Financial Inclusion in India

By Knowledge@Wharton | October 31, 2014

The usual image of how creativity happens: A composer inadvertently hears a melody rising from a babbling brook, or an ad agency creative director crumples page after page of aborted ideas ripped from the typewriter until the right one lands. But creativity, some claim, can come from a far less elusive muse — from a structured process, one that opens up the ranks of the creative to a wider swath than the Steve Jobs, Jonas Salks and Franz Schuberts of the universe.

On August 15, India’s Independence Day, Prime Minister Narendra Modi announced a national mission of financial inclusion. Called the Pradhan Mantri’s Jan-Dhan Yojana — the Prime Minister’s People’s Wealth Program — it envisions bank accounts for all Indians. In its first phase, ending August 14, 2015, the target is 75 million accounts. “I wish to connect the poorest citizens of the country with the facility of bank accounts,” said Modi. “There are millions of families who have mobile phones, but no bank accounts. We have to change this. The change will commence from this point.”

Earlier prime ministers had made similar grandiose announcements, with few results. Indira Gandhi started a campaign against poverty, but it never gained traction. Manmohan Singh started a campaign against unemployment, but that failed to take hold as well. The Modi government is still in its honeymoon period; people are willing to accept Jan-Dhan as a plan but not a reachable destination.

On August 28, Modi formally launched the program. Banks across the country had been working overtime to make the necessary arrangements. On the first day, more than 15 million accounts were added. “It is the end of financial untouchability,” Modi noted. “It is the beginning of freedom from poverty.”

It’s not just the accounts that enticed people to the camps set up by the public sector banks. Every account holder will get a RuPay debit card, launched by the Reserve Bank of India (RBI)-promoted National Payments Corporation of India (NPCI); accident insurance cover of Rs.100,000 (approximately $1,650); life insurance coverage of Rs. 30,000 for those opening accounts before January 26 (celebrated as Republic Day in India), and an overdraft facility of Rs. 5,000.

“Never before in economic history have 15 million bank accounts been opened in a single day,” said Modi. “Never before have insurance companies issued 15 million accident policies in a single day. Never before has the government of India organized a program of such scale — over 77,000 locations — with the participation of so many chief ministers, union ministers, and government and bank officials.”

ICICI, India’s largest private sector bank, opened only 100,000 accounts that day. “ICICI Bank has been working on a comprehensive financial inclusion plan over the past four years,” MD and CEO Chanda Kochhar told Knowledge@Wharton. “Through our network, we cover approximately 15,600 villages and have brought more than 18.5 million unbanked people into the banking fold. We aim to open 2.5 million accounts under the yojana, taking the total number of accounts under our financial inclusion program to more than 20 million.” As of September 8, major private sector banks taken together opened just 580,000 accounts.

Reasons for Concern

It remains to be seen whether the program will lead to big changes. “This is a small step and the take-up is encouraging,” says Wharton finance professor Krishna Ramaswamy. “It might lead to small and improved savings in an accountable and hopefully trustworthy way.”

The skepticism comes in part due to questions about the veracity of the numbers themselves. RBI governor Raghuram Rajan has publicly warned the banks not to run after records. “We have to make sure the Jan-Dhan Yojana does not go off track,” he said at a conference on September 15. “The target is universality, not just speed and numbers.”

According to H.K. Pradhan, professor of finance and economics at XLRI Jamshedpur, there are concerns of duplicate accounts from people who may have opened them “without really understanding what they were doing.” He adds that the issue will be sorted out when biometric identification is introduced. But there could be operational complications: Anybody in India can open multiple accounts, so how can there be a different rule for the currently unbanked?

The second — and more important — issue is that India’s problem of financial inclusion is gargantuan. According to World Bank data, only 35% of Indians have an account with a formal financial institution. This is 42% in the case of men and 27% for women. Only 8% have debit cards and 2% credit cards. According to the government’s 2011 Census, 58.7% households utilize formal banking services.

Rating agency Crisil, a Standard & Poor’s company, has a financial inclusion index called the Inclusix. The all-India Inclusix score is 40.1 (which mean that about 40% of the country has access to formal banking services). There are wide variations — from 62.2% in the southern region to 28.6% in the eastern region.

The high-powered Nachiket Mor committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, set up by the RBI, found that 60% of the rural and urban population did not have a functional bank account. “India’s financial inclusion indicators, particularly in banking, put it below the median of countries, and bank accounts are a first step to inclusion,” says Rajesh Chakrabarti, executive director of the Bharti Institute of Public Policy at the Indian School of Business.

