Financial Inclusion: An Approach to Inclusive Growth

Debabrata Das Professor of Business Administration, Tezpur University, Tezpur, Assam And Reshma Kumari Tiwari Research Associate, ICSSR Project, Tezpur University, Assam 1. The Context Inclusive growth aims at equitable and even distribution of the benefits of growth ensuring participation of all sections and regions of society in the growth process (Thorat, 2008 i). It enables the poor to contribute towards and share the benefits of economic growth. As the market forces often promote those who have market power and economic growth powered by them mostly detour the poor and disadvantaged who constitute a major part of our population. Therefore, the effectiveness of various socio-economic programmes and policies (both by the framers and regulators of financial sector) for promoting economic growth and upliftment of the poor should be considered in terms of their success in achieving the basic objective of raising the standard of living of the masses and reducing the inequalities (Sengupta, et al, 2008ii). The rich has easy access to financial services even in poor countries. Statistics reveals that countries with the highest number of households below international poverty line normally have lowest access to deposit account. The banking sector caters mainly to the richest population leaving aside the poorest with fewer options (CGAP/The World Bank, 2009iii). An inclusive financial sector is a precondition to inclusive growth (Annan, 2003)iv. An inclusive financial sector is one that serves all the sections of the society on an equitable basis. Broadening access to finance is considered as the most important device to achieve growth as easy access to finance facilitates economic empowerment of the poor which may lead to inclusive growth. Ianchovichina and Lundstrom

also maintain that the development of financial sector is crucial for inclusive growth (Ianchovichina and Lundstrom, 2009)v.

2. Financial Inclusion: A holistic approach Financial Inclusion broadly implies lack of hindrances in using the financial services, whether the impediments are price or non price barriers to finance. Financial inclusion is viewed as a device for the new vision of inclusive growth which ensures equality of opportunity for all (Chakrabarty, 2009)vi. Financial Inclusion needs to be seen as an instrument that would move the wealth effect towards a neutral domain. Thus, as a concept Financial Inclusion has the potential to contribute substantially towards inclusive growth (Mehrotra, 2009vii). The process of financial inclusion can be started with credit inclusion through enhancement of current formal credit delivery mechanism; followed by an overall approach for capacity building1, developing new models for effectual outreach and resorting to technology based solutions. It is an arrangement for the poor removing the constraints in accessing the financial services and creating a financial system which enables the poor to avail of the benefits including benefits of technological innovations aiming at inclusive and economic growth in the long-run. It is an agreed fact that the needs of the poor are mainly taken care of by the informal financial sector. Microfinance being the most successful and vibrant sector has been catering the needs of the poor since 1970s and have greater outreach by providing easy and timely access to finance. Microfinance institutions (MFIs) are contributing immensely towards financial inclusion and inclusive growth. Financial inclusion has gained momentum over past few years as an important
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Capacity Building implies that before providing access to finance to low income clients, they should be provided with some training, to utilise the same such as suggesting measures for improving credit absorption capacity especially amongst marginal and sub marginal farmers and poor non-cultivator households etc. Source: NABARD

