The tragedy of financial inclusion

Financial Express has just compiled its annual publication- India’s best banks for 2009-10.

I cannot locate the online version. There is a brief interview of RBI Deputy Governor, K.C. Chakrabarty. One of the questions was:

Will you allow sophisticated derivative products in the market?

We should not be concerned about derivatives products. Rather we should be worried about providing basic banking products to everybody…………

……The problem is that we are not at all concerned of the 90% of the country living without their access to credit. Moreover, 50% of population does not have access to any kind of banking products. I think that we should be more concerned about these issues. We are one of the poorest countries in the world. The problem with the poor in the country is that they can get money at a 50% interest rate from moneylenders or even 30% interest rate when it comes to microfinance institutions. Still, they are unable to get credit from  financial institutions at even 15% rate of interest. That is the tragedy.

Tragedy indeed. I also don’t understand why microfinance institutions charge poor such high interest rates. There have been reports that despite such high interest rates, defaults are near zero. Why not lower interest rates then? High interest rates were charged initially because there is no collateral and there are chances of default. With latter not happening why not lower it? What is their cost of funds? Is it also that high?

You keep hearing how banks try and get big ticket loans by offering lower interest rates than other banks. And the rates are usually lower than Prime Lending Rate. So those who can pay are charged lower interest rates and those who can’t are charged higher. 

Another problem is despite many years of financial inclusion policies, we still have such huge  numbers of unbanked population. Why? Some blame government/RBI policies for their restriction on banking licences but research shows it was policies of government/RBI in 1980s (if you want to open an urban branch, you need to open four rural branches) which led to whatever little rural penetration we have. This led to lower poverty. As the policy was eased, rural branches opening became slower and poverty increased. So where do we go from here?

In the same FE magazine on banks, Indusind MD & CEO makes a nice comment:

Are operations in remote places possible?

It can be profitable. If you treat financial inclusion as an obligation to eb met at the end of the year, then it is a loss making proposition. But if you work on it through out the year as business plan, it can be profitable. 

Financial inclusion unless it is embedded in business, is a loss making proposition. We are strong in the area of micro financing. We give a lot of three wheeler loans in rural areas. We provide loads to village women through microfinancing schemes. We have zero delinquencies.   

Based on this, RBI’s recent policy moves to improve financial inclusion will only work if banks take them as business plans. It should not result in an year end compulsion.

First, the lead bank in each district has been asked to draw a roadmap by the end of this month (March 2010) for ensuring that all villages with a population of over 2,000 will have access to financial services through a banking outlet, not necessarily a bank branch, by March 2012. There will be an intermediate target to be achieved by March 2011. Banks will have to harness technology and innovate low cost business models to accomplish this.

Second, all domestic public and private sector commercial banks have agreed to come up with their specific, Board approved Financial Inclusion Plans (FIPs) by March 2010 to be rolled out over the next three years. These Plans will have both qualitative indicators and quantitative milestones.

Third, we have urged all banks to include criteria regarding financial literacy and financial inclusion in the performance evaluation of their field staff.

We all know how these targets can be misused.

So in a way I agree with Chakrabarty. The onus is on the banks to build proper financial inclusion plans and see it as a business opportunity. Some lessons can be taken from FMCG companies which have become so aggressive in rural India.

Otherwise, it will continue to remain a tragedy producing tons of research on how to go about it.

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One Response to “The tragedy of financial inclusion”

  1. K R Vaikuntam Says:

    I dont know why Mr Chakravarty is making it out to be a either or situation. Derivatives are required for hedging risks. Nothing wrong with them per se. As Avinash Persaud has correctly pointed out, you can make huge losses with the simplest products – as happened with the sub-prime mortgages. Complexity is sometimes required.

    Financial Inclusion will come with the necessary technological improvements for handling a large number of small value accounts. It is the experience that for the front end to be simple the back end may have to be complex. That is why the suggestion to license foreign banks to operate exclusively in rural/ semi urban areas. They may bring in the innovation required.

    And micro finance institutions have to charge a higher rate not only to cover default but also to meet the costs of door step banking. What is wrong with them now is that the original promoters have sold out to private equity who are asking for high return on equity quarter on quarter as they always do and this treats micro finance as a sprint instead of the marathon that it actually is

    – Vaikuntam

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