This is an edited version of Rohini Nilekani’s Uncommon Ground, where she brings together titans of industry and leaders of civil society to explore eight themes that are highly relevant for our future development. In this episode, she moderates a discussion on financial inclusion and credit for all, with Vijay Mahajan, Chairman of the BASIX Group, and Uday Kotak, Vice Chairman and Managing Director of Kotak Mahindra Bank. These conversations explore the middle ground between the ideological divisions that often polarise the business and voluntary sectors. In course of these rare dialogues between leaders who have sometimes been adversaries, a number of common concerns emerge.
Rohini Nilekani: What do we mean by financial inclusion and why is it important?
Vijay Mahajan: To understand what financial inclusion is, we can take the example of cell phones. A decade ago it was difficult to make a phone call, and 10 years before that, without STD PCOs it was virtually impossible unless you were one of the elites. At the time we didn’t have telecom inclusion. But today, with more than 250 million cell phones and several million landlines, we have fairly widespread access to telecom services. Financial inclusion means exactly the same thing in the world of financial services, of which the basic gateway is a bank account. Through that you can do several things such as save, send money across places, borrow money, make insurance premium payments, etc. So financial inclusion means an individual participating in the organized financial sector of the country. Therefore they would have exposure to a wide range of financial services which would include mutual funds and equities, in addition to banking insurance. Essentially, it would mean an organized financial sector inclusion of millions of Indians into the mainstream Indian financial sector.
RN: Can you tell us about how the nonprofit sector has been working to build up the demand for financial inclusion in lower economic classes and rural India?
VM: While the primary financial service that the poor need is to save, they are firstly given access to credit. They need credit for meeting consumption needs during the lean season, as well as unexpected costs like if there’s an illness in the family. These are relatively small loans. Since we’ve just had a major loan waiver announcement, it’s pertinent to look back at the last major loan waiver in 1989. RBI data shows that it was a time when roughly 20% of total bank advances were made to what’s called ‘small borrowers’ i.e. below Rs.25,000. After the loan waiver, that number decreased steadily, and in 2004 it was about 5.4% of the total advances. So while the rest of the economy grew, the poor got less and less of the pie of the formal sector.
Loan waivers may have the intention of helping the currently indebted poor, but it signals to formal financial institutions that they are getting into a risky situation if they give those loans in the future. So eventually, they pull their hand back and there’s enough data in India to show that. As formal lending started decreasing, the nonprofit sector came up with an innovation called the ‘self-help group.’ This idea was conceived by nonprofits like MYRADA in Karnataka, and PRADAN in North India. It was then adopted by the RBI and NABARD in 1992. Now it’s become a nationwide program and there are more than 3.5 million self-help groups with about 45 million women who have been linked with banks. So that’s in some ways a step towards financial inclusion.
RN: Why is the promise of financial inclusion still unfulfilled? What can be done in terms of regulations or government policy to allow private enterprise to reachout, innovate and deliver where it is needed?
Uday Kotak: We are beginning to look at financial inclusion as an opportunity to be able to expand the market. For example, in the telecom sector, the reason why companies went to small towns was not because of any intervention by the government, but because they saw it as an opportunity. My view is that if appropriate strokes are given to the financial sector in general, there is a serious opportunity to look at financial inclusion as a business opportunity. At the same time, it will serve the need of getting more people into the organized financial sector. To do this, we need to have a big picture approach to making the private sector and the banking sector focus on financial inclusion, without getting into micro-management or trying to create subsidies. If we take the example of small-ticket loans, we know there was an issue with the way the recovery process was working. There we saw that the pendulum moved to the other extreme where the borrowers and the defaulters were ganging up together to not repay by design, and therefore financial institutions decided they’d rather not be in that business, leading to financial exclusion. If the government intervenes, rather than deciding to take care of defaulters’ loans, they could intervene in the interest rate subsidy directly to the banks. So if lending banks believe in taking 14% interest because of the perceived risk, then the government could give the bank a direct subsidy of 6% to defer that cost.
