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WorldOctober 1 2014

Financial inclusion mission targets India's unbanked

The Indian government is looking to break the cycle of poverty in the country's rural and urban areas by ensuring every household has a bank account. Rekha Gupta Menon reports on how banks are working to bring the Indian unbanked into the formal banking network.
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India has embarked on an ambitious financial inclusion initiative that aims to bring 75 million unbanked Indian households into the formal banking network. Driven by the central government, the objective of the scheme is to open at least one bank account per household by next January, less than six months from the date of launch.

In a country where most government programmes take months, if not years, to bear fruit, this scheme has gotten off to a remarkably swift start with the new government pulling out all stops to ensure its smooth implementation. The national mission of financial inclusion, known as the Pradhan Mantri Jan Dhan Yojana (PMJDY), was first mentioned in the maiden budget speech of finance minister Arun Jaitley in July and then formally launched to much fanfare on August 28.

India’s mission of financial inclusion includes a list of benefits that come with the basic bank account – an overdraft facility of Rs5000 ($80) once the account has been operational and active for six months, personal accident insurance of Rs100,000 and a RuPay debit card (RuPay is India’s domestic card network). Customers opening bank accounts before January 26, 2015 have the additional incentive of life insurance cover of Rs30,000.

Assigning targets

Deemed a national priority, the Indian government assigned ambitious targets for individual players, which helped banks open 15 million accounts by the first day of the financial inclusion scheme. State Bank of India (SBI), the country’s largest lender by Tier 1 capital, opened 2 million accounts. Another state lender, IDBI Bank, opened more than 362,000 accounts, while the country's largest private sector bank, ICICI Bank, opened 100,000 accounts.

“The target of reaching 75 million households will be achieved by the scheduled date,” says Arundhati Bhattacharya, chairman of the SBI. “Doing it in a mission mode is always good because then there is urgency to it and you get the whole job done as a project. There is a start date and end date, and monitoring. So the job gets done faster.”

Shikha Sharma, managing director and chief executive of leading private sector lender Axis Bank, says: “India has a large population and the financial inclusion mission will certainly gain traction. If we could do 15 million accounts in two to three days then 75 million does not seem too difficult to achieve. Whether it is going to end up covering every single Indian household in the process we have to see. But we will definitely be much better off than [we are now].” Axis Bank opened 41,747 bank accounts on the first day of the PMJDY scheme.

Building on past efforts

While the PMJDY initiative might have some innovative features and a renewed urgency, it is not necessarily breaking new ground. The national mission of financial inclusion builds on work done in the past decade in terms of regulation, innovative business models and technological developments.

Ms Sharma says: “There has been a lot of focus on financial inclusion for several years by the RBI [Reserve Bank of India] – talking about financial inclusion, making regulatory changes and banks have evaluated different business models. So it is not as if [the PMJDY scheme] is a bolt from the blue. We have to look at the scheme in the context of a lot of preparation that has already been done.”

Commenting on the strategy of going about the financial inclusion effort on a war footing, Ms Sharma believes that working towards a target in a “mission mode” is often effective. “It is a good time for the industry to go on a mission mode. If it was done before the preparatory work was completed then it may have been less effective,” she says.

Ms Bhattacharya adds that technological developments have played a key role in facilitating the mission. “Putting up a brick-and-mortar branch is very expensive and earlier there were lots of challenges around infrastructure and communication technology. With the technology available today it is much easier to do financial inclusion now,” she says. 

Harnessing technology

Financial inclusion has long been at the top of the agenda for the Indian government and the banking industry regulator RBI. In the 1960s, major commercial banks were nationalised with a key objective of extending the reach of banking services throughout the country. This had limited impact, as many banks approached financial inclusion as a regulatory obligation.

Banks also shied away from investing in remote branches due to the poor communication and transport infrastructure. Low population density, small ticket sizes and complicated processes led to high operational costs and low returns. Low financial literacy and a preference for cash transactions further added to the challenges.

More recently, from the mid-2000s, the RBI initiated several measures to foster financial inclusion. To help reduce the cost of providing banking services in remote locations, for instance, the RBI allowed banks to enlist intermediaries as their banking correspondents to provide last-mile delivery of services. It also provided guidelines to enable banks to leverage ongoing technological developments, such as mobile banking, and adopt low-cost technology-based business models such as kiosks and ultra-small branches.

Other steps initiated by the RBI included introducing the concept of basic bank accounts with very low or minimum balance requirements, and simplifying the bank account opening process through paperless electronic authentication known as e-KYC, or electronic know your customer. E-KYC is based on a unique identification project, also called Aadhaar, which was launched in 2010 to provide all Indian citizens with a unique number associated with 12 biometric markers. The RBI also urged lenders to provide banking services to villages with a minimum population of 2000, and advised all banks to develop and implement board-approved three-year financial inclusion plans starting in April 2010. 

Banking connectivity

All of these efforts resulted in banking connectivity in villages growing five-fold between 2010 and 2014. Of the 600,000 villages in the country, more than 380,000 now have banking outlets. Notably, nearly 88% of these banking outlets are serviced by banking correspondents. RBI figures also indicate that there has been substantial progress in opening accounts that provide basic banking facilities. In the past four years, basic accounts have grown more than three times from 73.46 million to 242.9 million.

