Jalanga (Orissa)/Waghave (Maharashtra)/Balahari Kalan (Punjab): Jalanga, a village in Orissa around 120km north of Bhubaneswar, was an unlikely place to discover a subtle change in the Reserve Bank of India’s (RBI) aims. On 3 December, talking to children in the village school about the central bank’s functions, RBI governor D. Subbarao said the three most important ones were to keep prices stable, supervize banks and make them lend to poor people.

RBI does not have clear-cut statutory aims. Over its 75-year history, maintaining price stability and ensuring credit flow to support growth have evolved into the main aims of monetary policy, former governor Y.V. Reddy had said in speeches. Has bringing about financial inclusion replaced supporting economic growth in the list of RBI’s priorities?

Subbarao’s actions in Jalanga seemed to suggest RBI placed a lot of importance on financial inclusion. Arriving in Bhubaneswar on 3 December after an overnight train journey from Kolkata, Subbarao drove to Jalanga and spent the day there talking to local bankers, villagers, schoolchildren and self-help groups (SHGs) as part of an outreach exercise. A few days before Subbarao’s Jalanga trip, RBI deputy governors Usha Thorat and Shyamala Gopinath visited rural Maharashtra and Punjab, respectively, as part of the outreach exercise on financial inclusion and financial literacy.

“I would not say RBI is forgetting growth," N. Srinivasan, a freelance consultant who spent most of his career with RBI and the National Bank for Agriculture and Rural Development, said. “They have introduced a qualitative dimension to it (growth)," he added.

Financial inclusion and inclusive economic growth have been overarching aims of the United Progressive Alliance (UPA) government in its first stint between May 2004 and May 2009, and also in its current innings. In 2009, RBI seems to have nudged financial inclusion up its list of priorities.

Some of Subbarao’s speeches in 2009, including one to staff members in April to mark the beginning of the central bank’s platinum jubilee year, are peppered with references to financial inclusion.

Equitable growth

“Giving people an opportunity to build better lives for themselves and their children" is how Subbarao described financial inclusion in a speech in Kolkata on 10 December. “It is important simply because it is a necessary condition for sustaining equitable growth. Economic opportunity is strongly intertwined with financial access," he added.

Shake-up: RBI deputy governor Shyamala Gopinath (centre) dances with schoolgirls during her visit to Balahari Kalan in Punjab as part of the central bank’s outreach programme for financial inclusion. Ramesh Pathania / Mint

Around 51% of the 89.3 million farmer households did not seek credit from either formal or informal source, according to National Sample Survey data of 2003.

In contrast, mobile phone penetration in India crossed 500 million by 30 September, covering almost half the population in less than two decades after its introduction. Data gathered in April showed 46% of cellphone owners did not have a bank account, indicating wider penetration of mobile telephony.

“I think there is so much potential to raise the level of financial inclusion," Gopinath said during her outreach exercise in Punjab. “The financial sector needs to grow more to meet the needs of the economy."

In its drive to bring more people into the formal financial sector, which includes access to insurance, RBI has placed banks at the forefront. “The Reserve Bank has made a commitment to the bank-led model of financial inclusion," Subbarao said in his Kolkata speech.

Limited reach

Banks are the top tier of India’s financial system in terms of assets. Yet, their physical presence is limited. Even where they have a presence, banks have evolved in a way which makes it challenging for the financially excluded to relate to them easily.

In Waghave, the outreach exercise organized for Thorat had a section where people could exchange soiled notes for fresh ones. But villagers appeared too shy to make use of the opportunity.

Srinivasan felt banks ought not to be the only ones who lead the move towards financial inclusion. “Banks cannot have the kind of engagement like microfinance institutions or cooperative societies," said Srinivasan, who wrote Microfinance India: State of the Sector Report 2009.

Srinivasan’s views were echoed by Munish Dayal, a partner at Baring Private Equity specializing in the financial sector. Dayal, who has had a stint at a foreign bank, felt that not making full use of the existing distribution system does limit reach. Non-banking finance companies (NBFCs), which are nimble, innovative and profitable, according to Dayal, are a part of the existing distribution system.

