Role Of Financial Institutions In Financial Inclusion

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October, 2010Issue : 4DIGESTRole ofFinancial Institutionsin Financial Inclusion

CONTENTSARTICLES1. The Case for Small Banks.01Ms. Bindu Ananth, President, IFMR TrustMr. Suyash Rai, Finance Foundation, IFMR Trust2. Role of Financial Institutions in Financial Inclusion.05Mr. Joseph Massey, MD & CEO, MCX Stock Exchange3. Role of Financial Institutions in Financial Inclusion.10Ms. Jayshree Ashwinkumar Vyas, Managing Director, SEWA Bank4. Financial Inclusion: The Way Forward .12Mr. N K Maini, Deputy Managing Director, SIDBI5. Financial Inclusion: Innovative Approaches .19Mr. M V Nair, Chairman and Managing Director, Union Bank of India6. INDIAN ECONOMY-AN UPDATE .247. POLICY UPDATES .27lBanking sectorlCapital Markets sectorlInsurance sector8. SURVEYS. 29lFICCI Economic Outlook Survey October 20109. SYNOPSIS OF PAST EVENTS. 32lConference on “Global Banking: Paradigm Shift”Theme: “Banking 2020: Making the decade's promise come true”lFICCI's Seminar on Pension: “New Pension Scheme: - Prospects and Challenges”9th November 2010, Hotel Taj President, Mumbai10.FUTURE EVENTS . 34lInteractive Session with Mr. Dominique Strauss-Kahn Managing Director,IMF December 2, 2010, FICCI Federation House, New DelhilFICCI - UNDP - Sa-Dhan Seminar on “Role of Bankers in Financial Inclusion”December 16th, 2010, FICCI, Federation House, New DelhilFICCI - SA-DHAN National Microfinance Conference, Jan 20th-21st,Hotel Ashok, New Delhi 2011lSeminar on IFRS: New Delhi

DISCLAIMERAll rights reserved. The content of this publication may not be reproduced in whole or in part without the consent of the publisher.The publication does not verify any claim or other information in any advertisement and is not responsible for product claim & representation.Articles in the publication represent personal views of the distinguished authors. FICCI does not accept any claim for any view mentionedin the articles.

ABOUT FICCIEstablished in 1927, FICCI is the largest and oldest apex business organisation in India. Itshistory is closely interwoven with India's struggle for independence and its subsequentemergence as one of the most rapidly growing economies globally. FICCI plays a leading rolein policy debates that are at the forefront of social, economic and political change. Throughits 400 professionals, FICCI is active in 39 sectors of the economy. FICCI's stand on policyissues is sought out by think tanks, governments and academia. Its publications are widelyread for their in-depth research and policy prescriptions. FICCI has joint business councilswith 79 countries around the world.A non-government, not-for-profit organisation, FICCI is the voice of India's business andindustry. FICCI has direct membership from the private as well as public sectors, includingSMEs and MNCs, and an indirect membership of over 83,000 companies from regionalchambers of commerce.FICCI works closely with the government on policy issues, enhancing efficiency,competitiveness and expanding business opportunities for industry through a range ofspecialised services and global linkages. It also provides a platform for sector specificconsensus building and networking.Partnerships with countries across the world carry forward our initiatives in inclusivedevelopment, which encompass health, education, livelihood, governance, skilldevelopment, etc. FICCI serves as the first port of call for Indian industry and theinternational business community.