Despite noticeable progress, challenges remain. Large pockets of the Indian population remain outside the banking network, in the clutches of moneylenders providing loans at as much as five times the market rate, unable to break the cycle of poverty.

Furthermore, a high percentage of basic bank accounts remain inoperative. The 2011 Indian census estimated that of the 246.7 million households in the country, 101.9 million did not have access to banking services. Of this, 76.4 million were rural households and 25.5 million were urban. More recent banking industry estimates suggest that 60 million rural households and 15 million urban households are still not covered by the banking network. It is these 75 million households that the PMJDY is targeting.

Reaching out

Financial inclusion initiatives in India can be divided into two phases, according to MS Raghavan, chairman and managing director of IDBI Bank. “The first phase was covering villages. That was a formidable challenge. The connectivity wasn’t there, business models were not in place. E-KYC and Aadhaar came much later. We managed to cover [300,000] villages in five years through a variety of business models such as the ultra-small branch, banking correspondents, point-of-sale terminals and so on,” he says. The ongoing national financial inclusion mission is the second step. “Here we are focusing our efforts on reaching individual households. The focus is on providing them with a variety of products such as overdrafts, micro insurance and so on,” says Mr Raghavan.

He points out that a key priority under the financial inclusion mission is to streamline the Direct Benefits Transfer programme, under which subsidies of government welfare schemes can be transferred directly into beneficiaries’ bank accounts. Currently subsidy payments are made through various modes such as cheques, cash and funds transfer. Nearly one-third of subsidies totalling more than Rs3000bn are stolen, says Mr Raghavan, which can be restricted under a Direct Benefits Transfer-linked banking model.

Apart from limiting theft, there are two critical benefits of paying subsidies directly into recipients’ bank accounts – it provides an incentive for account holders to regularly use their bank accounts and it offers banks a viable business model. Both of these benefits directly address the issues that have impacted financial inclusion initiatives in the past.

“A key challenge in achieving financial inclusion has been banks’ reluctance in investing in people and resources to reach out to these low-income customers due to the perceived high operational costs and low returns,” says R Gandhi, deputy governor at the RBI. The national mission of financial inclusion, he adds, aims to effectively address this issue: “The government has agreed to pay a 2% commission on all Direct Benefits Transfers into these bank accounts. Additionally, with regular inflow of funds, some percentage of these funds will remain with the bank. So it will give banks an incentive to consider financial inclusion as a viable business opportunity.”

Mitigating risk

Naresh Makhijani, partner and head of financial services at KPMG in India, states that apart from ensuring the low cost of transactions and maximising transactions on accounts opened to ensure stickiness for customers and economic viability for intermediaries and banks, it is extremely important to mitigate risks arising out of delinquencies, fraud and cash mismanagement.

Mr Raghavan agrees that concerns regarding fraud and delinquency are valid given the attractive benefits such as the $80 overdraft that the PMJDY offers. However, he says that the default rate of rural borrowers is typically at a manageable 4% to 5% level. “It makes economic sense for banks to cover the underbanked populace. Moneylenders are flourishing in the country, charging interest rates of 50% or above, but they are still able to recover their money. If the non-banked population can pay moneylenders at the exorbitant interest rates, then they can certainly repay bank loans at a 12% interest rate,” says Mr Raghavan.

Mr Makhijani says that with banks making available a variety of financial products, including microcredits, to the poorest sections of society, financial education plays a crucial role in the success of their inclusion plan.

Ms Bhattacharya of SBI agrees: “People from the low-income category have to be taught how to use a bank account, why it is good to have a bank account, repaying loans and how they can leverage it. Without financial literacy, opening up an account means that people will not use it.”

Financial literacy is, incidentally, one of the core pillars of the national mission of financial inclusion. Rural bank branches will, for instance, have a dedicated financial literacy cell to provide training on how to manage money and credit facilities.

Sustainable banking

As well as ensuring better levels of financial inclusion, India's banks have to make an effort to ensure that customers access banking services in a sustainable manner, according to Paresh Sukthankar, deputy managing director at HDFC Bank. “The customer has to be enabled to ensure that his or her own livelihood is generating the kind of returns so that funds come regularly into their account. Funds can also come in through the Direct Benefits Transfer scheme. It is only then that the bank account will make a difference to the person who is being financially included and thereby make a difference to the banking system,” he says.

Mr Sukthankar says the challenge is in drawing people into the banking system and improving their comfort level, as the time and effort required is fairly significant. He gives the example of an initiative that HDFC Bank is involved in, where rural women not only receive credit but also receive training in occupational skills, credit counselling and financial literacy. About 10% of bank staff were involved in this initiative, which contributes to less than 1% of the bank’s balance sheet. Mr Sukthankar says: “Inclusion is not just opening an account. Inclusion is bringing the person into the financial system in a viable manner.”

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Read more about:  Asia-Pacific , India