore that the regulator allow more small finance banks to be established, with the ability to provide both asset and liability products to their clients.

(b) Focus on Risk Mitigation. The Committee is of the view that the levels of risk, that poor face, may have to be first brought down through physical methods—soil and water conservation for reducing drought risk in case of crop insurance; herd vaccination in case of livestock insurance; and preventative health care, safe drinking water and sanitation, in case of health insurance. A key policy implication therefore is to increase investments that lead to intrinsic risk reduction so that insurance can be offered at premia that minimize the need for subsidies. Once this is done, it will be useful to use public funds to build awareness about insurance as a critical financial service, since greater demand for insurance can bring down costs due to scale economies. At the same time, the customer service issues in terms of claim processing delays and deductions need to be monitored tightly and penalties enforced on erring companies. Finally, to mitigate the risk arising out of exploitation of poor farmers by big traders, ITC‟s e-chaupal method or facilities of storing produce in the warehouses need to be formally implemented. (c) Targets, Subsidies and Public Goods. Summarised as under:-

(i) The imbalance in the priority sector lending has been correctly pointed out by the Committee. The Report strongly recommends the political will to revisit the norms. Failing that, it suggests the categories that truly impact the underserved (such as direct agriculture and the weaker sections category) be preserved and strictly enforced even as the process of broadening other categories continues. It further recommends that all banks—domestic and foreign—should be subject to uniform priority sector lending requirements. With the weaknesses observed in RBI‟s proposed The inter-bank participation certificates (IBPC) scheme, the Committee proposes the scheme of tradable „Priority Sector Lending Certificates‟ (PSLC) for loans beyond 180 days and the whole process monitored by an agency like NABARD. (ii) Further, a liberalized interest rate regime should be accompanied by a transparent way of communicating to borrowers up front what the all-in cost of a loan will be (a simple number which reflects the effective interest rate they are being charged when all fees are included), public disclosure of margins on loans to the priority sector relative to reasonable cost benchmarks, and an effective system for tackling consumer grievances.


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(iii) The Committee believes that well-targeted subsidies provided directly to the poor are a more useful option than subsidies to financial entities for provision of services. Notwithstanding this belief, there is still a case for the provision of subsidies for services in remote areas or to target underserved segments. Another useful step would be to provide existing subsidies and cash transfers to the poor via bank accounts to encourage their use of the banking infrastructure. (iv) Public intervention may be needed to promote simple low-fee savings instruments that are indexed to the stock market and available for purchase in small units by small investors, savings funds, etc. This would allow small investors to tap into the large gains that equity market investors have enjoyed the world over in recent times. It would also allow them a better savings instrument than savings accounts that have given them miserable real returns in the past. Currently, the lack of PAN numbers among the poor prevents the wider dissemination of such products. There may be a case to subsidize the provision of PAN numbers for poor clients who wish to participate in this scheme.

(d) Cost Control Through Use of Technology. The transaction and operating costs can be reduced by some innovative use of technology by banks. The Committee cites the example of mobile service providers to make the point. A system of common payments, systems with participation by multiple banks, can reduce transaction costs and substantially increase the deployment and utilization of POS terminals. Further, technology can be significantly leveraged for acquiring customers through Banking Correspondents who would have unique identities and access based on technology. Finally technology has to be used to reduce provisions for bad debt. Credit ratings for retail customers and a unique citizen ID are critical in this regard. Capturing all the transactions electronically and mandatory sharing of data with a credit bureau would significantly help in this direction. (e) Infrastructure for Financial Inclusion. The Committee believes that it is important to improve the infrastructure for inclusion. In other words, the issue of credit infrastructure, including the creation of a national ID, the use of land as collateral, and personal bankruptcy, which are all measures that would improve the poor‟s access to financial services. Another area that falls broadly in the ambit of financial infrastructure for inclusion is the provision of interest-free banking. Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products results in some Indians, including those in the economically disadvantaged strata of society, not being able to access banking products and services due to reasons of faith. This non-availability also denies India access to substantial sources of savings from other countries in the region. The Committee recommends that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. (f) Financial Literacy. The Committee is of the considered view that a good understanding of the costs and benefits of various financial services, the impact of inflation on savings, and the trade-off between risk and return can help households choose the right products for their needs and weed out dubious schemes from truly beneficial ones. The Committee believes that efforts to promote financial literacy should start early. Starting around Vth standard, students could be introduced to terms such as income, expenditure, savings, deposits, interest, insurance, etc. In addition, TV channels could be encouraged to run educational programmes on financial issues such as household budgeting, savings, insurance, and pensions.


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4 – What has been Implemented?

4.1 Focus To analyse the developments since submission and publication of this Report well over four years ago, we may focus on the six key recommendations made by the Committee. All the six proposals have been listed in the previous section under serial 3.4, including its sub-sections. The analysis is au under:-

