Financial Inclusion in Liberalised India – a Ringside View

Financial inclusion is a major thrust area of the banking sector today. Although it started during the earlier UPA regime, it received a serious push at different levels under the NDA government from 2014 onwards. About the outcomes of these measures, mixed reports have been appearing.

But how did the concept emerge? What role did the governors of the Reserve Bank of India (RBI) play in influencing the changes? Will the changes in the policies and the institutional framework intended to accelerate financial inclusion meet the goals? A new book, Talking Financial Inclusion in Liberalised India: Conversations with Governors of Reserve Bank of India, edited by IIM Bangalore Prof M.S. Sriram, tries to find answers.

In his lengthy introduction to the book, Prof Sriram, an expert in the field of micro finance, dwells upon two arguments that dictated the reforms in the financial sector: one political and the other intellectual. He suggests that the period saw a gradual shift from the first to the second.

The main part of the book contains conversations with six governors – C. Rangarajan, Bimal Jalan, Y.V.Reddy, D. Subbarao, Raghuram Rajan and Urjit R. Patel (the current incumbent) – who shaped the evolution of financial inclusion. In the process, he takes us through the diverse undercurrents that brought in the changes. The third part of the volume provides the summary of the recommendations of various committees including the Rangarajan Committee on Financial Inclusion (2008) which influenced the changes.

During the early years of state ownership of major banks (1969 to 1991), the government as the owner and policy maker and the RBI as the monetary authority laid emphasis on making banks accessible to the masses both geographically and socially. Bank offices were opened in remote parts of the country; credit was made cheaper, and made available to the vulnerable sections of society.

Through special schemes like Lead Bank and Integrated Rural Development Programmes, and new institutions like the Regional Rural Banks (RRB), National Bank for Agriculture and Rural Development (NABARD) and Small Industries Development Bank of India (SIDBI), thrust was given to specific goals of meeting both spatial and sectoral needs for finance. The public sector banks (PSBs) opened specialised branches dispensing credit for agriculture and micro, small and medium enterprises (MSMEs) to give focused attention to these segments. These policy interventions and specialised institutional framework were backed by what Sriram calls ‘political argument’.

It is relevant to recall the objectives for which two specialised institutions were set up in the pre-reforms era. The RRBs were established ‘for the purpose of development of agriculture, trade, commerce, industry and other productive activities in the rural areas, credit and other facilities, particularly to the small and marginal farmers, agricultural labourers, artisans and small entrepreneurs’ (preamble to the RRB Act, 1976). Similarly, the Small Industries Development Bank of India (SIDBI) was set up for the promotion, financing and development of industry in the small-scale sector (SIDBI Act, 1989). After the Micro, Small and Medium Enterprises Development Act was enacted in 2006, these enterprises were also brought under the ambit of SIDBI. The institutional structure was thus mandated to assist borrowers in the margin and in identified geographical locations.

A shift in emphasis

During the course of reforms, the political argument was replaced by, again to quote Sriram, the ‘intellectual argument’, the core of which was profitable and sustainable banking. The successive committees on financial sector reforms, starting from the Narasimham Committee-I in 1991 to the P.J. Nayak Committee in 2014, laid stress on market forces to be the key allocator of financial resources virtually jettisoning the targeted lending introduced after 1969.

This shift in emphasis had serious ramifications on the availability of bank finance to several sectors like farming and MSMEs. While the institutional framework subsisted and economic growth was on the upswing, the widening rich-poor divide and the situation of jobless growth coupled with the farming crisis underlined the urgency of a course correction at the policy level. The continued inadequacy of formal banking facilities in certain regions like central India and the Northeast exposed the lacunae in the new approach towards branch expansion programme.

Analysing the dialogues with the governors, Sriram rightly observes that RBI believed that market forces would not discover the market for the excluded and vulnerable and, it pitched for mandatory intervention (p.13). It was governor Y.V. Reddy who, in his monetary policy statement of 2005, underlined the need for financial inclusion as a deliberate strategy to reach out to the excluded people (p.65). The RBI introduced the scheme of opening basic savings bank accounts, known as ‘no-frills-accounts’. The concept of financial inclusion emerged as a policy tool to meet the growing needs of such vulnerable sections.

