Recently in Chhattisgarh, a Business Correspondent’s (BC) team faced a situation straight out of a Bollywood movie: a sprint for survival in a remote district—not from Maoists, but from a hostile tribal community wielding knives.
After a two-hour-long trek across challenging terrain, the shocked young executives of the BC, which acts as an extended branch, reached the bank’s brick-and-mortar branch. The base branch was the closest physical link to 30-odd households spread across four isolated villages for last-mile delivery of cash withdrawals and deposits.
The experience of these executives is emblematic of the financial illiteracy in the country’s far-flung areas that is still posing a challenge to financial inclusion. Forget about credit, insurance, or investment; the community was not forthcoming even for basic banking services. But this is not a unique situation. This is a situation that banks, non-banking financial companies (NBFCs), microfinance institutions (MFIs), and financial institutions grapple with in rural India, as 30 per cent of Indian villages are still hampered by financial illiteracy and poor connectivity. The task of serving them falls squarely on BCs, who bear the costs, even though their own viability hangs by a thread.
This situation exists not for want of trying; since Independence, governments have prioritised financial inclusion. Early efforts included nationalising banks, establishing co-operatives, lending to the priority sector, forming regional rural banks, the National Bank for Agriculture and Rural Development (Nabard), self-help groups (SHG), BCs, the establishment of the NBFC-MFI category, and granting specialised banking licences such as small finance bank (SFB) and payments bank.
These efforts gathered significant steam under the BJP-led NDA government. The Jan Dhan Yojana, launched in 2014, is a shining example of this, with a staggering 486.5 million bank accounts having been opened till 2022–23 that had a cumulative deposit balance of Rs 1.98 lakh crore. That was followed by the Mudra loan initiative in 2015 to give small entrepreneurs a boost, handing out a whopping Rs 3.82 lakh crore of outstanding loans by FY23. In 2015, the government also decided to issue differentiated banking licences to SFBs and payments banks, which have a combined balance sheet of more than Rs 2 lakh crore now. The Reserve Bank of India (RBI), too, has been actively working towards this end. It is laying more emphasis on “usage” and “quality” of services than just “access to financial services”.
But financial inclusion isn’t just about banking; it is wider, encompassing insurance, pension, savings accounts, credit, and more. And when seen from this perspective, there is still a mountain to climb. “Financial inclusion is definitely a contributor to the financial well-being of individuals and enterprises, but it is not the primary one. We need to focus on the financial well-being of individuals,” says Seema Prem, Co-founder and CEO of FIA Global, a corporate BC for commercial banks.
Bank-Led Model
Back in 2014, there was visible optimism that total financial inclusion was within reach. That August, a whopping 18 million bank accounts were opened in just one week under the Jan Dhan Yojana, a feat that merited an entry in the Guinness World Records.
But the actual work for banks starts after accounts are opened, as these new customers have to be provided with services. Enter the last-mile foot soldiers, the BCs, which include small business owners, agents, retired professionals, and diverse entities such as NGOs, NBFCs, co-operative societies, and MFIs.
Nearly 10 years since that record-breaking feat, the enthusiasm has clearly dissipated (See chart ‘Beyond the Bank Account’). This is partly because the viability of the BC foot soldiers is itself in doubt today. In the last 10 years, banks have not revised the pricing for BCs. For instance, many of these far-flung villages have about 500 residents, and not all of them transact every month. Assuming 200 transactions in a month, with an average transaction income of Rs 10, the total income for a BC would be Rs 2,000. “How can you even cover the operating expenses, let alone take care of your family? This is an area that the government should focus on,” says a banking correspondent, speaking on the condition of anonymity.
The closest parallel to their efforts is the ATM. But the ATM interchange charge has increased from Rs 15 in August 2012 to Rs 17 in January 2022. That is not the case with micro-ATMs or the Aadhaar Enabled Payment System (AePS). ATM interchange fees are paid by a customer’s bank to the bank whose ATM is used by the customer.
