Against this backdrop, the purpose of the chapter is to analytically assess the financial inclusion process in India, drawing upon international experience and the Indian evidence. Toward this end, the rest of the analysis unfolds as follows. First, we provide a background of financial inclusion in India, encapsulating the philosophy, rationale, and the process. In the subsequent section, we dwell on the international experience, highlighting the key takeaways and providing evidence as to how well India matches up in its financial inclusion efforts in the cross-country sample. Next, we explore how the global financial crisis reshaped the financial inclusion agenda. Fifth section discusses the Indian experience, emphasizing some of the key initiatives that have been undertaken in recent times, supplemented with empirical evidence, as appropriate. The penultimate section syncopates the role of central banks in the financial inclusion drive, and the chapter ends with some concluding remarks.
Inclusive Finance: Philosophy, Rationale, and Process
Inclusive finance is as much about protecting customer interests as it is about ensuring the availability of essential financial services to all strata of society at a reasonable and affordable cost (Reddy, 2012). Accordingly, financial sector regulation has endeavored to ensure that these needs are met, while at the same time advocating the need for financial literacy to ensure that customers do not fall prey to financially disquieting credit arrangements.
In the Indian context, the role of the financial sector in promoting financial inclusion can be traced to the 1960s. The overarching emphasis of the Reserve Bank was towards channeling the flow of credit to the productive sectors of the economy and hitherto unserved sections of the populace. Starting with the two-phase bank nationalization process, major initiatives such as priority sector lending requirements, establishment of development banks and Regional Rural Banks, and SHG-BLP were initiatives aimed at expanding banking services to the grass-root level. While critics have been agnostic of the efficacy of this approach, research appears to suggest that such a bottom-up strategy made a significant dent in rural poverty (Burgess and Pande, 2005).
Notwithstanding these initiatives, ensuring full-fledged financial inclusion continued to elude the policymakers. While it is difficult to conclude with certainty the reasons thereon, a few broad generalizations can be made.
First, the rapid expansion of low-documentation lending within an insufficiently developed legal and institutional framework in the credit market exerted a dampening effect on the process.
Second, the lack of reliable credit reporting systems that could have limited problems of overindebtedness and of borrowing from multiple lenders were not in place. These problems were aggravated by the absence of well-functioning personal bankruptcy laws that hindered the orderly discharge of excessive debts.
Third, the sector was affected by non-economic interventions in the credit market: MFI clients were implored to stop repaying their loans ahead of elections. The politicization of the process turned it into a tool for rent-seeking and led to a shift away from its primary purpose.
Fourth, it was recognized that to hasten the process brick-and-mortar branching needed to be complemented with affordable technological innovations. However, the costs of technology proved prohibitive and impeded large-scale penetration.
These considerations led the Reserve Bank to reorient its emphasis towards financial inclusion with a more micro-centric focus. With banks being the mainstay of the financial system, it has emphasized a bank-led model for financial inclusion, although it has also permitted non-bank entities to partner banks in their financial inclusion drive. This contrasts with the widely cited experience of Kenya, which employed a non-bank-led model to drive its financial inclusion agenda (Aker and Mbiti, 2012). Besides, banks were provided the flexibility to determine their own strategies for rolling out financial inclusion plans, based on their business philosophy and risk appetite, within an overall time-defined target. The idea inherent in this strategy was to refocus the perspective of banks towards financial inclusion from mere social obligation to a viable business opportunity.
As the concept of inclusive growth came to the forefront of policy agenda, the agenda of financial inclusion assumed even greater prominence (Government of India, 2008). In November 2005, a new concept of basic banking ‘no-frills’ account with nil or very low minimum balance was introduced to make such accounts accessible to vast segments of the population. The nomenclature was subsequently changed in 2012 to Basic Savings Bank Deposit Accounts (BSBDAs) for all individuals with zero minimum balance and the facility to use an ATM card/Debit card. Also, to facilitate easy opening of accounts especially for small customers, Know Your Customer (KYC) guidelines were greatly simplified. The process has been fine-tuned, with gradual improvements in the modalities and logistics.
At the same time, the branch authorization policy was also relaxed. To further step up the opening of branches in rural areas, commercial banks were directed to open at least a quarter of their total branches in hitherto unbanked areas of the country.
However, the difficulty of opening brick-and-mortar branches in all remote corners of the country necessitated the search for innovative solutions. In this context, banks have been encouraged to improve banking penetration through Business Correspondents (BCs)/Business Facilitators (BFs). Contextually, such a ‘correspondent’ banking approach has also been adopted in countries like Brazil to distribute welfare grants to the unbanked, with great success. The list of correspondents has expanded over time, enabling banks to provide doorstep delivery of services, thereby addressing the ‘last mile’ problem. Riding on technological advancements, banks have leveraged on mobile network providers to make available banking services to the lowest common denominator. This hybrid model finds echo in the experience of Philippines wherein a combination of the brand and execution of the service by a mobile network operator in partnership with a commercial bank substantially improved access to finance for households. Besides, other countries have also adopted several out-of-the-box ideas for financial inclusion (Box 1).
Box 1: Innovative ideas for financial inclusion
Out-of-the-box ideas have been employed by several countries in order to increase banking penetration in un- and under-served areas, often leading to very encouraging results.
In Chile, for instance, supermarket chains have started writing credit histories for their unbanked clients, by means of extending small store credit, which can be expanded based on positive repayment records and which can then translate into broader access to credit. This is financial empowerment in action — especially when combined with consumer protection measures and financial education for preventing over-indebtedness.
In Brazil, lottery kiosks, pharmacies, supermarkets, and other retailers are used as business correspondents for banks. Upon launching Bolsa Familia, a conditional cash transfer programmer in 2003, the government determined that all benefits would be paid through Caixa Econômica Federal, Brazil’s public sector bank. However, as many beneficiaries lived in remote areas, without access to banking services, Caixa Econômica had to transport cash for the distribution of monthly benefits at very high costs. Therefore, Caixa started employing correspondents in municipalities where the costs of distribution were particularly high and started to administer the sales of Brazil’s wide-ranging lottery program. This led to a large network of small lottery stores called Lotéricas that began accepting bill payments and the distribution of social transfer payments besides offering additional financial services from Caixa. In many areas, as many as 55% of the households pay their bills through these lottery shops.
In South Africa, television and radio have been used for the delivery of financial literacy training. One such