Financial inclusion: Long due but are we ready yet?

Around 38% of banks have branches in rural India while a mere 40% of the country's population has bank accounts. The number of bank braches has risen from 8,700, at the time of bank nationalization in 1969, to around 85,300 presently. However, only 32,000 of these are in rural areas. The average population per bank branch is 13,900.

The government has planned financial 'Swabhiman' - a program to ensure banking facilities in habitation with a population in excess of 2,000, by March 2012. The program will use various models and technologies, including branchless banking through business correspondants.

Pranab Mukherjee says that the finance ministry expects to cover at least 73,000 new habitations, with a population of 2000 and above, and we will open at least 5 crore new accounts. "The business correspondants will help reach banking facilities to these interior areas, through technologies that reduce cost and have the ability to record banking transactions and to communicate the record of such transactions, to the bank using the internet facilities and GPRS," he states.

Rajeeb Mukherjee, senior Vice President of HDFC Bank believes that the bankers are convinced of the use of convergence to achieve such tasks. "We as a banker have 100% confidence in the convergence instrument of the future and will be the mechanism by which the customer will be doing his transactions, including banking," Rajeeb asserts.

Financial inclusion is a broad term but in simple words it means, credit for the poor, bank accounts for them and the discounted rate of interest. Amitabh Verma, an IAS officer, now a principle secretary in government of Bihar, Bindu Ananth, President, IFMR Trust and Samaresh Parida, Strategy Director, Vodafone Essar, in an exclsuive interview with CNBC-TV18's Siddharth Zarabi, discuss what financial inclusion is all about.

Below is a verbatim transcript of their discussion on CNBC-TV18. Also watch the accompanying videos.

Q: Could you take us through what financial inclusion entails?

Verma: Financial inclusion implies that everybody should have a bank account, a saving bank facility, credit facility, remittance facility and micro insurance and should qualify for micro finance. A well regulated and a good institutional structure, in the last about 60 years has not been able to deliver it to more than 70% to the Indian population. We need to have more informal structures, informal guidelines and informal systems to deliver to the people, with a lot of decentralization.

Q: What is the current status of the financial inclusion? 

Verma: Over 65% of people do not really have the access to banking facilities. More than 85% have no access to credit facility.

Q: Given that over 40 years of past when we decided to nationalize our banks, why do you think the industry not able to deliver?

Verma: The banking structure itself cannot deliver to the population we are trying to target. We need other modes which can deliver as well. If you try to thrust this responsibility on the banking system, it will be a failure as we have seen for over the last 60 years.

The RBI issued our banking correspondent guidelines in January 2006. It includes many categories like - primary cooperative societies, non-profit companies, and section 25 companies. However, we have got a fix on section 25 companies only.

The idea was that every branch manager should be in a position to appoint a banking correspondent, for a particular village. We have six lakh villages in the country, we have 50,000 rural branches, so,if each one appoints about 12 banking correspondents on an average, we cover the whole country. However, there have been restrictions on banks appointing individuals as banking correspondents.

Q: Why is there such a restriction?

Verma: There are some restrictions in the RBI act. They do not allow people to collect public deposit without being licensed by the RBI.

Q: Why don't we get post office workers?

Verma: There are guidelines which restrict it to happen. The RBI has allowed kirana shops now to become banking correspondents. Bankers have raised an issue over it and there are many creditability issues as well.

Instead we can use the individuals in the villages, who are already delivering a credit. It may not be a formal credit structure but they know the basics - who to give, how to give, when to give, when to recover, how to recover, how much to recover, and when. Therefore, instead of trying to train and motivate officers of the banks or that of the government officers who are again transferable, who get promotions and move out, it is better to have people who can be connected.

Q: Is micro finance the instrument for achieving the objective of financial inclusion? Do you think the current model of micro finance industry can deliver?

Verma: You are trying to compare the rate given by the micro finance institution with the rate which the banks are charging. You are not comparing the rates of interest at which the loan is available to the people you are trying to cover. 

