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Report No. - IN

INDIA

Scaling-up Access to Finance for Indias Rural Poor

September 6, !!"

FINAN#$ AND PRI%A&$ S$#&'R D$%$('P)$N& *NI&Sout+ Asia Region

Document of the World Bank

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Ac no ledgements

This report is the product of an Economic and Sector Work (ESW) activity of the South AsiaRegions inance and !rivate Sector "eve#opment $nit% task managed &y !riya 'asu(SAS !)% and undertaken in co##a&oration ith the ationa# *ounci# of App#ied EconomicResearch ( *AER)% e "e#hi+

The report as prepared &y a team #ed &y !riya 'asu (SAS !)+ ,a-or contri&utors to thereport ere. ira- /erma (SAS !)% !radeep Srivastava and Ra-esh Shuk#a ( *AER)% $#rich

ess (AR") and eora 2#apper ("E*R3)+ The peer revie ers ere An-a#i 2umar ( *S )%As#i "emirguc42unt ("E*R3) and A&ayomi A#a ode (W'5 !)+

The report dra s heavi#y on a Rura# inance Access Survey (R AS) for 5ndia% Wor#d 'ank 6

*AER (7008)% undertaken as part of the ESW on Access to Rura# inance+ 5t a#so dra s on anum&er of &ackground papers that ere commissioned as part of the ESW study% notay. (i)9,icrofinance. Ana#ytica# 5ssues for 5ndia: &y ;onathan ,orduch and Stuart Rutherford< (ii)9,icrofinance in 5ndia. 'anyan Tree and 'onsai: &y /i-ay ,aha-an and 'harti Ramo#a3upta< (iii) 9Revie of Rura# inance 5nstitutions in 5ndia: &y Ramesh "eshpande and ira-/erma< (iv) 9The $se of e !roducts% !rocesses and Techno#ogy in the "e#ivery of Rura#

inance in 5ndia: &y $#rich ess and eora 2#apper< (v) 95nforma# inance in Rura# 5ndia: &y;ock Anderson and ira- /erma< and (vi) Agricu#tura# *ommodity ,arkets in 5ndia. !o#icy5ssues for gro th &y Susan Thomas+

The authors gratefu##y ackno #edge guidance received from ;oseph de# ,ar !ernia (SAS !)and ,ari#ou $y ( S=!")% and he#pfu# comments from *onnie 'ernard and "ina $ma#i4"eininger (SASAR)% and ;im anson ( S=!")+ Administrative support as provided &yAnita "Sou>a and eather ernandes (SAS !)+

The report incorporates he#pfu# suggestions from the !rime ,inisters =ffice% ,inistry of inance of 3overnment of 5ndia% the Reserve 'ank of 5ndia% ationa# 'ank for Agricu#ture

and Rura# "eve#opment% Sma## 5ndustries "eve#opment 'ank of 5ndia% various commercia# &anks in 5ndia% microfinance practitioners and other key stakeho#ders% that ere provided onan ear#ier draft discussed at a orkshop in e "e#hi in e&ruary% 700?+


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&A ($ 'F #'N&$N&S

$/$#*&I%$ S*))AR0

I. IN&R'D*#&I'N......................................................................................................................................

5 "5A S R $RA 5 A *E A "S*A!E +++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

What are the financial needs of the rural poor?......................................................................................4 Rural finance service providers...............................................................................................................5

II. A##$SS &' R*RA( FINAN#$ IN INDIA1 &2$ $%ID$N#$..........................................................3

S$!! @ S5"E 5 "5*AT=RS = A**ESS T= 5 A *E ++++++++++++++++++++++++++++++++++++++++++++++++++++A**ESS T= R $RA 5 A *E . E /5"E *E R=, T E " E,A " S5"E +++++++++++++++++++++++++++++++++++++++

Access to savings/deposit accounts........................................................................................................14 a!ments "ervices # $imited use% high cash econom!..........................................................................15 Access to &redit......................................................................................................................................15 Access to 'nsurance................................................................................................................................1( )he 'mportance of 'nformal *inance.....................................................................................................1(

