The philosophy of financial inclusion

We seem to have reduced the discussions on financial inclusion to a mechanical exercise in arithmetics, namely, geographically covering unbanked areas, or covering sections of population or groups of population which have remained outside the reach of the formal institutional financial framework. Financial inclusion means much more than that. There is an inadequate appreciation of the broader dimensions of financial inclusion. Since bankers and financial experts who have ground level experience of promoting financial inclusion have gathered here today, I thought it appropriate to seek to provide an outline of the discourse on what might be broadly termed as the philosophy of financial inclusion.

The starting point of this broader theme is that inclusive growth is an essential prerequisite for financial, economic, political or social stability.  To quote Dr. Subbarao, Governor, Reserve Bank of India: “Over the past 60 years, we have seen several episodes of economic growth in different parts of the world.  One clear lesson of this experience is that growth is sustainable only if it is inclusive.  Governments around the world are therefore anxious that even as they pursue economic growth, they must make that growth process inclusive.”  Inclusive growth in the real sector is, in turn, largely driven by financial inclusion and an inclusive financial system.  India has adopted a bank-led model for bringing about financial inclusion and hence banks are at the centre stage of the whole process of inclusive growth.

There is another strong reason why I chose to address this broad theme. After the global financial crisis of 2008, banking in the US and Europe has fallen from grace.  It is no longer the noble profession it once used to be.  Today, bankers may not be exactly “a despised breed,” as the London Economist once described the chief executives of Enron, Worldcom and Xerox corporations of yesteryears: but very few bankers continue to be proud of belonging to the profession.  Management professionals in India, who intend to pursue banking or a financial career should be aware of this situation.

Unfortunately, this global crisis seems to have made little impact on Indian policy makers entrusted with financial sector reforms. We continue to seek to mimic western, mainly American or British banking models: we swear by Basle norms and passionately seek to adopt “international best practices” of western financial institutions.  We continue to be intoxicated with the market theology of profit maximization for banks and financial institutions. The post-2008 crisis warrants the need for a different species of bankers and financial professionals, who could blend profitability criteria with social banking, as Indian policy makers of the 1970s have successfully demonstrated.  And not those who can sell their souls for a mess of pottage.

At this stage, we must pay tribute to the vision of Indian policy makers of yesteryears, who were pioneers in this philosophy of financial inclusion.  Much before financial inclusion became internationally fashionable, they had blazed the trail.  Promotion of rural credit is a statutory responsibility of the Reserve Bank of India since its establishment in 1935 – an unusual feature of central banks the world over.  The nationlisation of major commercial banks in 1969 and the subsequent widening and deepening of the banking system through a branch expansion programme unprecedented in the history of world banking and through fixation of priority s ector lending targets – are remarkable achievements indeed, of which we are proud.  In the initial stages, it was natural that the emphasis was on the physical reach of banks. 

The initial goal of providing access to banking services in all villages with a population of more than 2000, by March 2012, has been successfully achieved. The Swabhimaan financial inclusion campaign is being extended to habitations with populations of more than 1,000 in the north-eastern and hilly States and a population of more than 1,600 in the plain areas. Out of 45,000 such habitations identified, some 10,450 have already been provided banking facilities by December 2012. Various models and technologies including branchless banking through business correspondents (BC) have been used.

The progress during the last two years has been quite impressive: Penetration of banking has increased manifold in rural areas.  At the end of March 2012, villages covered through business correspondents (BCs) constituted more than 80 per cent of the total number of villages covered under financial inclusion plans (FIPs).  The total number of ‘no-frills accounts’ surpassed 130 million.  However, the catch is that only 2 per cent of these accounts had overdraft facility.  Most of these accounts were thus dormant accounts.