According to a report by global consulting firm Frost & Sullivan, India’s continued growth can only be assured “if steps are taken to ensure that social and economic development is inclusive.” Financial inclusion has moved into public consciousness only over the past decade or so. “Financial inclusion can no longer be treated as a fringe subject,” notes Jayanta Nath Mukhopadhyaya, director of the J.D. Birla Institute (department of management). “It has to be recognized as an important part of the mainstream thinking on economic development.”

The immediate challenge for banks, Pradhan says, will be acquiring the technology needed to facilitate more financial inclusion. “Moreover banks need to convert the old and dormant accounts into the new financial inclusion accounts in order to get the accident coverage and overdraft facility for the account holders.” This means that some of the work done on financial inclusion so far will have to be duplicated.

“There is much more to financial inclusion” than simply opening accounts, says M.S. Sriram, visiting faculty at the Centre for Public Policy at the Indian Institute of Management in Bangalore. “The state needs to put its resources to ensure that the infrastructure backbone is available — which means that there is ubiquitous presence of interoperable point of sale devices that allow people to transact without a hefty fee…. Once this architecture is available, the poor will start transacting.”

Chakrabarti adds that the government “seems to be fighting the symptoms rather than the disease. The point is for the formal banking system to be present when needed and be superior in convenience and efficiency. However, the approach taken seems to be to lure people into banking through incentives and to hope that the habit sets in. The trouble is that once the sweetener goes away, day-to-day banking provides little benefit in convenience to many users at the bottom of the pyramid.”

Long Road Ahead

The consensus of opinion is that Jan-Dhan is a worthwhile effort, but it’s too early to say whether it will succeed. “As compared to its predecessor — the Swabhiman scheme — this program has a high possibility of success due to two major strategic improvements,” states Rana Kapoor, MD & CEO of YES Bank and president of apex chamber Assocham. “First, it mandates provision of ATM-cum-debit cards to each account holder instead of the Smartcard (for thumbprint authentication) as earlier, where the customer was solely dependent upon agents or business correspondents. ATM debit cards give 24-7 access to savings, which is critical for the below-the-poverty-line population. The quantum of savings is limited and probability of emergency requirements is high.”

Kapoor says that the unbanked cannot be subject to one-size-fits-all schemes. “Among the currently excluded population, there are two broad sub-categories,” Kapoor notes. “There is (the) segment that has both need of financial services and the inclination to pay reasonable charges for them. The rapid proliferation of microfinance institutions and gold loan non-banking finance companies highlights this potential. The other segment is that of people heavily dependent on state subsidies for their livelihood. For this segment, though the other financial services may not be relevant, having a savings account to receive these subsidies without pilferage is highly desirable.”

According to Sriram, the main problem in achieving meaningful financial inclusion in India is the mechanism used for carrying out transactions. “This translates into the physical outlet where the transaction could happen and the interoperability of this outlet with other possible sources of payments apart from the users’ own transactions.”

The physical outlet where the transaction could happen is also a matter of debate. Kapoor has been talking about ATMs. Others are pushing for more bank branches. The new banks recently licensed are supposed to concentrate on this area. “We will prove that serving the poor is sustainable and cost effective for a bank,” C.S. Ghosh, chairman of microfinance institution Bandhan, which has been granted a bank license, told morning daily DNA.

Others feel that it’s necessary to widen the scope of the business correspondents (BCs), retail agents that work with banks to provide financial services at locations other than branches and ATMs. The correspondents were created in January 2006 in response to guidelines issued by the RBI.”We currently have a presence across 499 districts in 28 states through more than 28,000 business correspondent/customer service points,” says Rishi Gupta, chief operating officer and executive director of FINO PayTech, a technology provider and business correspondent to banks. “The number of business correspondents deployed is dependent on partner banks and their mandates. Given the scale of the financial inclusion program, a larger network of business correspondent agents is imperative to reach out to the unbanked masses.”

While the modalities and the project infrastructure will need fine-tuning, there is one basic fear hanging over the Jan-Dhan: Will it turn into a massive subsidy scheme with a damaging impact on the government’s finances? “The accounts can become a good way of providing directed credit, but the overdraft and insurance coverage can very well make it a giant subsidy scheme in itself,” says Chakrabarti. “It is clearly an expensive scheme with no clear plans for creating a sustained demand for inclusion.” Kapoor is more neutral. “Though the current BC-based delivery mechanism does envisage banks subsidizing the cost of opening and maintaining these accounts, these operating costs are still manageable at the banks at an aggregate level. However, if we add the cost of potential defaults due to the overdraft facility, it will become quite a burden on banks.”

