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India – Can Financial Inclusion Drive a Rural Recovery?

Crises often present opportunities and lead to revamping of systems and procedures. Rural India, even before the global economic crisis, has been on the threshold of exciting changes which have the potential to transform and infuse a fresh dose of energy and hope into a hitherto neglected sector. The environment may now be even better suited to progress on a key development issue: Financial inclusion.

K. Seeta Prabhu
.To be sure, the global financial crisis and related emerging issues such as the large scale return of migrants who have lost their jobs in towns, prospects of a drought in many parts of the country due to insufficient and irregular rainfall, and the continuing rise in the prices of commodities for daily consumption have cast a shadow on prospects of rapid growth that is difficult to ignore.

In these times of distress, what could have offered succor is a well-established and functioning financial sector that offers a range of products suited for the rural clientele and enables and supports those with meager incomes to tide them over tough times and secure their livelihood. The crisis may offer just the incentive needed to forge a much more active financial sector that will lead a resurgence of the rural sector and, in turn, the entire economy.

There is much to be done. While India aggressively pursued bank nationalization way back in 1969 to widen the reach of banks leading to a network of around 70,000 bank branches, the country continues to flounder on all the indicators of financial inclusion – ease of access, availability and usage of the formal financial system. The overall reach of the banking system has been unsatisfactory. The latest report of the Reserve Bank of India, released last month, indicates that only 59% of the adult population has bank accounts. For the insurance sector the picture is dismal. The insurance density ratio — defined as the volume of premiums to population — was only 33.2 in India in 2006. In Europe, it is over 30 times higher.

In rural India, the picture is even grimmer. The RBI study shows that among the 89.3 million farmer households in the country, more that half do not access credit either from institutional or non-institutional sources. Only 27% of farm households borrow from formal sources of credit. Despite several measures to expand banking services to rural areas, rural branches of banks continue to be avenues for deposit collection rather than the active deployment of credit for productive use. The cooperative banking system is also in a state of disarray which limits its reach. In 2006, around half of the Primary Agricultural Credit System, which comprises grass-root-level institutions catering to the credit needs of farmers, was loss-making and the situation has only deteriorated further since. The situation in the poorer states with larger rural populations is even worse.

“The very fact that rural India did not rely on the use of financial instruments was seen as a reason for its relative immunity from the direct impact of the crisis.

The rapid expansion of self-help groups and micro-finance institutions has extended a modicum of financial services to the poor. Since 1992-93, banks have been linked to the self-help groups under a government program and the groups have been better able to access credit from the formal sector. In 2008, an estimated 45 million households were linked to the formal banking system through self-help groups.

However, reports indicate that the groups cater more to the upper crust of the poor and their reach has not touched the poorest of the poor. A 2007 study by the National Council for Applied Economic Research, a Delhi-based think tank, indicated that in Uttar Pradesh, the proportion of self-help groups with a majority of “non-poor” members was as high as 63%. In Andhra Pradesh, widely hailed for its success in these groups, this proportion was 43%.

Moreover, the size of loans provided is so low, it is of little use for economic purposes. A 2008 report by Delhi-based non-profit Access Development Services indicates that the average loan size of the micro finance institutions is of the order of 3500-5000 rupees ($50-70) to be repaid within a period of one year. Given such miniscule amounts as credit, most borrowers have used micro finance for easing temporary liquidity problems to pay off loans and for the purchase of consumer goods such as TV sets, rather than to enhance their livelihood opportunities.

Recently the National Rural Employment Guarantee Scheme has initiated the use of smart cards and the services of 155,000 post offices across the country to pay the wages of those who are engaged in manual labor to tide them over a lean period.

This has provided an impetus to the use of financial services by the poor. For instance, the Andhra Pradesh government is using smart cards to transfer NREGS benefits and social security pensions to 5 million beneficiaries. A similar number is being addressed in Rajasthan through efforts at financial inclusion that are in an experimental stage.

The RBI, in an attempt to enhance the reach of financial services, adopted the “Business Correspondent Model” in January 2006. This model seeks to use the services of non-governmental organizations, micro-finance institutions and other civil society organizations as intermediaries in providing financial and banking services. This has met with partial success. Data shows that out of 50 public sector and private sector banks, only 26 banks have so far reported appointing business correspondents, through which under one million no-frills accounts had been opened by March this year.

The expansion of mobile banking services is another area that is being explored. An estimated 440 million mobile phones spread across the length and the breadth of the country offer an easy platform for the extension of a range of financial services.

A start has been made in providing greater financial access but most commercial banks are focusing almost exclusively on provision of credit. However, there is more to financial services than access to credit. Credit can benefit only a small proportion of the rural population that has the entrepreneurial skills to use it productively to expand their opportunities. For most, mitigation of risk, availability of saving options, and bridging finance through a lean period are the more immediate requirements. To foster “inclusive growth,” there is a need to develop a range of services suited to various categories of the poor and vulnerable.

For financial services to play their legitimate role in financing sustainable livelihood opportunities, it is essential for the menu to have a range of services such as affordable and flexible credit for livelihood finance; access to risk mitigation services like health, weather, asset and life insurance; access to vulnerability-reducing services like warehouse receipt finance; and access to financial services like micro pensions.

The devastating effects of the global financial crisis were muted in India thanks to the large domestic demand. The very fact that rural India did not rely on the use of financial instruments was seen as a reason for its relative immunity from the direct impact of the crisis. While this may well be true, it also reflects the relative lack of financial access to a large proportion of households. The volatility of the global financial markets may in fact compel financial institutions to rediscover the huge potential offered by the Indian financial market that has remained unexplored thus far. This is where the big opportunity lies for boosting financial inclusion.

The NREGS, business correspondents, along with a commitment to “inclusive growth” provides a conducive climate for the introduction of innovative tools that take into account the specific needs of the rural customer. The private sector’s role and initiative will be crucial in determining the pace and growth of this sector. There seems to be a win-win situation for both the private sector and the rural poor. The private sector can ensure expanded business by exploring the potential of rural markets while the poor, by having greater access to financial services, can further their livelihood opportunities and hope to move out of poverty in the foreseeable future.


September 28, 2009 - Posted by | Uncategorized |

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