It has now been realised that physical reach is only the beginning of the process of financial inclusion, which cannot be reduced to mere tokenism.  The focus should now be on multiplying the number and volume of transactions in these accounts.  The Reserve Bank of India (RBI) has now addressed the issue of giving a qualitative content to the concept of financial inclusion.  Banks have been advised to offer a minimum of four basic products to these customers: a basic savings bank deposit account with emergency credit facility like overdraft; a remittance product for electronic benefit transfer, a savings product like a recurring deposit and a facility for entrepreneurial credit, like general credit or ‘Kisan Card’. We are thus taking the process of financial inclusion a step further.  Reaching the potential customer is not enough: he should be enriched by actually conferring the benefits of banking on him.

The road to financial inclusion is not always paved with good intentions. The recent crisis witness by the microfinance sector provides an instance of how in the name of facilitating financial inclusion, profit making microfinance institutions metamorphosed into glorified money-lenders charging usurious interest rates of 30 to 40 per cent to small borrowers.

The government of Andhra Pradesh deserves to be congratulated on its ordinance issued in 2010 which spelt out clearly the malpractices of such MFIs: “whereas these SHGs are being exploited by private microfinance institutions (MFIs) through usurious interest rates and coercive means of recovery resulting in their impoverishment and in some cases leading to suicides…” What was more tragic was that the public sector financial institutions and the RBI became co-conspirators in this metamorphosis. Support to these modern-day Shylocks was extended from public sector banks (PSBs), NABARD and SIDBI. The support was blessed by the RBI which allowed the banks to treat lending to MFIs as priority sector lending. Thus resources of public financial institutions were used to boost profits of private MFIs. Even after the crisis, RBI’s Malegam Committee has “sanctified” a 26 per cent interest rate for MFIs. This is most unfortunate because historically the RBI has acquired the image of a guardian angel of small farmers or small borrowers generally. The for-profit MFIs represent the predatory face of financial capitalism.

The Malegam Committee’s “approval” of the exorbitant interest rate is ironical for two reasons. First, it is inconsistent with the basic objective of financial inclusion as we understand it today. We will discuss it presently. Secondly, one begins to wonder whether there is, among policy makers, particularly those based in Delhi, a bias in favour of big borrowers of the corporate sector and against small borrowers. The finance minister has no hesitation in publicly persuading the RBI to bring down lending rates to the corporate sector, from the present level of say 11 or12 per cent. But he looks the other way when the Malegam Committee approves the usurious interest rate of 26 per cent for micro finance institutions.

It is in this context that the clear definition of financial inclusion provided by the RBI recently is welcome.

“Financial Inclusion is the process of ensuring access to appropriate financial products and services needed by all sections of the society in general and vulnerable groups, such as weaker sections and low income groups in particular, at an affordable cost, in a fair and transparent manner, by regulated players.”  The key words are: “affordable cost.”

It may be appropriate to refer here to another ironical development in the area of financial inclusion. The effort of directing credit to priority sectors can be traced away back to 1968. And yet in 2011-12, public and private sector banks advances to priority sectors were lower than the target of 40 per cent of adjusted net bank credit – at 37.2 per cent and 16 out of 26 public sector banks could not meet the target. With all the noise we are making about financial inclusion, this default is difficult to understand.

Analytically, there is another interesting point to take note of. Within the priority sectors, especially within agriculture and micro and small enterprises, a majority of loans were concentrated in relatively larger accounts. Here also there is a bias towards bigger borrowers. Thus there is need to change credit concentration within priority sectors in order to further facilitate the process of inclusive growth in the real sector. (See box IV 3 Priority Sector Lending – is there a Bias towards Bigger Credit Needs? Report on Trend and Progress of Banking  in India, 2011-12, RBI, 2012).

Turning to the global scenario, the ugly face of predatory financial capitalism manifested itself in all its rawness in the global financial crisis of 2008. We are all familiar with the financial meltdown when the icons of American and European system – commercial banks, investment banks, mortgage houses and insurance giants collapsed like a pack of cards. The 2008 global financial crisis has been categorised as a “Great Fraud” because the fraud was systemic and not confined to any institution or a segment of the financial system. The crisis started as subprime mortgage crisis in August 2007. In simple terms, housing loans were extended aggressively to borrowers who did not have the capacity to repay. Many subprime mortgages were “Ninja Loans” – standing for no income, no jobs and no assets. Superimposed on this subprime lending was the securitisation of debt process. The process has been described as a “package of dodgy debts of some Alabama unemployed man turning into a high grade structured Enhanced Leverage Fund of a leading Wall Street firm”.

