While there is extensive literature to show the crisis was triggered by the combination of under-pricing risk, complex financial engineering and a poor regulatory framework, the key to financial inclusion lies in adopting a two-pronged strategy:
First, fostering institution building, product and policy innovation capable of handling the "informationally opaque" borrowers, especially small businesses and farmers - borrowers without long credit histories suitable for credit-scoring; secondly, promoting of financial literacy and education to reduce information asymmetry itself to enable an expansion of mainstream credit markets with increasing participation by the excluded.
The Indian banking sector has acquired a greater degree of resilience due, inter alia, to the financial reforms implemented in a gradual and sequential manner within a participative process aimed at reduction in statutory preemptions, while stepping up prudential regulations and adopting international best practices taking into account the India-specific conditions at the same time.
An assessment of the banking sector performance shows that banks in India have experienced strong balance sheet growth in the post-reform period in an environment of operational flexibility. Improvement in the financial health of banks, reflected in significant improvement in capital adequacy and improved asset quality, is distinctly visible.
These significant gains have been achieved even while renewing our goals of social banking viz, maintaining the wide reach of the banking system and directing credit towards important but disadvantaged sectors of society. Thus, financial inclusion has been an integral part of the overall economic thinking, though this emphasis has acquired enhanced visibility in the recent years.
The financial inclusion model followed in India is aimed at providing access to formal banking to a large section of socially and economically excluded segment of population and improving its social/economic status.
The amounts involved are very small and spread over large geographical areas over large number of banks/financial institutions and do not involve any complex financial instruments. Thus, the argument that financial inclusion is fraught with the danger of jeopardising the financial system is not true in the Indian context, as is enumerated below:
The evolving Indian paradigm for financial inclusion, though not having any statutory backing, embodies various novel ingredients enumerated above. Making affordable financial services available to the un/under-served has been the cornerstone of the evolution underlying institutional development, product and policy innovation in India.
The Indian banking system is multilayered, comprising 82 scheduled commercial banks (SCBs), 92 regional rural banks (RRBs), 4 local area banks (LABs), 1,813 urban co-operative banks (UCBs) and 107,497 rural co-operative credit institutions.
The self-help-group bank linkage programme, adoption of Business Correspondent Model leveraging the post offices and setting up the Banking Codes and Standards Board of India (BCSBI) are illustrations of institutional creativity crafted to Indian conditions. The branch licensing policy followed by the RBI has an inclusive bias, while taking care of the viability aspects.
The involvement of the State Level Bankers' Committee (SLBC), simplification of know-your-customer (KYC) norms, introduction of the Banking Ombudsman Scheme and no-frills accounts (number of such accounts, which was less than half a million in March-end 2006 and rose to 7 million a year later, jumped to about 13 million by the end of December 2007), and Financial Sector Plan for North Eastern Region are the manifestation of inclusive centric-policy initiatives.
Yet, only 27 per cent of farm households are indebted to formal sources (of which one-third also borrow from informal sources). Thus, there is a huge unfinished agenda. However, India has the advantage of suitable infrastructure (institutions, products and policies) for scaling up efforts for financial inclusion in a big way.
The most effective catalyst for financial exclusion is economic development. Finance follows economics. Hence, there is a need for the financially excluded districts to catch up with the rest.
Nevertheless, in a wider canvas, micro finance, micro insurance, new delivery channels, and credit counselling would have to be integrated. For better outcomes, there has to be joint and concerted efforts on the part of the Government, the formal financial sector, voluntary organisations and SHGs. More focused attention on various fronts is called for.
There has been a measured streamlining of the banking architecture over the years, including refocusing the SCBs, consolidating RRBs and revamping the co-operatives. However, the LABs are not able to make significant headway in terms of redeeming their mandate.
The Rangarajan Committee on Financial Inclusion has recommended that the RBI may consider revisiting the LABs, in view of their inherent potential for ushering in financial institution. Thus, any blueprint for restructuring LABs needs to mitigate their inherent weaknesses such as meagre capital, restrictions on geographical jurisdiction, etc.
Recognising the fact that only 27 per cent of the eligible rural farming population has access to the formal banking system, the RBI has instructed banks to open a no frills account with zero or very low minimum balance.
Such a basic bank account should be supplemented by an account which has the potential for generating income, maybe linking up with SHGs. The role of SLBCs in furthering financial inclusion may be augmented by extending its coverage to all districts (from the current stipulation of one district) in a timebound manner.
The scope of collaboration of public, private and non-profit organisations for designing and conducting the financial education programmes could be explored. Leveraging IT for scaling up has to be top priority.
A National Rural Financial Inclusion Plan (NRFIP) may be launched with a clear target to provide access to comprehensive financial services, including credit, to at least 50 per cent of financially excluded households, say, 55.77 million, by 2012 through rural/semi-urban branches of commercial banks and regional rural banks.
The remaining households, with such shifts as may occur in the rural/urban population, have to be covered by 2015.
The latest Budget has announced certain measures incorporating some of these suggestions. As regards supporting funding costs in the initial stages, the Rangarajan Committee recommended two funds with Nabard namely, the Financial Inclusion Promotion & Development Fund and the Financial Inclusion Technology Fund with an initial corpus of Rs 500 crore (Rs 5 billion) each to be contributed in equal proportion by the central government/RBI /Nabard (these funds have since been set up).
To sum up, the evolving paradigm for financial inclusion in India does not have any resemblance to the US sub-prime crisis and efforts directed to achieve financial inclusion India do not possess the adverse potential for jeopardising the Indian financial/banking system. On the contrary, financial inclusion will enhance the viability of the banking sector through a process of deepening.
The authors are with Reserve Bank of India. Views expressed here are personal.
