Will India’s New Focus on Financial Inclusion Pay Off?


When India launched the Jan Dhan (people’s wealth) program a year ago, many observers regarded it as an experiment that would fail. But while the program may not have measured up to the claims of its proponents, evidence shows it has had some positive impacts.

Jan Dhan was launched on August 28, 2014. It envisaged making every Indian a holder of a bank account. Similar attempts had been made earlier, but the programs were not attractive enough to yield results. The literacy rate in India is defined as those who can read and write with understanding. Numeracy is defined as the ability to do basic math. Only 30% of Indians qualify as being financially literate based on that yardstick.

But, according to numbers on the ground, so far 174.5 million bank accounts have been opened from an overall population of nearly 1.3 billion. Some 46.25% are zero-balance, which means the account holder withdrew the entire balance on the same day it was deposited (like the character in the 1910 Stephen Leacock essay, My Financial Career). In Leacock’s case, this behavior was the result of fear of the bank; in India, the reason has to do with the way the program is structured.

All subsidy payments to the poor go directly into the bank account. This is what makes it imperative to have one. Jan Dhan saw the opening of 10 million accounts in a single day, a fact that quieted the army of skeptics wondering whether white collar bankers could succeed in the villages where most of the unbanked live. This was indeed a challenge. But as former ICICI chairman K.V. Kamath said at a Wharton India Economic Forum meeting in Mumbai, India cannot progress until millions of poor people are able to participate in the banking industry.

The process of financial inclusion in India is much older than the Jan Dhan program. The Reserve Bank of India (RBI) licensed several new banks like HDFC Bank, which were successes, and Global Trust Bank, which were failures. The second phase saw the opening of banks such as Kotak Mahindra Bank and Yes Bank. Now, the third phase is underway. Bandhan Bank, which received an RBI license in 2014, began operations on August 25. A license has also been granted to the Infrastructure Development Finance Company (IDFC).

In another move with far-reaching consequences, the RBI has permitted 11 payment banks to open shop. These are new stripped-down type of banks, which are expected to reach customers mainly through mobile phones rather than traditional bank branches. “The payment banks are not allowed to offer lending facilities,” says the RBI.

“With more than 600,000 villages and less than 50,000 rural bank branches, banking infrastructure still has a long way to go.”–Rajesh Chakrabarti

The licensees — who are allowed to accept deposits up to Rs. 100,000 ($1,152) — include Aditya Birla Nuvo; Airtel M Commerce Services; Cholamandalam Distribution Services; Department of Posts; FINO PayTech; National Securities Depository; Reliance Industries; Dilip Shanghvi, founder of Sun Pharmaceuticals; Vijay Shekhar Sharma, CEO of Paytm; Tech Mahindra and Vodafone M-Pesa.

“This is the first time in the history of India’s banking sector that the RBI is giving out differentiated licenses for specific activities,” notes the RBI. “We have more than 90,000 M-Pesa agents and already provide people in remote areas a convenient way to transfer money and make payments in a safe and secure manner,” adds Vodafone managing director and CEO Sunil Sood. The telecom services provider is looking at a partnership with ICICI Bank.

RBI governor Raghuram Rajan has clarified that neither the payment banks nor the new entities to be licensed will pose any threat to the banking establishment. In fact, the payment banks have been a bee in his bonnet for some time now. On the other hand, RBI deputy governor H.R. Khan said at the Bandhan Bank inauguration that the banking industry is set to become more competitive. Demand for financial services is likely to grow with much of the population being brought into its fold.

Payment banks have been popular in other countries. In Kenya, for instance, two of every three adults use the system. India, with a mobile tele-density of 77.27 (at the end of March 2015) is among the highest in the world on this parameter. Payment banks thus have great potential. The share of rural areas in mobile phone connections was 42.08%. (The Kenya service was launched by Vodafone and M-Pesa.)

“Payment banks will play a big role in helping India become a cashless economy.”–Ashvin Parekh

Payment banks may mark a sea change in the banking system in India. Not so the new banks to be licensed; there is a good probability of these overlapping with the universal banks now in existence. In another move, the RBI has promised to issue licenses for smaller banks in September. “Bandhan and IDFC will have to get into universal banking and, over a period of five to 10 years, some of the new smaller banks may also expand their activities gradually across different states and become ready to be universal banks,” says Ashvin Parekh, managing partner of Ashvin Parekh Advisory Services.

A big challenge to the system will be in terms of human resources. Though Indians are known to be bankers to the world (several from the subcontinent have served as CEOs of global banks), they lack talent at home. “The interesting challenge that will now be posed before the new banks, as well as the incumbents, is that of human resources,” says Rajesh Chakrabarti, executive vice president for research & policy at the Wadhwani Foundation. “That is a hard ceiling — policy cannot change it overnight. It takes years and generations to develop. So the ball even in the banking sector is already moving to the court of skill development and education. The best of the banks — old and new — will now have to struggle with this.”

Shinjini Kumar, leader for banking and capital markets at PwC India, notes that key challenges outside the banking system also have a big bearing on inclusion. “Those are actually much harder to deal with,” Kumar pointed out. “For example, the whole challenge around small business data availability or taxpayers’ records or land records, legal recourse against defaulters or even arbitrary action by states against financial system providers, etc.”

A Collaborative Effort

While the government of India has made financial inclusion a major priority, many of these initiatives reflect a collaborative effort on the part of several individuals and institutions. The external advisory committee (EAC) under the chairmanship of Nachiket Mor, director of the central board of the RBI, has been working on it for some time now. The report has had to pass through several committees.

“While the new efforts at financial inclusion have timed close to the Prime Minister’s thrust on financial inclusion, the foundations of these new efforts have been painstakingly and consistently laid over the years,” says Chakrabarti. “The speed has accelerated since Rajan took over at the RBI. Financial inclusion has always been in his cross hairs. Even the Rajan report on financial sector reforms, way back in 2008, underlined the need for financial inclusion and talked about the unnecessarily excessive differentiation between banks and non-banking finance companies. It is systematic progress right through the very influential Mor committee that submitted its report well before the elections paved the way to this day.”

Chakrabarti adds: “With more than 600,000 villages and less than 50,000 rural bank branches, banking infrastructure still has a long way to go to reach adequacy, but this is undoubtedly a big and long overdue step for expansion. Twitter 

“It will redefine banking because much of what we left on the table for the informal system should now become banking staple.”–Shinjini Kumar

A Two-Tier System

Universal and payment banks today constitute a two-tiered banking system with the former focusing on large-value transactions while the latter concentrate on service penetration and inclusion efforts. According to Chakrabarti, “There is no doubt that there will be turf overlaps and competition, and large network banks like State Bank of India (SBI) clearly have a lot to lose to the new competition. But then, all competition ultimately shapes up the incumbents.” He predicts that in the long run, some payment banks will emerge as key savings mobilizers and graduate into universal banks. Alternately, they may choose to remain payment banks. “But the overall system will become more efficient and inclusive, which is the whole point,” Chakrabarti says.

Parekh says that different categories of banks have different roles to play. “To my mind, the strength of a small bank lies in understanding the economic activity of the community it is serving,” he notes. “Payment banks are a different animal. They are completely about financial inclusion. Payment banks will play a big role in helping India become a cashless economy.”

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