“There is a case for increasing the interchange for micro-ATM and AePS transactions, as it has not been raised in the last decade despite inflationary pressures and higher costs of operation. This lack of parity impacts the overall quality of services,” says Amit Kumar Jain, Whole-time Director and COO of Fino Paytech Limited, a technology solutions provider.
Some banks are now on the BC platform for lead generation. “What we often fail to realise is that a branch serves an existing customer base of, say, 5,000. While the bank headquarters expects the BC to fill in the details, the branches are instructing [BCs] to handle all the work. They heavily rely on this free resource, making them responsible for collecting documentation, verifying property, and more; all this results in a mere 0.1 per cent commission. So, for a loan of Rs 1 lakh, the commission is only Rs 100. How can this cover the cost of fuel?” questions a Mumbai-based BC. One solution, Prem suggests, is to extend the co-lending facility that is currently offered only to NBFCs, to systemically important BCs. Co-lending is the process by which two or more lenders give out money to an individual.
There is another anomaly. Though BCs are allowed to serve multiple banks, they cannot choose the products offered (savings bank account openings or gold loans). “We don’t have the discretion to choose the products to provide. The decision lies entirely with the bank,” says Fino’s Jain.
Currently, regulations specify that the last-mile player is permitted to represent only one bank for a specific product or service. However, customers prefer a single point for accessing all banking services. “The basic tenets of the BC model have stayed the same as they were at the time of introduction, around 2006,” complains another BC.
“There is a difference between rural and urban outreach. We as MFIs could achieve more in terms of credit penetration if there is a relaxation of qualifying norms,” says H.P. Singh, CMD of microfinance firm Satin Creditcare Network Ltd.
The SHG Model
One of the big innovations in the financial services realm has been the concept of self-help groups, where 10–20 individuals, especially women, open bank accounts in the name of the SHG. There is a lending facility that is four to five times the size of the group’s pool of savings. Currently, there are more than 13.4 million SHGs with savings of Rs 58,892 crore and loan outstanding of Rs 1.88 lakh crore (See chart ‘The SHG Model’). They are quite popular in the South, finding mention in many south Indian movies. The southern states have a 50 per cent share in savings and a whopping 70 per cent share in loan outstanding amongst all SHGs.
But it is critical for these SHGs to transition gradually into micro-enterprises, says Shaji K.V., Chairman of Nabard. “In the third or fourth cycle of loan repayment, SHGs as a whole should either evolve into micro-enterprises or some members, jointly or severally, should establish their own micro-enterprises,” he says.
Of course, in an ideal scenario, individual members would set up their own ventures, but Nabard is initially encouraging groups of five to six SHG members to form an activity group or joint liability groups (JLGs) to access funds to establish a micro-enterprise. Nabard launched JLGs in the mid-2000s to provide credit to small and marginal farmers and the poor.
Sources suggest that the Ministry of Cooperation is also toying with the idea of helping SHGs transition into co-operatives. “A federation of SHGs should evolve into a co-operative with diverse activities organised into smaller groups. As a unified entity, they can establish businesses and value chain activities, including a supermarket. Additionally, e-commerce platforms and ONDC (Open Network for Digital Commerce) can facilitate the marketing of their products,” says Shaji.
But not everybody is convinced. “The SHG design of the micro-enterprise programme is flawed,” asserts a consultant. “People are unable to establish viable micro-enterprises. The micro-enterprises they are establishing are typically confined to low-margin industries like pickle or papad manufacturing,” says a private banker.
“The overconcentration of SHG or JLG members venturing into the same business segment is leading to intense competition and hindering their financial stability,” remarks another private banker, emphasising the need for diversification in their entrepreneurial ventures.
Another significant effort in financial inclusion was the launch in 2015 of the Mudra loan scheme to finance small business enterprises. It allows loans up to a maximum of Rs 10 lakh for small-, non-corporate-, and non-farm enterprises.
