Role of Financial Inclusion for Inclusive Growth in India

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Role of Financial Inclusion for Inclusive Growth in India- Issues & Challenges

by

Dr. Vighneswara Swamy and Dr. Vijayalakshmi

I. INTRODUCTION

Amartya Sen (2000) convincingly argued that poverty is not merely

insufficient income, but rather the absence of wide range of capabilities, including

security and ability to participate in economic and political systems. Today the term

‘bottom of the pyramid’ refers to the global poor most of whom live in the developingcountries. These large numbers of poor are required to be provided with much

needed financial assistance in order to sail them out of their conditions of poverty.

Accordingly, there is felt a need for policy support in channeling the financial

resources towards the economic upliftment of resource poor in any developing

economy. This paper is an attempt to comprehend and distinguish the significance

of Financial Inclusion in the context of a developing country like India wherein a

large population is deprived of the financial services which are very much essential

for overall economic growth of a country.

The consensus is that finance promotes economic growth but the magnitude

of impact differs. Financial inclusion is intended to connect people to banks with

consequential benefits. Ensuring that the financial system plays its due role in

promoting inclusive growth is one of the biggest challenges facing the emerging

economies. We therefore advocate that financial development creates enabling

conditions for growth when access to safe, easy and affordable credit and other

financial services by the poor and vulnerable groups, disadvantaged areas and

lagging sectors is recognised as a pre-condition for accelerating growth and

reducing income disparities and poverty. Access to a well-functioning financial

system, by creating equal opportunities, enables economically and socially



Role of Financial Inclusion for Inclusive Growth in India-Issues & Challenges 2

excluded people to integrate better into the economy and actively contribute to

development and protects themselves against economic shocks.

II. FINANCIAL INCLUSION

Importance of financial inclusion arises from the problem of financial

exclusion of nearly 3 billion people from the formal financial services across the

world. The review of literature suggests that the most operational definitions are

context-specific, originating from country-specific problems of financial exclusion

and socio-economic conditions. Thus, the context-specific dimensions of financial

exclusion assume importance from the public policy perspective. The operational

definitions of financial inclusion, have also evolved from the underlying public policy

concerns that many people, particularly those living on low income, cannot access

mainstream financial products such as bank accounts and low cost loans, which, in

turn, imposes real costs on them -often the most vulnerable people (H.M. Treasury,

2007). Thus, over the years, several definitions of financial inclusion/exclusion have

evolved. In the Indian context, Rangarajan Committee (Report of the Committee on

Financial Inclusion in India (2008)) defines it as: "Financial inclusion may be defined

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." The financial services include the entire gamut -

savings, loans, insurance, credit, payments etc. By providing these services, the

aim is to help them come out of poverty.

Global Experiences

While in developed countries, the formal financial sector comprising mainly

the banking system serves most of the population, in developing countries, a large

segment of the society, mainly the low-income group, has little access to financial

services, either formal or semi formal. As a result, many people have to necessarily

depend either on their own sources or informal sources of finance, which are

generally at high cost. Most of the population in developed countries (99 per cent in




Denmark, 96 per cent in Germany, 91 per cent in the USA and 96 per cent in

France) has bank accounts (Peachy and Roe, 2004). However, formal financial

sectors in most developing countries serve relatively a small segment, often no

more than 20-30 per cent of the population, the vast majority of whom are low

income households in rural areas (ADB, 2007).

Recent data (Table-1 in Annexure-1) shows that countries with large

proportion of population excluded from the formal financial system also show higher

poverty ratios and higher inequality. Typically, countries with low levels of income

inequality tend to have lower levels of financial exclusion, while high levels of

exclusion are associated with the least equal ones. In Sweden, for example, lowerthan two per cent of adults did not have an account in 2000 and in Germany, the

figure was around three per cent (Kempson, 2006). In comparison, less than four

per cent of adults in Canada and five per cent in Belgium lacked a bank account

(Buckland et al, 2005). Countries with high levels of inequality record higher levels

of banking exclusion. To illustrate, in Portugal, about 17 per cent of the adult

population had no account of any kind in 2000 (Kempson, 2006).