At present loans are available at rates ranging from 60% to 120 %. Hence, as against that, if a micro-financial situation, if you get rates from 25% to 30%, it is quite doable. Our belief should be that with scalability, increased volumes, greater efficiency and more competition in the market, the rates will automatically come down and we have seen the rates coming down and stabilizing around 25%. 

However, one has to remember that there is a cost of borrowing. When the bank lends, the rate of interest charged is only its cost of lending. A person travels to the branch, and you have to travel at least 3 or 4 times to get a loan. So, if you take a loan of about Rs 5,000 from a bank branch, you go for a five times to the bank, get a loan sanctioned, it will cost you about Rs 500. So that is 10% of the loan amount which we are borrowing. In micro-finance we are getting a small credit amount. So, the 10% micro finance you include the cost of borrowing and the cost of lending and then you complete your rate of interest. 

The confusion which centers here is because we use a word called interest, on small loan accounts; we call it the cost of transaction. People would in a parliamentary democracy be able to access it even better. Rates of interest cannot come down below 22-23% for such category of people. Globally, where you have micro finance, it has shown that such rates are very easily sustainable.

Q: Last year, the finance minister announced a financial inclusion fund and a technology upgradation scheme too. What can a budget do when it comes to furthering financial inclusion?

Verma: We already have 3 funds - the micro finance development equity fund, the financial inclusion fund and the financial inclusion technology fund. The utilization of some of the others has not been as expected.  In the budgetary exercise, we try to find where we can give some incentives to the banks as and when we appoint the banking correspondant.

The Rangarajan committee has suggested a certain category restrictive individuals as banking correspondants - retired government officials, army men, and retired teachers can already participate but you need to expand it. If a person a correspondent is not efficient, you will have to change him/her in the next year and appoint someone else. This will bring a sense of competition and improve performance. 

Q: A huge section of our population and vast areas of our geography have no access to even basic financial services and therefore it is both, a question of products and reach. Where do you think we are in terms of the metrics?

Ananth: The last five years, we have made a lot of progress across the business correspondant effort and the micro finance institution effort. We have added anything between 50 to 60 million individuals who are outside the financial system into the formal system.

Q: There is a total financial inclusion network spread across 200 million individuals in the country?

Ananth: Yes, it is around 200-300 million. The good news and the tough part is that we have easily another at least 500 million to bring back into the system.

Q: It is also a business opportunity?

Ananth: It is a business opportunity and an important policy objective. It is hard to think about inclusive growth when 500 million people are completely outside the formal financial system.

Q: One of the key things that your trust proposes is the concept of risk aggregators, risk transmitters. How is that linked to financial infusion?

Ananth: The key idea is that there is need for village level presence - a customer facing channel that's close to the customer not more than three to four kilometers walking distance. We need the kind of entities who are good at delivering outreach in operating in very difficult remote conditions and are not typically, the ones who are great at managing vast pools of fisc.

Our core idea is that the country needs - many institutions that are present all over remote parts of the country, ones capable of dealing and transacting with the customer and we need large well capitalized institutions like commercial banks, insurance companies that can manage risk effectively, as compared to a small entity.

Q: What is the ultimate entity to deliver financial inclusion? 

Ananth: Given the size of the problem, we need multiple business models. The need is to create room for the multiple approaches to emerge, in terms of regulations and policies.

Q: Are you hinting at a need for a further regulatory change and a new framework?

Ananth: In the past five years it has really opened up, in terms of the ability to move forward in the financial inclusion agenda. However, it is just the beginning and as we look ahead, there is going to be much more business modeling innovation - from both policy as well as RBI and other regulators regulation. The objective should be - to expand the number of players who are coming in, reduce the barriers to entry, make sure there is no incumbent bias in any of policy making.

Q: What would you want Pranab Mukherjee as the Finance Minister to do to create the right mood for enabling financial inclusion?

Ananth: I would emphasize on few things - one is regulatory certainty, it is important to clarify what are the regulatory jurisdiction so that there is certainty for customers, for lenders and for investors. Secondly, how can we really make sure that there is room for a lot more new models to emerge? We are involved in some work Kshetriya Gramin Financial Services. It's really a new approach at doing the regional rural bank which is an idea that's 50 years old. The question is can we encourage more entrants to come in and try disruptive stuff.