Despite noble intentions, the scheme has resulted in substantial losses for banks. “The approach of imposing targets on commercial banks for disbursing these loans has proven to be flawed,” says a banker. For example, the State Bank of India, the country’s largest lender, has experienced gross NPAs (non-performing assets) consistently above 16 per cent for the past five years in this category. The asset quality track record is similar for other banks. Sources suggest that the government is working on revising the Mudra scheme. A significant drawback stems from public sector banks’ aggressiveness. Initially, the government had established targets, including geographical sub-targets, for banks.
Yawning Credit Gap
To understand the persistence of gaps in financial inclusion, it is crucial to see the changed landscape of the banking sector in India. One feature is banks’ reluctance to offer small-ticket loans. That has opened up the space for MFIs. But these organisations have been unable to meet the significant demand for such services. A report by MicroFinance Institutions Network (MFIN) pegs the segment’s potential demand in 2023–24 at Rs 13 lakh crore—that translates to a credit gap of 70 per cent compared with current figures.
MFIs, which drew inspiration from Bangladesh’s Grameen Bank model of JLGs to offer credit to a group of underprivileged women, followed the SHG initiative in the late 1990s. They offer non-collateral loans, in which each of the five to 10 group members is a guarantor for the other members. The total loan portfolio of the segment stood at Rs 3.48 lakh crore (see chart ‘Giving Credit’). But this amount is paltry when compared with the total loan outstanding in the banking system of Rs 120 lakh crore.
“There needs to be a concerted effort to step up operations in the bottom 300 districts. Today, microfinance operations cover 633 districts, out of which 88 per cent are concentrated in the top 300 districts,” says Alok Misra, CEO and Director of MFIN.
Agrees Jiji Mammen, Executive Director & CEO at Sa-Dhan, an RBI-appointed self-regulatory organisation for the microfinance industry, who says more than 80 per cent of micro-credit is concentrated in 10 states.
To help matters, Nabard came out with a scheme in 2017 to boost JLG financing by commercial banks. “There can be a surgical approach to covering the 300-odd districts that are not covered because they are far flung. It should give some interest rate subsidies or a credit guarantee to a new customer for the first two cycles, etc.,” says Sanjay Agarwal, Senior Ratings Director at CARE Ratings.
According to Ganesh Narayanan, CEO of microfinance firm CreditAccess Grameen, everybody is catering to the same micro-loan segment, but cost structures are different. “NBFC-MFIs have a higher borrowing cost while banks and SFBs have higher operating costs. So, it kind of balances out. Some MFIs like us are even priced lower than banks. It is simply because better efficiency, higher customer retention and innovative products are resulting in lower opex,” he explains.
But it is a segment that is susceptible to big event risks. In the past, state governments in Andhra Pradesh and Assam have acted against MFIs, which created a huge risk for lenders. Events like the pandemic and demonetisation, too, have impacted the sector.
Last March, new microfinance regulations were introduced to standardise rules for all players. The income eligibility for households was increased to Rs 3 lakh, expanding the net. This has allowed institutions to serve the middle segment between microfinance and traditional banking, eliminating the rural-urban distinction. Under the new regulations, NBFC-MFIs can have variable pricing for different customers. “We believe that the addressable market is around 170 million households, out of which, 120 million are rural. The industry penetration is around 38 per cent,” says Narayanan.
Experts suggest that microfinance must be scaled up through a credit guarantee scheme. “The entire pool of the existing Rs 3.5 lakh crore micro-loan portfolio is unsecured. We are working with the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTCME) for a credit guarantee scheme,” says Misra of MFIN. CTGCME is a government-supported initiative to facilitate credit flow to MSMEs.
One big change in this landscape has been introduced by the influx of digital app-based lending platforms and fintech, or financial technology, players. They lend without a physical presence and often get confused with microfinance by local agencies. An MFIN report says more than 60 per cent of digital lending through platforms and mobile apps is to low-income, new-to-credit (NTC) borrowers, which is the microfinance segment as defined by the RBI.
