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Indira Rajaraman: More complete financial inclusion

The report on financial inclusion focuses on expanding access for deposits, but not enough on expanding access to credit

Indira Rajaraman 

Indira Rajaraman

The Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households (the Nachiket Mor Committee on financial inclusion) has delivered a detailed report in a very short time. The architecture it envisions for a more inclusive financial structure recommends, in essence, moving away from the current structure of several overlapping full-service banks offering a comprehensive array of services over the entire country, towards functionally differentiated and regionally segmented banks.

The report recognises that the poor save; that they need a safe, interest-earning formal repository that is easily accessible in the face of income and event risk; and that the mobile phone network, supplemented by business correspondents, is the best way by which to reach vast swathes of the hinterland. It recommends that the present network of prepaid instruments and e-wallets, provided in a limited way by a few authorised mobile phone service companies, be allowed to grow into payments banks which will allow cash withdrawals.

But these payments banks will not engage in the task of providing local credit. They will be required to invest the entirety of their funds in government securities of the kind that satisfy the statutory liquidity ratio (SLR) of commercial banks today. With this, the report envisions that the SLR of commercial banks can be brought down, since there will be a much wider base of banks sharing the burden, thus setting the stage for corresponding release of commercial bank funds for other lending. In fact, it is envisioned that the SLR of commercial banks can eventually be reduced to zero.

If all savings going into payments banks are channelled into government securities in this manner, the architecture would work like a giant suction pump putting new catchment savings to work for the government, but disregarding the credit needs of the savers. In the structure we have at present, provincial branches of national banks have tried to grapple with the problem of deploying local deposits towards local credit, but not very effectively. Regional rural banks (RRBs) and co-operative banks were set up for exactly that purpose, but were beset by capture and mismanagement. Self-help groups (SHGs) were devised to channel the savings of groups of the poor into meeting their credit needs. They have been effective in some regions but not in others.

But the new payments banks offering the facility of banking through mobile telephones will successfully compete away the deposit base of local banks and branches, and credit will become that much harder to access in the hinterland. If another of the report's recommendations is implemented - that payments banks must offer at least one type of deposit at a nominal rate of interest exceeding the rate of consumer price inflation - other deposit-collecting institutions will either have to follow suit or risk losing their deposits altogether. Even without that, the payments banks will sweep up hinterland savings, so that it is vital that some of their deposits go into meeting local credit needs. The first correction necessary, therefore, is that payments banks must invest to some extent in the wholesale banks which, the report visualises, will fund the banks assigned the task of providing retail credit.

The idea of wholesale banks funding retail credit providers is a good idea in itself, because it helps to pool risk, but unless payments banks are required to place a mandated minimum with wholesale banks, the architecture will defeat rather than promote better access to credit, surely a key dimension of financial inclusion.

The report retains the task of retail credit provision in the rural hinterland with the present structure of local branches of national banks, RRBs and co-operative banks. These networks in their present state do not inspire much confidence, least of all in their ability to engage in arm's length diligence in assessing lending risk. But the report has very little to say on how their functioning could be improved. Nor does it survey what by now is a fairly large literature on SHGs, to identify why it works in some regions and not in others.

A further deficiency is that credit access is dealt with as a spatial issue, which it is to some degree, but not entirely. In urban India, where physical access is near total, transactional access to credit is close to zero, especially for service providers, who are typically nomadic between and within cities, and may have no urban address at all. These groups require credit outreach of the kind the report does not discuss at all. The nomadic status of these groups calls for credit that is shaped to their needs, in both quantum (small) and duration (short), in the way moneylenders do, but at hopefully lower rates through better risk management than what moneylenders charge.

The structure envisioned retains the received framework of priority sector lending targets, adjusted (APSL) to give higher weightage to underserved sectors - agriculture and services. These are then interacted with higher weights for underserved districts to yield APSL multiples by district and sector, which will be revised every three years.

The APSL is too complex to work in practice. The report claims that these APSL weights will free banks to specialise in a sector in which they have expertise, but for that there is no need for weights. Weights would actually push banks without the necessary expertise to go into high-weight sectors. All that is needed is that sub-targets within the PSL be done away with.

Larger APSL multiples of four are prescribed for lending to private companies installing and operating weather stations. This will move even such credit as at present flows to the poor into uses very far away from them. And the incremental contribution of those weather stations, even if they function properly, to reducing farm risk is a bit remote.

There are no easy answers to the problem of meeting the needs of the poor for small loans in a default-proof manner. What is certain is that APSL weights will not do the job.

The writer is a retired professor of economics

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First Published: Mon, March 24 2014. 21:50 IST