Will Banking Services Witness a Structural Shift to improve

financial inclusion in India

by Amit Bhushan

Come January 2009, the Banking & Financial Services

market in India is about to open up. The Capital Markets anticipate a

rush of Foreign banks with deep pockets to make some big bang

acquisitions in order to acquire instant market access. So, there's a race

among existing bankers (those that want to sell out) to establish

presence in urban & semi-urban regions where presence is valued by

the Foreign players interested in India & seek better valuations. Thus

we are witness to a Banking boom on the stock indices, while large

swathes of rural pockets remain unbanked. This is inspite of RBI

shouting from Rooftop about financial inclusion which included almost

one year of licensing freeze, in order to bring around reconsideration

(change of heart) among existing institutions (make them to focus on

rural unbanked areas). Alas, the unbanked districts have still not made

much progress, with Banks merely paying lip service by nodding to the

regulator but doing little to make life easier for people in these districts.

It may be noted that this is inspite of over 30 years of bank

nationalisation & with government still retaining control of over half

the industry. There is need to understand why is our banking structure

so shy of making services available to these areas & especially gives no

heed to their credit requirements even as the system is overflowing with

liquidity for over 5 years now. What are the other challenges that need

to be tackled by the banks/institutions, like challenges in growth of

savings; management of payment systems for these area etc.? How are

the present institutions structured or are they really designed to take

care of these peoples' needs? Lastly, would availabiliy of more Capital

by having Foreign institutions with deep pockets solve the problem by

itself or more importantly, are the upcoming players even interested to

take on these challenges.

Let us first understand the structure of present consumer

banking market in India & how the private institutions/bank are

catering to this market. Presently, the retail/individual market consists

of a large chunk of customers (savings account) each contributing very

small deposit size by international standards (averaging less than USD

200/-). Only approx. top 3% of these consumers who work for the
organised sector at middle to senior level or own an independent small

business (who can afford a savings account balance of USD 2000/+)

may be a suitable audience for the Foreign Banks. Incidently, it is these

set of customers who can be the audience for a host of other products

like Credit Cards, Insurance, Housing/Auto/Personal Loans, other

savings & investment products like deposits, Mutual Funds etc.

through which banks can gain additional income & therefore are a

center of attraction for all players. The other challenge is to provide an

effective payment system to the masses. The average payment size is as

low as USD 30/- approx. & is likely to fall to even lower levels if banks

becomes the preferred route of payment over the present system of

'Cash' (or transfer of currency notes) transactions. The last issue is lack

of use of technology solutions like 'ATM/phone' due to ignorance or

reluctance to change which leads to a consumer conducting a large

number of small transactions at the 'Branch' with its resultant costs.

Also, most transactions being paper based viz. Cheques/DD so have a

higher processing costs as well as constituting higher risks besides the

time involved.
 Lack of penetration of the savings & payment products also

posses other challenges. This is in the form of lack of customer

information with the bank. A bank is unable to measure the customers

ability to generate income/revenues/savings & therefore is unsure about

his repayment ability. It is also unaware about the customers

transactions with other clients of repute because of lack of account

information or other such reliable data for the purpose of credit

evaluation. With agricultural land being of little use to the bank as

collateral (due to RBI guidance & other laws), non-availability of

'authorised housing' (due to lack of reach of development/municipal

authorities) & other such hinderence; adequate collateral is also not on

offer to the banks, for them to rely upon. The only collateral that could

be available is 'Grain' stock & other such produce, Farm equipments,

livestocks etc. available with the village farming community. Now

since the avarage size of Farmland holding is about 2 acres, one can

imagine the average amount/value of the holdings. Therefore, it should

be easy to conclude that there is a general unavailability of quality

collateral. So far the banks have been able to meet these challenges by

making credit available to select dependable/identified borrowers who

work more as consolidator (trader) of Farm produce & thus could offer

bigger & more manageable/bankworthy size of collateral and that too

in order to meet their priority lending target rather than servicing a

bankable customer. Thus the story to rural lending is more about

regulatory escape routes than of developmental banking. This also

explains the lack of knowledge of banking among our masses

alongwith non-availability of bank accounts which is central to this

discussion.