“Lending to such customers using a remote and automated process is also done without adhering to micro-finance regulations like household income assessment and repayment capacity checks. The use of surrogate indicators is a poor replacement for in-person interactions and runs the risk of nudging borrowers inadvertently into over-indebtedness and also undermining underwriting,” states MFIN.
Beyond Banking
Considering the situation with banking, it isn’t surprising that other products like insurance and mutual funds see little traction. “The commission is not allowed to solicit insurance or MF [products]. Regulators don’t allow the agents to be paid. These are push products,” says a player.
Some suggest that RBI, which holds vast amounts of KYC data on customers, should use this as a common repository for all financial services players. “Our customers are categorised as tiny or basic customers, yet this data is not shared with Sebi (markets regulator the Securities and Exchange Board of India) or Irdai (Insurance Regulatory and Development Authority of India, the insurance regulator). The most urgent requirement is inter-regulator coordination,” says Prem.
The market needs curated micro-insurance products. “We are in the process of launching an innovative insurance savings product that suits our customers through one of our insurance partners. We will probably be the first to provide such an offering. The insurance partner is working to source Irdai approval. In the next 10 years, we can expect to see a significant change in insurance absorption amongst our customer,” says Narayanan of CreditAccess Grameen. In fact, the absence of such products has opened the door for riskier chit funds.
Moving Away From The Mandate
RBI’s decision to issue licences in the SFB and payments bank categories has also not yielded the desired results. Payments banks were non-starters, and SFBs have ambitions to diversify into non-micro segments to protect depositors from portfolio concentration in unsecured portfolios. SFBs are becoming increasingly similar to private sector banks in their focus on urban areas and middle-class customers, say experts.
“They are becoming similar to private sector banks. They are becoming more urban. They are slowly abandoning their rural, low-income franchise. Over time, I see them chasing middle-class urban customers,” says a market player who preferred to stay anonymous.
SFBs argue that they need to diversify, but they are simply not as competitive as they once were. For example, some SFBs are offering higher deposit rates than full-scale banks. This increases the cost of funds.
“But just having a liability set-up in urban and metro areas will not work. So, SFBs will end up doing large-ticket loans. They have no option but to accept business that will come their way in urban areas and metros. The share of microfinance is coming down,” says a banker. In addition, SFBs are subject to the same compliance requirements as private banks.
At the same time, the regulatory advantages of operating as an NBFC are diminishing, prompting them to seek conversion into SFBs. Large NBFCs aspire to become banks as funding becomes a big issue. And SFBs, in turn, are aspiring to become universal banks like HDFC Bank or ICICI Bank.
After the small bank debacle in the US, where start-up-focussed banks faced asset-liability mismatches, RBI is also very cautious about the Indian SFB space. Some banks are slowly testing the microfinance market by acquiring MFIs, and there are fresh faces in the game. Experts suggest there is going to be more activity here.
But malpractices abound in this space. RBI Governor Shaktikanta Das recently sounded the alarm when he said that certain NBFC-MFIs had relatively high net interest margins. “The interest rates are linked to the cost of operations. The sources of funding are also limited. There is also an obligation towards shareholders,” says one player.
Besides, the sector has a reputation for accidents and defaults. RBI’s recent decision to increase risk weights on unsecured loans has already caused a ripple. Fintech players masquerading as micro-loan providers in the sub-Rs 50,000 category via apps are already running scared. A banker jokes that fintech is a solution for the difficult terrains of India, where mobile has at least reached. Perhaps the BCs won’t have to face tribes brandishing knives. But that’s not an immediate possibility because of the low smartphone penetration. In fact, fintech firms are also on RBI’s radar for playing regulatory arbitrage. They are actually operating in the microfinance domain without following the standard operating procedures.
For all the stakeholders in the space, it is essential that RBI and the government act fast to recapture some of that enthusiasm that boosted financial inclusion a decade ago. Till then, total financial inclusion will remain a dream.
@anandadhikari