national initiative for including the poor into formal financial system by making available a variety of essential financial services such as savings, credit, insurance, cash payment and transfer facilities at an affordable cost for poverty reduction and social enhancement of underprivileged section. The United Nations declared 2005 as International Year of Microcredit to build an inclusive financial system2 (www.yearofmicrocredit.orgviii). The initiative towards financial inclusion is in line with the Directive Principles of State Policy3 which aims at promoting equality of opportunity for all and reducing economic inequality. Financial Inclusion not only augments the economic growth4 but also facilitates inclusive growth of the country.Financial inclusion works in a holistic framework of growth starting from addressing poverty alleviation to economic development and from social inclusion of the poor to creation of viable business opportunity for them. This also transforms the economic growth into inclusive growth. 3. Poverty alleviation broadening access to finance Access to finance helps to equalize opportunities and reduce inequalities (World Bank, 2008ix). Financial inclusion strives to eradicate poverty. Joan Robinson (1952) explains where enterprise leads, finance follows (Robinson Joan, 1952 cited in Mehrotra et.al 2009)x. The creation of micro enterprises will generate wealth for the poor as well as create demand for finance to refuel
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The objective of the Year of Micro credit is to unite the Member States, UN Agencies and Microfinance Partners in their shared interest to build sustainable and inclusive financial sectors and successful achievement of the Millennium Development Goals (MDGs). The objectives include access and promotion of the contribution of microfinance and micro credit to the MDGs by increasing public awareness and understanding of the same as crucial part of the development equation and promote inclusive financial sectors by supporting sustainable access to financial services and encouraging innovation and new partnerships to build and enhance the outreach and success of micro credit and microfinance. Source: http://www.yearofmicrocredit.org/pages/whyayear/whyayear_learnaboutyear.asp
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Directive Principles of State Policy are the guidelines to central and state governments of India, to be kept in mind while framing the laws and policies as an endeavor to promote the welfare of the people and reducing economic inequality and opportunities. These principles are considered fundamental in governance of a country and these principles should be applied in making laws to establish a just society in country. Source: en.wikipedia.org 4 It is mostly measured as the rate of change in GDP. Economic growth relates only to the quantity of goods and services produced. Economic growth is either positive or negative as negative growth is linked with economic recession/ depression.

its growth. Financial inclusion will equip the poor with the necessary financial services indispensable for the development and smooth functioning of their micro enterprises, as financial inclusion does not aim at providing only credit but also to a variety of financial services such as saving, insurance, cash transfer and payment facilities along with financial advisory services for their comprehensive financial inclusion. The revised estimates for 2005 reveals that 1.4 billion people (one in four) of the developing world, lived below the international poverty line of $1.25 a day in 2005 prices (Ravallion

and Chen, 2008xi). The distressing statistics shows globally more than over two billion people do not have access to finance (United Nations, 2006xii). Moreover data shows that some of the countries with large proportion of population suffer from lower financial access in terms of deposits and/ or loans (per 1,000 adults) and/ or lower outreach of bank branches5 and low density of branches per 1,00,000 adults with varying degrees (Table 1).Some constraints in broadening access to finance are geographical, or physical access as the average distance from household to branch (or ATM) may be too high. In cross-country regressions, Beck, DemirgucKunt, and Levine (2004), find that financial development alleviates poverty and reduces income inequality6 (Beck, Demirg-Kunt and Levine 2004xiii). Thus a financial system which caters to the needs of the poor will boost the poverty alleviation efforts. Poverty is the result of lack of resources to generate income. The poor needs access to finance to initiate/ support their micro entrepreneurial activities which may enhance their standard of living. Financial inclusion is nothing but an amplification and expansion of poverty alleviation efforts (Karmakar, 2008)xiv.

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However density of bank branches acts as initial but crude indicator of access to financial services. Their results indicate that financial development exerts a disproportionately positive influence on the poor and alleviates poverty both by boosting growth and by reducing income inequality.

Table 1: Financial Access: Commercial Banks

Country Deposits Accounts per 1,000 adults Valu e (% of GDP) Average account value (% of income per capita) 110.0 123.8 235.1 42.4 Loans Accounts per 1,000 adults Value Average (% of account value GDP) (% of income per capita) Outreach Branches per 100,000 adults Total Urba Rural n 9.3 5.2 12.2 6.7 12.6 11.6 10.5 9.1 10.9 3.5 2.6 .. 1.7 .. 9.7 4.4 .. 3.6 5.8 2.6 .. .. .. 1.9 6.2 .. 7.3

India 680.5 51.0 38.2 453.2 Banglades 318.7 49.0 38.1 1,374.6 h Brazil .. 28.7 .. 390.1 33.6 119.1 Indonesia 484.3 41.8 119.6 180.6 29.7 227.7 Korea .. 63.9 .. .. 75.0 .. Republic Malaysia 2,226.7 110.4 71.0 972.9 119.1 175.3 Philippine 516.9 55.7 167.2 .. 30.4 .. s Sri Lanka 1,651.8 44.5 35.1 487.0 41.5 110.7 Thailand 1,498.0 86.0 72.8 275.6 92.2 424.3 Notes: .. is not available Source: CGAP/The World Bank, 2009, Financial Access 2009, p-p, 54-56

