Can India Achieve Financial Inclusion within the Next Few Years?

The new Government of India has made financial inclusion one of the corner stones in its modernization aspirations for the country. In his first budget speech earlier this month, Finance Minister Arun Jaitley set the target of a financial account for each woman and each man in every Indian household by August 2015. This ambitious target is a recognition of how important access to basic financial transaction services -- and ultimately to better savings, credit and insurance options -- is for full economic citizenship in a country where more than 80 percent of people live and work in the informal economy.

The Finance Minister also put his weight behind the recent financial sector reform design of the Reserve Bank of India (RBI). Connecting every Indian family with the formal financial system within a year is a steep aspiration. And while it might take it little longer, a recent visit to India convinced me that over the past few months, the pieces have come together for India to make huge progress.

A woman holds a bank card A woman holds a bank card

Photo Credit: Ahsan-ul-Haque Helal, India

Using the key levers the government has at its disposal in the context of supporting a sustained market development effort, here are the elements that promise a real breakthrough:

Enabling Regulation
In June, RBI started to take action on the recommendations from its recent Financial Inclusion Committee report. It already dropped several of the last restrictions on the banking correspondent (BC) model. Non-bank finance companies (NBFCs), previously excluded, can now become correspondents and, most importantly, the requirement for any BC outlet to be within a 30-kilometer radius of a bank branch has been removed. That radius requirement heavily favored the incumbent state-owned banks, which have the relatively largest branch network. Now, a poor-focused start-up bank with a single branch in, say, South Mumbai can create BC presence in rural areas throughout India by partnering with a fast-moving consumer goods company, or other players with a deep presence in rural India.

Last week, RBI also issued draft regulations for the new concept of a payment bank. Such a license will allows a mobile telephone company to operate mobile money subsidiaries and prepaid card instrument issuers to overcome the cash-out restrictions that have prevented the rapid uptake of the mobile money services that have proven so successful in East Africa. Payments banks would be allowed to facilitate payment transactions and take deposits, but not extend credit. As a mirror image, the reform plans also envisage the concept of credit-only banks for rural areas. India's deep and sophisticated domestic capital market is expected to intermediate the deposit-taking and the credit-extension of these specialized players.

Supporting Infrastructure
As witnessed throughout the developing world, mobile telephone penetration continues to deepen in India and reached 886 million by the end of 2013. The unique biometric ID ("Aadhaar") has enrolled 646 million people, and RBI has allowed for the unique ID to be used as corner-stone in a digital compliance regime to meet the regulatory "Know-Your-Customer" requirements. This dramatically lowers the cost of opening a financial account for both consumers and providers alike.

Last month, I visited with participants in a current RBI pilot that utilizes Aadhaar to open virtual wallets in real-time for the recipients of domestic money transfers. In this scenario, every Aadhaar number essentially becomes an instant financial account and allows people to receive cash from a money transfer even if they have no account at any financial institution. If the new payment bank regulation enables similar approaches, India's financial inclusion aspiration could become true almost overnight.

Catalytic Government Usage of New Payment Channels 
India has some $60 billion worth of social programs and retail subsidies. The new government seems determined to reform these programs, switching to targeted benefit payments from generalized subsidies (e.g., for cooking gas) where that is not yet the case, and shifting all payment flows from cash to digital channels.

In addition to G2P payments, India has an estimated $60 billion in international remittances (e.g., from the Gulf to Kerala) and conceivably the same amount of domestic remittances along the corridors from the big urban centers back to the villages in the populous states of northern India, which also have some of the poorest people of the country. Together, these flows should contribute significantly towards the economic viability of the new or expanded banking channels the RBI's reform efforts are creating.

Between far-sighted enabling regulation, investments in 21st century infrastructure, and the willingness to channel its own transactions to lubricate the system, India is pulling all the right levers to advance financial inclusion and economic citizenship. It will be one of the most exciting places to watch, and to learn from, over the next few years in this regard.