NBFCs also happen to be the critical link in the microfinance sector. According to Srinivasan’s 2009 microfinance yearbook, the three largest microfinance outfits in terms of loans are SKS Microfinance, Spandana Spoorthy Financial Ltd and Share Microfin Ltd. All of them are NBFCs.

RBI has adopted a tough regulatory stance towards NBFCs, and over the last decade has curtailed the number which can raise deposits to lend. In Jalanga, Subbarao’s reply to a question from Mint on the role NBFCs would play in RBI’s game plan to bring about financial inclusion was unclear.

“NBFCs serve a valuable purpose, they can provide niche loans. I cannot say anything beyond that," Subbarao said.

No poor cousin

According to the microfinance yearbook, the number of clients with small loans in the banking system (including regional rural banks) on 31 March 2008 was 41 million. On the same day, microfinance institutions, or MFIs, had 14 million clients, and SHGs had 47.1 million.

SHGs currently dominate the microfinance segment, but incremental growth is coming largely from microfinance institutions, many of which are organized as NBFCs.

In 2008-09, outstanding loans of microfinance institutions increased by 97% over the previous year to Rs11,734 crore. The outstanding loans in the books of banks to SHGs on 31 March 2009 was Rs24,196 crore, higher by 42% compared with the previous year.

“The emerging new reality is that the MFI channel is not the poor cousin any more. There are initial signs that MFIs are crowding out the banks from the sector in southern states," the microfinance yearbook said.

MFI loans are often priced at more than 20% and have been a cause for concern. In 2007, a Bill to regulate the microfinance sector was tabled in the Lok Sabha. The Bill was not cleared as it did not statutorily cap lending rates, which the Communist parties, at that time the UPA’s parliamentary allies, found unacceptable.

The sheer growth in volume of clients recorded by the microfinance sector would make them a key player in any financial inclusion strategy. In 2008-09, the microfinance sector added 8.5 million clients compared with the 6.9 million added by the banking system. The scale at which the microfinance industry has grown has also led to questions about the potential problems which lie ahead, as Mint’s Banker’s Trust column noted on 21 December.

A key issue in financial inclusion could be the difficulty banks might face in reaching out directly to the financially excluded. “The last mile is very expensive," Dayal said.

In Jalanga, State Bank of India had a stall which displayed the hand-held machines used by its business correspondents to reach out to people in the village. According to RBI, business correspondents are meant to be the bridge between poor people and the organized financial system. Individuals and microfinance institutions, among others, can function as business correspondents.

In Jalanga, State Bank of India had outsourced the job of identifying and recruiting business correspondents to Mumbai-based outfit Zero Microfinance and Savings Support Foundation. The outfit handled the function for State Bank of India across a few regions, said its director Lokanath Panda, who was present at the stall.

Non-formal channels

It is not only brick-and-mortar outfits that have been active in financial inclusions. Mobile telephony has the potential to deal with challenges in remittances. A solution to this aspect would immediately translate into significant savings for the poor.

According to Subbarao, “Although there are no firm figures, I have been told that thousands of crores of rupees of remittances take place across the country today, predominantly from migrant labour, and over 90% of this happens through non-formal channels."

The extent of penetration of mobile telephony and low costs make it a good source to bring a larger part of remittances into the formal channel.

At the India Economic Summit held in November, Manoj Kohli, chief executive officer and joint managing director of Bharti Airtel Ltd, India’s largest mobile phone company, said: “Our objective is to be a pipeline between the unbanked and banking system."

According to Kohli, Airtel has undertaken a pilot project to assist domestic remittances.

RBI has made attempts to calibrate its guidelines on using mobile service providers in financial transactions based on experience and feedback.

On 24 December, RBI relaxed encryption needs for transactions up to Rs1,000, which is expected to lower transaction costs. For the moment, RBI’s financial inclusion game plan may be bank-led, but Subbarao has indicated the central bank would keep its options open on the strategy.

“Should banks fail to come forward and exploit this opportunity of financial inclusion, the Reserve Bank will not hesitate to explore other models of furthering financial inclusion," Subbarao said in Kolkata.