PREFACEAs we release the fourth issue of our widely acclaimed bi-monthlydigest, it gives me immense pleasure to learn that since its inception inApril 2010, in a short span of time, FICCI's 'Banking and Finance Digest'has gone a long way, in facilitating a comprehensive forum to promoteactive debate and raise pertinent issues that concern the who's who ofthe entire BFSI sector in the country. I am hopeful that this Digest willfurther cement FICCI's fundamental role in guiding the course of actionand recommending course correction for our stakeholders.FICCI's extensive network of Industry members has given an overwhelming response to ourprevious issue 'Indian Financial Markets-2020'. Through the candid opinions of the gurus ofthe financial world, the last issue endeavoured to track the growth trajectory of the financialmarkets over the next decade and identify the roadblocks that could impede the growth ofIndian economy in general and the Indian Financial sector in specific.One of the major issues facing our economy today is that of promoting “Inclusive growth”.Majority of the Indian population has remained financially excluded either because of poorpenetration of the financial services available or because of the dire state of financialliteracy in the country. Although the poor have received some relief, through centre/statefunded anti poverty schemes in the form of cash handouts and bailouts, the very concept of“inclusive growth” is still without a realistic pathway.In this regard, the current issue of our journal aims to bring to the forefront perspectives ofexperts from India Inc. and financial sector intermediaries on 'Role of Financial Institutionsin Financial Inclusion'. Financial Institutions along with the government as a facilitator of anenabling environment for growth can play a larger role in fostering the process of financialinclusion and ensuring sustainable sources of livelihood and raising the standards of living ofthe poor.We thank our partners MCX Stock Exchange for extending their support to help achieve ourendeavour.We do look forward to views and suggestion from the readers to help us improvise thecontent of the journal and make it more relevant and informative.Dr Amit MitraSecretary-GeneralFICCI

ARTICLESThe Case forSmall BanksMs. Bindu Ananth, President, IFMR TrustMr. Suyash Rai, Finance Foundation, IFMR TrustIn what could become a welcometrend, the RBI has started puttingout detailed discussion notes onfuture policy steps. Recently, thecentral bank released a discussionpaper presenting the pros and cons ofvarious approaches to new bank1licenses . Though the paper doesn'tclearly favour any particular structure,it does seem to be tilting towards oraway from certain possibilities. Onepossibility that the paper seems to bealmost squarely opposed to is ofallowing more small, local area banksto be set up in the country. The paperlays out some arguments opposingthe idea of small banks, and citesexperience with small banks like localarea banks and urban cooperativebanks to make a case against them.As far as performace of local areabanks is concerned, the record initself doesn't prove that the small1banks don't stand a chance. TheIndian experience with small bankshas been a mixed one, and there areexamples of well performing banks inalmost every category of small banks(local area banks, district creditcooperative banks, urbancooperative banks, etc), as there areof non-performing ones. This is truefor big banks as well. This process isinherent to the process ofdevelopment of institution-types,and the key is to ensure learning andapplication of "design principles"that make banks successful, ratherthan writing off entire categories ofinstitutions. If there are indeedinherent weaknesses in the model,which are unmanageable, then themodel should very well be discarded.If there are advantages in the model,and weaknesses that can bemanaged by some structuralinnovations, then there is no realneed to discard the small banksmodel itself.Before we consider the challenges tostability and continuity of smallbanks, and ways of managing thesechallenges, the key question to ask is:what really are the advantages ofsmall, local banks? Interestingly, theThe paper is available at: pdfFICCI's Banking & Finance Journal 01