Financial inclusion seeks to reduce the unjustified concentration of economic power in the hands of the richer section of society and to achieve equitable distribution of benefits of growth. It provides an opportunity to the poor to avail of the benefits of advanced economy both in terms of financial as well as technological support by satisfying their unique needs7 which need timely and easy access to finance to fight poverty. Data reveals that countries with large proportion of population not having access to financial services shows higher poverty ratios measured by both national and international poverty lines
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Unique needs means the products should be within the reach of the poor and its cost should be reasonable which matches the demands and requirements of the poor.

(Table 2). Efforts towards enhancing the financial outreach by providing an access to finance to the unbanked and unemployed poor may result in poverty reduction and social cohesion by enabling them to carry out some entrepreneurial activities.

Table 2: Financial Inclusion and Development Indicator

Country Composite indicator of Financial Inclusion (per cent of population with access to financial services) Poverty (per cent of Population below national poverty line) International Poverty Line (per cent of Population below $1 a day) Unemployment during 2000-04 (per cent) Gini Index

1 India Banglades h Brazil China Indonesia Korean Republic Malaysia Philippine s Sri Lanka Thailand

2 48 32 43 42 40 63 60 26 59 59

5 4.3 3.3 9.7 4.0 9.9 3.5 3.5 9.8 9.0 1.5

6 32.5 (199900) 31.8 (2000) 58.0( 2003) 44.7 (2001) 34.3 (2002) 31.6 (1998) 49.2 (1997) 46.1 (2000) 33.2 (199900) 42.0 (2002)

28.6 (1999- 35.3 (1999-00a) 00) 49.8 (2000) 36.0 (2000a) 22.0 (1998) 4.6 (1998) 27.1 (1999) .. 15.5 (1989) 36.8 (1997) 8.2 (2001b) 16.6 (2001a) 7.5 (2002a) <2 (1998b) <2 (1997b) 15.5 (2000a)

25.0 (1995- 5.6 (2002a,c) 96) 13.1 (1992) <2 (2000a,c)

Notes: a = expenditure base; b = income base; c = preliminary data; .. denotes no data. Source: World Bank, 2008, Finance for All Policies and Pitfalls in Expanding Access; Washington, p191, 192 and World Development Report, 2006-Equity and Development, pp 278, 279

Finance plays a leading role in mainstreaming the marginalized section of society especially in developing countries by providing easy and timely access to finance to satisfy their small and frequent needs. Financial Inclusion not only augments the economic growth8 but also facilitates inclusive growth of the country. Economic growth is denotes the increase of per capita gross domestic product (GDP) or other measure of aggregate income. According to the statistics by Census of India, 2001 around 72 percent of the Indias population reside in rural India comprising of over 6,00,000 traditional villages (http://wiki.answers.comxv) and do not have easy access to finance and if these disadvantaged section of society is provided with easy and timely access to various financial services and uses the same for various productive activities, they can substantially contribute towards GDP of the country. 4. Relevance for India According to NSSO Survey 59th Round about 50 million (on average 51.4% farmer households out of 89 million) Indian households do not have access to credit either from institutional or noninstitutional sources. Around 73 percent of total farmer households in the country do not have access to formal credit (Rangarajan, 2008xvi). The scenario of farmer households not having access to formal credit as a proportion to total farmer households is particularly grim in the north east region (above 95 percent), followed by eastern region (above 80%), central region (above

It is mostly measured as the rate of change in GDP. Economic growth relates only to the quantity of goods and services produced. Economic growth is either positive or negative as negative growth is linked with economic recession/ depression.