Based on above information, it is easy to conjecture that a

Foreign institution which generally deploys high cost technology &

personnels, prefers using English over local languages for transactions

& insists on authenticated records for credit evaluation over other

methods, might find going to rural markets a bit more challenging to

their appetite. Therefore a regulatory insistence on Banks to

mandatorily open a certain percentage of branches in Rural unbanked

areas, a policy on minimum percentage lending to priority sector (need

to be made more sharp edged by defining geographies, maximum

single borrower lending norm), regulatory intervention for mandatory

low/zero cost/no frills savings/payment product are the measures in

right direction to regulate non-serious players. Most of these regulatory

measures are right now advisory in nature (do not have norms to have a

minimum percentage of total customers under these products & where

we have norms, penalties are undefined or very low), however if the

same becomes mandatory, most of the aggresive foreign players might

have to rethink their India strategy. This being so, because at present

they are only focussed on the top 10% of the creame customers(3% of

the population) that India has to offer viz. just 0.3% (total 30 million

customers) of the total market which is cream-de'la-cream' of India &

have been able to avoid the service resposibility towards the not so well

to do. That foreign banks have been able to slug it out inspite of tough

competition from domestic players, have given them confidence to go

for more investments & increase their reach to the segments they

wanna serve. However, the big question is if these players can really

serve 'the bottom of the pyramid' in a profitable & sustainable way?

Would they be sensititve to the regulatory cues & be willing to meet the

social resposibility to reach out to the poor. And lastly what measures

can be taken if these institutions fail to fulfill these requirements.

Would RBI be able to muster enough strength to penalise such

behaviour strongly to keep market players sensitive & well behaved

towards the needs of the country & its people.

If international experience in such regards is taken into

account, it is always the domestic institution which have taken the lead

by channelising the domestic savings towards the areas in need of

capital & investments. The foreign institutions have normally ushered

in new technology & better benchmarks in services, but refrained from

taking excessive/unknown risk thus limiting themselves to financing

larger & better known institutions & brands. This is because of their

lack of deeper understanding of the socio-cultural settings in the target

country & the opportunities as well as risk hedges offered by such

settings. Frequently, these institutions are unable to incorporate & adapt

to these systems & setting, owing to their pedigree/traditions/

experiences, shareholders resistance, regulatory restrictions in the home

country, lack of managerial conviction about the new ideas prevalent in

the target market etc. These institution play on their branding,

international recognition & linkages, service standards, technology etc.

to market themselves and see financial inclusion as government's job to

manage. Frequently even credit protection programmes, taxation

benefits & chunks of profitable government business are sought as

subsidy to meet even a miniscule part of these social requirements if

direct susidy in not available. Their strength lie in creating an

internationally benchmarked savings & investment product. They are

most likely to remain weak in payment products owing to their lack of

reach & in credit/loan products due to their lack of knowledge of local

practices & settings. They are also unable to fully grasp the traditional

trade linkages between trading families & understand risk hedges

offered by such socio-cultural-economic environment.

Now having understood the market, let us look at strategies

that foreign banks can adopt towards lending. These banks can adopt a

scorecard based credit underwriting model based on actuarial risk

analysis of credit data available with the rating companies or other

institutions and use the same to distribute small ticket loans & thus

spread risk over a larger chunk of customers & draw comfort from the

same. They can have a transaction backed financing approach such as

factoring, bill discounting, supply chain financing etc. They can also

build upon products based on current/new legislation on warehousing

to create a warehoused goods financing model. They can also look at

supply chain financing for their international customers & similar other

structured solutions. These products can be in addtion to their

traditional arena of strength viz. Corporate lending. However with such

product suit, reaching out to unbanked area which are deficient in

enterprise & industy and have low value agri-based produce, is quite

challenging if not impossible. Therefore, its likely that while Foreign

institutions shall look forward to excellence in savings & investment

products by leveraging their international experience, providing a

dependable payment mechanism shall be an arena left with the

domestic banks since it is the domestic banks which have the reach in

most of the 10,000 odd clearing zones & have access to the remote

rural areas with their physical presence.

Now lets take a look at other actions of the regulator/RBI. It

has placed restriction on usage of agency for solicitation of business in

especially liabilities business, it has effectively deprived the foreign

banks of much needed reach (or read cheaper distribution mechanisms)

and creation of local informed community of influencers that such

system provides. Also, for rural areas to embrace technology solution

which shall ultimately bring down costs, it should have its own

champions from within their community rather than outside and with

the banks. Therefore these actions have effectively raised the cost of

acquisition of customers & place greater hurdles for these banks

towards meeting regulatory guidance & fulfilling social responsibility

of reaching out to the poor. Clearly there is scope for large domestic

banks to acquire a niche space in provding payment solutions which

shall be difficult for the new players break into. Thus we are likely to

see banks which are likely to specialise in providing savings &

investments products and another set in providing payment solutions.

