Banking on Innovations - Profitably Capturing Rural Opportunities

Dr Debesh Roy

1. Introduction

A significant rural-urban disparity characterizes the Indian economy. The disparity is manifested in terms of various parameters like physical and social infrastructure, income and wealth, employment opportunities, and access to basic amenities of life, including banking and financial services. Even after 65 years of Independence 68.8 per cent of India’s 1.21 billion population lives in rural areas, but the contribution by the rural sector to the net domestic product at factor cost is only 40 per cent (National Accounts Statistics 2010). Moreover, rural poverty as estimated by the Planning Commission was 45.8 per cent in 2004-05, as against 25.7 per cent in urban areas (Government of India, 2012).  A large section of the rural poor still do not have access to the formal banking channel. Further, the backward regions of the country, too, lack basic financial infrastructure.  The recent slowdown in the growth of the Indian economy has also adversely affected the rural economy vis-à-vis the urban economy.

The banking sector has a key catalytic role to play in the development of the rural economy. Ever since the nationalization of banks, implementation of the Lead Bank Scheme and priority sector lending, and the subsequent creation of Regional Rural Banks (RRBs), there has been a focus on providing banking services to the remote areas of the country, more as a social commitment rather than as a business opportunity.  Thus, financial inclusion should not mean just opening of “No-frill accounts” or issuing of Kisan Credit Cards (KCC).  Rather, banks need to focus on profitably capturing rural opportunities, as a world of business opportunity could be found at the ‘bottom of the pyramid’.

2. Rural Banking – Issues and Challenges

Inadequacy of Rural Credit

Nationalization of commercial banks and the setting up of RRBs facilitated the expansion of bank branches in the remotest corners of the country. However, the share of rural credit in total credit outstanding was a meagre 9.6 per cent as on 31 March 2011, having declined steadily from 14.1 per cent as on 31 March 2003 (Table-1). Similarly, the share of semi-urban credit declined from 13.8 per cent to 11.1 per cent during the period under review. On the other hand, the share of credit in the urban/ metro centres increased from 72.1 per cent (31 March 2003) to 79.3 per cent (31 March 2011).

Table - 1

Population Group-wise Credit Outstanding of Scheduled Commercial Banks

(As on 31 March)     

(Amount in INR crore)

Year	Rural	% share	Semi-urban	% share	Urban/Metro	% share	Total
2001	68882	12.8	71106	13.2	398446	74.0	538434
2002	87713	13.4	90156	13.7	478124	72.9	655993
2003	106479	14.1	104149	13.8	545339	72.1	755967
2004	109907	12.5	114871	13.0	655534	74.5	880312
2005	160479	13.9	142836	12.4	849152	73.7	1152467
2006	199423	13.2	174794	11.5	1139624	75.3	1513841
2007	235704	12.1	212753	10.9	1498643	77.0	1947100
2008	323132	11.3	255998	9.0	2268467	79.7	2847597
2009	309626	10.9	311089	10.9	2226998	78.2	2847713
2010	385150	11.5	367859	11.0	2592160	77.5	3345169
2011	392449	9.6	451987	11.1	3231210	79.3	4075646

Note: Figures in parenthesis indicate percentage growth over previous year

Source: Handbook of Statistics on the Indian Economy 2011-12, Reserve Bank of India. Calculations of growth and percentage share are those of the author.

As per extant RBI guidelines agricultural advances should constitute at least 18 per cent of net bank credit. However, banks as a whole have never been able to achieve this benchmark. The share of agricultural advances to adjusted net bank credit  in case of public sector banks increased from 15.7 per cent (2000-01) to 17.6 per cent (2008-09) but decreased to 15.9 per cent (2010-11)[1]. Thus, the share of agricultural advances by public sector banks continued to fall short of the mandated 18 per cent of net bank credit. However, the public sector banks continued to achieve the overall priority sector advances target of 40 per cent of net bank credit. 