ARTICLESRBI paper cites financial inclusion(i.e. expanding access to financialservices) as the main objective forproviding more bank licenses. Let'sstay with this objective. Firstly, smallbanks have proven advantages inprocessing "soft" information, whichis crucial for lending. ProfessorJeremy Stein of Harvard Universityhas argued that such institutions arelikely to be more successful wheninformation is "soft" and cannot becredibly transmitted. In contrast,large hierarchies perform betterwhen information can be costlessly2"hardened" and passed along . Thereis documented tendency for bankmergers to lead to declines in smallbusiness lending. Studying theempirical evidence on large/multinational banks, Professor Atif Mian ofUniversity of California, Berkeley,shows that greater cultural andgeographical distance between aforeign bank's head quarter and thelocal branches, leads it to furtheravoid lending to "informationallydifficult" yet fundamentally soundfirms requiring relational3contracting . Greater distance alsomakes them less likely to bilaterallyrenegotiate, and less successful atrecovering defaults. Thesmall/domestic banks have beenshown to have more smaller/local(profitable) clients. Such differencescan be economically large enough topermanently exclude certain sectors23of the economy from financing bysuch large banks.This ability to process soft, localinformation is particularly crucial inIndia, where "hard" information(credit history etc) about a vastmajority of people is not readilyavailable. In other words, the mainway for banks to know about mostclients in India is to access andprocess local knowledge, mostlycaptured through local presence, andsmall banks have proven to be muchbetter at doing this. Big banks tend toskim the surface, where small bankscan and usually do go deeper andpossibilities are limited, it has greaterprovide services to many more.incentives to try harder to growComplete financial inclusion meansvertically, by serving more people inproviding financial services in a highthe geography and providing morequality, so that people use theservices to the same clients,services actively. Quality can beenhancing the financial inclusionunderstood in terms of theagenda.convenience, flexibility and reliabilityof these services, which are universal Now, let's discuss some of theweaknesses/challenges identified byterms, but must be defined locally.the RBI discussion paper. AccordingFor example, different timings forto the paper, the key inherentbank branch may be deemedweaknesses of the small, local areaconvenient in different parts of thecountry, and this has to be managed bank model are: a) unviable anduncompetitive cost structures due toon the basis of local understanding.small size, b) high concentration riskThe second big advantage of a smalland higher risk of adverse selectionbank is its ability to be agile aboutdue to geographical concentration, c)local preferences for providinglimited ability to attract professionalconvenience and flexibility requiredstaff and competent managementto use banking services effectively.dueto salary and locationThirdly, if an institution's horizontalconstraints, and d) lax governancegrowth (across geographies)The paper is available at: es/hierarchies-jf-final.pdfThe is paper is available at: id 63170502 FICCI's Banking & Finance Journal

ARTICLESstandards because of concentratedownership. Though these could becritical challenges to stability andcontinuity of small banks, there areways to mitigate most of theseweaknesses. For example, theconcern about costs is primarilyrelated to the inability of small banksto incur large capital expenditures fordeploying systems like core bankingsystems, or risk managementplatforms. Innovations in recent timeshave made it possible to develop andoffer these systems ApplicationService Provider (ASP) form, whereinthe user doesn't need to incur largeestablishment expenses, but pays onthe basis of usage. The softwareindustry is churning out suchsolutions regularly.the bank can use the savingsmobilized. For example, it couldmake it mandatory to invest most orall of the short-term savings in cashor government securities (narrowbanking). Other such solutions couldbe considered for managing thisweakness.Attracting professional staffs andmanagement is easier if the bank,true to its nature, focuses onrecruiting and nurturing local talent.Corporate governance issues can bebest addressed by requiring that theownership is not very concentrated,and the board composition is ahealthy mix of independent directors,executives and promoters. Also,oversight of these institutions couldbe strengthened by regular and closemonitoring by investors and lendersThe concentration risk can also beto the bank. If the system is mademanaged if the risk is properlytransparent and market-based, themanaged by the bank, withmarket participants would besystematic risk regularly transferredto entities or markets able and willing incentivised to monitor theto hold the risk for a fee. For example, institutions and ensure quality, thusa local area bank is highly vulnerable adding to the regulation andsupervision by the risk of flood in the area, whichwould lead to a run on the depositsThe key point is that, if we doand high defaults on loans. A big partacknowledge the importantof such systematic risks should beadvantages of small banks in meetingtransferred out from the small bank'sthe objective of financial inclusion,balance sheet, while the bank shouldwe can find many ways of addressinghold the risks it can manage. Thisthe challenges cited in the RBI paper.could be done by securitization orThere are strong reasons to believeparametric insurance on the portfolio,that the advantages are substantialand could be made mandatory byenough to find and deploy theseRBI. Also, these banks can be asked tosolutions.maintain higher capital adequacy. Insome cases, the regulator couldInterestingly, The issue of optimalseverely restrict the ways in whichsize of the banks is being debatedinternationally, especially in wake ofthe recent financial crisis, which hasonce again brought forwardquestions about the optimal size ofbanks from the point of view ofservice quality as well as systemicrisk. Emergence of more high qualitysmall banks could create a morefragmented and competitive bankingsector, which will also minimize the"too big to fail" threat that much ofthe world banking sector faces.This argument for more small banksin no way undermines theimportance of other financialinstitutions. World Bank's ChiefEconomist Justin Lin recently wrote apaper arguing that small local banksare the best entities for providingfinancial services to the enterprisesand households that are mostimportant in terms of comparativeadvantage. While his argument forsmall banks is spot on, he also arguedthat the size and sophistication offinancial institutions and markets inFICCI's Banking & Finance Journal 03

