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Financial inclusion: An enabling environment for economic development It is being increasingly realised that the trickle-down effect is not automatic and in deeply unequal societies, such as India, has to be facilitated by policy. For the Commonwealth and others, inclusive growth is seen as essential for social and economic development, and financial inclusion (FI) is perceived as an integral part of this. This article seeks to look at the Indian experience of financial inclusion and analyses the approaches from the perspective of the role of the state, regulators, banks and non-governmental organisations (NGOs). Lessons are then drawn from each of these perspectives. Briefly put, the Indian experience shows that the right kind of partnerships between the state, regulator, financial sector and NGOs – in a variety of approaches – can be successful in achieving greater financial inclusion. It also shows that political attitudes towards interest rates can be counterproductive and may deter the emergence of a sustainable business model. The role of the state From nationalisation to ‘priority sector’ credit Financial inclusion is a buzzword that is now a part of the global vocabulary in development. Even though the term FI only entered the Indian lexicon in 2004–05, the country has a long history of implementing policies that extend formal financial services to marginalised populations and areas of the country. The Indian experience in the immediate post-independence decades shows that state ownership and control of banks1 resulted in the spread of banking into remote areas2 with the outcome that banking coverage is now significantly more sophisticated than in other similar countries. Further, governments at the centre and state level have adopted policies to transfer all welfare and other benefits to the citizens through bank accounts (direct benefit transfers). This has given a huge push to FI and has brought greater transparency to the system. It has provided banks with a revenue source that can justify the investments they need to make payments infrastructure available to all the beneficiaries of government schemes and welfare payments. It has also minimised leakages and fraud. However, financial exclusion in the country continues to be quite high. This suggests that state control of banking does not automatically achieve financial inclusion, rather, that in the absence of the state, ownership exclusion is likely to be higher. As per extant public policy, all banks in India, whether in the public3 or private sector, have to ensure that 40 per cent of their loans are made to priority sectors, including agriculture, small industry and small business, smaller housing and education. Of this 40 per cent, ten per cent of total loans have to be made to the weaker sections within these priority sectors. Foreign banks are required to loan 30 Commonwealth Governance 86 Handbook 2014/15 per cent and, in their case, export credit is counted as a priority sector. These prescriptions have been in force since the early 1970s – initially, the amount required was one-third, but this rose to 40 per cent in 1985. The mandating of credit for priority sectors has had the beneficial result of ensuring adequate credit to agriculture, small housing and education. In the case of the small industry and small business sectors, however, the impact on exclusion is not significant and a large share of the borrowing of this sector is still from informal sources. Within priority sectors, there is preference towards larger ticket loans to minimise transaction cost. The lesson here is that, although priority sector lending rules can have a positive impact on access to finance for some sectors, mandated lending is not sufficient to ensure adequate finance for the small industry and small business sectors. Further, cases of misclassification in the country are prevalent as banks try and avoid the penal provisions for not achieving the mandated requirement. A subset of schemes, including credit-linked subsidy poverty alleviation, in which public sector banks provide the loans and the governments provide capital subsidy to improve the bankability, are also present in India. It was found that, while such schemes may yield some positive outcomes, they tend to suffer from similar defects, partly due to political patronage and misdirection of subsidy. As such, it was concluded that integrated area planning often lacks proper implementation and subsidy schemes linked to individual loans are often miss-allocated and misused. Credit guarantee schemes Initially, India’s central bank, the Reserve Bank of India (RBI), administered a credit guarantee scheme through one of its subsidiaries giving partial but significant guarantee cover against credit default in the small-scale industrial, professional, selfemployed and small business sectors. The scheme was not sustainable and had to be wound down. After some years another credit guarantee scheme for the small-scale industry and services sector was started by the government to encourage banks to make collateral-free loans. So far the scheme has been successful in encouraging collateral-free lending to the small industry and services sectors, but it is too early to comment on its sustainability. The role of the regulator Branch licensing policy Under the banking law in India, banks require the specific approval of the regulator to open branches. This regulation has been used as an instrument of FI in India. For many years the policy required Usha Thorat


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