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More than half the adult population in Asia’s third largest economy still does not have access to formal financial services. Promoting financial inclusion, or the process of spreading banking services to the far-flung corners of the country, has been a mammoth challenge for the Reserve Bank of India (RBI) and the government.

At the Clarity Through Debate—The unbanked: The way ahead and financial inclusion event, panellists called for innovative technology-based financial inclusion models as the only solution to bring banking services to millions of unbanked people in the country.

Panellists included M.G. Vaidyan, deputy managing director, State Bank of India; Chandra Shekhar Ghosh, chairman and managing director of Bandhan Financial Services Pvt. Ltd; Rajeev Ahuja, head of strategy at Ratnakar Bank Ltd; Vijay Mahajan, chairman, Basix Group; Biksham Gujja, chairman of SKS Trust Advisors Pvt. Ltd; and V. Vaidyanathan, chairman and managing director of Capital First. The debate was moderated by Mint’s deputy managing editor Tamal Bandyopadhyay. Edited excerpts:

What are the problems you face in your business when you lend to small borrowers?

Vaidyanathan: The question of why we are doing this business (of financial inclusion) is very important in the context of our business. We felt we should do some business, which banks don’t do. Because if we do the same business which banks do, such as home loans and car loans, then with their rate advantage, we will be out of business. We often find banks find it very uneconomical to do small loans of 30,000 or 50,000. We have done about 800,000 loans in the last four years. Of this, about 500,000 customers are micro, small entrepreneurs taking loans of 30,000 to 1 lakh. The challenge we face is, most of these customers do not have a bureau track record. Second is, the traditional way of underwriting won’t work for these customers, because the cost of doing such an underwriting is very expensive. The third issue is identity frauds. We have solved this by using credit scoring, credit underwriting in the form of technology.

Vaidyan: When we started financial inclusion through BC/BF (banking correspondent/banking facilitator) model, there was no technology. Also there was no viability. Still, State Bank of India (SBI) and other banks went ahead with financial inclusion, because we believed in that. Today, the growth we are witnessing in the economy is significantly because of the growth in villages. India has one of the best models for financial inclusion. Majority of the farmers who have taken loans from SBI are small farmers.

Biksham Gujja: There are no two questions about whether we should do this (work on financial inclusion) or not. Twenty years ago, none of us would have visualised that we will have this much connectivity. In the next 20 years, the credit system will be fundamentally different. I read in a newspaper that when the former RBI (Reserve Bank of India) governor moved to Hyderabad, he had a tough time opening an account because of KYC (know-your-customer) norms. If that has to happen, there must be something wrong fundamentally.

Is this business profitable for Ratnakar Bank? Are you doing this for survival or by force?

Ahuja: We started our journey as a new transformed bank two-three years ago. We had to pitch against SBI and so many other banks for the segment of the market which is quite well banked and understood. We bet that financial inclusion—what we call development banking—would become a fairly significant business for us in the next five to 10 years. We created a bank within a bank for that, our entire financial inclusion strategy is structured on a very different platform than the conventional bank. We don’t use the same technology. We use what’s available and what’s light and what easily can be deployed in the remotest part of the country.

Obviously, there has to be a roadpath to profitability, you cannot just be doing this to fill priority sector guidelines. We are actually on the path to becoming a viable financial inclusion business.

The second thing that has helped is a lower threshold in using the documentation for KYC. Third is networking and standards. Someone will have to take on the issue of technology entry cost so that the application services provider makes money … the creation of the network is important. The standardisation of payments platforms by NPCI (National Payments Corporation of India), NEFT (National Electronic Funds Transfer ), IMPS (Immediate Payment Service) and the entire standardisation of the mobile payment platform—these are standards that will help us lower the entry cost.

Everything is not going great in the microfinance sector. Basix is in a crisis mode. At the macro level, what has gone wrong and what is the way forward?

