Talking Financial Inclusion in Liberalised India

Conversations with Governors of the Reserve Bank of India

M. S. Sriram

• Publisher: Routledge India
• Year: 2017
• ISBN:
  9781351336819
• Edition: 1
• Topic: Économie
• Subtopic: Banques et services bancaires

This book presents a set of conversations with five former Governors of Reserve Bank of India (from 1992 onwards) on the topic of financial inclusion. Two key aspects are introduced in the conversations with each Governor: the initiatives that were undertaken during their tenure and their responses to some of the current issues. Further, they examine the reasons and justifications for significant decisions and measures that were undertaken or withheld. The discussion captures the evolution and approach of the central bank in addressing a variety of questions pertaining to financial inclusion.

The volume is an important contribution to the study of India's continuous but not entirely successful efforts in increasing the reach of its formal financial sector. It reconstructs how the policy approach to inclusive banking has progressed and resisted commercial and market imperatives to safeguard the deprived and dispossessed sections of society.

With its wide-ranging blend of conversations, documentation, research and commentary coupled with its engaging style, the book will interest students and researchers in the areas of development, banking, macroeconomics, public administration and governance, as well as academics, analysts, policymakers, think tanks, journalists, media and those concerned with the Indian economic policy.

1
Conversations with Dr C. Rangarajan^*

Dimensions of financial inclusion

MSS: You have not only served RBI as a Governor, but also have been involved with this topic. You have been the Chair of the Committee on Financial Inclusion. You have later served on the Prime Minister’s Economic Advisory Council. The question is about the differing roles of the RBI and the government on the agenda of financial inclusion. Is there some congruence given that the government is largely making policy while the RBI is charged with licencing institutions and ensuring that the institutional architecture works? You have been on either side and must have straddled with both these views.

CR: The term ‘financial inclusion’ emphasises one aspect of what is being described as inclusive growth. Inclusive growth is a much broader concept, in which the economic policy makers will have to ensure that benefits of growth accrue to all sections of society and that, in particular, the bottom deciles of the population benefit from growth. In one sense, financial inclusion is a subset of growth. Financial inclusion has been interpreted to connote the spread of the organised financial system to cover the vulnerable groups. It includes the provision of various types of facilities. As far as the banking system is concerned, it is expected to provide deposit and payment facilities and credit to the poor.

MSS: Yes, but if we go back in history for a long time, even though financial inclusion should have been all encompassing; it has mainly been credit driven.

CR: I see financial inclusion as having three dimensions. One – spatial, in the sense that the organised financial system must reach out to all regions and evenly spread. Two – sectoral, financial inclusion must take care of the credit needs of all the sectors of economy not only including agriculture and industry, but also sub-classifications of agriculture. And three – the emphasis on the organised financial system reaching vulnerable groups and people with low income.

If you look at the evolution of financial inclusion, earlier attempts were largely on the first two dimensions. The thrust of the branch banking system was motivated by the desire to see that the banking system is spread all over the country, and it also reaches out to semi-urban and rural locations. Then come PSL norms, which looked at provision of credit for specific sections like agriculture and small-scale industries. While PSL also had some elements of reaching out to the vulnerable sections, I would say it was only one element. It is the third dimension which focuses primarily on the vulnerable groups, in my view, is the unique dimension of financial inclusion. Therefore, the focus is on how to get the organised financial systems to reach out to the poor or poorest of the poor. This is, in fact, the special dimension of financial inclusion.

There has been an evolution of thinking on inclusion, but the latest emphasis is on vulnerable groups. Within the vulnerable groups the emphasis has been on not only providing credit facilities, but also providing other savings and payment facilities.

MSS: There have been multiple approaches in trying to achieve the difficult task of financial inclusion. In your report you had laid out a road map for financial inclusion with time bound targets and had also suggested a mission for monitoring this. If you look at the Prime Minister’s Jan Dhan Yojana (PMJDY) ¹ it seems to have been rolled out on a mission mode, though not as a separate mission. Are there differences between what your committee ² (Rangarajan 2008) has advocated as a mission and the way PMJDY has rolled out? What do you think are the achievements and problems in the approach of PMDJY?

CR: Mission mode actually means setting time bound targets, monitoring the progress and making midcourse corrections if necessary. When we suggested a mission mode, the targets set included extensions in relation to both deposit accounts as well as credit. If PMJDY has similar objectives, the government should come out with periodical reports on deposit accounts and credit extended. While there is much reporting on the number of deposit accounts and the amount collected, there is not adequate information on credit provided.

