Financial inclusion needs another model

Khatakholna, or opening basic bank accounts, is all the rage now. Whether it is the RBI’s no frills accounts or the Prime Minister’s Jan Dhan accounts, the growth of such accounts has been notable.

While the number of no-frills or zero-balance account holders touched 103.21 million in 2012, up from 49.33 million in 2010, more than six crore Jan Dhan accounts have been opened at breakneck speed since its launch.

Since millions of Indians don’t even have a bank account, these are laudable efforts, at least when measured through the prism of intent.

But on the credit side, the mainstay of RBI’s financial inclusion drive since the late 1960s has been the priority lending scheme, which requires banks to set aside a share of credit for the weaker sections.

Presently, banks are required to direct 40 per cent of their total credit to the ‘priority sector’ (PSL) consisting mainly of agriculture and allied activities and small and medium enterprises. In further directives, the RBI has mandated a sub-target of 18 per cent of banks’ credit for the agricultural sector.

So far these regulatory provisions haven’t yielded the desired results as both the agricultural and MSME sectors continue to reel under a credit crunch.

Moreover, it has been often found that banks are only too keen to fulfil the given targets by hook or by crook as the deadline nears, thus leaving the purpose of inclusion unserved.

It is known for example that commercial banks buy out loans from non-banking entities and pass them off as PSL.

Still, banks regularly fail to fulfil the prescribed limit. The evidence of PSL’s impact on financial inclusion is scant.

In the process though, banks have amassed large NPAs and this is part in due to priority sector lending.

The net non-performing assets (NPA) of all banks increased to 1.68 per cent of the total loan of the banking system at the end of 2012-13, rising from 1.28 per cent in the previous financial year.

The ratio of gross NPAs to gross advances snowballed from 2010 to 2013 and the public sector banks shouldered much of this load. In fact in 2013-14 the ratio went up further to 4.03 per cent.

These NPAs are then periodically written off by the government, resulting in added pressure on the fiscal deficit. The priority sector has historically constituted a large share of total NPAs in the banking sector, although non-priority sector NPAs have also grown in recent times.

In FY 2011-12, the priority sector loans constituted 47 per cent of total NPAs.

Among the issues presently faced by the banking system is the fact that all banks are required to do everything.

The Nachiket Mor committee has, among other things, recommended changing the existing norms so as to allow (and incentivise) banks to specialise, instead of requiring to carry out activities in all sectors (and regions).

Throwing light on the limitations of the mandate driven approach, the ex-Deputy Governor of RBI KC Chakrabarty once said “if banks do financial inclusion as a target, it can never happen.”

The private low-cost housing finance sector has emerged as a trailblazer for specialised banking, a sector where intense competition has actually gone on to foster inclusion in the area.

While low cost housing comes under the RBI’s priority sector, traditional commercial banks have consistently turned their backs on sections of the population which have very low and unpredictable flows of income.

More often than not, complex documentation requirements (income certificate, specific identity proofs, etc) of these banks push customers away to non-banking entities that are playing a role in inclusion by giving out small ticket loans.

While according to RBI guidelines, housing loans below ₹25 lakh to individuals and families add up as priority sector lending, the average loan amount of Micro Housing Finance Corporation, one of India’s low-cost housing finance companies, is only ₹4.54 lakh.

In contrast, the minimum home loan amount for the country’s largest lender State Bank of India is ₹5 lakh. The gap is clear and unambiguous.

A number of these low-cost housing finance companies are targeting informal customers who form 70 per cent of the customer base in this segment and lack official documents. Interest rates charged by these entities are generally higher than traditional housing loans disbursed by existing commercial banks.

But due to an exclusive focus on the sub-sector, and a knowledge of the same, these entities bring in innovations in procedures that attract customers.

What is particularly impressive is that these companies, despite lending to a segment that is perceived as irresponsible and classified as ‘high risk customers’, have a gross NPA share of total advances that is negligible.

While the PSL obligations rightly keep bankers from disproportionately serving the rich, it is perhaps also time to focus some of our policy attention away from the vanilla/one-size-fits-all approach and adopt best practices from across the board.

This includes leveraging domain knowledge of specific entities like, say, those in the low cost housing segment, and letting competition thrive.

Credit driven financial inclusion is going to be a reality sooner than we think if banks are pit against each other to acquire the non-urban, non-rich market share — and not just directed to achieve targets by fair means or foul.

The writer is a research associate with a Delhi-based firm