“The bottom line of banks will be affected if the scheme has to be kept alive through subsidies,” adds Pradhan. “It must be self-sustainable. With cash transfers under several welfare programs getting directly into the account holders, the user frequency will also increase. The RuPay card, which is interoperable across the banking system, as well as usable at merchant establishments, can open up a plethora of transaction opportunities for the unbanked, including wage payments to migrant workers. So the potential for broadening and deepening of financial services to underserved markets and regions is huge.”

Chakrabarti of ISB is skeptical. “The program in itself does not look very different from the ‘No-frills account’ drive that was done years ago and (resulted in) millions of accounts opened, most of which remained dormant,” he says. Adds Sriram: “Until now, no large-scale, centrally driven program has worked. There is no reason to believe that this will work, unless there is a business case for it. Schemes result in a flurry of activity and show instantaneous results, but to sustain these, there has to be a business case.”

Building a Business Case

The government, however, has already articulated a business case, specifically that banks should profit from the float as the numbers are enormous. And the Jan-Dhan is creating the infrastructure for direct benefit transfers including subsidies, pensions and payments under the National Rural Employment Guarantee Act. The banks will get a 2% commission on these transfers. The accident insurance will be funded by the NPCI from the revenue generated from RuPay credit card transactions. The life insurance coverage details are yet to be worked out. The Rs. 5,000 overdraft will apply to only accounts in which there have been a certain number of transactions.

But there are other costs. Banks have to spend Rs. 100 to Rs. 150 per account on the necessary paperwork, the cost of holding camps, and the commission paid to BCs who are authorized to open accounts in places remote from bank branches and camps. These are zero deposit accounts, so the question of a float doesn’t arise if too many people take that option.

That fear has at least been partly laid to rest. In a cabinet meeting to review the progress of the scheme, it was revealed that as of September 8, 30.2 million accounts had been opened. Banks have collected deposits of Rs. 14,965 million. This works out to Rs. 495 per account. The RuPay cards have lagged, with only 3.36 million being issued.

Another prong of Jan-Dhan is financial literacy. “Financial literacy has to be accorded the highest priority, which should be appropriately blended with consumer protection measures,” says Pradhan. “This is where the role of banks and other channel partners such as insurance companies is important.” Adds Mukhopadhyaya: “We have to increase financial inclusion of the poor by increasing awareness of available financial services and strengthening financial literacy. Due to inadequate financial infrastructure and illiteracy, we will have to leverage using IT.”

Adds Ramaswamy: “The program is introducing the ideas of insurance and savings alternatives to a huge population — and that, in my view, will take place in India very quickly, if the take-up of mobile phone usage is a decent predictor.”

The Promise of Mobile

The vast penetration of mobile usage in India is also one big reason why Jan-Dhan could work. At the end of July 2014, the country had 919 million mobile connections — only China is ahead of that total. According to a State Bank of India (SBI) report, the vision is to “gradually move in a direction where every poor person is able to operate his bank account from his mobile, as mobile penetration is higher than financial services penetration.” Low-income populations benefit the most from technological innovations such as mobile payments, mobile banking and borrower identification based on fingerprinting and iris scans, reported the World Bank. “Innovations make financial services cheaper and easier to access for the poor, women and rural residents, especially those living in remote, less populated regions without brick-and-mortar bank branches,” says the Bank’s 2014 “Global Financial Development Report.”

Though Jan-Dhan mandates that mobile banking be made possible through ordinary mobile phones, smartphone adoption is picking up steam in India, as well. A functional smartphone is being retailed for the relatively low price of Rs. 1,999 ($33). The largest countries for smartphone sales in 2014 will be China (283 million), India (225 million), and the U.S. (89 million), research company Mediacells predicts.

Smartphones for the unbanked? Believe it or not, there may be more smartphones in the villages of India than in the cities. Sunil Sood, chief operating officer of Vodafone, says that the rejected technology of urban India trickles down to rural areas. Mobile service providers often encourage this, as their concern is the number of connections and talk time. And mobile banking transactions are already up sharply. “From June 2013 to June 2014, we have more than tripled our per month value of transactions from Rs. 3,332 million to over Rs.10,000 million – which is the first for any bank in India,” says an ICICI spokesperson.

The Mor panel had suggested that every Indian would be provided with a bank account by January 2016. Two of its members — Axis Bank CEO Shikha Sharma and Bank of Baroda chairman and managing director S.S. Mundra — felt this was too ambitious. In a note attached to the report, they said that January 2018 was more realistic. Modi had initially fixed August 14, 2015, as the date of completion of the first phase of his program. Now he wants it done by January 26, 2015 — one year before the target set by Mor and three years before Sharma and Mundra.