When the crunch occurred, these sophisticated structured credit products proved to be not worth the paper they were printed on. Thus a whole host of factors were responsible for the culmination of the financial crisis: the feeding of the speculative bubble in the US mortgage market by reckless credit expansion, the selling of large amounts of subprime mortages, the peculiar securitisation of mortgage loans, the speculative trading of such securities in the global financial markets, the fraudulent ratings by otherwise respectable credit rating agencies. The fraud was thus systemic. In the advance economies (AEs), understandably there is widespread public resentment at the irregularities in the functioning of the financial institutions, particularly casino banking and at obscenely high level of remuneration paid to senior management in some cases. In these economies, banking has fallen from grace as a noble profession it used to be. The Financial Inquiry Commission in the US has laid bare for all to see the shameless greed and moral decadence of the Wall Street banker.  The “Occupy Wall Street Movement” reflects the public resentment over the behaviour of financial actors. To restore the trust, Dr. Reddy, former governor, RBI, has advocated “inclusive finance” – a commitment to access of essential financial services to all segments of the society.

“Society has put its trust in central banks.  Central banks have to ensure that bank managements and the financial sector in general serve the masses and not merely the elite or financially active.  In the ultimate analysis, central banks are trustees, agents to look after the interest of masses.”

While on the subject, a reference may be made to another mini fraud revealed more recently. The reference is to the LIBOR (London Inter Bank Offer Rate) scandal.  For many years, the rate enjoyed the reputation of being market determined by supply and demand for funds – and was used as a standard for many financial transactions internationally.  Recently, it was discovered that this rate was rigged, managed and manipulated. Some multi-national banks involved in the determination of the Rate were punished by regulators by made to pay huge fines. So much for the integrity and transparency of international bankers.

There is now a call for the revival of ethical values.  The American Economic Association has mooted the idea of a code of ethics for finance professionals, regulators and academics.  Robert Shiller proposes that the best way to do this is ‘to build good moral behaviour into the culture of Wall Street.”

Fortunately, Indian public sector bankers are a different lot, completely committed to the cult of financial inclusion. This commitment manifested itself in the zeal with which they pursued the extension of banking throughout the length and breadth of the country in the 1970s. Bringing the rural sector, which was particularly isolated from the rest of the country, into the mainstream of modern banking, was a stupendous achievement. In fact, it formed part of the process of modernisation of the rural economy itself.   The trials and tribulations of bankers involved in this task under the Lead Bank Programme are well documented. And banking professionals at that point of time were not being paid princely sums.

What is required today is the same ‘small borrower-friendly’ banking culture. Public sector bankers should go beyond profit making and try to upgrade the enterprises to which they lend – may be for farm or non-farm enterprises – and catapult the borrower into a higher income trajectory.   Mere tokenism of making banking services physically accessible will not do. Profitability and social banking need to be blended. Financial inclusion in a meaningful sense thus warrants the same commitment on the part of bankers, particularly public sector bankers, that they displayed during the Lead Bank Programme.

Institutes of management in India, which offer courses in banking and finance would do well to incorporate into their syllabus a paper on the philosophy of financial inclusion. This paper should lend an overall perspective with which young bankers in India could pursue their professional career, avoiding the pitfalls that their counterparts in America and Western Europe were trapped in causing the global financial crisis of 2008.

(The paper is the full text of the Presidential address by Dr. N A Mujumdar, who was the long serving and illustrious editor of the Indian Journal of Agricultural Economics. This address was delivered at a March 2013 national seminar on financial inclusion)