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23 July 2014 Submitted by Blake Goud (not verified)

Thanks for an interesting post and for highlighting the important steps the Indian government is taking with respects to financial inclusion. However, there is a key area omitted in the discussion: the reluctance of a large share of the Muslim population of India (est. at 177 million people) from using interest-based financial services and the reluctance of the Reserve Bank of India (and the government) to facilitate the establishment of Islamic banks. This does appear to be changing with reports of a committee within the RBI, but unless there are sharia compliant alternatives available, financial inclusion will exclude a large segment of the population.

28 July 2014 Submitted by Tilman Ehrbeck (not verified)

Thank you, Blake. You raise an important point. CGAP has explored the potential of Sharia-compliant approaches in promoting financial inclusion among Muslim populations (see for example, One of the key challenges however is understanding the nature of the demand for Islamic microfinance. The few studies researching demand are incomplete or yield contradictory results. Most of these studies have been enterprise surveys that simply inquire about respondent preferences for Sharia-compliant services. IFC-funded surveys demonstrate demand varies widely across countries and anecdotal evidence suggests that some respondents who express a preference for Islamic products still opt for traditional products when given the choice. In the Global Financial Inclusion Database (Findex), using the information from Muslims in 148 countries, respondents listed religious preference as the lowest factor of importance when choosing to open a formal financial account. Not much is known about the nature of demand for sharia-compliant services in India. I understand the RBI approved a sharia-compliant non-banking company (Cheraman Financial Services) last year so this may signal a greater openness to consider sharia-compliant banking services in the future.

25 July 2014 Submitted by Sachin Bansal (not verified)

Thanks for this comprehensive post! Things are surely going to change soon in India. New government's slogan also says "acche din aane wale hain” which means good days are going to come soon. We have witnessed a lot of regulatory changes over last 10 years and now we are very close to a big bang in the financial inclusion space in India.

Now, all the stakeholders involved are realizing the importance of not just focusing on increasing access of financial services for the low income households, but also on enhancing the value offered by these basic banking accounts. Also, the focus has shifted to offering multiple financial products to address diverse needs of low income people to encourage them to shift from informal sources to formal channels.

28 July 2014 Submitted by Tilman Ehrbeck (not verified)

Thank you, Sachin.
You are making important, related points in the conclusion of your comments. As we know from the "financial diary literature," poor households are typically users of a broad range of financial services to create livelihoods, build assets, smooth consumption, and manage risks. Today, they largely use the age-old, informal mechanisms. To be valuable to them, new formal alternatives have to be more convenient, more reliable, and cheaper

29 July 2014 Submitted by Sachin Bansal (not verified)

Agree Tilman! As per my experience, even high quality customised financial products designed after intensive market research for low income people, delivered at their doorstep sometimes fail to take-off... as just providing access to a trusted and cost effective (cheap) product is not enough.. A good product also needs to be supported by proper marketing channels, backed by financial education and high level of customer service. All this should be in place to break the initial entry barrier for early adopters and then word of mouth will do all the MAGIC!

We are also planning to do a small sample research to access the less than desired take-off of one such savings product in India..

28 July 2014 Submitted by Blake Goud (not verified)

Thank you for replying Mr. Ehrbeck. I understand and agree with your points about the challenges in identifying specific areas of demand that can be served by Islamic banks in India where there are no Islamic banks now. As you mention, the RBI does seem to be offering greater flexibility about potential for Islamic financial institutions and there are some institutions working on alternative methods (e.g. Zayd Chit Fund, a sharia compliant chit fund based in Bangalore).

It is hard to project what the ultimate take-up would be in demand for Islamic banking and/or Islamic microfinance. In some contexts (e.g. in the GCC), Islamic banks have started as smaller windows for conventional banks to serve their customers and prevent them from switching to standalone Islamic banks which has over the course of 40 years allowed growth of Islamic banking assets to rise to ~25% in the UAE, ~35% in Kuwait and over 50% in Saudi Arabia.

