Universal Financial Inclusion in India - The Way Forward

7/28/2019 Universal Financial Inclusion in India - The Way Forward

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empowers the poor to take charge of their lives. At close toa quarter of the population, the official headcount figuresin India are already worrying, yet, the actual proportion ofpopulation which is not growing with the mainstreameconomy is even larger. Financial Inclusion is both acrucial link and a substantial first step towards achievinginclusive growth.

The liberalized, increasingly global, market driveneconomy of India today, has failed to facilitate inclusivegrowth. In recognition of this, the government and theReserve Bank of India, have initiated steps to createenabling conditions for inclusive growth.

This paper talks about the macro picture of financialexclusion, some conceptual approaches to understandexclusion, early steps towards and imperatives for

financial inclusion in India.

With the GDP growing by around 8.5 percent to 9 percentper year, the Indian economy is marching ahead. India isnow the fourth largest economy in the world on apurchasing power parity (PPP) basis and ninth on amarket exchange rates (MER) basis. This rapidexpansion is expected to continue as growth in theservices and high technology manufacturing sectorsaccelerates. However, agriculture, which continues tosupport over 60 percent of the population, is growing by alittle over 2 percent. In addition, the organized sectoremployment presently comprises less than 10 per cent ofthe workforce, leaving the vast majority of the workingpopulation with irregular income streams and inadequateaccess to financial services including cushion againstunforeseen circumstances.

Access to affordable financial services - especially creditand insurance - enlarges livelihood opportunities and

Universal FinancialInclusionin India:The Way Forward

S.Ramesh* and Preeti Sahai**

* Vice President, International Initiatives, BASIX and ** Manager, BCO, BASIX

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Magnitude and Spread of FinancialExclusion

What is Financial Exclusion?

Financial exclusion is experienced by both developingand developed economies alike. The World Bank

estimates that 2.7 billion people, over half the populationof the developing world, live on less than US$2 a day. Inthe UK over one million adults are believed to be without abank account or other basic financial services.

Reserve Bank of India data shows that as many as 139districts suffer from massive financial exclusion, with theadult population per branch in these districts beingabove 20,000 and only 3 percent with borrowings frombanks. On the assumption that each adult has only onebank account (which does not hold good in practice, sothat actual coverage is likely to be worse) on an all Indiabasis, 59 percent of the adult population in the countryhas bank accounts. 41 percent of the population is,therefore, unbanked. In rural areas the coverage is 39percent against 60 percent in urban areas. The unbankedpopulation is higher in the poorer regions of the country,and is the worst in the North-Eastern and Eastern regions.

Credit markets have much more exclusion, as the numberof loan accounts constituted only 14 per cent of adultpopulation. In rural areas, the coverage is 9.5 per centagainst 14 per cent in urban areas. Regional differencesare significant with the credit coverage at 25 per cent forthe Southern region and as low as 7, 8 and 9 per centrespectively in North Eastern, Eastern and Centralregions. The extent of exclusion from credit markets canbe observed from a different perspective as well. Out of203 million households in the country, 147 million are inrural areas 89 million are farmer households. 51.4 percent of farm households have no access to formal orinformal sources of credit while 73 per cent have noaccess to formal sources of credit. As per NSS 59th rounddata, only 37 percent of the urban self-employed haveaccess to credit.

Financial exclusion could be looked at in two ways:

1. Lack of access to financial services which could bedue to several reasons such as:

n Lack of sources of financial services in our rural

areas, which are popular for the ubiquitous money lendersbut do not have (safe) saving deposit and insuranceservices.

n High information barriers and low awarenessespecially for women and in rural areas.

n Inadequate access to formal financial institutions thatexist to the extent that the banks couldn't extend theiroutreach to the poor due to various reasons like high costof operations, less volume and more number of clients,etc. among many others.

n Poor functioning and financial history of somebeleaguered financial institutions such as financialcooperatives in many states which limit the effectivenessof their outreach figures.

n Primary Agricultural Cooperative Societies (PACS),

which number around one lakh are also oftenexclusionary, as their membership is restricted to personswith land ownership. Even to their members, not manyPACS offer saving services.

2. Lack of access to formal financial services in of bothrural and urban areas, but is a larger issue in cities andsmall towns. The distinction between access to formal andinformal services is crucial to understand, as informalfinancial markets suffer from several imperfections, whichthe poor pay for in many ways.