77%) and southern region (above 30%)xvii (Situation assessment Survey of Farmers, NSSO, 2003). A shocking 30-35 percent of the total population in India still lives below the poverty line. Poverty characterized by low health and nutrition levels, high infant mortality and illiteracy, is now almost the same in terms of the proportion of population in rural and urban areas. It is estimated that around 400 million people, still live in absolute poverty defined as less than $1 per day (Ultra poor), accounting for more than 36% of the total population in India. Around 60% of people in some pockets of BIMARU states live with less than half a dollar a day (Arunachalam, 2008xviii). The financially excluded sections largely comprise of small vendors, marginal farmers, landless laborers, people engaged in self employment and unorganized sectors, urban slum inhabitants, migrants, tribal minorities, socially excluded groups, senior citizens, physically challenged people and women. Financial exclusion is a multi-dimensional problem, which both the developed and developing countries endeavor to overcome. The reasons being low income, lack of identity proof, illiteracy, distance from bank branches, lack of banking habits, high transaction costs, lack of banking knowledge or insufficient knowledge on banking products and attitude of bankers9. While India has recorded impressive growth rates in excess of 7 percent over last couple of years, what has become more apparent is the dualistic nature of the Indian economy. Economic gaps are indeed widening across various sections of society and regions. According to National Sample Survey Organizations (NSSO) 61st Round poor people constitute 27.5 per cent of the countrys total population. On an all India basis, 59% of adult populations in the country have
9

Wrong notion that amount has to be of considerable volume each time to be the reason for not opening no- frill accounts. Source: Financial Inclusion in Gulbarga: Finding Usage in ACCESS

bank accounts, in other words, 41 percent of the population is unbanked. In rural areas, the coverage is 39 percent against 60 percent in urban areas (Thorat, 2007xix). Thus, a large proportion of population is excluded from the formal financial system, leading to greater dependence on the informal and exploitative sources of credit. The Committee on Financial Sector reforms (Rajan, 2009xx) has rightly pointed out that there are three most important factors for financial sector reform. Firstly, to include more Indians in the growth process to make it more inclusive; secondly to promote growth itself; and thirdly to enhance financial stability, flexibility, and resilience to protect against the turmoil witnessed by the emerging economies earlier, and is affecting developed and industrialized economies now. 5. Indian Initiatives Over the years several initiatives have been taken by the Government and the Reserve Bank of India to addressing the need of empowering the poor. Government of India has given a new dimension to its efforts by ensuring inclusive growth in the eleventh five year plan as it is a term coined and stated in the eleventh five year plan aiming at a growth pace which is not only rapid but also inclusive and broad based removing the inequalities in the participation and sharing the benefits of growth process (Planning Commission, Government of India, 2008) xxi. The Reserve Bank used the term financial inclusion in its Annual Policy Statement of 2005-06 for the first time and has taken several initiatives for promoting financial inclusion such as no frills10 accounts, introduction of Business Correspondent (BC)/Business Facilitator (BF) model, promotion of financial literacy, and adoption of Information and Communication Technology solutions for achieving greater inclusion (RBI, 2008-09xxii). To increase the level of Financial

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The Reserve Bank advised the scheduled commercial banks and RRBs in November 2005 to make available a basic banking no-frills account with nil or low minimum balances as well as charges, that would make such accounts accessible to vast sections of the population. Source: RBI Annual Report 2007-08

