India’s Changing Banking Landscape Will Drive Inclusive Growth

by K Gangopadhyay and R Sensarma - Nov 4, 2015 06:03 PM +05:30 IST
India’s Changing Banking Landscape Will Drive Inclusive Growth

In this age of inclusive growth, financial inclusion has become an important parameter not only to measure economic development but also to drive the same.

Financial Inclusion as for development

In the age of industrial revolution, the measurement of economic development was the amount of sulphuric acid produced by the country. In this age of inclusive growth, financial inclusion has become an important parameter not only to measure economic development but also to drive the same. If the citizens of a country can have better access to finance, they can leverage this access to generate opportunities for a better life.

Financial Inclusion makes a billion entrepreneurs

In the case of India, the need for securing financial access is even dire. India has a lot of human capital in every nook and corner of the country which needs encouragement for producing entrepreneurs. The decentralized way of providing encouragement lies in assuring access to credit, which can happen only with financial inclusion. The centralized way is through government subsidies. Even that can efficiently reach the targeted population if financial inclusion is secured.

Financial inclusion secures multiple long term benefits such as prevention of leakages of government subsidies, channelizing household savings into the financial system and access to loan for potential entrepreneurs. Thus, empowerment of poorer sections of our population crucially hinges upon financial inclusion.

Saradha Scam

The Saradha group of companies ran a Ponzi scheme (busted in 2013), which demonstrated how the absence of financial inclusion ends up fuelling financial fraud. Saradha group—by offering exorbitant commission to its agents—reached the unbanked population of West Bengal who, in the absence of formal banking access, often found Saradha as the only option to invest their savings. Had formal banking reached the unbanked, the temptation to invest with Saradha would have been definitely lesser. Lack of financial inclusion, therefore, causes corruption and embezzlement, which may not be always obvious.    

Pradhan Mantri Jan Dhan Yojana (PMJDY)

One of the ways for the government to achieve greater financial inclusion is to encourage regular banks to open bank accounts for the poor. Modi government’s first big program was Pradhan Mantri Jan Dhan Yojana (PMJDY) that created so far more than 11 crore accounts till this month. Scepticism still exists in certain circles over whether the owners of these accounts were actually financially excluded. However from the point of view of increasing the efficiency in delivering government benefits, this is undoubtedly a welcome move from the government. Moreover in recent times transactions in these no-frills accounts have seen an increase which is an early indicator of success of this policy for financial inclusion.

Prime Minister Narendra Modi launching the Pradhan Mantri Jan Dhan Yojana (PMJDY) in New Delhi on August 28, 2014.
Prime Minister Narendra Modi launching the Pradhan Mantri Jan Dhan Yojana (PMJDY) in New Delhi on August 28, 2014.

Social Welfare Net

The Modi government also attempts to build a social welfare net around financial inclusion. Once the poorer sections of the population have bank accounts, they can enrol themselves into three national welfare schemes created by the government. Two of these schemes provide life insurance and accident insurance of two lakhs each for a nominal premium.

The third scheme, Atal Pension Yojana, gathers monthly payment from those who are currently not covered by formal sector pension schemes. In return for these monthly contributions which are made up to the age of 60, the subscriber receives pension for rest of his/her life. These kind of savings are called temptation-proof assets. Research suggests that the poor suffer not only on account of low earnings, but more so for their inefficient management of savings. Scarcity clouds their judgment and they end up worse off than even what their earnings allow them. A pension scheme, that collects contribution on a regular basis, will definitely help the poor by letting them utilize their own earnings optimally.

Technology Banking

This unparalleled rise in bank consumers— in the process of ensuring banking for the unbanked—poses a new challenge for the banking sector. Addition of bank branches is time-consuming and a costly process. Moreover, a new branch is far less likely to reach the unbanked hinterlands than the urban professionals.

The easier way to achieve the last mile connectivity is by exploration of technology. India can look up to West African nations like Kenya for success stories in mobile banking services. The Economist magazine observed that payment for a taxi-ride using mobile banking is easier in Nairobi, the capital of Kenya, than in New York, the Mecca of World’s financial institutions. India’s mobile penetration rate is already more than 70%. In smartphone and internet usage, India is rapidly catching up with developed countries providing tremendous scope for technology-enabled banking.

New Banking Licenses

Moreover, in the interest of financial inclusion, Reserve Bank of India has issued three types of banking licenses to new entities in the present year.

—Universal Banks

Two new universal banks that have come up are IDFC and Bandhan. Bandhan is the top MFI in India in terms of the client outreach—a whopping 65 lakh that is almost double of its nearest competitor. The more institutions like Bandhan that work at the grassroots get banking licenses, the less it will be likely that poorer sections can be entrapped by Saradha like Ponzi schemes.

—Payments banks

Eleven entities, most notably Department of Posts, got payment banking license that allows these entities to take deposits from consumers of up to one lakh rupees without lending rights. The broad idea is utilisation of the Department of Posts network whose unparalleled outreach can be leveraged to ensure financial inclusion for the rural populace. There are several other such payments banks which have got the license based on tie-ups between existing banking institutions and technology partners. This will help them to benefit from each other’s core competences to offer banking services to the unbanked.

—Small finance banks

Another ten licenses were awarded to small finance banks that operate under severe restrictions and are not allowed to lend to the corporate sector. Most of these small finance banks are erstwhile MFIs who would, for the first time, be able to raise low cost retail deposits. They would in turn charge lower interest rate to their loan clients thus fostering growth in rural entrepreneurship.


India’s Changing Banking Landscape Will Drive Inclusive Growth

To facilitate the non-corporate business, often called India Uninc, another initiative is Micro Units Development & Refinance Agency Ltd. (MUDRA). Although it was launched as an alternative institution for providing credit to the poor, it is currently operating as a subsidiary of SIDBI and engaged in refinancing MFIs as well as providing new loans. If well managed, MUDRA could end up funding large numbers of entrepreneurs and grassroots ventures in the country.

India can see its future as a soft power and knowledge economy. Our traditional knowledge system, if nurtured properly, can contribute massively to make India an economic superpower. To move this gigantic powerhouse, what is urgently required is access to credit for a billion entrepreneurs who currently lurk in the hinterlands.

See also:

Kaushik Gangopadhyay and Rudra Sensarma are Associate Professors of Economics, Indian Institute of Management , Kozhikode.
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