ARTICLESthe developed world are notappropriate in emerging markets.This is not necessarily true, becausesmall banks and larger financialinstitutions/markets complementeach other in many ways. While theformer have distinct advantages indelivering high quality services at thefront-end, the latter are required formanaging certain systematic risks atthe back-end, providing support tosmall banks for designing appropriateproducts, and supplying capital forsmall banks and large projects.High quality small banks can carryforward what effectively started inthe last round of bank licensing in1993. From the cohort that startedwith that round of licensing, thebanks that managed to succeed (likeICICI Bank and HDFC Bank) carriedthe paradigm of banking to the nextlevel, taking it forward from what thethen existing banks were doing, thusexpanding access to a much largernumber of people. They did so withincreasingly sophisticated productsand higher levels of efficiency. Smallbanks can take this process to thenext stage, picking up from whatthese banks have done (or aredoing), and taking the bankingrevolution to the next frontiers - theremote, rural areas, and the underserved parts of population in urbanareas.About the AuthorBindu Ananth is the President of IFMR Trust, a Chennai-based organisation working with the mission of ensuring that every individualand every enterprise has complete access to financial services. She worked with ICICI Bank in its microfinance practice between 2001and 2005 and was Head of the new product development group within the bank's rural finance business in 2007. She founded theCentre for Microfinance, IFMR, and has published in the Small Enterprise Development Journal, the Economic and Political Weekly,the OECD working paper series and the IFMR working paper series.Ms. Bindu AnanthPresidentIFMR TrustSuyash Rai works with IFMR Finance Foundation, a subsidiary of IFMR Trust. The Foundation's strategy is to use research, policyadvocacy, knowledge management and strategic partnerships to pursue the mission of ensuring complete access to financial servicesfor every inidividual and every enterprise. Prior to joining IFMR Finance Foundation, he worked in the Social Initiatives Group of ICICIBank. He has published in the areas of health economics, financial system design, and rural finance.Mr. Suyash RaiFinance FoundationIFMR Trust04 FICCI's Banking & Finance Journal

ARTICLESRole of FinancialInstitutionsin Financial InclusionMr. Joseph MasseyMD & CEO, MCX Stock ExchangeThe level of development of thefinancial system in a country isone of the best indicators of itsgeneral economic development.Efficient financial institutions andmature capital markets-primary andsecondary stimulate economic growthby efficient mobilization of savingsand making those available forproductive investments. Financialinstitutions not only ensure growth ofthe economy but also help inachieving social returns. There is acritical role to play by every financialinstitution in the process of financialinclusion and promote inclusivegrowth by ensuring opportunities forall in the society. Financial inclusionimplies that the population in acountry has access to a diverse rangeof financial products and services notonly at an affordable cost but also in aconvenient manner. It is a state whenfinancial products and services arepromptly delivered by a range ofproviders-public and private to everysegment of the population.The capital markets in India areunderdeveloped. The equity marketsuffers from high concentration andlow market breath along with hightrading costs. The capital formation islimited as a large portion of volumeis contributed by non-delivery trades.The corporate debt market isconspicuous by its insignificant size,growth and development. Themarket faces severe systemicproblems. The market share of top 5cities only has grown over the lastdecade; liquidity is concentrated in avery few listed companies; about70% volume comes from indexfutures and options based on a singlebenchmark; an efficient corporatebond market is missing and interestrate derivatives are almost absent.Less than 2 per cent of the country'spopulation directly participates in thecapital market as compared to over 9per cent in China and about 20 percent in developed countries likeUnited Kingdom and United States. InIndia, less than 10 per cent of listedshares are held by domesticindividuals. This signifies the extentof exclusion and poor developmentin the country when compared tocountries like Taiwan whereindividuals hold around 40 per centof the listed shares and contribute toover 70 per cent of the trading.Nearly 55 per cent ( 65 billion) of theIndia's total financial savings go intobank fixed deposits annually insteadof getting channelized to marketlinked instruments. Raising riskcapital at low rates is very importantfor corporates as it promotesinvestment and employment in thecountry. Thus, financial institutionshave a great responsibility indeveloping and deepening the capitalmarkets, by contributing to financialinclusion in the country.FICCI's Banking & Finance Journal 05