Local Area Banks

MSS: If we look at this from the perspective of policy makers there have been two approaches. One is the institutional approach, where we have specialised institutions like Regional Rural Banks (RRBs) and Local Area Banks (LABs). The other is the policy prescription, which categorises or allocates a certain portion of portfolio to agriculture, which you call a sectoral dimension. Do we need to do both or do you prefer one over the other? Or should these get dovetailed? One approach looks at the spatial dimension and the works on the sectoral dimension.

CR: Dimensions of financial inclusions are so vast that I don’t think that any approach focusing on only one type of instrument or institution is appropriate. In fact, there is scope for all types of institutions to play a role. The banks have a role, an important role to play in terms of all the three dimensions of financial inclusion.

MSS: I would like to take one example on LABs. You were very supportive of LABs during your tenure. You even tried to revive the idea when you gave the Financial Inclusion Committee report. But after your tenure, the RBI as an institution has never been comfortable with a large number of small banks. When the draft guidelines for SFBs were issued, it was conceived as LABs with restricted areas. But the final guidelines offered SFBs a national footprint. I spoke to Dr Rajan about this, and he gave two arguments for the change. One, a large number of applicants would be MFIs in any case, and they already had a footprint that was much larger, and it was a valid demand from them. Second, it was very difficult for the RBI to regulate small institutions.

CR: Well, we have experimented with various types of institutions. First there was the thrust on bank branching. Then we found that it was not working completely to meet the objective. Then we set up RRBs, which are a partial success. But RRBs are government (or banks) owned. Therefore, we thought that if an institution which is privately owned can focus on small people and small lending, it could be great. We have our counterparts in urban areas – the Urban Cooperative Banks (UCBs), which are extremely small, even compared to LABs. Some of them are very small and successful.

Therefore, we thought that LABs, like the RRBs, must have some commitment to a particular area and commitment to people working in an area. To set up small banks and give them the all India footprint will not make much impact. If it is going to be a small institution, it better be confined to one area. But, for some reason or the other, my successors did not think it was a workable idea.

Institutions survive and grow only if regulators and authorities provide support. If they have concerns about viability of institutions, automatically new institutions do not come up. In fact, they did not invite new applications for LABs after the first round.

MSS: Yes. They did not. In fact, the RBI set up a committee under the chairmanship of G. Ramchandran ³ (Ramachandran 2002) to examine the further licences to LABs. ⁴ The report makes a peculiar conclusion that no further licences to LABS should be given, while admitting that LABs have not been given the opportunity and that it is too early to conclude.

CR: Yes… We thought it was a good experiment.

Regional Rural Banks

MSS: Let me come back to you regarding the RRB issue. Your report had suggested that there should be no further consolidation of the RRBs. Your report came out in 2008 but there has still been some consolidation, and now we have stabilised it to 56. We don’t know whether it will be further consolidated. There was this sense that there should be one RRB per state or two RRBs per state. By doing this are we looking at only the viability part of it?

CR: What is the concept of RRBs? The concept of RRBs is essentially close to a LAB. The region was not defined in terms of a state; the region was defined to be much smaller.

MSS: It was, in fact, closer to the village co-operatives.

CR: Being bound with the region was an important dimension of the concept. And that will create local interest and local initiatives. So, if we merge RRBs across districts and create one per state, I don’t know whether the RRB will be different from a commercial bank.

MSS: The other thing that has happened with RRBs is an amendment to the act, which allowed a fourth shareholder to come in. State government, central government, sponsor bank and a private investor could be shareholders, provided that the combined shareholding of the state and the central government does not go below 50%. And along with it there also came a provision that there would be an independent director whom they would appoint, who might be outside the system. Is that a good direction to go? Will that get some dynamism in RRBs?

CR: Basically, we are converting RRBs into ordinary commercial banks. After this change, will they remain committed to the original mandate? It is not very clear. Because inclusion of the private sector by itself is not a bad idea; this we had done with the nationalised banks and with LABs. But we need to see how this will play out.

Small Finance Banks⁵

MSS: There are two differing views on this. If it is an SFB, for instance, Dr Reddy believes that it should confine to geography and penetrate deeper, and it should never aspire to become a universal bank. Dr Rajan, on the other hand, believes that if you are a SFB, then you grow into a universal bank subject to the qualification requirements.

CR: I suppose that good NBFCs have graduated to become small banks and even bigger banks.