Policy Response to Financial Exclusion – Country Experiences

The policy responses to such exclusion have been varied. Two major kinds

of policy responses have been implemented by central banks in response to

financial exclusion: codes of practice and specific legislation. In Belgium, a banking

bill was enacted which has been implemented since October 2003. In addition to

setting out the minimum standards for basic bank accounts, it also specifies the

ceiling on charges and a minimum number of free face-to-face transactions. In

France, the law on exclusion of July 1998 reiterated the right to an account first set

out in the 1984 law and has since then simplified the process of exercising the right

to an account. In Canada the legislation enacted in June 2001 requires all banks to

provide accounts without minimum opening balances regardless of employment or

credit history, with minimum identification requirements. A Financial Consumer






consultative committee (DCC) and strengthening local institutions such as co-

operatives and RRBs; (iii) using technology for furthering financial inclusion; (iv)

advising banks to open a basic banking ‘no frills’ account; (vi) emphasis on financial

literacy and credit counseling; and (vii) creating synergies between the formal and

informal segments.

III. FINANCIAL INCLUSION AND INCLUSIVE GROWTH IN INDIA

From an annual average growth rate of 3.5 per cent during 1950 to 1980, the

growth rate of the Indian economy accelerated to around 6.0 per cent in the 1980s

and 1990s. In the last four years (2003-04 to 2006-07), the Indian economy grew by

8.8 per cent. In 2005-06 and 2006-07, the Indian economy grew at a higher rate of

9.4 and 9.6 per cent, respectively. Reflecting the high economic growth and a

moderation in population growth rate, the per capita income of the country also

increased substantially in the recent years. Despite the impressive numbers, growth

has failed to be sufficiently inclusive, particularly after the mid-1990s. Agricultural

sector which provides employment to around 60 per cent of the population lost its

growth momentum from that point, though there has been a reversal of this trend

since 2005-06. The percentage of India’s population below the poverty line has

declined from 36 per cent in 1993-94 to 26 per cent in 1999-2000. While India has

witnessed unprecedented economic growth in recent past, its development has

been lopsided with the country trailing on essential social and environmental

parameters of development. The approach paper to the Eleventh Plan indicated

that the absolute number of poor is estimated to be approximately 300 million in

2004-05. Accordingly, the 11th Five Year Plan has adopted “faster and more

Inclusive growth” as the key development paradigm.

The importance of this study lies in the fact that India being a socialist,

democratic republic, it is imperative on the policies of the government to ensure

equitable growth of all sections of the economy. With only 34% of population

engaged in formal banking, India has, 135 million financially excluded households,




the second highest number after China. Further, the real rate of financial inclusion

in India is also very low and about 40% of the bank account holders use their

accounts not even once a month. It is universally opined that the resource poor

need financial assistance at reasonable costs and that too with uninterrupted pace.

However, the economic liberalization policies have always tempted the financial

institutions to look for more and more greener pastures of business ignoring the

weaker sections of the society. In India, the financially excluded sections comprise

largely rural masses comprising marginal farmers, landless labourers, oral lessees,

self-employed and unorganized sector enterprises, urban slum dwellers, migrants,

ethnic minorities and socially excluded groups, senior citizens and women. Some of

the features of financial exclusion in India are captured in Figure-1 (Annexure-5).Some of the important causes of relatively low extension of institutional credit in the

rural areas are risk perception, cost of its assessment and management, lack of

rural infrastructure, and vast geographical spread of the rural areas with more than

half a million villages, some sparsely populated (Mohan, 2006).

It is essential for any economy to aim at inclusive growth involving each and

every citizen in the economic development progression. It is in this context that

financial inclusion should be aimed at inclusive growth in the Indian context. Select

macro-economic and financial indicators of Indian economy are presented here

below in Table-4 (Annexure-4).

IV. ISSUES AND CHALLENGES

India currently faces several issues and challenges in the area of Financial

Inclusion for Inclusive growth. Salient among them are stated here below;

1. Spatial Distribution of Banking Services: Even though after often

emphasized policy intervention by the government and the concerted efforts

of Reserve Bank of India and the public sector banks there has been a

significant increase in the number of bank offices in the rural areas; but it is




not in tune with the large population living in the rural areas. For a population

of 70% only 45% of bank offices provide the financial services.

