Articles

India’s Banking Challenge: Finclusion

By: Aritro Datta

Financial crises in the last couple of decades have engendered the need for scientific research of the factors causing them in the modern economy while also making investigation of main economic indicators, the institutional environment and financial sector interrelation, the pivotal areas for economists to focus upon.

In effect, it is the activity of the banking system that catalyses the general development of any nation’s economy. By being an integral part of market infrastructure, the banking system is in a bilateral connection with the real sector.

In India’s context, we are still tackling a diverse set of challenges facing the banking industry, particularly, when it comes to penetration or the reach of banking services. The majority of financial sector research is focused on the investigation of financial development and economic growth interrelation according to the usage of various econometric methods.

Empirical research assumes and proves the existence of such interrelation, but the analysis often mentions only dependence on GDP. Thus, in this study, various variables and other factors are looked at to highlight the theme of financial inclusion and the role of the banking and financial sector in achieving it.

The Disparity Conundrum

Despite being the world’s largest democracy, the fifth-largest nation in terms of gross domestic product(third in terms of purchasing power parity) and a nation who has been consistently one of the fastest-growing developing economies over the past few decades, India has close to a third of the population living below the poverty line.

What is more astonishing is that only 40 percent of the Indian households have bank accounts, and this inequity in access deteriorates in rural areas with only 38 percent of the 117,200 branches of scheduled commercial banks operating in these areas.

Let us now find out how the statistics presented above are inter-related.

Rise of Banking in India

Banking in India began in the 1770s with the opening up of the Bank of Hindustan and the General Bank of India, both of which failed to sustain for long enough. Fast forward a few hundred years, India now has a total of 34 banks. If systematically important NBFCs and online payment banks are included, the number stands at 218.

India today has the highest number of commercial banks in the world with an almost slight skewed distribution towards urban areas over rural ones. But because more than 70% of India lives in rural areas, the number of branches in rural India falls way more than short.

To add to the woes of the banks and policy makers, it was found that around 52% of respondents wanted to keep their savings at home rather than a bank as per a survey by NABARD. So, the question at hands needs a solution that is directed at increasing penetration while at the same time tackling the predicament of influencing consumer behaviour as a significant number of them believe that they can’t trust the bank with their money.

As stated above, simple metrics like the number of banks or the number of accounts is never a true reality of the financial condition of a nation. For a country like India, where the majority of the people are either uneducated or struggle to earn two square meals a day, it is indeed a monumental task to carry out the duty of financial inclusion.

So far, we have so established the fact that the banking sector holds a major
role in the task of financial inclusion. Before we understand how the banking sector can play a part in ameliorating the status quo, let us understand how financial inclusion can affect the economic condition of the country.

Breaking down the numbers

A statistical analysis was conducted by CRISIL to understand the interplay between various variables that weigh in while assessing the economic condition of the country.

In this study, the CRISIL index named ‘CRISIL Inclusix score’ is used to perform statistical analysis. CRISIL index (from here on referred to as ‘Inclusix’) is a score assigned to each of the states, basically, an index to “Measure India’s progress on financial inclusion” based on the following parameters:

i.   Number of branches per lakh of population in a state

ii.  Number of loan accounts per lakh of population in a state

iii. Number of small borrower loan (credit limit of up to Rs.2 lakh) accounts as     defined by RBI per lakh of population in a state


iv. Number of agricultural advances per lakh of population in a state

v.  Number of savings accounts per lakh of population in a state

The following table summarises the correlation study of the CRISIL Scores for India and various factors that affect the financial inclusivity of India.

We can very well establish the factors on which the banking sector works to play an important role in the task of financial inclusion and economic growth. We must also understand that the list is not exhaustive and there exist various other factors apart from the ones stated above. Factors such as demographic description, political situation, social circumstances among many others also affect the financial condition of the nation.

A Deep dive into the factors

In this section, we shall look at the two of the main factors stated above, how they can affect the economy and what role the banking industry plays in it.

Poverty Rate
As has been stated in the earlier analysis, the poverty rate in India plays a major role in the context of financial inclusion and development. As one can see figure below, the issue of poverty is not limited to any region of any state. Poverty has been a war India has been fighting since the time of its Independence.

When it comes to eradication of poverty the RBI has a major role to play. In the past, it has directed the banking institutions to provide loans on concessional terms to certain sectors. RBI has contributed to Long-Term Operations funds to finance industrial or agricultural development through the IDBI, NABARD, Small
Industries Development Bank of India and so on, again, on concessional terms. In recent times, given the increasing inequalities among States in the rate of growth in the reform period, a question arises whether poverty reduction has taken place mainly in those states which have demonstrated significant progress in reform and consequently these states have simultaneously registered impressive improvements in the growth of GSDP.

Some fast-growing States especially in Southern and Western parts of India appear to have recorded a decline in poverty, while some others, especially in North India where GSDP growth is lagging do not appear to show a reduction in poverty. Thus, State-level analysis deserves to be looked into carefully before concluding that reforms have failed to reduce poverty or that the assumption of ‘trickle-down’ has been invalidated.

Per capita Income

If you go back 30 years, India and China were roughly at par, whether you compare by per capita income in terms of PPP [purchasing power parity] or by current
market prices. Starting in 1990, China zoomed whereas India just lumbered along.

Today, China’s GDP is five times that of India and their per capita income is nearly five times India’s figures. China fears that it will get locked into a middle-income trap. India fears that it will get locked into a low-income trap.

Why this humongous difference in their growth trajectory you ask?

Growth in both India and China was driven by investment. India’s per capita income increased at only around 1% annualized rate in the three decades after its independence. Since the mid-1980s, India has slowly opened up its markets through economic liberalization losing out on decades of development during this period.  After more fundamental reforms since 1991 and their renewal in the 2000s, India has progressed towards a free market economy. Though India’s per capita income has been increasing the rate of increase has decreased over the years.


The Gini coefficient measures the income-equality as shown in Graph 6 India still falls behind most of the developed and developing economies. (Gini score of 0 refers to complete income equality)

The Future Ahead

As the Indian case has illustrated, the central bank and government have been taking measures, as part of their normal policies, to ensure the availability of financial services for all segments of the population. Developing countries have been promoting microfinance, which has been recognized as a form of financial inclusion.

Financial inclusion or Finclusion, along with financial stability, has become the joint responsibility of central banks and governments. However, developing and emerging market economies are factoring in on innovation with more and more startups focussing their efforts to solve problems in this space.
It is through adopting best practises and promoting innovation that we can achieve our stated objectives for Finclusion.

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