Mahajan: The one thing that is still to be fixed is the widespread belief that if the poor have to be provided services, it must be done in a subsidised manner or as an act of charity. And this belief has kept the poor from getting those services; it has kept the regime of rationing, queuing, patronage alive. In practice, by excluding the poor from a set of services, we are making them pay five-seven times the cost. By charging full cost and marginal profit on that, we would enable near universal coverage, perhaps, except for the destitute and the very remote.

Unless that principle is accepted across the board, we will continue to suffer from massive exclusion. What is the votebank of the politician is the notebank of the MFIs (microfinance institutions). Every time an MFI gives a new loan, it liberates a family from patronage of the political kind to being self-sufficient. Today there are 30 million borrowers of the microfinance sector. With those kind of numbers, it becomes a political threat. Because you are taking away the politics of patronage and replacing it with self-sufficiency and that requires the political leadership to change. Unless that fundamental value reform happens, we will always be on thin ice. We will always see situations like today. Neither the N. Chandrababu Naidu government (in Andhra Pradesh) has yet been sworn in, nor has the Telangana Rashtra Samithi government (in Telangana) been sworn-in, but both have announced loan waivers. As long as we have this ability of somebody writing off loans given by a legitimate financial institution, which has borrowed legitimately and continue to owe it, we will see a repeat of the Andhra crisis (when MFIs came under the scanner of authorities after reports of suicides because of alleged coercive recovery methods adopted by them). Till then we will not really have a self-sufficient, self-propelled financial inclusion sector. But one that will be driven by regulation, or by exhortation.

Do you find this problem of politics in expanding your work?

Ghosh: I don’t want to create an enemy. But I would like to elaborate how we are working on our mission. Out of the total unbanked people, 63% are in the northeast; 14% of the people have access to credit; out of that 7% access to credit goes to the Northeast and 8% credit access is in the eastern region. We know where the need for financial inclusion is. It is the eastern region, including the Northeast.

When I started this programme, I had not heard about the term financial inclusion. I saw that people needed money to run or expand business. They were dependent on moneylenders, who charge 1% per eight hours, which is about 700% annually. There was a big gap. Hence, we started this programme of micro credit. But we are also fully dependent on banks. Banks said that if your business is not financially viable, I cannot give you money. So when I started it, I thought how I can develop a financially viable model and convince banks to fund me. Now, people may say we are another form of moneylenders, depriving others, everything is right. But tell me who has come to serve the poor?

India is a big country and if 41% of the country is unbanked, we would like to reach more people. But for now we are focusing on the eastern region. Out of our total clients of 55 lakh, 75% are from this region. The challenge is because we are taking loans from banks at 13% interest and reaching to people, for which cost is high. On this basis we are pricing our product and help them increase their income and we also increase our income and slashing their cost for funds. Until these people are not regulated by banks, they are not financially included. When we become a bank, these clients will become bank customers, which means that they will not only get credit services but also access to savings, fixed deposits, insurance and remittance, which will be a full-fledged financial inclusion. I started it as a need of the people and accordingly designed the product and process to reach to them and survival for both me and them. It is only now that people say it is financial inclusion.

Vaidyanathan: This concept of saying that banking is a right of citizens, this right-based thinking is the problem. In the private sector there is only opportunity, no security. The private sector will tell the government that if it is a right of the citizen, then you provide. Every bank will report I have 20 or 30 million of financial inclusion accounts, they will meet all the statistical numbers and nobody can prove or disapprove how many of them are active or no.

We should get away from rights and say how are we going to make it happen. It is like the state setting up a railway line. The trains that are running on it could be private. The regulator has to make sure that supply exceeds demand—why not 15 or 20 more banks? You can say that there could be a systemic problem but then there could be solutions also. For example, in Mumbai, if you tell banks to open as many branches as you want, automatically people will find there is not enough opportunity and go to tier-3 or tier-4 (towns). More supply is one part of the solution and the second part is to make it as profitable an entity as possible.