ARTICLESEfforts of government andfinancial institutionsIndia has demonstrated a long termgrowth trajectory. However, a largesection of Indian population hasremained financially excluded fromeven the basic opportunities andservices emerging in the financialsector. To address the issues offinancial inclusion, in June 2006, theGovernment of India appointed a"Committee on Financial Inclusion"under the Chairmanship of Dr. C.Rangarajan. The Committee hasdefined Financial Inclusion as "theprocess of ensuring access tofinancial services and timely andadequate credit where needed byvulnerable groups such as weakersections and low income groups atan affordable cost."Role of financial institutions in adeveloping country is vital inpromoting financial inclusion. Theefforts of the government topromote financial inclusion anddeepening can be further enhancedby the pro-activeness on the part ofcapital market players includingfinancial institutions. Besides,fostering a policy environment wherefinancial institutions can thrive is anequally important task to beaccomplished by the government.They can be instrumental inachieving greater financial deepeningand market penetration in Indianeconomy by devising products andservices tailored to meet preferencesof the investing community as well asof the lower income population.Strategies of innovation, creditcounseling, financial education andproper segment identificationadopted by financial institutions canhelp in taking the product andservices to the masses. A matureinstitutional set-up can also deviselow cost distribution mechanism fortaking multiple financial productsand services across the country.Financial institutions also generateinclusive growth by creating anddistributing wealth along withmaking capital available forcorporates, especially for small andmedium enterprises across thecountry.Generating incomes andmobilizing savingsAccess to financial services leads toincrease in household incomes.Access to a wider set of financialconveniences like credit, savingsproducts, payment systems/services,insurance products keep thehouseholds well equipped to absorbfinancial shocks, stabilize theirincomes and also helps them inbuilding their assets.India has been experiencing a robusttrend in gross domestic savings as aproportion of GDP since 2000. Thegross domestic savings rate hasimproved from 23.6 per cent of GDPin 2001-02 to over 30% currently.The household savings have alsocontinued to grow and as per RBIestimates, the net financial saving ofthe household sector in 2008-09 is10.9 per cent of GDP at currentmarket prices. When compared tointernational standards, India's gross06 FICCI's Banking & Finance Journalhousehold savings rate as percentageof disposable income is impressive.Financial institutions can efficientlymobilize the household savings andmake these available fordevelopmental projects. The role ofinstitutions in savings mobilization isalso crucial when a vast number ofSMEs in India face constraints inraising risk capital.Financial integration and therole of banks and otherfinancial institutionsA greater degree of integrationbetween financial institutions canhelp achieve 100% financialinclusion. To realize this, it requiresgreater integration of network ofbanks, exchanges, insurancecompanies, fund houses and otherfinancial bodies and institutions tofacilitate and benefit from crossselling.RBI has considered fosteringcompetition as an important step in