(a) Overall Organisational Structure. In one word, “Nothing” has moved on this proposal and political will, as it is paralysed for quite some time now, may be seen as the real cause of such a lack of progress. The recent action of allowing more bank licenses cannot be seen as implementation of this proposal since the basic ideas behind two issues are absolutely divergent. (b) Focus on Risk Mitigation. Yet again, no progress has been made beyond existing schemes related to soil conservation and testing, water conservation and many kinds of insurances that collectively, unfortunately, remain on paper in most of the cases. Commodity exchanges are still beyond reach of common farmers because of technical issues related to quantity aggregation and price assessment. Warehousing Development and Regulatory Authority (WDRA) had already been formed before the publication of this Report. Though some developments have taken place in this regard, the ones as visualised by the Committee, are yet to see light of the day. Sadly, the WDRA‟s efficacy or rather lack of it has stood out during recent NSEL crisis. (c) Targets, Subsidies and Public Goods. Interestingly, priority sector lending guidelines were being revised roughly at the same time when this Committee was beginning its work in 2007. Another revision of the same did take place in 2011 (http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=7460&Mode=0) and same are valid as of now. A close look at the 2011 guidelines does show a few changes, though subtle, in line with the Report under analysis. While issues like loan for bailing out distressed farmers (who have taken loans from non-institutionalised sources), loan against warehouse receipts as well as future crops, special attention to the marginalised sections of farmers, provision of IBPCs, overdrafts of Rs 50,000 from no-frill accounts, investment in securitised assets, no processing fee for loans up to Rs 25,000 and definite instructions on occurrence of shortfall in such lending have been steered into a direction as sought by the Report, many other issues like special treatment to foreign banks, huge allocation towards educational loans vis-à-vis agricultural loans, non-initiation/non-introduction of PSLC, de-regulation of interest rate ceilings and enforcement issues with usury laws remain unaddressed. While no one would expect a 100% implementation of the Report in our context, the real implementation still falls short of fraction that could have been fairly expected. Subsidy-related recommendations, likewise, remain unimplemented till date. Bank transfers have been started for payments towards NREGA but focus has suddenly shifted towards LPG and Food Security provisions and unfortunately, both the processes are marred by numerous hiccups. (d) Cost Control Through Use of Technology. With the introduction of mobile banking and removing transaction fees on electronic transactions by public sector banks, some headway has been made. But a true multi-bank ATM system is a far cry, especially in light of the resistance raised by banks when free unlimited usage of ATMs of one another was being formulated. Today, ceiling is at five transactions

http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=7460&Mode=0


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per month. No concrete data, however, is available about the actual costs post implementation of electronic banking but it can be estimated safely that huge strides must have been made over intervening years since 2007/08. Undoubtedly, electronic banking (online as well as mobile) has come a long way since then. (e) Infrastructure for Financial Inclusion. The recommendations/proposals in this regard have largely been on the drawing board for long and appear to be in an inert state as of now. Some developments, however, appear to be taking place. Kerala state now has a few banks working on zero-interest basis but such a development has been very narrow. A bit of personal bankruptcy clause stands addressed in the 2011 guidelines on priority sector lending, as indicated above. (f) Financial Literacy. The dream of financial education at a young impressionable age remains a dream and yet it is worth the mention that CBSE has, of late, introduced projects and such like curriculum at 10+2 level. One is not sure about the actual connect between recommendations of the Report and implementation of project work curriculum by CBSE but for an optimistic mind, there appears to be some connect, even though it may not be formal.

5 – What Next?

5.1 Dynamics of Implementation At one point in the Report, the Committee had hinted towards the fact that in our country, decisions take long times and many old studies (done and forgotten) suddenly come into play once such decisions are taken. Also, in light of a more than obvious paralytic state of policy making over past few years, change of cabinet ministers heading MoF, global financial uncertainties, and a potential backlash against financial liberalization, the Report has not been used as a guide for implementation. And yet, in a country where such Reports are suddenly dusted out of the cupboards when decisions are taken in the future, the Report has done a great job of agenda-setting, which will be extremely fruitful in coming years.

5.2 Future The timing of this analysis, as a matter of co-incidence, closely follows a news Report that had appeared in the Economic Times on 16 September 2013 (http://articles.economictimes.indiatimes.com/2013-09-16/news/42114164_1_financial-sector-raghuram-rajan-hundred-small-steps). As per the said Report, (we quote), “Next up on India's reforms agenda is the financial sector. After retail, aviation and fuel prices, the government is getting ready to roll out the long-overdue, next generation of measures aimed at freeing up the country's financial sector and a framework for this could be in place as early as next month……. The plan to kick off the process, stalled for many years, was discussed in the run-up to the appointment of Raghuram Rajan as Reserve Bank of India governor and has the highest political sanction. The reforms blueprint will lean heavily on the two high-profile Reports already available with the government, one of them authored by Rajan himself. "We will have a framework ready soon and will take it to the Financial Stability and Development Council (FSDC) for deliberation before the measures are rolled out," a senior finance ministry official told ET…..” (we unquote). When viewed in light of the fact that post taking over as FM, Mr PC Chidambaram has been working towards overcoming the policy log-jam and also the fact that chairman of the ibid Report is now the Governor of the RBI, it appears logical that policy makers have no

http://articles.economictimes.indiatimes.com/2013-09-16/news/42114164_1_financial-sector-raghuram-rajan-hundred-small-steps

http://articles.economictimes.indiatimes.com/2013-09-16/news/42114164_1_financial-sector-raghuram-rajan-hundred-small-steps


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option but to move ahead with long over-due financial sector reforms. Again, expecting the decision makers to implement the complete Report in letter and spirit would be an unfair thing to do, especially due to various political and other hurdles and yet even if one third of all the proposals (ie 12-15) are implemented, it would be a big step forward. Looking at the things as they stand today, we do not have many options in any case….. or do we?

Submitted By:- Richa Dev

Manoj Kajla Pawan Kumar

Col Ajay K Raina, SM

PART ANALYSIS OF CHAPTER NO 3 : BROADENING ACCESS TO FINANCE (From the Study Report titled, “A...

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