Direct Institutional Credit to Agriculture and Allied Activities

Direct institutional credit to agriculture and allied activities has increased from INR 91,654 crore  in 2000-01 to INR 4,38,198 crore[2]. The annual growth rate of institutional credit increased from 12.6 per cent in 2000-01 to attain a peak of 26.3 per cent in 2004-05 . The high growth rate during 2003-04 to 2004-05 was mainly due to Government of India’s thrust on “doubling of agriculture credit”. The focus on financial inclusion and also the implementation of the Agriculture Debt Waiver and Debt Relief Scheme, 2008, led to the increase in the growth rate in direct agriculture credit from 18.5 per cent in 2008-09 to 22.6 per cent in 2009-10.  Institution-wise it may be observed that the overall high growth trend in direct credit to agriculture and allied sector was due to the high growth rates achieved by scheduled commercial banks and RRBs. Except for the year 2003-04, cooperative banks experienced very slow growth rates (and negative growth during 2007-08).

The trend in the institution-wise share of direct institutional credit to agriculture and allied activities, reveals a steady increase in the share of scheduled commercial banks from 41.1 per cent in 1999-00 to 72.0 per cent in 2009-10. During the same period the share of cooperative banks declined steadily from 51.5 per cent to 17.4 per cent. The share of RRBs increased slowly from 7.4 per cent to 10.6 per cent, during the period under review. The trend indicates that commercial banks have been able to exploit the potential for agriculture credit, due to their technological and financial strength and innovations.  Thus, in spite of having bigger presence in the rural areas, the institutionally weak cooperative banks have lost out due to lack of modernization, a weak management structure, and political interference in their operations.  The financial position of RRBs, however, has been improving steadily during the past decade due to modernisation, recapitalisation and mergers, which is reflected in an improvement in their credit operations.  

Level of Agricultural NPAs

During the period 2004-12, the gross NPA ratio in agriculture was higher than the corresponding ratio in the non-agricultural sector, except during 2009 and 2010. This was partly due to the implementation of the agricultural debt waiver and relief scheme. In 2011-12, agricultural NPAs rose by 47 per cent as against the NPAs in the non-agricultural sector which rose by 40 per cent. The rise in agricultural NPAs during 2011-12 could be due to the lagged effect of double-digit growth in agricultural credit during the last four years (2006-07 to 2009-10), the general economic slowdown and also, possibly, the new system-wide identification of NPAs (Subbarao, 2012).

Financial Exclusion

Historically, the rural poor in India have experienced difficulties in obtaining appropriate access to financial services. Hence, they are heavily dependent on informal sources such as moneylenders, especially for non-productive consumption purposes and other emergency requirements such as medical expenditure. The benefits of growth due to reforms, have concentrated in the hands of those already served by the formal financial system. An essential pre-requisite for inclusive and sustainable growth is capital formation through credit and financial services. Therefore, access to banking and financial services is essential for achieving faster and inclusive economic growth.

Weak Capital Formation in Agriculture

A robust increase in capital formation is a pre-requisite for sustainable development of agriculture. This is mainly due to the daunting task of increasing agricultural production in tandem with the increase in population. One of the most alarming features of the development of agricultural sector in India during the last couple of decades has been stagnation in capital formation.  The share of agriculture sector’s Gross Capital Formation (GCF) in GDP declined from 2.2 per cent in 1999-00 to 2.0 per cent in 2003-04, and increased marginally to 2.6 per cent in 2004-05 and 2.9 per cent in 2010-11 (Government of India, 2012). This low share was mainly due to stagnation or even a decline in public investment in irrigation particularly since the 1990s. Capital formation in agriculture is dominated by the private sector, and its share in the total has been maintained at a range between 82.2 per cent in 1999-00 and 82.4 per cent in 2008-09. Availability of enabling infrastructure, investible resources and expected rate of return on investment are the principal factors which determine private investment in agriculture. Private investment in agriculture can be boosted with improved availability of credit for agriculture and liberalized trade for agricultural products.

