Rural Banking in India

Rural Banking in India

Rural development occupies a significant place in the overall economic development of the country and Darling’s statement (1925) that “the Indian peasant is born in debt, lives in debt and dies in debt,” still remains true for the great majority of working households(55-60 per cent of India’s population) in the countryside.

Three phases of rural banking policy since 1969

1^st phase following the nationalization of India’s 14 major commercial banks in1969—The declared objectives of the new policy, known as “social and development banking”, were the following:

·         To provide banking services in previously unbanked or under-banked rural areas;

·         To provide substantial credit to specific activities including agriculture and cottage industries; and

·         To provide credit to certain disadvantaged groups such as, for example, Dalit households.

2nd phase began in the late 1970s and early 1980s:

·         Two major instruments of official anti-poverty policy were developed: loans-cum-subsidy schemes targeted at the rural poor and state-sponsored rural employment schemes (Integrated Rural Development Programme (IRDP))

·         An expansion and consolidation of the institutional infrastructure for rural banking

3^rd phase—Post Liberalization:

·         Redistributive objectives “should use the instrumentality of the fiscal rather than the credit system”

·         Directed credit programmes should be phased out

·         Interest rates be deregulated

·         Capital adequacy norms are changed (to “compete with banks globally”)

·         Branch licensing policy be revoked

·         A new institutional structure that is “market driven and based on profitability” be created,

·         Part played by Private Indian and foreign banks be enlarged

Challenges facing Indian Rural Banking—

Priority Sector Lending:

·         Priority sectors are broadly taken as those sectors of the economy which in the absence of inclusion in the priority sector categories would not get timely and adequate finance.

·         Typically, these are small loans to small and marginal farmers for agriculture and allied activities, loans to Micro and Small Enterprises, loans for small housing projects, education loans and other small loans to people with low income levels

·         The major challenge is to bring all farmers into the institutional credit framework—

Need to make priority sector lending competitive and commercially viable

·         By reorienting the approach of banks to look at priority sector areas as the challenges in priority sector can be overcome only if banks consider priority sector lending as part of normal business operations of the banks and not as an obligation.

·         Rural untapped market offers a big business opportunity to the banks and banks need to innovate new products which cater to the needs of farmers, weaker sections and other vulnerable sections of the society, develop new delivery channels and embrace technological developments which will reduce the delivery costs— a viable business proposition

·         Need to lay emphasis on direct delivery of credit to the poor beneficiaries i.e. without the involvement of intermediaries, which will ensure better management of risks and also reduction in transaction, delivery and administrative costs for these loans, which being essentially small ticket, low value high volume loans, do generate profits translating to a stable low cost deposit stream for banks and to the fortune at the bottom of the pyramid.

Regional Rural Banks:

Regional Rural Banks (RRBs) were established in the year 1976 as a low cost financial intermediation structure in the rural areas to ensure sufficient flow of institutional credit for agriculture and other rural sectors— Narasimham committee

·         RRBs were expected to have the local feel and familiarity of the cooperative banks with the managerial expertise of the commercial banks.

·         RRBs are jointly owned by GoI, the concerned State Government and Sponsor Banks, the issued capital of a RRB is shared by the owners in the proportion of 50 percent, 15 percent and 35 percent respectively

·         RRBs operate under the control of two institutions, the National Agricultural Bank and Rural Development (NABARD) and Reserve Bank of India (RBI)

Financial Inclusion:

Financial Inclusion (FI) 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 mainstream institutional players.

2006: Reserve Bank permitted banks to utilise the services of non-governmental organizations (NGOs), micro-finance institutions (other than Non-Banking Financial Companies) and other civil society organisations as intermediaries in providing financial and banking services through the use of business facilitator and business correspondent (BC) models. The BC model allows banks to do “cash in-cash out” transactions at a location much closer to the rural population, thus addressing the last mile problem.

Combination of strategies— ranging from relaxation of regulatory guidelines, provision of new products and other supportive measures to achieve sustainable and scalable Financial Inclusion; as well as close monitoring

Issues being faced—

Not treated as an Efficient Business Model:

·         Banks are pursuing FI as a regulatory requirement rather than treating it as a business model.

·         Banks have to realize that the bankability of the poor holds a major opportunity for the banking sector in developing a stable retail deposit base and in curbing volatility in earnings with the help of a diversified asset portfolio and therefore, Financial Inclusion programmes should be implemented on commercial lines as a sustainable and viable business model

·         Ensure that poor people who deserve credit are provided access to timely and adequate credit in a non-exploitative manner

·         Reasons—

• Higher non-performing loans in rural areas because rural households have irregular income and expenditure patterns—compounded by the dependence of the rural economy on monsoons, and loan waivers driven by political agendas
• Low Ticket Size: The average ticket size of both a deposit transaction and a credit transaction in rural areas is small. This means that banks need more customers per branch or channel to break even. Considering the small catchments area of a branch in rural areas, generating a customer base with critical mass is challenging.
• High Transaction Cost: due to small loan sizes, the high frequency of transactions, the large geographical spread, the heterogeneity of borrowers, and widespread illiteracy
• Higher risk of credit: Rural households may have highly irregular and volatile income streams. Irregular wage labour and the sale of agricultural products are the two main sources of income for rural households.
• Information Asymmetry: Since many rural people do not have bank accounts, there is a lack of information on customer behaviour in rural India

Government’s policies:

·         High fiscal deficits and statutory pre-emptions imposed on banks

·         Persisting interest rate restrictions—“floors” on short-term deposit rates and lending rates, “caps” on small loans

