The inclusion project

A little more than a week ago, World Bank chief Jim Yong Kim praised Prime Minister Narendra Modi for launching the Pradhan Mantri Jan-Dhan Yojana (PMJDY), which he called an “extraordinary effort” at financial inclusion. According to the Union finance ministry, India has attained 99 per cent financial inclusion, measured as households’ access to bank accounts. Within three months of launching the PMJDY, the government entered the Guinness Book for opening the largest number of bank accounts in the shortest time. This is a remarkable achievement. In the past, state policies of financial inclusion overwhelmingly relied on extending credit to poor households through subsidised schemes like the Integrated Rural Development Programme or self-help groups (SHGs) and no-frills bank accounts.

Private-sector initiatives, such as microfinance, also showed the limits within which lenders functioned. Unless financial instruments are designed for specific needs of the poor, they remain underutilised and costly for the providers and are, therefore, non-sustainable.

The PMJDY accelerated the RBI’s previous efforts at promoting financial inclusion by opening bank accounts. This scheme received strong support from public- and private-sector commercial banks. With the provision of insurance and transfer facilities, along with overdraft facilities, under the PMJDY, there is a clear focus on expanding the portfolio of financial instruments available to all households. The RBI, too, renewed its inclusion mandate by issuing two new bank licences and rules for setting up small banks and payment banks.

Small banks will provide deposits and loans, geared towards under-served segments. Payment banks will offer a limited set of products, mainly demand deposits, remittances and transfers, but not credit. These recent measures have provided a much-needed push for financial inclusion. However, there remain some key gaps.

Post offices currently offer few financial services. But these can be augmented. Our analysis of a recent geospatial survey of financial service providers in Uttar Pradesh and Bihar shows that households have the best access to post offices, measured in distance. On average, households are 2 km from the nearest post office, while the distance to the nearest ATM is three times as much. The nearest microfinance institution (MFI) is more than 15 times the distance. Financial inclusion strategies should leverage the already existing and extensive postal network, especially since the original mandate of the postal department has weakened.

Another widespread network is that of registered chit funds. But these have so far been excluded from the formal financial sector.

Research shows that chit funds are universal, with the appeal of a bottom-up approach to financial inclusion. In most parts of India, large groups participate in different forms of savings-credit arrangements with each other. Under a chit fund scheme, a group of individuals comes together to pool money and, at the end of each specified period, this collection is loaned to individuals within that group. This is an efficient circulation of money and also serves as an insurance option in financial duress.

Chit funds are similar to rotating savings and credit associations. India formally institutionalised chit funds through the Chit Fund Act, 1982. It is now well established that chit funds cater to segments not served by either MFIs or banks. They have tremendous potential to promote entrepreneurship at low-income levels. They must be part of the national financial inclusion strategy. People must be educated about the difference between chit funds and other deposit-taking companies like collective investment schemes, multilevel marketing companies and prize chits. A critical move would be to initiate amendment of the Chit Fund Act, making it less onerous and more user-friendly, thereby encouraging the unregistered sector to fall in line.

The financial portfolios of poor households are as diverse as those of the richest, with an average of 10 financial instruments per household. But the formally offered products are limited. The instruments provided and facilitated by the financial sector must be designed to meet the specific needs of the market segment. The success of Bank Rakyat Indonesia (BRI) has several lessons for India. The BRI provides commercially viable financial services loans and savings along with other financial products to poor households. It built a customer base of 30 million depositors through tailoring products and services, incentivising people to better utilise their savings accounts. BRI accounts are structured to encourage more savings than loans. Also, each bank unit (branch) functions as an independent entity with its own targets. There are discussions of bank reforms in China along the BRI model.

Financial safety nets can only be met through well-designed and easy-to-understand insurance products, including health, life, property, crop and other instruments meant to mitigate shocks. Research indicates that though the access to credit and savings instruments serves as an insurance mechanism, these are expensive in comparison to formal insurance. The PMJDY provides some insurance, but is limited to accident and life. The Rashtriya Swasthya Bima Yojana (RSBY) aims to provide health insurance coverage to all BPL families, and more than 37 million families have been enrolled. It remains to be seen whether this is an effective tool to protect poor households from health shocks. Previous research shows that a limited understanding of health insurance results in a significantly lower claims-to-coverage ratio for the low-income segment.

The Agriculture Insurance Company was set up in 2002 for insurance coverage to farmers. It has rolled out three schemes. Given that crop insurance has suffered financially globally, it might be worth taking stock of India’s performance. Also, insurance cover to the rural poor has to extend beyond crops to livestock, property and weather insurance.

Technology must be leveraged to lower the operating costs of small-ticket instruments that are more expensive. Institutions should have the autonomy to experiment with management practices and financial products. Technological options have widened with India’s booming telecom sector. In Kenya, M-Pesa is a gamechanger and its businesses rests solely on transactions via the mobile phone.

Raising awareness and imparting financial literacy are critical for the utilisation of financial instruments and for better financial decision-making. Awareness about financial risks can prevent people from investing in dubious schemes. Such schemes are particularly rampant amongst vulnerable sections, as recent scams such as Saradha (which is not a chit fund) have highlighted.