Q: Perhaps at Panchayat level institution, right?

Ananth: Yes, and something that's kind of closer to the customer, multiple products, not necessarily bracketed very narrowly. Lastly, from the budget perspective, I would emphasize to continue to focus on addressing public infrastructure gaps. It is difficult for private entity to do inclusion. I would include things like broadband in remote places that makes it easy to access financial services.

Q: We are in a store that is a business correspondant for basic financial services, basic banking services. Do you think, eventually, this store could muff into a full-fledged banking outlet?

Parida: Only 170 million peoplehave bank accounts in the country. However, when it comes to moblie phones, there are 750 million SIM cards in the country today.

Q: Of which atleast more than 500 million would be very active users?

Parida: That is correct. So, even if you take out maybe 100 million out of that 500 million, 400 million people should be opening their bank account and should be able to transact through a banking transaction. They don't have to go to a bank. So, it gives convenience to the people to come into the banking fold. Therefore, a lot of people who are excluded from banking will get the opportunity to come into the banking fold. Hence, from that perspective, it is the future of banking.

Q: You have a project that you started with HDFC Bank and you call it M-Paisa. Could you tell us about this pilot project?

Parida: Yes, we have partnered with HDFC Bank and have a global product called M-Paisa. It is running in three countries in Africa and has almost 17 million people already on that platform.

Q: You mean to say Africa is ahead of us in this?

Parida: In some respect yes Africa is ahead of India. So, we have started this pilot project. People largely in the rural area are given the opportunity to open a bank account with HDFC and the account opening is simple - one has to  come into the store, open an account, transfer money, deposit money, also withdraw money or pay merchants or they can top-up your mobile phone balance or can transfer money from one person to another etc. Hence, all that is possible.

Q: In terms of the mobile phone network, are there any security issues that people should be worried about?

Parida: Absolutely not. In fact, a transaction done through a mobile phone is much more secure. You have an audit trail, you can trace back many transactions to see where the money has gone and who has it been paid to etc. So, it is all in the system. In fact, the government also trusts the telecom companies to protect the security of the country. So, we do help the government in that respect. We understand the whole concept of security.

Q: A basic understanding of this project would suggest that this also has the potential of reducing the banking transaction cost in the system, is my assumption correct?

Parida: We think mobile banking will become big beacuse you can do a lot of transactions at a minimal cost.

Q: Are you saying that in a rural Indian environment, where there are issues of reach and viability, for any business - mobile banking could be the solution?

Parida: Yes, it is the solumtion. Also, the telecom companies have a number of outlets all over the country. For example, our company has more than 1.5 million outlets. So, it gives distribution reach to the bank riding on top of the telecom and it is the biggest advantage that the banking system will get.

Q: What kind of overall targets at the industry level could we say can be achieved down the road in two or three years down the line? How many people would actually have this basic no frills banking service availability? 

Parida: It is very difficult to put a hard number to this. It will not happen overnight. Even if 100 million more customers come in to a base of 170 million, you are talking about increasing the total base by 60%.

Q: We are discussing this right before Budget 2011. So, is there something that you as a industry expert would want to be done as far as enabling environment is concerned to further provide a boost to mobile banking and financial inclusion?

Parida: Lot of steps have already been taken. The Reserve Banks policies are moving in the right direction to make inclusive banking possible. The areas where the regulators can take a look at would be how to minimize paper work, in terms of getting a person into the banking fold . You should be able to transfer the accounts with no frills and should be allowed with no pass book because these are small accounts. They are all people who will have a balance of Rs 100 to Rs 200.

You need not impose the whole weight of the banking system on these accounts. If these are taken care of then the mobile banking will flourish.

Q: So, that is where you would want Finance Minister Pranab Mukherjee to make a enabling statement and ultimately the RBI to do more to ensure that this thing really takes off?

Parida: We hope so. 

For the complete discussion, watch the accompanying videos...