·         Government’s domination of and interference in rural banks, particularly RRBs and cooperative banks, further distort bankers’ incentives;

·         Inefficiencies arising from weak governance & poor management,

·         Weak regulatory standards & Lack of supervision

BC Model – Viability issues:

·         Scarcity of staff

·         Inadequate commissions

·         Accounts opened have remained non-operational

Infrastructure:

·         Technology issues: Non-availability of physical and digital connectivity as well as low rural television-density

·         Lack of Bank branches—Limited delivery capability as ATM penetration is low and other channels such as Phone and Internet Banking are non-existent

·         Poor physical and social infrastructure—unpaved roads and limited access to modern transportation

Small Rural Borrowers Find Rural Banks Unattractive:

·         Rural banks do not provide flexible products and services to meet the income and expenditure patterns of small rural borrowers

·         The transaction costs of dealing with formal banks are high—Procedures for opening an account or seeking a loan are cumbersome and costly (with high rejection rates), and, clients often have to pay hefty bribes (ranging from 10 to 20 percent of the loan amount) to access loans. This makes the ultimate cost to borrowers very high (despite interest “caps”).

·         Banks demand collateral, which poor rural borrowers lack — Land, remains the predominant form of collateral. But, poor households very often do not have clear titles to their land, and in any case, this collateral is seldom executed, so it is just another cost with little benefit in practice

Financial Literacy:

Financial Inclusion and Financial Literacy are two sides of the equation. Financial Inclusion acts from supply side by providing financial market/services that people demand whereas Financial Literacy stimulates the demand side by making people aware of what they can demand. Therefore, access to financial services and Financial Education must happen simultaneously and must be a continuous, an ongoing process and must target all sections of the population.

Importance: the low levels of literacy and the large section of the population still out of the formal financial system

Need to-

·         Evolve an appropriate Business Model & an Efficient Delivery Mechanism

·         Create awareness of basic financial products through dissemination of simple messages of financial prudence in vernacular language—activities included publication of comic books on banking and RBI; games on Financial Education; arranging school/college visits for creating financial awareness; participation in exhibitions/fairs/melas at the State & District levels; conducting essay competitions and quizzes in schools to create awareness about banking and RBI; outreach programmes undertaken by theTop Management and Regional Offices; RBI’s Young Scholars Scheme, etc.

Education:

Why—For economic development and raising overall living standards

·         Facilitate economically weaker sections of the society to avail educational loans from scheduled banks with modified easier norms

·         Loans for education should be seen as an investment for economic development and prosperity, since knowledge and information would be the principal driving force for economic growth in the coming years

New Approaches and Products to Improve Rural Access to Finance in India:

SHG-Bank Linkage Program—championed by the National Bank for Agriculture and Rural Development (NABARD).

Have targeted poorer segments of the rural population in an effective manner, reducing the vulnerability of clients. But outreach, volume of lending, and average loan size remain limited.

Key challenges facing the initiative are:

(a) Inadequate attention to group quality could jeopardize longer-term credibility and sustainability.

(b) Capacity constraints and the cost of group formation

(c) State-owned banks have been lending to SHGs at higher interest rates

Microfinance Institutions— Like SIDBI

·         Limited outreach and scale of Indian MFIs reflects the absence of an enabling policy alongside a legal and regulatory framework, hindering the ability of MFIs to mobilize member deposits, equity, and raise debt from external sources.

·         MFIs are also constrained by the lack of adequate capacity and skills in financial control and management, management information systems (MIS), new product design, etc.

Partnerships between Private Banks, Micro-financiers, and Service Providers—

·         Pursuing innovative approaches to microfinance—as a potential business and not merely as a social or priority sector lending obligation.

·         Key innovations include a pilot scheme by ICICI Bank that uses NGOs or MFIs, traders, or local brokers (who are close to the farmer by the nature of their business) as intermediaries/“service providers” for originating, managing, and collecting loans to groups of small and marginal farmers.

·         Banks are also experimenting with an approach now termed the “Integrated Agricultural Service Provider” (IASP) approach, whereby the bank identifiesan IASP—one that has a good relationship with farmers and which provides genuine and timely information through extension services— and enters into a tripartite agreement with the IASP and the output buyer. This reduces transaction costs and the risk exposure of all parties, and, therefore, presents a potentially low-cost way of serving the rural poor engaged in marginal or small farming.

The Kissan Credit Card—

Reducing both borrowers’ transaction costs as well as delays in accessing and renewing crop loans; but the success of the KCC scheme has been uneven

Key to success

·         Develop appropriate products for this segment of customers—Appropriate products and fair lending rates would automatically eliminate the moneylender

·         Shortening of turn-around time—Interventions in some sectors:

Wheat—

·         Issuance of a smart card to procurement agents

·         Installation of an electronic data machine (EDM) at the mandi backed by the e-payment system RuPay

·         Quick generation of MIS and reports

·         E-approvals by the procurement agency

Milk—

Leveraging the technology of Point of Sale (PoS) terminals for small operations and full-scale ATMs for larger dairy societies— the process enables the instantaneous capture of milk quantity and quality data, converting them into an accounting entry that credits the farmer’s account, and a micro-ATM or cash dispenser is made available for farmers to draw money from

·         Digitisation of banking: will help access a wider range of customers in rural India

-Digital applications (wallets, mobile-to-mobile payments) are adding to transaction traffic

·         Inculcate saving & banking habit: Critical to conduct financial literacy and credit counselling programmes, offer skills training to enhance income generation, form self-help groups and fund these groups for income-generating activities thereby enabling the delivery of viable credit to the rural poor in a sustainable manner