Some attributes of informal financial services, due towhich there is exclusion, are:

a. High risks to saving: loss of savings is an easilydiscernible phenomenon in low income neighborhoods inurban areas.

b. High cost of credit and exploitative terms : creditagainst collateral such as gold is even more expensivethan the effective interest rates, similarly, rates paid byhawkers and vendors who repay on daily basis are veryhigh.

c. High cost and leakages in money transfers : thedelays in sending money home through all informalchannels add to these.

d. Near absence of insurance and pension services :life, asset, and health insurance needs.

Another key aspect of financial exclusion is the lack offinancial education and advice. In India, as the basic


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Financial Inclusion therefore, is delivery of not onlybanking, but also other financial services like insurance,pension, remittance, mutual funds, etc. delivered ataffordable, though market driven costs. Opening a no-frillsaccount is just a beginning to a continuous process of

providing banking and financial services. Once the firststep of safety of savings is achieved, the poor requireaccess to schemes and products which allow theirsavings to grow at rates which provide them growthbeyond mere inflation protection.

If over half the adult population of India is excluded fromformal financial services, there has to be something in themanner of design and delivery of financial services whichdoesn't match with the needs of the currently excludedsegments. The growth of microfinance over the lastdecade is proof of the fact that financial services can bedelivered to the poor and underserved, albeit the starting-point is a 'different mindset'. The idea is not to critique thepresent financial system for its failures, but to build on theadvances in banking systems and information technologyand synergize these with the core learning's ofmicrofinance. This will help us build a model for near-universal financial inclusion.

Microfinance in India has been a success of sorts, andeven the worst critics argue that microfinance institutionshave proven the point that there is a market at the bottomof the pyramid. There is, however, a gap between the waymicrofinance is configured right now, and the pathtowards comprehensive financial inclusion. The reasonslargely draw from the current institutional, legal andregulatory framework. The laws permits microfinanceinstitutions to deliver credit, and to offer insuranceproducts in partnership with insurance companies, buttheir ability to deliver savings, investment products andmoney transfer services are both limited and not costeffective. The enabling framework for financial inclusionstands substantially strengthened by the recent BusinessCorrespondent guidelines of the Reserve Bank of India.

We contend that the solution exists, and that thecomplementarities of comprehensive financial services

The Conundrum of Financial ExclusionWhere do We Seek Solutions?

literacy rate is low supporting basic financial capability isindeed not just necessary, but also equally difficult.Financial exclusion is often related to more complexsocial exclusion issues, which makes financial literacyand access to basic financial services even more

complex.

The regulator takes great care to ensure safety of savingsof all depositors in the banking system. The financiallyexcluded, who are often also from the lower incomesegments, however, continue to face very high risks totheir savings. It is unacceptable that a service as basic assafety of savings be denied to a citizen, regardless of thelevel of economic activity, income class or any social ordemographic categorization. We argue that a basic

banking account should not be considered a luxury, but afundamental right of every citizen. This no-frills savingbank account is only a necessary, but not a sufficientcondition for financial inclusion of the poor.

n Daily cash incomesn Frequent purchase of stocks, largely in cashn Seasonality of incomen High expenditure on health (as a proportion to total

income)

n No income in periods of absence due to ill healthn Sending money to family in villagen Small, regular fee for child's education

1. A bank account, where he/she can save smallamounts at regular intervals ideally with savings beingcollected at their place of work or a specified point oftransaction (SPOT) in the locality

2. Micro-Credit for working capital to increase stock andbusiness. This credit can be short term and repayment tobe configured at regular intervals. Savings history andcredibility checks to be used as a proxy for collateral.3. Insurance for life

4. Health Insurance for minor illnesses andhospitalization

5. Investment plan for child's education

6. Pension for old age

What, therefore, is Financial Inclusion?

Attributes of the Financial Life of a Street Vendor:

What kind of financial services are needed forsuch a customer?

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side, the extent of exclusion which exists requiresintervention at very large scales. Though the RBI haspermitted the banks to engage business facilitators andbusiness correspondents to reach the masses, this modelhas not taken off yet. The scale is possible only through an

effective delivery system supported and managed bystrong and healthy professional managed institutionalframe work.

The RBI circular on Business Correspondent Modelallows, NGOs/ MFIs set up under Societies/ Trust Acts,Societies registered under Mutually Aided CooperativeSocieties Acts or the Cooperative Societies Acts of States,section 25 companies, and Post Offices to act as BusinessCorrespondents. Most organizations incorporated in

these forms have social mandates, with less emphasis onbusiness model. The present guidelines exclude NBFC-MFIs from the ambit of being a Business Correspondent.