ARTICLESpromoting financial inclusion. Theaverage population coverage by acommercial bank branch in urbanareas has improved from 12,300 inJune, 2005 to 9,400 in June 30, 2010and in rural and semi urban areasfrom 17,200 in June 30, 2005 to15,900 in June 30, 2010. However, alarge chunk of underprivilegedpopulation still lacks access to formalbanking services. RBI is promptlyconsidering giving some additionalbanking licenses to corporates andalso to non banking financialcompanies.Banks have a larger role to play infostering financial inclusion given 400million account holders and 80,500branches. As a part of its 100%financial inclusion drive, it hasenabled kirana store owners, retireddefense personnel and schoolteachers NGOs/MFIs, trusts, nonprofit companies, post offices,cooperative societies to assist asBusiness Correspondents in reachingthe unbanked areas.The RBI aspires to provide a bankaccount to those desirous to have oris potential users who should have anaccount. RBI launched the Lead BankScheme back in 1970 which wasfollowed by the establishment ofRegional Rural Banks (RRBs) in 1975.Recognizing the potential for financialinstitutions to help achieve greaterfinancial inclusion, the High LevelCommittee to Review the Lead BankScheme (2009) has suggestedcontinuation of the scheme with adecentralized approach for widerfinancial inclusion.Banking system constitutes the backbone of capital markets. In recenttimes, banks have been performingvarious functions apart from theconventional banking activities andthey generate greater revenues fromthe fee-based services like retailbanking, commercial banking,investment banking, assetmanagement, portfoliomanagement, transaction servicesetc. Fee based services have becomemajor sources of revenue for bankslike HSBC and Citi Bankin India,where their contribution accounts formore than 50 per cent of the banks'revenue These services cater todifferent customer bases like retailclients along with institutional andcorporate clients. Encouraging nonconventional banking activities cannot only enhance financial inclusionbut also boost banks' business.they facilitate diversification of risk.The Indian mutual fund businessconstitutes only 1 per cent of theglobal mutual fund sector, but holdsimmense scope for growth. Nearly7.7 per cent of the country's totalsavings are diverted into mutualfunds. However, fund houses haveonly 2,500 branches as compared to80,500 bank branches. Hence theexisting banking network needs to beutilized for penetration of mutualfunds which is limited mainly in top10 cities and to only around 5 percent of the households.To foster greater integration, RBI haspermitted banks to enter agreementswith mutual funds for marketing anddistributing mutual fund products.Banks can also offer discretionaryportfolio management andinvestment advisory services. SEBIhas very aptly allowed online tradingA number of countries use theof open-ended mutual funds on thebanking sector to distribute mutualstock exchanges. This hasfunds. European mutual fundsencouraged retail investors topredominantly use banks as theconveniently invest in mutual funds.major distribution channel with aWith 200,000 such terminalsmarket share of 53 per cent. Inallowing investors in over 1,500Finland, approximately 70 per cent of Indian towns to invest in the stockassets are managed by banks. Themarket, the network of brokeringAmerican Bankers Associationcompanies has spread to semi-urbanestimates that 3500 banks (aroundareas and is now increasing its focus1/3rd of banks) in the US sell mutual on retail investors. Such cross sellingfunds. Some merely refer customers results in bringing to the marketsto outside brokerage houses; othersenough products and services andmanage their own mutual fundseach intermediary can havewhile around 10-15 per cent of funds economies of scale along withare sold through banks.promoting financial inclusion.Mutual funds play a significant role in Greater integration of insurancemobilizing the household savings and companies with other financialbringing them to capital markets asintermediaries is expected to aidFICCI's Banking & Finance Journal 07

ARTICLESfinancial inclusion. Off late, onlineinsurance policies have beenpromoted whereupon agents'commissions have tapered downmaking it more cost effective for theend-consumer. Recent guidelines byIRDA in the context of ULIPS onminimum lock-in period, switchingoptions, simplicity and transparencyin product and in disclosure normsregarding charges are a welcomestep towards attracting and retainingmore customers.Financial institutional effortsto foster financial literacyLack of financial literacy is the majorhindrance in spreading financialinclusion. This has resulted in themore than 50 per cent of savings ofthe household sector and of thefinancially illiterate getting drained innon financial investments. Banks andfinancial institutions need to look atfinancial inclusion not as a socialresponsibility or obligation but as abusiness opportunity and it needs tobe meticulously integrated in theirbusiness activities. This can makebanks and financial institutionscontribute to financial inclusion on alarger scale and at a rapid pace. Apro-active role by banks in providingsimpler and affordable products candraw the lower income groupstowards the formal financial system.Financial and education institutions,financial intermediaries and localcorrespondents need to take upsuitable initiatives to heightenfinancial literacy among people. RBIhas recommended that financi

in Financial Inclusion'. Financial Institutions along with the government as a facilitator of an enabling environment for growth can play a larger role in fostering the process of financial inclusion and ensuring sustainable sources of livelihood and raising the standards of living of the poor.

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