Inclusion, RBI aims at connecting people with the banking system and not merely opening up of bank accounts. Several initiatives by RBI for broadening access to finance such as formulating the Kisan Credit Card (KCC) scheme in 2001; introduction of no-frills account in November 2005; issue of general credit cards (GCC) akin to Kisan credit cards to provide hassle free credit in December 2005 (However, total number of GCCs issued by banks as at end-March, 2009 was only 0.15 million.); simplification of know your customer (KYC) norms; use of Information technology like Smart cards (for opening bank accounts with biometric identification), Mobile Banking, Electronic Benefit Transfer (EBT11), 100 % Financial Inclusion Drive, Business Facilitator/ Business Correspondent Model, Liberalization of bank branch and ATMs expansion, establishment of Financial Literacy and Credit Counselling centers are the important tools of financial inclusion (Subbarao, 2009xxiii). Guidelines have been issued to banks to enhance outreach of banks by utilizing the services of civil society organizations, farmers clubs, non-government organizations (NGOs), post offices etc. as business facilitators and business correspondents in January 2006 (Circular no. RBI/200506/288 on January 25, 2006); State Level Bankers Committees (SLBC) have been advised to initiate action for identifying at least one district in their state/ Union Territory for 100% financial inclusion in April 2006; Banks have been specifically advised that borrowers with loans settled under the one time settlement scheme will be eligible to re-access the formal financial system for fresh credit; launch of a multilingual website in 13 Indian languages on all matters concerning banking and the common person. The initiatives taken by RBI during 200708 include revision of guidelines on lending to the priority sectors; strengthening of the rural
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Linking of the financial inclusion drive with social security schemes (such as National Rural Employment Guarantee Programme (NREGA) will facilitate governments to make payment of wages into the bank accounts of beneficiaries through the Electric Benefit Transfer (EBT) method. This will minimize transaction costs including leakages. In parts of the country where such EBT has already taken off, the results are impressive and the experience of both payers and recipients extremely satisfying.

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cooperatives and restructuring of regional rural banks; simplification of the procedures and processes for lending to the agriculture and micro, small and medium enterprises (MSME) sectors; emphasis on scaling up information and communication technology (ICT) solutions to achieve greater outreach and reduce the transaction cost in May 2007. The Reserve Bank has liberalized the policy for ATM12 by permitting schedule commercial banks in June 2009, to install Off-site ATMs at centers/places identified by them, without having the need to take permission from the Reserve Bank in each case. This is a push to the financial inclusion drive making available the technological support on a wider scale. The Union Budget for 2009-10 states that the State Level Bankers Committees will identify the under-banked or unbanked areas in their respective States/ UTs and devise an action plan for extending banking facilities to all these areas within the next three years. The Budget proposed to set aside a one-time grant-in-aid of Rs.100 crore to ensure provision of at least one centre/Point of Sales (POS) for banking services in each of the unbanked blocks in the nation (RBI, 2008-09). 6. Concluding Remarks While addressing the issue of financial inclusion, other factors also play a key role in the market. This is because efficiency, innovation and cost-effectiveness are the key to serve the financial needs of the poor. The Planning Commission of India in its recent report on financial reform has come out with suggestions in several fronts organizational structure facilitating financial inclusion; focus on risk management, subsidies and public goods, use of technology, improving infrastructure and financial literacy (Rajan, Raghuram, 2009xxiv).For financial inclusion the availability of products and services is not enough. Effective mechanism should be developed to bring the marginalized section of society into formal financial system. Local financial
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As on May 31, 2009 there are 44,857 ATMs in India. Source: Chakrabarty, 2009, Pushing Financial Inclusion Issues, Challenges and Way Forward, At 20th SKOCH Summit 2009, Mumbai on July

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institutions have a better understanding of the needs of the common people and suitable financial products and services may be developed to serve the poor. Financial inclusion needs substantial efforts in understanding the requirements of the poor, counseling, financial literacy, screening and monitoring. For this, simple procedures and practices based on local needs should substitute highly standardized and automated processes adopted by banks (Bernanke, 2006)xxv. The financial system must be responsive to the needs of the poor. The provision of timely and adequate bank credit at affordable cost is important for sustainable and long term inclusive growth.

