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Apr 2012

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Money

The Indian Financial Inclusion Scenario - Initiatives and Lessons

M.I. Dholakia
Nov 2009

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Financial inclusion has become a buzzword internationally – even in developed financial markets there are concerns about those excluded from the banking system. The barriers to access to formal banking system have been identified as relating to culture, education (especially financial literacy), gender, income and assets, proof of identity, remoteness of residence, and so on. Efforts are being made by the authorities- especially banking regulators to improve access to affordable financial services through financial education, leveraging technology and generating awareness in order to create enabling conditions such that markets become more open, more competitive, affordable and inclusive.

Limited access to affordable financial services such as savings, loan, remittance and insurance services by the vast majority of the population in the rural areas and unorganized sector is believed to be acting as a constraint to the growth impetus in the various sectors identified for growth in the country. Access to affordable financial services - especially credit and insurance - enlarges livelihood opportunities and empowers the poor to take charge of their lives. Such empowerment aids social and political stability. Apart from these benefits, inclusion imparts formal identity, provides access to the payments system and to savings safety net like deposit insurance. Hence inclusion is considered to be critical for achieving inclusive growth; which itself is required for ensuring overall sustainable growth in the country.

Magnitude and Spread of Financial Exclusion- What is Financial Exclusion?

Financial exclusion is experienced by both developing and developed economies alike. The World Bank estimates that 2.7 billion people, over half the population of the developing world, live on less than US$2 a day. Reserve Bank of India data shows that as many as 139 districts suffer from massive financial exclusion in India, with the adult population per branch in these districts being above 20,000 and only 3 percent with borrowings from banks. On the assumption that each adult has only one bank account (which does not hold good in practice, so that actual coverage is likely to be worse) on an all India basis, 59 percent of the adult population in the country has bank accounts. 41 percent of the population is, therefore, unbanked. In rural areas the coverage is 39 percent against 60 percent in urban areas.

The unbanked population is higher in the poorer regions of the country, and is the worst in the North-Eastern and Eastern regions. Out of 203 million households in the country, 147 million are in rural areas 89 million are farmer households. 51.4 per cent of farm households have no access to formal or informal sources of credit while 73 per cent have no access to formal sources of credit.

Financial exclusion could be looked at in two ways:

1. Lack of access to financial services which could be due to several reasons such as:

• Lack of sources of financial services in our rural areas, which are popular for the ubiquitous money lenders but do not have (safe) saving deposit and insurance services.

• High information barriers and low awareness especially for women and in rural areas.

• Inadequate access to formal financial institutions that exist to the extent that the banks couldn't extend their outreach to the poor due to various reasons like high cost of operations, less volume and more number of clients, etc. among many others.

• Poor functioning and financial history of some beleaguered financial institutions such as financial cooperatives in many states which limit the effectiveness of their outreach figures.

• Primary Agricultural Cooperative Societies (PACS), which number around one lakh are also often exclusionary, as their membership is restricted to persons with land ownership. Even to their members, not many PACS offer saving services.

2. Lack of access to formal financial services in both rural and urban areas, but is a larger issue in cities and small towns. The distinction between access to formal and informal services is crucial to understand, as informal financial markets suffer from several imperfections, which the poor pay for in many ways. Some attributes of informal financial services, due to which there is exclusion, are:

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