Rural Infrastructure Deficit

It is widely acknowledged that lack of infrastructure is a major constraint for growth and poverty alleviation. Improvement in rural infrastructure is, therefore, crucial for broad-based inclusive growth of the economy and for bridging the rural-urban divide. All forms of infrastructure viz., power, rural roads,  irrigation projects, watershed development, warehouses, cold storages, market infrastructure, education and training institutions, hospitals and health care centres, among others, is vital for high growth rate of the rural economy and for reducing poverty.

3. Reforming Rural Financial Sector

Modernization of Rural Branches and Rural Financial Institutions – Low Cost Model

Rangarajan (2012) has expressed the view that although in principle the BC model is faultless, the experience of banks in the operation of the BC model has not been very satisfactory, as the BCs who are generally employed by ‘not-for-profit’ companies, are not adequately compensated. While he believes that the system of BCs should be made to work better, at the same time there is a need to explore alternatives like low cost brick and mortar branches at panchayat headquarters. Low cost CBS-enabled branches/ extension counters could also be opened in regulated agriculture markets, warehouses and cold storages for the benefit of farmers.   The need to reopen the issue of local area banks (LABs) has also found favour with Rangarajan (ibid.).  

In order to promote financial inclusion in the remote unbanked/ underbanked areas of the country, and to make the BCs function more effectively, the RBI has advised scheduled commercial banks (including RRBs) and LABs to open low cost intermediate brick and mortar structures viz.  Ultra Small Branches (USBs) between the present base branches and BC locations, so as to provide support to 8-10 BC units at a reasonable distance of 3-4 km.  These USBs should have minimum infrastructure such as CBS terminal linked to passbook printer and a safe for cash retention for operating large customer transaction, and should be managed by bank officers/ employees. These USBs should lead to efficiency in cash management, documentation, redressal of customer grievances and close supervision of BC operations.

Financial inclusion policy should also involve strengthening of Rural Financial Institutions (RFIs), viz. RRBs and cooperative credit institutions through recapitalization and the creation of IT infrastructure, viz. CBS. With a view to furthering the cause of financial inclusion, NABARD has decided to offer support to cooperative banks in CBS. Commercial banks and more recently RRBs have moved ahead by leveraging technology to enhance their operations.

New Banking Licences

The RBI issued draft guidelines for licensing of New Banks in the Private Sector on 29 August 2011 (RBI, 2011a). The guidelines underscore the need to promote financial inclusion as follows:

a)     The bank should operate on Core Banking Solution (CBS) from the beginning.

b)     The bank shall comply with the priority sector lending targets and sub-targets as applicable to other domestic banks, and  at least 25 per cent of its branches in unbanked rural centres (population up to 9,999 as per 2001 census) to avoid over concentration of their branches in metropolitan areas and cities which are already having adequate banking presence.

c)     The RBI will consider allowing the new bank to take over and convert the existing NBFC branches into bank branches only in the Tier 3 to 6 centres.

d)     Existing branches of the NBFC in Tier 1 and 2 centres may be allowed to convert into bank branches only with the prior approval of RBI and subject to the existing rules / methodology applicable to domestic banks regarding opening of branches in these centres and also subject to maintaining 25% of the bank branches in unbanked rural centres (population up to 9,999 as per 2001 census). 

RBI has advised commercial banks that while preparing their Annual Branch Expansion Plan (ABEP), they should allocate at least 25 per cent of the total number of branches proposed to be opened during the year in unbanked rural centres (RBI, 2012).

4. Profitably Capturing Rural Business Opportunities

Banks need to provide a simplified, as well as fully loaded banking experience, while reducing costs and achieving increased profit.  Further, access to financial services should empower the rural poor to take up income generating activities, which could raise their living standards and in the process develop long term partnership with banks. It is being increasingly realised that financial inclusion is not about social banking without profitability concerns, but that it could well be a profitable business proposition for banks. The delivery models should aim at generating revenue rather than being cost centric such that customers get quality banking services at their door step while simultaneously creating business opportunities for the banks (RBI, 2011).