2. Regional Distribution of Banking Services: The analysis by the authors

brings to the fore that there has been uneven distribution of the banking

services in terms of population coverage per bank office in the six regions

viz; Northern, North-eastern, Eastern, Central, Western and Southern

regions of the country.

3. Bank Branches are required to be increased as it has a direct impact on the

progress of financial inclusion. It is clearly established that as the bank

branches increase number of bank accounts also increase significantly.

4. Poverty levels are having direct relationship with the progress of financialinclusion. The authors have established in their study that as the poverty

levels decrease financial inclusion also increase. As such, there should be

multi fold strategic approach in such poverty dominated areas for financial

inclusion.

5. SC/ST population: It is ascertained by the authors’ study that in the areas of

Scheduled Castes/Scheduled Tribes population the progress of Financial

Inclusion is slow which indicates that the efforts for Financial Inclusion has to

be increased significantly in such areas in order to bring in social and

economic equity in the society.

6. Overcoming Bankers’ Aversion for Financial Inclusion

Even though no banker openly expresses his aversion for the financial

inclusion process, overtly it can be noticed that they are averse to it in view

of the cost aspects involved in opening of no frill accounts.

V. RECOMMENDATIONS AND POLICY CHOICES

Twenty One Steps for Twenty First Century Financial Inclusion

The authors present here below Twenty One recommendations and policy choices

for successful financial inclusion for inclusive growth in India.




Step 1: A New Financial Architecture to Suit the Needs of Inclusive Growth

Keeping in view the dynamics of the changing economy, there is a strong need to

restructure the financial system particularly the rural financial system. The present

system which was enshrined in the late 70s greatly needs a rigorous relook.

Step 2: Coordination with UIDAI

Government of India’s ambitious programme of issuance of multi-purpose Unique

Identity Cards by UIDAI should be of great help for achieving financial inclusion.

There needs to be proper systematic coordination with UIDAI in order to make the

best use of it for the purpose for financial inclusion.

Step 3: Formation of National Financial Inclusion Mission

The authors recommend formation of National Financial Inclusion Mission on the

lines of National Literacy Mission to carry out systematic and coordinated drive for

financial inclusion.

Step 4: Involvement of Education Sector for furthering Financial Inclusion

Involving educational institutions, particularly college students for financial inclusion

drive would not only be cost effective but also would create wide public awareness.

Step 5: Establishment of Financial Counseling Centres

Financial Inclusion drive should not be short-lived; instead a systematic effort

should be structured by establishing FCCs (Financial Counseling Centres) on the

lines of e-Seva centres in Andhra Pradesh for providing financial services.

Step 6: Building Client Capacities

As the saying goes “teach him to fish instead of giving him fish”, it should be the

effort of all the concerned (particularly the financial institutions) to develop these

poor people as prospective customers. Building client capacities would definitely

help all the stakeholders and would to a vibrant financial system




Step 7: Partnership with Dedicated NGOs and MFIs

Partnering with trustworthy and acclaimed people’s organisations would definitely

accelerate the process of financial inclusion especially in the rural areas. Specific

financial as well as non-financial incentives have to be designed for the spirited

involvement of such organisations

Step 8: Financial Inclusion as a Part of Course Curriculum in High Schools

Financial Inclusion should be imbibed into the course curriculum in high schools so

that the students would understand the importance of financial inclusion for

inclusive growth in the economy which in turn would motivate them to automatically

participate in the financial system.

Step 9: Digitise the Documentation Process for Opening of Bank Accounts

One of the often stated reasons for slow pace of financial inclusion has been the

hassles involved in opening of bank accounts and availing of loans from financial

institutions due to the long process of documentation. To overcome this, there is a

need to digitise the public records for dual purpose of easy accessibility and

storage.

Step 10: Strategize the Provision of Bank Credit

Need is felt to strategize the provision of bank credit to the rural farmer households.

