You have played a pivotal role in reinforcing financial inclusion during your tenure at the RBI. We can begin by addressing that issue broadly. There is a statistic by McKinsey indicating that in 2005, only 47% of India's household savings was tapped by the financial system. How have we progressed since then?
I think that each statistic has to be used carefully and seen in comparison with the trend over a period of time. In March 2004, there were 59 savings and current accounts per 100 adult population – in March 2010, the number had risen to 92. The number of borrowal accounts per 100 adult population rose from 12 to 18 in the same period. This data shows a huge improvement in the population coverage of bank accounts between 2004 and 2010 but it does not necessarily mean that we have more inclusion – other indicators such as access in terms of distance, number of transactions per month, access to loans, etc, also have to be seen in conjunction with the number of bank accounts to determine how far we have come.
Do you think the financial inclusion debate and agenda in India today is appropriate in its emphasis? Are we focusing on the right issues, measures and priorities or are we missing the woods because of the trees?
The current focus is on reducing the physical distance and time or cost taken to reach a banking outlet, whether it is a branch or branchless agent. This is the right focus because without this we cannot, by any measure, have financial inclusion. We also need to increase people’s access to basic financial products. We must develop products that are suitable to the local communities and can be scaled up and made technologically compatible. We must also ensure that the IT-based solutions work without disruption and are ubiquitous. We also need to understand that the focus on JLGs (Joint Liability Groups comprise four to ten individuals who come together for the purpose of bank loan against mutual guarantee) and SHGs (Self-help Groups) does not imply losing sight of household cash flows. Responsible lending should go hand in hand with financial inclusion. The BC model (the business correspondent model recommended by the RBI proposes that in areas inaccessible to banks, entities such as kiranas, retired teachers, PCO operators, petrol pump owners, and companies through their retail network, can be authorised to perform financial operations including opening and maintaining accounts) has to be developed, strengthened and demonstrated to be viable.
Given the fact that you spent almost four decades in RBI, what is your historical perspective on financial inclusion? Specifically, has Priority Sector Lending (PSL) as a tool for financial inclusion generated more costs than benefits?
Having interacted with some emerging market economies that gave up directed lending completely and having heard about their experience, the impression I got was that they wish they had not given it up completely; their banks seem to focus only in the cities and large towns and do not meet the needs of sectors, where the policy makers would really like to see the flow of credit and penetration by the formal financial services. Even if pricing is totally free, as is the case in these countries, there is a shying away from rural areas and low income sections of the population.
Whether the costs of PSL are more than the benefits, I think we need to undertake research on the risk-adjusted return of priority sector portfolio as compared to other sectors. My intuitive feeling is that within PSL, banks have focused on loans above Rs 2 lakh (other than for crop loans where there is interest subvention). For loans up to Rs 2 lakh, interest rate caps were in force till recently. In SME and retail trade, the interest rates are usually higher. However, the benefits and costs of PSL cannot be seen only in terms of risk-adjusted return. We also have to measure the impact on output employment and impact on human capital as housing and education are part of PSL. We also need to assess whether PSL requirement has led to crowding out of credit for non-priority sectors either through reduction in flow or through increase in interest rates and if so, the impact of this on GDP and employment.
The Malegam Committee reckoned that the problems in the microfinance sector were exacerbated by the fact that banks lent to these MFIs (Microfinance Institutions) as part of the priority sector lending norms. If banks have to seek MFIs to fulfill their "priority sector lending" commitments, why not disband this via medium and let MFIs raise money competitively from the banks like any other corporate borrower?
Unlike other PSL, microfinance is not linked to any specific activity. The truth is – and this is now well known – that the sheer easy availability of credit that can be used for any purpose, makes the low-income households borrow much more (especially for consumption) than their repaying capacity. Treating all loans to MFIs as eligible for PSL status has led to MFIs accessing concessional sources of credit and this drove up volumes and securitisation drove up values. If Malegam committee has chosen to retain PSL status for the portfolio complying with certain conditions, the reason is to ensure that the poor do get access to credit through this route while ensuring that the loan is linked to income generation and livelihood. The MFIs that do not meet the criteria will have to raise funds like any other borrower and this would be at higher interest rates.
Now that the RBI has accepted the Malegam recommendations, what should the MFIs focus on?
All lenders whether NBFCs (Non-Bank Financial Companies), MFIs or even banks getting into retail low-income lending will be well-advised to keep track of household cash flows while taking credit decisions. They should also provide a session of financial education to the borrowers so that they understand the implications of over-borrowing, especially for consumption purposes. Further, there is a need to insure against an incentive structure for borrowers intermediaries and lenders that gives rise to irresponsible lending and irresponsible borrowing.
To rein in a few rogue players who may have charged usurious interest rates, is it an appropriate strategy to clamp down on the entire sector by imposing an interest rate cap of 26% together with substantially more operational procedures that would increase the MFIs operation costs significantly? Would it not lead to significant credit rationing and defeat the entire purpose of expanding financial inclusion through microfinance?
[This article has been reproduced with permission from ISBInsight, the research publication of the Indian School of Business, India]