SHG-Bank Linkage Programme (SHG-BLP)

The SHG-Bank Linkage Programme (SHG-BLP), over the past twenty years has become the common vehicle in the development process, converging important development programmes. From the viewpoint of bankers the SHG-BLP has proved to be a cost effective business proposition. Further, the average recovery of loans disbursed to SHGs has been found to be around 90-95 per cent. The programme had resulted in 74.6 lakh saving-linked SHGs and 47.9 lakh credit-linked SHGs as on 31 March 2011 (NABARD, 2011). Overall, 53.4 per cent of total rural households are members of SHG-BLP. Therefore, there is a need for a massive upscaling of SHG-BLP, as it would not only spread the benefits of financial inclusion to a vast majority of the poor and the financially excluded, but would also provide banks with a cost effective business model.

SHG-BLP 2

The implementation of the SHG-BLP during the past two decades has demonstrated that it is an innovative and cost-effective business model for banks. It promotes empowerment of rural poor, especially women, by enabling them to develop habits of thrift and prudent financial management by availing micro-credit, and managing micro-enterprises. However, while there are noteworthy accomplishments, there are certain issues which continue to affect the programme, viz. (a) inadequate outreach in many regions, (b) delays in opening of SHG accounts and disbursement of loans, (c) impounding of savings by banks as collateral, (d) non-approval of repeat loans even when the first loans were repaid promptly, and (e) multiple membership and borrowings by SHG members within and outside SHGs and limited banker interface and monitoring. Accordingly NABARD has issued guidelines with a view to encourage banks to take the SHG-BLP to a higher trajectory, which could prove to be a more profitable and sustainable business opportunity. The SHG-BLP2 is a new business model which would include the following components: (a) for mature SHGs that have been supported with a few cycles of credit, the requirement of credit for purchase of capital assets, etc would increase, and hence, banks could approve term loans to these groups in addition to the cash credit limit; (b) in case of few members of an SHG graduating faster to start or expand economic activities requiring much higher levels of loans than required by other SHG members (who may not be willing to stand guarantee for larger sized loans), banks may encourage them to create enterprise/ livelihood based JLGs, within the SHG, and provide them appropriate amount of loan; (c) in order to further strengthen the banker’s comfort and confidence in financing of SHGs, a few risk mitigation mechanisms, viz; self-rating tools by SHGs, conduct of audits at SHG level, etc are recommended; (d) considering the growth in SHG financing already achieved as well as the future potential, it is essential that SHG and JLG financing finds an appropriate place in the bank’s corporate and strategic plans; (e) financing banks should also strengthen their monitoring of SHGs and capture SHG data through their CBS platforms.

Financing Joint Liability Groups (JLG)

The Rangarajan Committee (Government of India, 2008) had recommended that adoption of the (Joint Liability Group(JLG) concept could be another effective method for purveying credit to mid-segment clients such as small farmers, marginal farmers, tenant farmers, etc. and thereby reduce their dependence on informal sources of credit. Studies conducted by NABARD, have shown that financing of JLGs is a good business proposition. NABARD has issued comprehensive guidelines on JLGs to Banks focusing on small and marginal farmers, oral lessees, tenant farmers engaged in farm sector and other clients under non-farm activities.