References:

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Thorat Usha, 2008, Independence Commemoration Lecture, 2008 delivered at Central Bank of Sri Lanka, Colombo on February 28, http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/83282.pdf
ii

Sengupta, A., Kanna, K.P., Raveendran, G, 2008, Indias Common People: Who Are They, How Many Are They and How Do They Live? Economic and Political Weekly, Vol XLIII No. 11, p49
iii iv

CGAP/The World Bank, 2009, Financial Access 2009: Measuring Access to Financial Services around the World, pp13, 14 Annan, Kofi, 2003 cited in United Nations, 2006, Building Inclusive Financial Sectors for Development, New York, May, p1 Ianchovichina, Elena (PRMED), and Lundstrom, Susanna (PRMED), 2009 What is Inclusive Growth?, February

10, p 12
vi

Chakrabarty, K.C., 2009, Financial Inclusion RBI Initiatives, a Presentation by Deputy Governor, RBI at National Seminar on Launching a National Initiative for Financial Inclusion organised by DFS, GOI at New Delhi on September,p6

vii

Mehrotra, Nirupam, et.al 2009, Financial Inclusion-An overview, Occasional Paper-48, Department of Economic Analysis and Research, NABARD, Mumbai, p2
viii

http://www.yearofmicrocredit.org/pages/mediaoffice/mediaoffice_pressreleases.asp World Bank ,2008, Finance for All Policies and Pitfalls in Expanding http://siteresources.worldbank.org/INTFINFORALL/Resources/4099583-1194373512632/FFA_book.pdf
ix
x

Access;

Washington,

p2,

Robinson Joan,1952 cited in Mehrotra, Nirupam, et.al 2009, Financial Inclusion-An overview, Occasional Paper-48, Department of Economic Analysis and Research, NABARD, Mumbai, p3 xi Ravallion Martin and Chen Shaohua, 2008 The developing world is poorer than we thought but no less successful in the fight against poverty, Development Research Group, World Bank, August 26,p1 xii United Nations, 2006, Advisors Group on Inclusive Financial Sectors, United Nations www.uncdf.org xiii Beck, T., Demirg-Kunt A.and Levine R.2004, Finance, Inequality and Poverty: Cross- Country Evidence, NATIONAL BUREAU OF ECONOMIC RESEARCH, Working Paper 10979, December, p5, http://www.philadelphiafed.org/research-and-data/events/2006/fedpolicy-forum/papers/Levine_paper2.pdf xiv Karmakar, K.G., 2008, Poverty Alleviation or Financial Inclusion? NABARD, July, p 3

xv

xvi

http://wiki.answers.com/Q/How_many_people_live_in_villages_in_India Rangarajan, C., 2008, Report of the Committee on Financial Inclusion, Ministry of Finance, Govt .of India, New Delhi,p2, Government of India, 2003, Situation assessment Survey of Farmers,NSSO,2003 Arunachalam, S. Ramesh, 2008, Scoping Paper on Financial Inclusion, The United Nations Development Programme, New Delhi pp

xvii

xviii

1,2
xix xx

Thorat,Usha, 2007, Financial Inclusion-the Indian experience HMT- DFID Financial Inclusion Conference, London 19 June 2007. Rajan, Raghuram, 2009, A Hundred Small Steps: Report of the Committee on Financial Sector Reforms, Planning Commission, Government of India, sage publication, New Delhi, pp1,18 xxi Planning Commission, 2008, Eleventh Five Year Plan (2007-2012) Inclusive Growth, Government of India, Volume 1, New Delhi, p2 xxii RBI, 2008-09, Report on Trend and Progress of Banking in India 2008-09, p 56,http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/CHP03201009.pdf
xxiii

Subbarao, 2009, Financial Inclusion : Challenges and Opportunities, Remarks by Dr. D. Subbarao, Governor, Reserve Bank of India at the Bankers Club in Kolkata on December 9, 2009
xxiv

Rajan, Raghuram, 2009, A Hundred Small Steps: Report of the Committee on Financial Sector Reforms, Planning Commission, Government of India, sage publication, New Delhi, pp58-72.

xxv

Bernanke S. Ben., 2006, Chairman of the Fed Reserve Board, speech at the Opportunity Networks Annual Conference at Washington DC, cited in Thorat, U., 2006, Financial Inclusion for Sustainable Development: Role of IT and Intermediaries ,speech at Annual Bankers Conference, Hydrabad, November4, 2006, www.rbi.org.in