FINANCIAL INCLUSION IS the flavour of the day. No financial sector seminar or conference these days goes through without participants holding forth on how financial inclusion is critical in India and how to go about attaining that. Indian policy makers have been labouring with this concept for a much longer time. From regional rural banks to local area banks to mobile and SMS banking, various models have been tried and continue to be tried to achieve financial inclusion. Unfortunately, nothing much seems to be making a dent on the problem of financial exclusion. A recent Bank Economists’ Conference in Mumbai also had a panel discussion on the subject but titled a shade differently – “how to profitably capture the financial services opportunities in the rural areas?”
What is the market?
When we talk of rural financial services opportunity, we have to be clear about what actually is the target market.
The rural population in India is close to 700 million. This population is engaged in both agricultural and non-agricultural income earning activities, though the bulk of their income is from agricultural activities only.
The rural sector broadly accounts for some 25 per cent of total national income – comprising 20 per cent from purely agricultural activities and 5 per cent from non-agricultural activities.
Per capita income in the rural sector is approximately Rs.20,000 per annum – this is an overall average and subsumes a range of incomes. The dispersion of incomes will be quite large considering that 75 per cent of the rural population is in the bottom 3 income / wealth quintiles.
Therefore, when we talk of rural financial services opportunity, are we talking about this 75 per cent of the rural population or the 25 per cent of the population which is in the top 2 income / wealth brackets?
Will mainline financial institutions such as banks find business opportunities in the bottom rungs of the rural income / wealth distribution “bankable?”
With low per capita incomes and skewed income / wealth distribution, mainstream financial institutions are likely to find it difficult to fashion a workable and profitable business model in this segment. (“Workable” and “profitable” business models, of course, have to be understood from the mainstream institutions’ perspective and their reliance on a set of financial / security criteria which makes lending opportunities credit-worthy!)
That it has not been proving attractive for them is clear from the fact that 70 per cent of the rural population does not have a bank account. The extent of exclusion from the credit markets is equally large. Out of close to 150 million rural households (of which there are 100 million farming households) in the country, some 75 per cent have no access to formal sources of credit while 50 per cent does not have access to even informal sources of credit.
Fundamental re-design towards MFIs is imperative
So, obviously, when we talk of profitably capturing financial services opportunities in the rural sector, we have to talk about some fundamental re-designing of the financial system and its delivery mechanisms – the emphasis has to be on non-banking financial intermediaries who have the requisite distribution and last-mile reach into the hinterland and the requisite credit disbursement, administration and risk mitigation skills.
The rapid strides made by micro-finance non-banks (micro finance institutions or MFIs) in recent years is testimony to the business opportunities and what kind of financial infrastructure – in terms of credit disbursement, risk management and administration,... - is needed to tap into that opportunity.
To be sure, there has been dissonance in how the micro finance model has operated and that has led to some friction in the system. But those aberrations and obstacles do not deny the fact that the micro model possibly provides the best mechanism to “profitably” provide organised financial services to large sections of the rural population.
The policy emphasis should therefore be on strengthening the micro finance and micro credit infrastructure – both in terms of better governance practices and in terms of channelising more lendable resources to MFIs from the organised banking system. If not the banking system, policy makers should actively work to facilitate increased access for the MFIs to the broader capital markets - either through securitisation or through ore conventional borrowing instruments such as retail deposits and debentures.
MFI model implies decentralisation
The MFI model means significant decentralisation of the system of financial intermediation in the country. Local and region-focused financial intermediation is what is called for in this vast country of ours. That this is the norm in countries with large geographies is amply demonstrated by the US model where thousands of region and area focused lenders / banks and other specialised types of financial institutions such as rural banks, mutual savings and credit unions operate alongside the “mainstream” commercial banks. There are some 8000 commercial banks in the US and but for some 40 banks headquartered in the major cities of that country, the rest are dispersed far and wide in that vast country.
If that is so in the US, it should be more so in India, which has a much larger population and also a much higher share of the population outside the mainstream financial system.
Mumbai: Make way for others
There has to be a decisive shift away from the top-down and centralised nature of the current financial system where mainstream financial institutions – like complying with the letter of the law – mechanically open and operate rural and semi-urban branch offices but without having any noticeable impact on the level of financial inclusion.
It is obvious that in such a decentralised system of financial intermediation, financial regulation and supervision also has to acquire a distinctive decentralised and regional focus. We cannot have one superfinancial regulator sitting in Mumbai and making regulatory policy on the thousands of region- ocused and region-specialised financial institutions operating across the country.
There can be one monetary policy for the entire country – that is, a policy which varies the degree of liquidity and monetary conditions at the aggregate level to steer the price of money to a desired level and in a desired direction. A single monetary policy for the entire country is natural since the country is politically unified, has a single currency and administratively functions under the same set of laws, rules and systems.
But, there cannot be one super regulator for an entire financial system that aspires for a decentralised focus. Again, the inspiration should come from the US where the Federal Reserve makes monetary policy for the entire country but regulation and supervision is dispersed at the regional level.
Critics may wonder why and how an example is being made of the US financial model, particularly in the backdrop of the global financial crisis that originated in the US.
To answer that, it may be pertinent to point out that a nuanced reading and understanding of the US model and the global experience since 2007 -2008 is called for. It should be noted that the financial crisis erupted in a part of the US financial system that was supervised at the national level. A significant part of the blame for the excesses that built up in the US financial system can be attributed to a colossal regulatory and supervisory failure at the national level.
That does not detract in any way from the validity and importance of the decentralised US financial model. It is important to learn lessons from history but equally important to learn the right lessons.