Mainstreaming Business Correspondent (BC) Model

It has been widely recognized that it is not feasible to have physical banking facility in every habitation. Hence, the financial inclusion strategy largely focuses on the use of information and communication technology (ICT) to expand access to banking facilities through Business Correspondent (BC), who carries a hand-held device which is networked to the bank’s systems.  The number of BCs in the country has increased steadily from 33,042 as on 31 March 2010 to 95,767 as on 31 March 2012[3]. However, in order to achieve 100 per cent financial inclusion, there is a need to mainstream the BC model by banks, by utilising the services of SHGs, NGOs, Farmers Clubs, Post Offices, PACS, retired school teachers, and other suitable persons and agencies.  There are 1,39,182 Post Offices in rural India, and they are in closest proximity (2 km on an average) to rural clients compared to branches of commercial banks, RRBs and cooperatives (5km on an average). Thus Post Offices functioning as BCs, could lead to a massive expansion in the outreach of banks.

Financing Infrastructure through Groups/ Federations

Infrastructure requirements as identified and prioritized in the Potential Linked Credit Plans (PLPs) prepared by NABARD at the district level could help State Governments in identifying rural infrastructure projects, and enable banks to ensure credit support to farmers and rural entrepreneurs in the project areas.  Completed projects under Rural Infrastructure Development Fund (RIDF) have led to the realisation of economic and social benefits in terms of creation of additional irrigation potential; generation of additional employment for the rural people; contribution to the economic wealth of the country; all weather connectivity to villages and marketing centres; and improvements in quality of life through better facilities in education, health and drinking water supply. Such infrastructure facilities promise to generate income and employment, improve the accessibility of the rural poor to banks, and also improve their savings habit and credit absorption capacity.

Banks could finance infrastructure projects like godowns, cold storage, minor irrigation, bulk milk coolers, refrigerated vans, food and agro-processing units etc., to producers’ organizations, Farmers Clubs, Farmers Club Federations, milk producing societies, and SHGs/ SHG Federations.  These could prove to be profitable business opportunities for banks, because financing SHGs/ producers’ organizations/ Farmers Club federations, instead of individuals, reduces transaction costs. Further, group dynamics promotes sound financial management and also enables better management of assets created out of institutional credit.

5. Technological Innovations for Cost Effective and Profitable Rural Banking

 Financial inclusion could be a cost-effective and profitable business proposition if appropriate low-cost technology is adopted by commercial banks and rural financial institutions.  Such technology should be able to reduce transaction costs of providing banking services in the rural, unbanked and backward areas of the country.  This would also increase the outreach of banks, thereby enabling them to expand their business. In this context, there is a need for banking service providers to enter into passive infrastructure sharing arrangements. Technology-enabled projects, viz. the Unique Identification Number (UID) project, CBS in RRBs and cooperative credit institutions, mobile banking, hand-held devices, smart cards, bio-metric cards, tech-savvy BCs, routing of payment under government sponsored schemes like MGNREGA, through banks, have the ability to catapult financial inclusion into mainstream banking business.

There is a greater concentration of ATMs in urban and metropolitan areas than in rural areas. However, the number and percentage of ATMs in rural areas has been on a steady rise in recent years. ATMs in rural areas in 2010-11 accounted for an increase of 37.7 per cent over the previous year. But while only 9.6 per cent of the total ATMs were located in rural areas, as on 31 March 2012, semi-urban, urban, and metropolitan centres accounted for 24.3 per cent, 32.3 per cent and 33.8 per cent, respectively (RBI, 2011). The share of the North Eastern region at 2.1 per cent was the lowest in the incremental deployment of ATMs in 2010-11, followed by the Eastern (11.6 per cent) and Central (14.3 per cent) regions, respectively (ibid.). Thus, there is an urgent need to expand ATM network in the rural areas and the financially excluded regions of the country.

KCC aims at providing adequate and timely support from the banking system to the farmers for their short term credit needs. Banks need to convert KCC and General Credit Cards (GCC) to electronic credit cards, which could enable farmers to withdraw cash from ATMs anywhere in the country. Banks may consider issuing multipurpose cards which could function as Debit Cards, KCC, and GCC, as per customer’s needs. Any other financial services/ products could also be embedded in the multipurpose card. The RBI has advised banks to consider introduction of a GCC facility up to INR 25,000 at their rural and semi-urban braches. The objective of the scheme is to provide hassle free credit to banks’ customers based on the assessment of cash flow without insistence on security, purpose or end-use of the credit.

