“The importance of finance to economic growth has also frequently been ignored by economists.”
Fed Governor, Frederick Mishkin in 2005
WHAT IS FINANCIAL INCLUSION?
We had two committees in past which give definitions of financial inclusion: Rangarajan Committee on Financial Inclusion which defines it 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.”
Raghuram Rajan Committee on Financial
sector Reform which described it as “Financial inclusion, broadly defined,
refers to universal access to a wide range of financial services at a
reasonable cost. These include not only banking products but also other
financial services such as insurance and equity products.”
Source: Adapted from the Rangarajan Committee Report
Source: IISS, 2007
The two definitions basically,
defines the Financial Inclusion as availability of diversified range of
financial products to all the people residing in the country, which was earlier
accessible exclusively to urban section of society. Here it is important to
note that financial inclusion is not only about credit, rather it talks about
all three levels of access: Contingency Planning, Credit and Wealth Creation.
It empowers, especially, the poor to take control of the lives and get
connected to main stream of country’s economic development.
WHY FINANCIAL INCLUSION?
India lives in its villages. The Rural population (% of
total population) in India was last reported at 69.90% in 2010, according to a
World Bank report published in 2012. Of late the rural economy of India is
transitioning from a mere agrarian society to encompassing other areas of
professions like manufacturing, service industry etc. From
1999 to 2009, 75% of all new factories came up in rural India, and 70% of all
manufacturing jobs were created there. Therefore, in order to
streamline the revenue that is being generated from this sector, it is very important to provide
efficient banking solutions to the bottom of the pyramid population. This
brings into light the importance of financial inclusion.
The rural population in India mostly belongs to the low
income, illiterate group. They rely on local money lenders for any financial
solution that they seek. The local money lenders usually take advantage of the
illiteracy aspect of the rural low income Indian and offer him the financial
solution that he is seeking for at a very high interest rate. This is leading
to increasing the rich and the poor gap in the rural economy. Also, the lack of
proper financial solution is acting as a major hindrance for further improving
the standard of living of rural India.
Also, during the course of unexpected circumstances like
illness, death, accident etc, this sect of population remains helpless without
any viable financial solution. Thus, financial inclusion, majorly targeting
this sector of Indian economy is very important for improving their standard of
living. also provides banks with fresh funds which can be further invested in
building the infrastructure in the society. Therefore, financial inclusion will
lead to a win-win situation both for the rural sector and the banking industry.
This sector earns wages on a daily basis or rather on a
weekly basis. They will look for an uncomplicated financial solution that can
give them quick access to their meager savings. It should also involve less
paper work. Also, the financial product should enable this sector to build
their assets and reduce their risk levels. Banking industry must tailor their
products on these lines. The current penetration of banking sectors in rural
India is very low. Life Insurance penetration hovers at less than 5%, equity
market penetration is less than 10% and fewer than 60% of households have
access to banking services. And, the current size of microfinance accounts is
21 million (Source: M-Cril Microfinance Review 2012). Therefore, there lies an
immense opportunity for the banking industry as well as there are 500000
villages which are yet to be provided with a formal banking channel.
However, of late this industry has been in severe turbulence
due to various reasons. Before understanding the reasons for this turbulence, a
glimpse of current industry scenario is presented below:
CURRENT INDUSTRY SCENARIO
Southern part of India has been the major hub for MFIs since
2003. However, due to the recent SKS crisis, there has been a variation in this
ratio.
Source: M-Cril Microfinance Review 2012
Recent fall of SKS Microfinance has been a major setback for
the industry. Also, excessive loan provision in the state of Andhra Pradesh and
atrocious methods adopted for collecting the money back reduced the cost
efficiency to a significant extent.
Source: M-Cril Microfinance Review 2012.
The average yield of the industry is lower than the global
median of 28%. This is expected to fall further because of the caps for
microfinance NBFCs. MFIs in India have the worst portfolio quality ratio in the
world.