Majority of the marginal farmer households are not at all covered by the formal

finance. As such public sector banks and the co-operative banks in the rural areas

have to sensitize about the need for provision of timely and cheaper credit to these

segments. Reserve Bank of India in consultation with NABARD should come out

with a comprehensive strategy for revitalizing the quiescent rural credit mechanism.

Step 11: Exclusive Focus on the Socialyl Excluded and the Poor

It is imminent to encompass the socially excluded sections and the poor like, tenant

farmers, oral lessees and share croppers, marginal farmers with small un-




economical land holdings, agricultural laborers, rural artisans and people involved in

making handicrafts and also majority of weavers in handloom Sector.

Step 12: Extensive use of Co-operatives

PACS (Primary Agricultural Cooperative Societies) could provide valuable services

to their members with a sense of belongingness. Accordingly, there is a need to

revitalize these cooperatives as per the Vaidyanathan Committee recommendations

and use them extensively for financial inclusion in the rural areas.

Step 13: Undoubtedly a Greater Role for NABARD

NABARD has to play a pro-active role by partnering with the rural credit institutionsin the field and identify new initiatives that will contribute to effectively improving the

extent of financial inclusion involving SHGs, MFIs, etc.

Step 14: Procedural / Documentation Changes

It is inevitable on the part of the regulators to find out an easy way of procuring the

documents for opening of bank accounts and availing loans. The present guidelines

are more tedious and result in huge costs for the poor in accessing the banks for

any kind of services. Simplifying Mortgage Requirements, Exemption from Stamp

Duty for Loans to Small and Marginal Farmers, Saral Documentation for Agricultural

Loans.

Step 15: Proactive Role of Government

State Governments should be asked by the Central Government to play a pro-

active role in facilitating Financial Inclusion. Issuing official identity documents for

opening accounts, creating awareness and involving district and block level

functionaries in the entire process, meeting cost of cards and other devices for

pilots, undertaking financial literacy drives are some of the ways in which the State

and district administration have involved themselves.




Step 16: A Role for Rural Post Offices

Post Offices in rural areas can be asked to provide their services in accelerating the

financial inclusion activity. In view of the postman’s intimate knowledge of the local

population and the enormous trust reposed in him post offices can be good use in

the process of financial inclusion

Step 17: Effective Use of Information Technology Solutions

The use of IT enables banks to handle the enormous increase in the volume of

transactions for millions of households for processing, credit scoring, credit record

and follow up. The use of IT solutions for providing banking facilities at doorstep

holds the potential for scalability of the Financial Inclusion initiatives.

Step 18: Adequate Publicity for the Project of Financial Inclusion

In a huge country like India, there needs to be huge publicity for popularizing the

concept and its benefits to the common man. In this direction, a comprehensive

approach has to be developed involving all the concerned at all levels to impress

upon the need for financial inclusion for accelerating the economic growth in the

country.

Step 19: Financial Inclusion as a Corporate Social Responsibility of all the Banks and Financial Institutions

It should be the endeavour of all the financial institutions to adopt financial inclusion

as a corporate social responsibility and chalk out strategies in tune with the national

policy on financial inclusion.

Step 20: Role of RBI

Reserve Bank needs to take a pro-active role in the accelerating financial inclusion

by involving all the stake holders in the financial system by using its power of moral

suasion as well as regulatory powers.

Step 21: Political Will




Political will is an all important aspect in any developmental effort. Political

leadership should accord adequate importance for financial inclusion in order to

motivate and mobilise all the weaker sections of the society in favour of financial

inclusion for their economic upbringing.

VI. CONCLUSION

Importance of financial inclusion arises from the problem of financial

exclusion of nearly 3 billion people from the formal financial services across the

world. With only 34% of population engaged in formal banking, India has, 135

million financially excluded households, the second highest number after China.

Further, the real rate of financial inclusion in India is also very low and about 40% of

the bank account holders use their accounts not even once a month. Financial

Inclusion has far reaching consequences, which can help many people come out of

abject poverty conditions. Financial inclusion provides formal identity, access to

payments system & deposit insurance. The objective of financial inclusion is to

extend the scope of activities of the organized financial system to include within its

ambit people with low incomes. Through graduated credit, the attempt must be to lift

the poor from one level to another so that they come out of poverty. There is a needfor coordinated action between the banks, the Government and others to facilitate

access to bank accounts amongst the financially excluded.

