The way to financial inclusion

In the mid-2000s, India embarked on an ambitious programme to ensure universal coverage of all households by financial institutions. This objective has been continued under the Prime Minister’s Jan Dhan Yojana (PMJDY) that intends all households to have at least one savings account at a financial institution. One year after the PMJDY’s initiation, more than 21 crore bank accounts have been opened, utilizing a network of more than one lakh business correspondents (BCs).

However, it is widely believed that many accounts were opened in response to political pressure on banks to achieve programme targets. Others may have been opened to avail of the insurance benefits that the accounts enabled or under the expectation that government transfers would require a savings account. As a consequence, duplicate accounts with zero balances represent a high percentage of the total accounts. Can this extensive network of BCs generate an increase in household savings in the face of such pressures?

In the past, the greatest difficulty in ensuring universal coverage by financial institutions was the relatively high costs of serving the poor. One reason is geographic: many of the poor live in small villages at some distance from the larger villages and small towns in which bank branches are located. Additionally, since many of the poor are employed in daily wage labour markets for unskilled workers, they are more likely to transact in small sums of money and at a higher frequency than salaried households.

Technological improvements that now allow financial transactions through point-of-service instruments have, however, enabled a model based on local bank agents that significantly lowers the costs of serving the poor. Banking through local agents also addresses many of the behavioural constraints believed to adversely affect savings. Research has shown that reminders or “nudges” to save, contracts that commit households to save, and peer pressure through social networks all enhance savings. BCs, who reside in the vicinity of their clients and are often from the same community, can more easily address such constraints.

To evaluate the effect of BCs on household savings, I utilized the financial inclusion drive that was initiated in 2009 with a Reserve Bank of India directive requiring lead banks to ensure coverage of all villages with a population of 2000 or more, either through a BC or a bank branch. The policy was subsequently changed to require BCs to cover not just the initially assigned village, but all villages within a designated “sub-service area”, that generally corresponds to the gram panchayat (GP).

Because BCs had initially been assigned to villages with a population of more than 2,000, the phasing of the programme followed this initial criterion: GPs that included a village of size 2,000 or more were the first to be “covered” by a BC, with coverage of other GPs encompassing only smaller villages following later. Exploiting this phasing, I evaluated the effect of BCs on savings by utilizing two surveys covering approximately 7,000 households across 12 districts of Karnataka, conducted in 2009, prior to the initiation of the financial inclusion drive, and in early 2013, when it was still being phased in. I compared the change in savings in this period by households in GPs that were covered by a BC to those that resided in uncovered GPs.

I found that BCs increased the total savings of both landowning and landless households; indeed, savings of the landless increased more than those of landowning households. This difference occurred primarily because access to a BC increased the wage income and hours of work of landless households, particularly that of women, a likely consequence of the tie-up between the financial system and Mahatma Gandhi National Rural Employment Guarantee Act.

However, though coverage by a BC significantly increased the financial savings of landowning households, the effect on the financial savings of landless households was much smaller, despite the larger increase in total savings of the latter. This appears contradictory to the research of behavioural economists who have argued that small changes, such as a shift from direct payment of incomes to a system whereby income is deposited in bank accounts, can significantly increase financial savings. Evidence from research on other welfare schemes that similarly directly deposit payments in beneficiaries’ bank accounts finds that households tend to withdraw the entirety of the deposit, frequently to pay down high interest loans from the informal sector that are still very prevalent.

This finding suggests that significant increases in financial savings are only likely to occur if the government also addresses some of the factors that cause households to borrow heavily from the informal sector. Surveys that we are currently running in Bihar suggest that, even now, moneylenders represent the major source of loans for rural households, accounting for 35% of total loans, with family members accounting for 26% of loans and commercial banks for just 10%. And the primary reason for borrowing is ill-health: 38% of loans (48% of the loans from moneylenders) are for health-related expenses.

The evidence, therefore, is mixed. Though BCs have increased savings for poor households, this increase is not primarily held in savings accounts. There is also evidence that BCs better serve households who reside in the larger villages of the GP, and that coverage increases with village size. This is in line with economic geography models, which suggest that the provision of local services, in the presence of fixed costs such as transportation costs, will favour regions in which population is more concentrated. This suggests that even in a local agent model of banking, there might be segments of the population that are excluded.

Anjini Kochar is the director of the India Program at the Stanford Center for International Development.

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