BENEFITS
It can generate millions of well paying jobs and more
importantly have an enormous multiplier effect on inclusion and economic
growth. It also hedges them against inflation. Financial inclusion encourages
poor people to save and bring them into formal financial intermediation system
and channel them into investment. These investments can be used in the projects
with greater return on investment than what could be invested by poor people
and sharing the profit with them. Moreover, large number of low cost deposits
would reduce the dependability of banks on bulk deposits and help them to
manage their liquidity risks and asset liability match efficiently.
Poor people would also get protection against the informal
sources of credit like money lenders, Ponzi and Pyramid schemes etc., which is
widely prevalent in the poorer region.
It has also been seen that there is a relationship between unemployment
rate and the financial exclusion.1 It reduces the prevailing
unemployment rate and therefore help people improve their lives. Apart from
this it has ability to tackle poverty and inequality as it empowers people to
save where they can get interest which is equivalent to market rates, which in
long run bring prosperity to the people.
CHALLENGES
The story does not end here. Although there are numerous
benefits of financial inclusion but it is very important to discuss the
hindrances which have led to toppling of microfinance industry as a whole and
the problems which deter its successful implementation.
The challenges can be divided into two types: demand side
and supply side. On the demand, there is lack of awareness about financial
services and products, which prevent the spread of even services suitable for
poor people. Lack of financial literacy and social exclusion also lead to
either people choosing wrong product or even abandoning the services. It has
also been observed that many of the products are not suitable to their needs
and neither any attempt is being made to do so.
The unfriendly and unempathetic behavior of employees in the
bank has lead to decrease in demand of products and services. On top of that,
exorbitant and oftentimes non-transparent fees, combined with burdensome terms
and conditions attached to the financial products, also dampens the demand.2
Source: Sa‐Dhan, 2012. The Bharat Microfinance
Quick Report 2011. New Delhi: Sa‐Dhan.
The figure above shows
the low level of penetration in some of the states
From the Supply Side, the three big challenges are: (i)
cost; (ii) lack of robust technology; and (iii) lack of awareness. Transaction
costs are high in the case of Microfinance. Because of current low volumes,
banks find that extending financial services is not cost effective. Furthermore,
lack of communication, lack of infrastructure, language barriers and low
literacy levels all raise the cost of providing services and inhibit bankers
from taking initiative from the supply side. Also, there has been less attempt
made to tailor the products according to the needs of the target customers.
Even in existing microfinance institution, there were some
drawbacks like moral hazards and large systematic problem. An example of this
can be found in Andhra Pradesh where the banks made multiple loans to the
already debt ridden borrowers. The Andhra Pradesh experience shows us that centralization
and standardization, leads to gap between the products available and the
requirement of people targeted. Also, involving private sector under
unregulated environment has resulted in Microfinance crisis.
CONCLUSION
From,
the AP experience we can summarize that the success of financial inclusion
requires an approach that is localized and dependent on customization of
products and services under proper regulation, rather than the present approach
that attempts to centralize and standardize the whole process. RBI is
playing an active role in this direction. Not only the government and the RBI,
but also private banking players should proactively participate in financial
inclusion. A recent effort of the government to open an exclusive bank for
women is also rightly targeted in this direction. Also, the government must
ensure that the poor not only have accounts but also sufficient amount in that
account for their sustenance.
REFERENCES
http://nabard.org/pdf/report_financial/Chap_II.pdf
http://www.iiste.org/Journals/index.php/JEDS/article/view/2910/2937
Raghuram
Rajan Report on Financial Sector Reform
http://planningcommission.nic.in/reports/genrep/rep_fr/cfsr_all.pdf
http://world-finance-conference.com/papers_wfc/99.pdf
http://www.bis.org/review/r091215b.pdf?frames=0
http://www.cgap.org/blog/tech-start-ups-and-financial-inclusion-trends-watch-2013
http://www.project-syndicate.org/commentary/the-benefits-of-financial-inclusion-by-daniel-schydlowsky#phw1opZEeUskRlXq.99
By
Soumya Chanduri (12PGP097)
Anupriya (12PGP063)
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