Role Of Financial Institutions In Financial Inclusion

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 regulator.to 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.