Banking aspirants face a long road to Bharat

Profitability to be a big speedbreaker for meeting RBI's mandate of 25% of new bank branches in rural areas

Banking aspirants are all chanting the rural mantra these days -- how India's hinterlands present a great business opportunity, etc. They hardly have an option as the Reserve Bank of India has mandated that 25% of a new bank’s branches have to be opened in rural areas.  

But all of them know it's not going to be easy getting into the rural areas. Here's why: Existing banks have about a third of their branches in rural areas, but their share of credit and deposit is abysmally low at 6-8% in FY 11, according to a recent report on rural banking by the CLSA. The report adds that the challenge is to improve profitability of rural operations simultaneously with growth. The small scale of operations and a track record of inferior asset quality are dragging profitability and de-motivating expansion plans beyond the regulatory mandate. 

Analysts contend that the profitability of such operations could be a drag on existing businesses. Priority sector lending is also proving to be a big challenge in areas with lower populations due to the high degree of non-recoveries. 

Regional rural banks, till some time, were making huge losses. After a massive restructuring exercise that included capital infusion and mergers of RRBs which bought down the total number of RRBs to 62, two are still making losses in FY 2012, against four in FY 2011, as per an RBI report. 

Also, financial literacy in the rural areas is low, and farmers’ incomes erratic. Higher costs and smaller ticket sizes of loans and deposits are also likely to constitute a huge deterrent in rural areas. Says G S Sundarajan, Group Director, the Shriram Group: “Rural is going to be a challenge. It's difficult to comprehend risk because most of the rural population don't have income proofs and no proper documents. The second is that there are huge fixed costs involved; so small ticket sizes of businesses might not be enough for a branch that caters to a small area.” 

Till some time ago, the RBI used to issue few branch licences, It has now eased its rules to allow banks to expand faster into towns with smaller populations. Banks can now open branches in Tier 2 to 6 cities (classified on the basis of population) without explicit permission from the RBI. Banks need to open at least 25% of their new branches in un-banked areas. 

Financial inclusion has been a part of the larger mandate of the RBI, which has been pushing banks to open more rural branches. Basic banking services such as a simple savings account is unavailable to a vast chunk of the rural population. A recent study by Crisil Inclusix says that India, with its population of 1.2 billion, has only 648 million savings accounts, In some areas, there's just one branch per lakh of population. 

But given the high costs of setting up branches, experts reckon that some of the banking licence aspirants with an existing distribution network could absorb these costs. Says Kumar “Applicants who have solved distribution to that extent can absorb some of these costs.” 

Some non-banking finance companies, however, say there is no reason to getting bogged down by the costs as there's potential in rural areas. Says Sundarajan: “We have built a community of 10 million customers and we have much experience in community lending.” Others agree. Srei Infrastructure, for example, plans to set up over 65% of new branches in rural areas. Says Hemant Kanoria, its CMD: “There's a great opportunity in rural areas if you can keep costs low. Much income is generated in rural areas.”

Banking aspirants are expected to make a slow and cautious start into the rural areas if they get a license. Says Kanoria: “We will have a slow start into the rural areas.”

That may be an understatement.