These aren't necessarily good analogues for the growth in India since they are middle- or high-income countries with small, relatively homogenous populations. Perhaps a better example would be more diverse Indonesia where Islamic banking is just a few percent of total assets, but has a wide variety of institutional forms (from rural banks, BPRS, to bait-ul-maal wat tamweel, BMTs, Islamic banks). It is also growing at an exceptionally rapid pace from this small base and has appealed to larger financial services companies like Allianz which offers microtakaful products.

While there is not much hard data on the prospects in India, there is a large population of Muslims (~170 million) so if there is even a slightly lower participation rate in formal financial services compared with non-Muslims, it would translate into a significant absolute number of people who are financially excluded. The two markets that CGAP has identified in two very good reports on Islamic microfinance (and products developed as part of the Islamic microfinance challenges) should be studied in more detail to get a better perspective on what issues/concerns consumers have about different products and how much of an issue cost is for their decision.

If cost is very important, then the lack of availability of Islamic microfinance (and high cost or shortage of funds to supply finance for the few operations in place) may be causing the low realized participation rate even though many would prefer to use Islamic products if only the pricing gap were not so wide or supply of financing were more available.

30 July 2014 Submitted by Y P Issar (not verified)

The discussion on the scope and possibility of introducing Islamic banking in India is very enlightening and covers a lesser known aspect of banking in India. As a banker with over 37 years spent in 9 Indian states, including 5 years in Muslim majority state of Jammu and Kashmir, my experience is that most of Indian Muslims are used to modern banking products and availing the same without demand for sharia compliant banking products. Bigger issue is that states like Uttar Pradesh,Bihar and West Bengal have low density of banking infrastructure, depriving large Muslim populations of any banking services, which may indicate a higher exclusion for them at national level. One view can be that it is better to expand modern banking all over India than introducing a new variable of Sharia compliant banking which will require large efforts and decades to mature in Indian financial system which having followed British law and practice is well advanced. Still if a reasonable demand for such products arises, Islamic banking must be provided.
Y P Issar
Centre of Banking for Poor

29 July 2014 Submitted by Y P Issar (not verified)

No, India can not achieve financial inclusion in next few years for the following reasons: Firstly, RBI has no faith in Indian private institutions when the matter of handling savings of public are concerned. Secondly, the claimed over two hundred thousand agent network simply does not exist operationally, more than 25 %.. Thirdly, the Indian banks do not offer basic bank account or small accounts freely, these being latest innovations still not adopted by field staff. Fourthly, RBI and Government of India have complicated Know Your Customers guidelines by frequently tweeking these, under Prevention of Money Laundering Act. Fifthly, too much discussion on new banks, small banks, payment banks,etc., have taken away the focus from the public sector banks who have slowed down their FI efforts, especially in difficult poor states. Sixthly, RBI has been wrongly claiming that financial inclusion efforts are viable, but the banks do not believe it internally. Seventhly, Indian economists have been diverting the attention/ efforts toward credit inclusion thus down playing the whatever achievements made by banks.Seventhly, G2P or Direct Benefit Transfer programme of previous government was discredited by the current regime, which will require policy U turn by the new government. Eighthly, unique ID programme also met the same fate at the hands of current dispensation, virtually killing an important national initiative, just because it was not passed by Indian Parliament and was an executive decision. Ninthly, we Indians have centuries of history behind us in denying benefits to poor and down trodden, and our financial and political leadership which mostly comes from higher castes have no commitment to real financial inclusion outcomes for the poor or the economy. Financial inclusion is like a river bridge whose construction requires all its supporting pillars to achieve a common height before the roof can be laid. It is almost impossible for a five thousand years civilisation to change in a few years even in the limited aspect of eliminating exclusion.
( Centre for banking for poor, Karnal 132001, India)

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