The current experience of MFI outreach in India showshigh growth and outreach to the poor, and at the sametime, limitations on the types of financial services that canbe offered by them. The BC framework allows for this to becorrected. However, currently, the legal form that allowsMFIs to grow in size and scale and access greaterresources, is not permissible as a BusinessCorrespondent. Most MFIs incorporated under other legal

forms, permissible under the BC framework, aim to re-register as NBFCs to attract capital for expansion andscale of business. Non Banking Finance Companies(NBFCs) should be brought under the ambit of BusinessCorrespondent framework, as they not only serve the needof scale through their high outreach, but also have accessto resources for professional management of anenhanced responsibility through the BC model.

The delivery of comprehensive financial services and the

management of inherent risks are crucial to achievingscale at low cost. This can be best achieved byprofessionally managed organizations with appropriatesystems and processes. Banking and financial servicesrequire a separate set of skills and knowledge and mostorganizations in the civil society will have to reorient their

Regulatory Aspects

Delivery of Services

(savings, credit, insurance, money transfers, mutualfunds, pensions) with the outreach mechanisms andcustomer comprehension of a microfinance institution,will build a model which can potentially redefine theparadigm of financial inclusion in India. This equation

seems to, conceptually, have what is needed for financialinclusion.

Operationally, this paradigm still has to be worked out.The pricing and cost structures are not established yet,nor are the expected returns.

NFA = No Frills Saving Bank Account

BC = Banks + Other Financial Institutions + MicroFinance Institutions + Information Technology

OFI = Insurance Companies, Mutual Funds, PensionCompanies

BASIX has now stepped in to test this equation forfinancial inclusion, and see what it takes to make thiswork. A recent agreement between BASIX (IGS), AxisBank and their technology partner A Little World (ALW),based on the Business Correspondent frameworkenables a configuration whereby the poor can bereached out to, starting with no-frills saving bankaccounts, and moving on to all other financial services.Operations have been initiated in Delhi and Muzzafarpurin Bihar. Within one month of operations, BASIX hascovered over a thousand customers with no-frills savingbank accounts.

The Business Correspondent (BC) framework is a step inthe right direction. At the same time, the need for scale,and the means to achieve scale, should be at the core ofany effort in this direction. The key is to deliver in a mannerthat suits the poor, and at low cost. A natural corollary tolow costs is the need for scale. Even from the demand

NFA + BC = FI

Where, BC = Banks + OFIs + MFI + IT

Steps Towards Financial Inclusion -Some Efforts by BASIX

The Bus iness Cor re sponden tFramework


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manpower and delivery systems to this task. Further,these organizations should set up points of transaction,which enables delivery of multiple financial services asalso act as last-leg delivery to the poor.

From the perspective of the banks, providing suchservices would have various risk associated with it. Themajor risks to the banks are legal, reputation andoperational risks. These risks are to be managed withtight and regular monitoring, developing systems andprocedures and by developing effective risk mitigatingtools and matrix. The banks can consider evaluatingthese institutions through various bench mark indicatorsand procedures like

n Capital Adequacy

n Governance

n Liquidity of the institution and placing minimumliquidity at banks concerned in the form of deposit

n Systems and procedures

n Regular inspection of the BC either through in houseor external auditors

NBFC-MFIs, registered with the RBI could be monitoredwith appropriate and tight controls, systems, procedureand risk mitigating tools and other bench mark norms like

CAR and liquidity, including penalty and withdrawal asbusiness correspondents.

Managing Risks

Way ForwardNotwithstanding the regulatory, operational and otheraspects in focus, financial inclusion is a complex issuewhich cannot be solved alone by any actors in the

system. Formal financial institutions such as, banks,insurance companies, mutual funds, pension companieswill have to join hands with small NGO-MFIs, largerNBFC- MFIs, and technology providers to enableinclusion. The strengths of these institutions will have tobe put together through sound collaborations for financialinclusion. Local and national presence organizationshave to ensure that these partnerships look at bothcommercial and social aspects to help achieve scale,sustainability, and impact.

This collaborative model will have to tackle exclusion in

two main ways:n By ensuring that there is a supply of appropriate andaffordable services available to those that need them

n By stimulating demand for appropriate financialproducts, services and advice with appropriate deliverymechanism

These different sets of institutions have to appreciate thepower of this model and collaborate to deliver to andreach the large number of masses by providingcomprehensive financial services and financial advice.

Such collaborations will also ensure that financialinclusion is not looked upon as a social obligation, butviable business models over time.

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Universal Financial Inclusion in India - The Way Forward

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