VII. REFERENCES

ADB, (2007): “Low-Income Households' Access to Financial Services”, International

Experience, Measures for Improvement and the Future; Asian DevelopmentBank

Buckland, J., and B. Guenther (2005): 'There Are No Banks Here, Financial andInsurance Exclusion in Winnipeg’ North End', Social Sciences and Humanities Research Council of Canada (September)

Caskey, J. P., C. R. Duran, C. R. and T. M. Solo (2006): 'The Urban Unbanked in




Mexico and the United States', World Bank Policy research Working Paper3835.

H.M. Treasury, (2007): “Financial Inclusion: the Way Forward”, HM Treasury, UK,

March.

Kempson, E. (2006): “Policy Level Response to Financial Exclusion in DevelopedEconomies: Lessons for Developing Countries”, Paper for Access toFinance: Building Inclusive Financial Systems, World Bank, Washington,May.

Kempson, E., J. Caskey, C. Whyley and S. Collard (2000): “In or Out ?” London:Financial Services Authority

Mohan, R. (2006): 'Agricultural Credit in India: Status, Issues and Future Agenda',

Economic and Political Weekly (March), pp.1013-23.

Peachy, S. and A. Roe, (2004): “Access to Finance - What Does it Mean and HowDo Savings Bank Foster Access?”, Brussels: World Savings Bank Institute.

Report of the Committee on Financial Inclusion in India (Chairman: C. Rangarajan)(2008), Government of India

Sen, Amartya, (2000): ‘Development as Freedom ’, Anchor Books, New York, 2000.

World Bank (2006), World Development Indicators, World Bank, Washington

World Bank (2008): “Finance for All - Policies and Pitfalls in Expanding Access”,World Bank, Washington

Annexure-1




Table-1: Financial Inclusion and Development Indicator

Country

Composite Index of

Financial Inclusion

(per cent of population

with access tofinancial services)

Poverty

(per cent of

population

belowpoverty line)

Unemployment

during 2000-04

(per cent)

Gini Index

1 2 3 4 5

India 48 28.6 (1999-00) 4.3 32.5 (1999-00)

Bangladesh 32 49.8 (2000) 3.3 31.8 (2000)

Brazil 43 22.0 (1998) 9.7 58.0( 2003)

China 42 4.6 (1998) 4.0 44.7 (2001)

Indonesia 40 27.1 (1999) 9.9 34.3 (2002)

Korean

Republic63 .. 3.5 31.6 (1998)

Malaysia 60 15.5 (1989) 3.5 49.2 (1997)

Philippines 26 36.8 (1997) 9.8 46.1 (2000)

Sri Lanka 59 25.0 (1995-96) 9.0 33.2 (1999-00)

Thailand 59 13.1 (1992) 1.5 42.0 (2002)

Source: World Bank (2006) and (2008).

Annexure-2

Table-2: Financial Inclusion Initiatives in different countriesCountry Legislation

instrument /

Policy Scheme

Objectives

United

Kingdom

Social Exclusion

Unit (SEU), 1997

To reduce social exclusion of which financial inclusion is an

integral part

Policy Action

Teams (PATs)

To look in an integrated way at the problems of poor

neighborhoods

Financial Inclusion

Task Force

1. Access to banking, access to affordable credit

2. Access to face-to-face money advice

Financial Inclusion

Fund

1. Access to banking services

2. Access to affordable credit

3. Access to money advice

United

States of

America

The Community

Reinvestment Act,

1977

1. Prohibits discrimination by banks against low and moderate

income neighborhoods

2. To make mortgage loans to lower-income households

3. banks are rated every three years on their efforts in meeting

community credit needs

Matched Savings

Scheme (MSS)

1997

1. Prohibits discrimination by banks against low and moderate

income neighborhoods

2. Matching money has to be spent on one of a range of

prescribed uses such as education, business or home purchase

France Banking Act, 1984 1. Any person with French nationality has the right to open an

account with any bank




2. If refused the aggrieved person can apply to the Banque de

France to designate a bank that should open an account

French Banker’s

Association (Basic

Banking ServiceCharter of 1992)