In 2011-12 NABARD initiated a pilot project linking KCC to a farmer’s mobile phone, which significantly reduces transaction costs. However, as every farmer does not have a mobile phone, NABARD has initiated a programme of linking KCC account to the biometric authentication of Aadhaar or NPR so that the KCC account holder is able to transact business almost anywhere.

There were 323.27 million mobile subscribers in Rural India, as on 31 March 2012 (TRAI, 2012). Thus, mobile phones could be a major instrument for rapid upscaling of financial inclusion. RBI’s operative guidelines on Mobile Banking issued in October 2008 were reviewed and relaxed in December 2009 by enhancing the limits for mobile banking transactions up to INR 50,000 for both e-commerce and money transfer transactions, and permitting the money transfer facility up to INR 5,000 from a bank account to beneficiaries not having a bank account (RBI, 2010). Mobile banking presents banks with the lowest per-transaction cost. Further, value added services like fund transfer, payment of telephone/ electricity bills and pre-paid mobile recharge could be enabled. The National Payments Corporation of India (NPCI) is looking to bring mobile-banking systems of different banks on to a common platform, which will enable money to be transferred from one bank to another via the mobile. However, mobile payments system is limited to a small segment of customers with high-end mobile phones.  In this context, Mittal (2012) has suggested that an easy-to-use technology needs to be ushered in which can be configured in low-end handsets. This could benefit rural customers the most.

ICT-enabled Mobile Banking Vans (MBV) could provide efficient and cost-effective banking services in the unbanked and remotest corners of the country. The MBVs units have CBS connectivity to provide all banking services, including deposit and withdrawal of money. The model has already been successfully tested by Bank of Baroda in Gujarat and Bihar. 

6. Conclusion

The economic backwardness of the rural economy offers enormous challenges and opportunities to the banking sector to play a catalytic role in rural development by providing affordable banking services to the remotest corners of the country, in a cost-effective and profitable manner. Creation of rural infrastructure, focus on financial inclusion, and adoption of various innovative and profitable rural business models through the use of IT infrastructure, by banks, promises to usher in rural prosperity in the near future.

References

Government of India (2008) Report of the Committee on Financial Inclusion, Chairman: C Rangarajan. www.nabard.org

Mittal, Sunil Bharti (2012), Transformational Hybrid: Mobile Banking in Naina Lal Kidwai (Ed.) Contemporary Banking in India, Businessworld Books.

NABARD (2011),  Status of Microfinance in India 2010-11.

Rangarajan, C (2012), The Indian Banking System: Challenges Ahead in Naina Lal Kidwai (Ed.) Contemporary Banking in India, Businessworld Books.

Subbarao, D (2012), Agriculture Credit - Accomplishments and Challenges, Speech by Dr D Subbarao, Governor, RBI , at the 30^th Anniversary Celebration of NABARD at Mumbai on 12^th July 2012. www.nabard.org  

Reserve Bank of India (2011), Report on Trend and Progress of Banking in India 2010-11

____________________ (2011a), Draft Guidelines for Licensing of New Banks in the Private Sector, August 29, 2011.

__________________ (2012), Annual Report 2011-12.

Telecom Regulatory Authority of India (TRAI) (2012), Indian Telecom Services Performance Indicators, January-March 2012, New Delhi

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[1] Source: Report on Trend and Progress of Banking in India, RBI (various issues)

[2] Source: Handbook of Statistics on the Indian Economy 2011-12, RBI.

[3] Table IV.6 Annual Report 2011-12, Reserve Bank of India.

(This paper was published in BANCON 2012 Compendium, released during Bankers' Conference (BANCON) 2012 - November 24-25, 2012, Pune, organised by Indian Banks' Association (IBA) & Bank of Maharashtra)