Mahajan: It could be done as charity, it cannot be done as subsidy, it must be done in a financially viable way. I totally agree that it’s got to be done through private sector participation and the private sector needs to have return on its investments, but the fact that it is a right is because of the fact that financial inclusion is necessary but not a sufficient condition for inclusive growth.

This economy is not going to grow at 8% or 9% if it’s going to be only the top half or the top one-third. If we are going to get to 8%, the base of the pyramid has got to grow and it has got to have access to financial services.

Vaidyan: Whether we call it right or need or whatever, the fact is that this system is already there in the villages. All the villages in this country with more than 2,000 people, banking services are already available either through an outlet or banking correspondent. Banks are actually running after people to open accounts. Now this banking account in itself in not adequate, we also have to go for other things such as fixed deposits. We already are piloting provisions for medical insurance, life insurance, mutual funds. We have to go to the next stage, which is providing value-added services. There is money in it, otherwise banks will not have this.

What are the principal things we need to expand formal financial services?

Gujja: There seems to be a fundamental issue of opening accounts not only for the poor but also the rich, that needs to be got rid of. I understand there is a kind of electronic universal account system. I think we need to push for that acceleration and whoever wants to open accounts should be done.

The next seems to be the last-mile problem. The banking correspondent seems to be working, but is there any way in which better partnerships can be forged? The political system will continue to be there. I think we need to figure out how to work with it.

Vaidyanathan: The role of the state has to be to encourage the creation of the network and ride on existing networks. For example, if supposing we have 800 million phone connections, how to make the entire financial system operate on the mobile network is something we have talked about for years, but have not achieved it. I do not see any reason why a labourer cannot give money to a mobile operator retail shop here and take his money out in Bihar—somehow, because of KYC or any other reason, we hold it out. If we open up that network, it will be the biggest benefit for financial inclusion. Number two is to create a lot more supply in the system, more banks in the system, because that is the surest way of making people, out of their own self interest, move to the tier-2, tier-3 cities. Financial inclusion is also not only an issue of villages. It is also an issue of poor of the urban areas—50% of Mumbai lives in slums and they may not have access to banking services. So right under our nose here, we don’t have inclusion and we are talking about the 600,000 villages.

Ahuja: Just have many more players, stop dictating pricing, otherwise you will end up pushing stress to some other part of the system. Have more players, not just banks, have competition—prices will always get settled.

Vaidyan: I had gone to a remote part sometime back and asked the manager of the banking correspondent outlet what people call him. He said people call him chhota manager. I asked, “Who is the bada manager?" The SBI branch manager to which it is linked, he replied. That shows confidence and we can multiply this and if that confidence risk mitigation can happen when there is hub and spoke model, loans can be given, insurance can be given and many things can happen. We have to use the hub and spoke model and that is happening very, very fast.

Ghosh: We have to create trust for each other, both the customer and service provider. Anyone can take a loan, but if they have to deposit money with me they will think 10 times, so how to build the relationship between the customer and staff, it is only then they will trust each other.

Mahajan: I agree with Vaidyanathan that we need to use the mobile network and Internet to dramatically increase penetration and reduce transaction cost. All this talk about funny money which cannot be tracked is nonsense because today you can even track each and every SMS. Second is, we need to decontrol pricing, but we need to simultaneously reduce entry barriers so that pricing is controlled through competition and not through regulation.

On top of all of this we need a national consensus that anybody who stands in a football field and announces a loan waiver goes straight to jail because it’s public money and there are studies which show that every time there is a loan waiver, legitimate credit dries up for the next three to five years. Today in Andhra Pradesh there is a 43% reduction in school education for poor households after microfinance was stopped, 17% reduction in food consumption, overall 19% reduction in their standard of living. All because microfinance was stopped. The going rate of interest is 10% per month. The microfinance act of AP has been a gift to moneylenders of AP— 10,000- 12,000 crore every year given to them.

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