Revisiting the Effectiveness of Financial Inclusion

In response to the Reserve Bank of India’s (RBI) call for financial inclusion – defined here as the “delivery of banking services at an affordable cost to sections of disadvantaged and low-income groups” – several banks launched “no frills” bank accounts, or “nil or low balance account[s] with charges that make [them] accessible to vast sections of the population.” These initiatives, however, have faced significant limitations in rural areas, namely due to two reasons:

There are two obstacles to greater financial inclusion. The first is simply commercial. Transaction costs for both banks and clients remain high, particularly in disbursing credit, which is essentially a high cost, distributed business. Further, interest rates remain high in the absence of structured credit assessments. The second obstacle is policy requirements such as know your customer (KYC) procedures that limit the geographical reach of financial services beyond physical bank branches. 

In response to these limitations, the RBI has established an independent external agency in order to evaluate the progress of financial inclusion in certain districts. According to the Business-Standard, the process will function in the following manner:

The State Level Bankers’ Committee (SLBC) will identify one district in each state for 100 per cent financial inclusion. He [RBI Deputy Governor V. Leeladhar] added that to bring more such districts under financial inclusion, RBI has asked banks to introduce more no-frill accounts and general purpose credit cards (GPCCs) with limits of up to Rs 25,000 in rural and semi-urban branches.

More after the jump.

The India Development Blog, however, reminds us of the limitations of the Committee’s recommendations for the introduction of more no frill bank accounts:

Our own research in Karnataka by CMF RA Minakshi Ramji, a summary of which was published in the RBI’s journal CAB Calling and presented at the RBI’s College of Agricultural Banking a couple of months ago, revealed that the BPL holders of “no-frills” savings accounts created during the financial inclusion drive there rarely used their accounts. Many weren’t even aware that they had accounts. This wasn’t the banks’ fault: frills or no-frills, it just doesn’t make sense for someone from a BPL household to spend 20 – 40 rs traveling to a bank branch in order to deposit 30 rs.

The solution remains unclear. However, the need for an evaluation of the approach, particularly with respect to its impact on the grassroots level, is critical.