Committed to providing; Affordable account, Cash Card, Free

access to a cash machine, Distance payment facilities, Bank

Statement and Negotiable number of cheques

Australia Australian Bankers

Association (ABA)

Code of Practice,

1995

1. Generic Account was introduced in 2002

2. Staff to give information about suitable accounts to low-

income customers

3. Face-to-face banking services even after branch closure

through alternative means such as franchising

4. Three months written notice to customers before closing any

Branch

Rural

Transformation

Centre Programme

(RTCP)

1. to provide banking and other transaction services to

communities without banking facilities

2. Using existing stores and post offices or stand-alone centres

3. Install Electric Point of Sale (EPOS) equipment in post officesBelgium Charter of BasicBanking Services,

1996

1. Provide a basic bank account with no minimum balance andwithout overdraft facilities

2. Credit transfers, direct debits, and deposit and withdrawal

facilities

3. If refused, customer must be informed the reasons, i.e.,

laundering, bad credit history, etc.

Basic Banking Act,

2003

Sanctions if principles of Charter on Basic Banking Services,

1996 are not applied

Canada Access to Basic

Banking Services

Regulations, 2003

1. Personal bank accounts to all Canadians regardless of

employment or credit history and with minimum identification

requirements

2. Banks/FIs to encash government cheques at no charge

Annexure-3

Table-3: Extent of Financial Inclusion- Some Select Countries

Country Percent of population with an account

USA 91

Denmark 99

Europe 89.6

Botswana 47

Brazil 43

South Africa 31.7

Namibia 28.4Mexico 21.3

Source: Rakesh Mohan (2006), Economic Growth,

Financial Deepening and Financial Inclusion

Annexure-4



Tab

1.

2.

3.5. S

6. S

7. S

8.N

9.

10.

11.

12.

13.

14.

15.

16.17.

18.

19.

20.

21.

22.

23.

24.

(Nu

25.

Dis

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26.

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le-4: SelectMacro-

opulation (in

er capita inc

DP (constancheduled Co

CB branches

CB Rural &

o. of ATMs

ank assets (i

SCB Gross

SCB Deposi

SCB Net Pro

Priority sect

SCB Loans

SCB Loans

No. of RRBsRRBs Assets

RRB Deposi

RRB Advan

RRBs Profit

No. of Local

LAB Assets

No. of Coop

No. of Kisan

mbers in mil

Financial As

bursed by Fi

Crores)

No. of No-frSource: Reser

F

f Financial I

Macro-Ecconomic ind

mn)

me*(in Rup

t prices) (inmmercial Ba

Semi-urban

n Crores)

dvances (in

s (in Crores)

fit (in Crores

r lending(in

/Cs under S

/S under SB

(in Crores)

ts (in Crores)

es (in Crores

(in Crores)

Area Banks

ratives

Credit Cards

lion)

sistance Sanc

ancial Instit

ill accounts e Bank of Ind

igure 1: F

acfi

a

clusion for I

nomic andicators

es)

rores) ks

ranches

Crores)

)

Crores)

LP(in 000s)

LP (in Crore

)

(LABs)

Issued

tioned and

tions

ia Publication

Ann

atures of F

Source: Co

Fi

Ex

No Insurance

No cess to ancial dvice

No realisable assets

clusive Gro

Financial I1992-9

872

7698

7921576

75821

33025

-NA-

38577

15198

26857

(-)415

59097

0.255

s) 0.29

1969860

6960

4474

(-) 311

-

-

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exure-5

inancial Ex

piled by auth

nancial clusion

No Bank A/C

Cr

No Payment

and transfer system

th in India-Is

ndicators3

86 (af

clusion in I

rs

o dit

No Saving

s

sues & Chall

f Indian Ec2008-09

1138

33299

430365480

64608

36204

43651

52,41,330

30,00,906

40,63,203

52,771

1,68,506

2831

16,149

ter amalgam145824

117984

69030

1830

4

786.6

97782

84.6

88,973

33,024,761

ndia

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Documents

Role of Financial Inclusion for Inclusive Growth in India