VM: The government also needs to invest heavily into public goods infrastructure. All small-ticket transactions, whether they’re savings, credit, remittances, or insurance premium payments, are very hard to do at any reasonable cost because transaction costs as the percentage of the ticket is very high. So we need a nation-wide electronic financial inclusion system – we call it NEFIS or NEFIS. Through this, you should be able to go to any STD PCO or any grocery shop and say, “I want to put Rs.100 in my bank account,” and you’ll have a card and it should go seamlessly and cost no more than an SMS. The government also needs to encourage a larger number of players to come into this business. For example, in the telecom sector, prices have constantly come down because the market is growing, volumes are growing, and therefore there’s competition. Whereas in the banking sector there is a complete closure to the private sector, and when it opened up, it’s been limited to very few players. Today anybody can start a bank in India as long as they have 300 crore of equity. However, in the United States, for example, there are 9,001 or 9,002 branches, what are called community banks. In Indonesia, there are 8,000 independent rural banks. Why is it that India has only about 25 or 30 big banks with branches everywhere?
RN: We know that 75 million households are directly in touch with moneylenders, who charge exploitative rates of interest but also provide a useful service. Why have banks not given moneylenders a run for their money?
UK: The government mandates banks to be giving at a particular rate of interest. But moneylenders are much more free to charge any rate of interest, and the cost to do so at the smaller ticket size is significantly higher. The availability of money to the small ticket is significantly more important than the absolute price of money, because he’s just paying so much more to the moneylenders. Ideally, the government should free up interest rates in this sector to banks and let them do what is commercially right. They will certainly be cheaper than the moneylender. Right now, the issue is lack of availability of credit. The borrower is still going out and borrowing at atrocious rates from an alternate source. They are better off getting it at reasonable rates through the formal source.
VM: For bankers, consumption credit is frowned upon, but in a country where about 25% of the rural population is landless and engage in wage labor, their physical well-being is an investment, and the only asset that they have. For example, if I am a farmer and I do not get work for 10 days continuously, it doesn’t mean I can stop eating or if somebody is ill in my family that I can’t take care of that person. So consumption credit for a poor household is a very productive credit, but it should become available at a reasonable rate of interest, and at the right time. The moneylender is able to make it available at the right time. You can go to his house at midnight and say, “I have to take a morning bus to the town to take my daughter to the hospital,” and he’ll give you a loan, but he’ll extract a large price for that. The only way we can give moneylenders a run for their money is if the formal sector could mimic some of these service levels. That’s not possible in face-to-face or branch-based transactions. We have to do banking beyond branches using precisely the kind of network I talked about earlier. small ticket transactions should be able to be done at STD PCOs, and grocery shops.
RN: What kind of financial services and other public infrastrcuture is required to curtail the tremendous downside risk for poor people or farmers?
UK: One of the greatest areas of financial exclusion in India is by the overall public policy posture. If we look at the last 20 years, the narrative was that investing in equities is risky, and the small guy must keep away. At the same time we’ve opened up for global pension funds where the small guy participated in the growth of India. Global companies benefited millions of individuals around the world, but the people in India were told, “Oh, this is risky.” So we have an unintended consequence of financial exclusion, because they have not participated in the wealth creation of India.
VM: Given that agriculture is a central livelihood, I think at least four types of insurance must be nearly universally available at a reasonable, affordable cost. The first is life insurance. We also need a majorly expanded, but eventually financially sustainable health insurance program. India’s current crop insurance program is very unsatisfactory, it loses money, and doesn’t serve the farmers, insurers, or bankers. So we need to redesign that. And finally, we need livestock insurance, because livestock is the next major alternate livelihood in rural areas. Unless we provide credit along with insurance, it will lead to involuntary indebtedness. In fact, providing micro-credit without micro-insurance is irresponsible. Insurance is actually selling well in smaller towns and villages. It’s also important that we understand that rural doesn’t necessarily mean farmer – the rural sector is a lot more than agriculture, it has significantly expanded into other services like agro-produce opportunities, trade, etc. The big issue here is the cost to serving smaller ticket transactions, and therefore we need technological solutions to arrive at a smarter cost model. In addition to this, we need to be welcoming to poor clients. We have agents who go door-to-door collected Rs.20 from vegetable vendors or shops, using a handheld device that instantly credits their accounts. So we have to find not just technologies, but methodologies to do this in a customer-friendly way.