While a renewed strategy to reach out was being put in place, the institutional framework in the form of RRBs was restructured in 2004-05 through state-wise mergers. Alongside, new institutions like local area banks, small finance banks, payments banks, MUDRA and Post Bank with specific mandates were also set up by, first the UPA government and after 2014, the NDA government. In 2014, the NDA government launched what it termed as its flagship scheme under the nomenclature Prime Minister’s Jan Dhan Yojana (JDY), which in reality was a repackaged basic savings bank accounts scheme of the preceding regime.

How far would these new institutions and a new strategy succeed in meeting the needs of the vulnerable? Was the restructure of RRBs rational? Will the new institutions succeed where the earlier ones failed to deliver? Will the JDY meet the goal of financial inclusion? The governors respond to these and related questions in the course of their conversations.

Viability and suitability

It is particularly relevant to comment on their views on three key issues namely, opening of accounts without balance, the viability of new institutions and the role of the market in promoting financial inclusion.

While C. Rangarajan is not convinced that sufficient credit is provided by the accounts under JDY (pp.40-41), Bimal Jalan questions the number game in the matter of opening accounts.(p.52). Reddy raises a more fundamental question: finance alone does not bring results (p.75) unless there is a host of services related to it. Recent studies which are in the public domain corroborate these perceptions.

Converting RRBs into state level banks run by the sponsor banks causes understandable apprehension in the minds of the governors. Rangarajan feels that they cannot work as commercial banks (pp.40-41). Jalan finds that the job of lending to agriculture cannot be taken up by non-banks, implying that RRBs would still be better suited for the job (p.60).

Raghuram Rajan is more forthright when he says (p.116) that we should maintain the local character rather than make them so big that policies are made in Delhi or Mumbai. Looking at the restructured RRBs and the new specialised institutions Reddy wonders if we are going for two financial systems: those meant for the poor and those meant for the non-poor? (P.84). With a fresh round of mergers of RRBs in the horizon, these views have contemporary relevance.

The viability and suitability of the new institutions too come for informed scrutiny from the governors. Jalan, Reddy and Rajan feel that Post Bank is not viable because it has no risk assessment expertise. The establishment of MUDRA Bank (Micro Units Development & Refinance Agency Ltd) triggers many serious questions. Reddy ponders over the roles assigned to National Housing Bank and SIDBI and also the specialised branches set up by PSBs. He asks if their performance is evaluated and says that the very model of MUDRA is questionable (pp.69-71). His successor, Subbarao, shares the same view and asks if it was necessary (p.99).

It is in respect of policy that the background of their ideology becomes sharp. While the former governors stress the need for regulation and monitoring to ensure stability of the financial system and flow of credit to the vulnerable sections through policy interventions, Urjit Patel, the current governor, would like the market forces to have a free role. According to him, economic growth will lead to more and more intermediation and the market will take care of the agenda with RBI taking a backseat (p.126). Even on opening branches at unbanked or underbanked centres he expects banks to go where the business is and thinks it is not the job of RBI to force banks into certain regions (p.129). One gets an impression that governor Patel is a firm believer in trickle-down effect of growth.

What do we learn from the discussions? Since its launching in 2014, regular reports have appeared highlighting the problems inherent in JDY scheme. In 2014, Sriram had underlined the need for transactions in the new account without which it would ‘be counting the numbers and touting the achievements’. In 2016, Prof Charan Singh of IIM Bangalore urged that the accounts be operational. A year later, another report in The Wire confirmed that dormancy and duplication were a major problem. According to a recent study, the problem of indebtedness has shown no sign of abating.

The tardy progress in the area of financial inclusion ironically conforms to the expectations of the governors who shared their views on wide-ranging issues connected therewith. The book helps a serious observer of banking and financial inclusion get a better perspective of the failures of financial sector reforms and enables them to better appreciate the thinking of RBI in making the financial sector responsive to the needs of the society.

T.R. Bhat was joint general secretary of All India Bank Officers’ Confederation from 1995 to 2009. His book, Reforming the Indian Public Sector Banks-the Lessons and the Challenges, was released in April 2018.