MSS: Like Bandhan.⁶

CR: Yes, like Bandhan. We cannot say that small banks should not become big, but by making area restrictions, we are creating a situation for greater benefits and greater focus. But without area restriction small banks could lose focus, and that is my concern. But, in any case, I am happy that the concept of a small bank has been accepted.

MSS: But there is a difference in how SFBs are seen (Reserve Bank of India 2016a) and how you had formulated the idea. Currently, they are addressing the dimension of vulnerable groups and not the spatial dimension. By putting loan ticket size restrictions and higher PSL requirements, the design is looking at customer groups rather than geographies.

CR: Our idea of LAB also was…

MSS: Vulnerable groups within spatial dimension.

CR: Right! I mean spatial was only an additional restriction… Were we looking at LABs to provide support to large industries in a particular area? No! The idea was really to provide support to smaller industries and agriculture, as they would have a better understanding of the local situation and provide support. That’s it.

MSS: That brings me to one more aspect. Despite these restrictions for LABs and RRBs which forces them to go to regions that are under-banked; despite the policy of encouraging banks to establish branches in underserved areas, and despite all the work that RBI has proactively done, the disparity still continues. The North-East and Central regions continue to be under-banked. Eastern and Northern regions⁷ have picked up in terms of rural branches. The contribution of RRBs in spatial presence in the North-East and East is significant. When the LABs were opened, most of the applications were in well-banked districts. So, are there some areas where people might think it is inherently unviable to do banking? Because if you are talking of banking being a subsector of inclusive growth and growth itself is not very vibrant, then how do we go forward? There isn’t an underlying monetised economy. So how do we deal with this?

CR: Well, you know in the evolution of financial systems, two types of development are possible: the demand-led development and the supply-leading approach. In the first case, banks or other institutions come into existence to meet a demand. In the other case, the institutions are set up by the state or others in advance of demand.

MSS: And they will create the demand…

CR: The easy route will be the demand following. LABs and SFBs will have to come in where the demand has to be created. Here, I think some special assistance may be needed. Where certain types of institutions are desirable but not coming up for viability reasons, some help can be given.

MSS: On this the government’s approach has been: if it is a difficult area, give interest subventions to the SHGs.

CR: I think we should take the approach of supporting the institutions. The better thing is to provide institutional support rather than interest subvention. Interest rates in some of these institutions are already low. Some refinance may be provided if an economic activity is not viable at the rates that are normal in the organised financial system. We should not have a structure whose viability is seriously in question. Institutions don’t come up on their own. Even in the case of SHGs, a lot of spade work had to be done initially to create the institutions. I think for institutional finance to flow, SFBs, or something similar, are needed. They may not be coming up on their own and, therefore, some effort will be needed.

MSS: At least to defray the fixed cost. In fact, the Usha Thorat Committee (Thorat 2006) that looked at the issues pertaining to banking in the North-East⁸ had suggested capital assistance for banks to set up branches, currency chests and other infrastructural facilities, creating an ecosystem for institutional finance to flow.

CR: Yes, the state government or somebody can do that. That is what is required.

Payments Banks⁹

MSS: The other thing is there are two to three new initiatives that the government has taken in the recent past. One is the SFBs, and we talked about it. The other set of institutions are PBs (Reserve Bank of India 2016b). I have not really fully understood how this would work at scale. Have you seen anything like this? What do you think?

CR: The emphasis on credit as a significant element of financial inclusion has been pushed to the background. Our original idea of financial inclusion started with the desire and intention to provide credit to the vulnerable groups. I agree financial inclusion en...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• CONTENTS
• Preface
• Acknowledgements
• Abbreviations
• Notes on contributors
• Introduction
• 1 Conversations with Dr C. Rangarajan
• 2 Conversations with Dr Bimal Jalan
• 3 Conversations with Dr Y. V. Reddy
• 4 Conversations with Dr Duvvuri Subbarao
• 5 Conversations with Dr Raghuram G. Rajan
• 6 Conversations with Dr Urjit R. Patel
• Annexure 1 Report of the Committee on the financial system, 1991
• Annexure 2 Report of the Committee on banking sector reforms, 1998
• Annexure 3 Report of the Committee on financial inclusion, 2008
• Annexure 4 Report of the sub-committee of the Central Board of directors of the Reserve Bank of India to study issues and concerns in the MFI sector, 2011
• Annexure 5 Report of the internal working group to revisit existing priority sector lending guidelines, 2015