Draft Report of the High Level Group on Services Sector

6.2.7 Financial inclusion

Despite years of policies aimed at achieving financial inclusion, a large share of Indian households do not have access to even basic financial services such as credit and savings. A new approach is needed to provide comprehensive financial services – credit, savings, insurance, remittances and pensions – to those who have typically not had access to them. This includes small farmers, rural and urban poor and other weaker sections. The goal should be to provide universal access to good quality, comprehensive, financial services at competitive prices by financially sustainable service providers who meet reasonable governance norms.
A number of committees have provided guidance on improving financial inclusion. Most recently, the C. Rangarajan Committee on Financial Inclusion (2007) made detailed recommendations on supply and demand side solutions to improve delivery of financial services through traditional and non-conventional channels. In addition, the Vaidyanathan Committee on restructuring of cooperatives (2004) and the Committee on Moneylender Legislation (2006) recommended policy measures to improve financial inclusion. Based on these and other reports, key government and regulatory policy measures that would help achieve financial inclusion can be broadly categorized in three groups as set out below:

1. 
   Provision of a level playing field for various financial services providers – traditional and non-traditional – to compete, subject to appropriate regulations: Given the historical preference for institutional provision of credit via state owned and controlled financial institutions (FIs), non-mainstream FIs such as micro-finance institutions (MFIs) arrived late in India. Indian MFIs have found a market niche by developing products and processes that appear better suited to meet the needs of their target clients than their institutional counterparts. Moreover, MFIs can be useful partners for commercial banks to provide financing to small borrowers. Key measures to facilitate the growth of this segment of financial service providers include: (i) measures to promote transparency in microfinance operations such as annual registration, rate monitoring and quarterly rate disclosures, and random audits; (ii) refraining from interest rate caps in microfinance, which have sometimes been imposed at the state level; (iii) measures to facilitate the development of non-credit services – savings, insurance, pensions etc. through regulatory support for pilots and hybrid models; (iv) a strong focus on urban microfinance to provide services to growing numbers of urban poor; and (iv) incentives that allow non-traditional players with strong rural presence and distribution networks to explore options to provide financial services.
   

2. 
   Rethinking priority sector guidelines: It is well documented that while priority sector lending targets did initially help push financial services to the underserved, they had little success in meeting the voluminous demand for credit, and largely excluded small borrowers. Moreover, the poor financial health of rural financial institutions primarily entrusted with providing credit to the priority sector is testament to the fact that these guidelines need to be seriously reconsidered if they are to meet their originally envisaged goals. It may be prudent to study this issue further, and consider the merits of some alternative proposals that have been made. There is increasing recognition among banks and financial institutions of the importance of serving this section, both as a socio-economic necessity and as a vast untapped growth opportunity. This includes both individuals and micro and small enterprises dependent on agriculture, as well as other lower income individuals and micro and small enterprises in both rural and urban areas. The key challenge faced by financial services providers relates to the cost of doing business and enabling credit, recovery and distribution infrastructure. Suggested measures could include allowing banks to self-set inclusive financial service targets, developing enabling infrastructure such as low-cost payment systems and credit bureaus, making priority sector lending obligations tradable, and using well targeted subsidies for specific areas where standalone operations would not be viable, but which are priorities from a policy perspective.
   

(iii) Generate demand for financial services by improving the infrastructure for rural lending in partnership with the private sector wherever feasible: Perhaps the greatest benefits of public policy initiatives towards financial inclusion are in the area of creating systemic infrastructure for provision of credit and other financial services. Specific measures include creating credit registries, national identification numbers, payment systems, electronic commodity and auction markets and weather measurement systems – all of which are public goods which would help stimulate economic activity. Other measures that would help generate demand for financial services include public investment in rural infrastructure programs, vocational training programs, and measures to improve market linkages that help micro entrepreneurs find reliable channels for marketing their products and services. Creation of International Financial Centre

The recent report of the High Powered Expert Committee (HPEC) on making Mumbai an international financial centre has highlighted the favourable conditions that exist in India to facilitate the creation of an international financial hub in the country. In addition to the reform measures for various segments of the financial sector, policy reforms to facilitate capital account convertibility, macroeconomic stability and creation of well functioning bond, currency and derivatives market are required to sustain financial sector reforms. The Group broadly endorses the findings of the HPEC and recommends that the policy measures highlighted in that report be implemented.