Now, it may be questioned as to why a single entity cannnot create

expertise in both products. The answer is to provide payment solutions,

it requires to have a larger number of branches & thus much higher

overheads while savings & investments products can be operated

through hub & spoke distribution structure keeping overheads lower.

Nonetheless, a few institutions shall definitely attempt to manage their

presence in both spaces which shall ultimately offer customers greater

variety of choices. Already, most PSU banks seem attempting to

specialise in payment solutions wherein, their bouquet offers customer

a cost effective & much faster (than earlier) payment/colletion solution,

however they still need to convince customers about their reliability by

developing and showing a better understanding of modern technology

& clear direction & strategy, which has not been witnessed thus far.

Most officers at these banks seem mesmerised by the glam of foreign

banks & pitch about their lower cost instead of a promise of service

excellence which the market is demanding. It is the new age private

banks which seem to be occupying/trying to occupy this space,

however they are limited in reach in terms of physical presence in

clearing zones & have a costlier service delivery system. In other

words, even as MNCs are knocking at the Indian market, domestic

players do not have their house in order, in terms of identifying a

suitable niche for themselves.

Now coming to making bank finance available to the rural

unbanked areas. Most of the methods like the scorecard based

approach, supply chain financing etc. Have already been attempted in

the market by new age private banks with limited success. They have

definitely made credit less cumbersome & more easily available to the

urban market. However, they have not been able to penetrate rural areas

due lack of data availability which hiders in development of a

successful lending model. Also application of any other type of lending

models seem to be too costlier for the people in these areas to be able to

afford. Banks so far have refrained from 'jewellary collateral' backed

lending which rural moneylenders resort to, for the lack of a systematic

approach towards this in the system of lending. A general lack of

professionalism also make rural enterprise finance a tad more risky

then financing its counterpart in city. The customers presence in a more

sophisticated, bigger & more matured market makes bank more

comfortable in lending them. Nevertheless some private banks are in

the process of creating onward micro lending institutions, which can

tackle providing small ticket finance to the rural enterprise & farmers.

If effective supply chain financing structure can be afforded to be run

for these rural micro enterprise by creating control or understanding on

input(disbursals to pre-selected sources or input providers) & output

(purchase assurances) sources, then such a structure can be an effective

mechanism. However, presently cost of such micro management is

humungous, with regulatory restrictions (which see it as exploitation)

& with high operations cost, thus making such credit, too costly.

Presently, banks are exposed to excessive risk taking & since these

institutions are risk averse by nature, hence lack of credit penetration.

Added to this is our politicians penchance of announcing Loan/interest

waivers & deferments which give rise to 'moral hazard' in the society

towards paying back such loans has led to the present situation. Given

such a sceanrio, a strong regulatory measure is definitely required such

as modification of certain regulations which affords bank a cheaper

access to customers & make them feel more comfortable towards

lending to the rural unbanked customers. The regulator can well be

advised to look at measures that shall bring down transaction cost such

a reduction in number of clearing zones (Since road infrastructure &

telecommunications are now much improved), hastening up launch of

systems like cheque turncation & making electronic fund transfers

available to rural areas also to reduce risks for the banks besides

offering a faster clearing mechanism. RBI can further try to reduce

credit cost by sponsoring a domestic credit cards company to compete

with likes of 'Visa' & 'Mastercard' but at lower transaction cost than

presently afforded by these institutions. Promotion/sponsorship by an

effective regulator can give such institution credibility & market access

to become an instant hit. It can also work towards creating a domestic

electronic telecommunication exchange system to counter with the

expensive 'SWIFT ' & thus greater reliability to present system of

transactions. Lastly , we can also explore a 'Gram Sabha' operated

warehousing facilities or such livestock upkeep scheme which are

reliable (may be outsourced on BOOT basis) & therfore a comfort

factor for the bank for easier lending. It should be noted that just by

adding more institutions without reduction of cost & enhancement of

reach to the customers, the goal of 'banking for all' may not be reached.

Therefore their exists a clear need that India debates solutions that

might work for this country, rather than making noise about the interest

been shown by international institutions towards out markets.