India’s financial system has developed tremendously in the recent years. Gradual reforms in the sector have held the economy in good stead. The relative immunity of the sector to the global financial crisis is testimony to the good health of India’s financial system. Having said that it, it cannot be ignored that significant bottlenecks exist in the system which need to be urgently dealt with. Financial services remain inaccessible to majority of the population particularly in rural areas. The trickle down approach can clearly not be expected to yield any results in this particular sector as the concerned issue is of accessibility.
Financial inclusion has been the aim of the Central Banking in India for many decades. However it has continued to be only a much coveted end goal with the path towards it not being deliberated enough. Many structured initiatives towards financial inclusion have been seen in the past by the government and the Reserve Bank. Some of these include rural branches for all scheduled commercial banks and sector wise percentage requirement in total loans for agriculture and SSIs. Without undermining the importance of these endeavours it can be claimed that these are not necessarily the ones that would drive financial inclusion in India in the years to come. In a country where adult literacy rate is only 66% (2008, UNICEF) the awareness and understanding of financial services still remains desirable. For majority of the population awareness of a model alternate to the local moneylender is virtually nonexistent.
The prerequisite for an economy with access of the masses to financial services is an adequate level of social and physical infrastructure, the absence of which poses an impediment in the process of financial inclusion. It is too late in the day to wait for our society to first achieve the desired social infrastructure and then move towards financial inclusion. The players in the financial sector including the regulator and all other institutions
The business model of traditional banking is extending loans to individuals and institutions on the basis of credit worthiness. A higher level of credit worthiness implies a lower cost of borrowing and vice versa. The issue for prospective borrowers in rural areas is that low degree of credit worthiness is coupled with an inability to pay a higher cost of borrowing.
Thus commercial banks are sceptical of extending loans to rural clients. The low amount of loan per capita also renders it infeasible to tread the paths of rural areas.
It is in light of such unique challenges that creative models for financial inclusion will have to take precedence over the conventional forms of credit growth that have been prevalent for years. One innovative idea that has become popular in many Asian countries is micro finance where a combination of community pressure and assistance ensures that loans are serviced by the borrowers. Branchless banking is another important initiative which is expected to yield results as access to information and communication technology increases. Third party business correspondents such as other financial institutions are also in branchless banking in handling account opening, conducting transaction etc.
Many other endeavours have been introduced in the recent years. A common thread that runs through all these is that they seek to deal with the either the problem of distribution of credit or disproportionate amount of credit risk for rural areas. Measures possessing scalability in dealing with these issues will help in achieving the target of making economic growth more inclusive for Indian economy.
Technology is the enabler that financial institutions will increasingly use to deal with the issue of distribution. But this will essentially become the point of parity in the long run. It is innovation in dealing with enhancing credit worthiness that will become the differentiating factor and decide the fate of India’s financial development. Transferring credit risk from high risk to low risk entities and eventually to risk aggregators will help in mitigating risk of the ultimate borrower. Some mechanisms for this can be reinsurance and securitization.
Mutual funds that invest some percentage of its portfolio in cooperatives and micro finance institutions will help in transfer of credit risk from high risk small borrowers. It is in implementing such a transfer of risk that an integration of large scale financial institutions with small localized financial institutions assumes importance.
Financial innovation has been popular in the economies of the developed world. Mechanisms of transferring risks away from high risk entities have helped in offering financial services to most segments of the economy. Such a model has also posed magnanimous problems as can be seen in the US Subprime mortgage market in 2007. India and other developing countries have the advantage of having witnessed a model of risk transfer that has failed. It is thus an opportunity to leverage form the lessons learnt by the whole world to develop a model of financial inclusion through our own customized approach of risk transfer and mitigation.
Written by
Aparna Kaicker
PGDM II
IMI, New Delhi
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