III. 42A& #'NS&RAINS A##$SS &' FINAN#$ F'R INDIAS R*RA( P''R5......................... 7

W @ ' A 2S ARE R E $*TA T T= E " T= R $RA * 5E TS ++++++++++++++++++++++++++++++++++++++++++++ $ack of credit information......................................................................................................................+,)he t!rann! of collateral........................................................................................................................+,Weak legal frame-ork and enforcement issues......................................................................................+1

overnment polic!.................................................................................................................................+1W @ " = S,A % R $RA ' =RR=WERS 5 " R $RA ' A 2S $ ATTRA*T5/E C+++++++++++++++++++++++++++++++

A sence of fle0i le products and services..............................................................................................+ )ransactions costs..................................................................................................................................+ &ollateral...............................................................................................................................................+(

I%. R$#$N& $FF'R&S IN INDIA &' I)PR'%$ R*RA( A##$SS &' FINAN#$1 &2$ R'($'F F'R)A(8INF'R)A( (IN9A:$S AND N$4 PR'D*#&S .................................................... 3

S 34 'A 2 5 2A3E A!!R=A* . 5 25 3 * =,,ER*5A ' A 2S T= 3 RASSR==TS ' =RR=WERS +++++++++++7 2o- 3ffective 2as "2 Bank $inkage Been in )argeting the oor?.................................................... , 'mpact on vulnera ilit! of poor households........................................................................................... +"ome $essons from "2 Bank $inkage.................................................................................................

e! concerns6 $imited outreach and scale of lending and issues in financial sustaina ilit!................ 4, 5*R= 5 A *E 5 ST5T$T5= S (, 5 S)+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

What has constrained the outreach and scale of 7*'s?........................................................................ T E 9SER/5*E ! R=/5"ER : , ="E = , 5*R= 5 A *E ! 5 =TE" '@ ! R5/ATE ' A 2S ++++++++++++++++++++++++++T E 2 5SA * RE"5T * AR" ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++R E*E T 5 =/AT5= S 5 , 5*R= 4 A " WEAT ER 5 S$RA *E +++++++++++++++++++++++++++++++++++++++++++* =,!=S5TE 5 A *5A SER/5*E ! R=/5"ERS ++++++++++++++++++++++++++++++++++++++++++++++++++++++++! =RT = 5= SE*$R5T5GAT5= +++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++! R5*E 5 S$RA *E A " R 5S2 , A A3E,E T ! R="$*TS =R AR,ERS +++++++++++++++++++++++++++++++++++++T E STRATE35* $SE = 5 =R,AT5= A " * =,,$ 5*AT5= TE* = =3@ ++++++++++++++++++++++++++++++++

%. )$$&IN: &2$ #2A(($N:$ 'F S#A(IN:-*P A##$SS &' FINAN#$ F'R INDIASR*RA( P''R1 &2$ P'(I#0 A:$NDA................................................................................................""

S*A 5 3 4$ ! , 5*R= 5 A *E ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++, A25 3 T E =R,A 5 A *5A SE*T=R ' ETTER AT ' A 25 3 T E R $RA ! ==R ++++++++++++++++++++++++++

$o-8cost -a!s of reaching the rural poor through the formal sector6 Role of Banks and overnment ................................................................................................................................................................4(

'mproving the incentive regime% and promoting competition6 Role of overnment polic!...................49ANN$/$S

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I. INTRODUCTION

:Access to financial markets is important for poor people. $ike all economic agents% lo- # incomehouseholds and microenterprises can enefit from credit% savings% and insurance services. "uch

services help to manage risk and to smooth consumption;.and allo- people to take advantage of profita le usiness opportunities and increase their earnings potential.

But financial markets% ecause of their special features% often serve poor people adl!;"ince poor peopleoften have insufficient traditional forms of collateral

W R$D B A@ % W R$D D 3 3$ 73@) R 3 R) +,,,8+,,1

inance is an eHtraordinari#y effective too# in spreading economic opportunity and fighting poverty+ To understand hy access to finance is so important for poverty reduction% e &egin

ith t o eHamp#es+ The first eHamp#e i##ustrates ho the poor may &e tota##y incapacitated henthey do not have access to finance% hi#e the second sho s ho a fe do##ars of financing canhe#p poor peop#e c#im& out of poverty% giving them the freedom to earn an independent% fu#fi##ing#ive#ihood+

The Stool Maker of Jobra Village1

There is perhaps no greater authority on how to make finance available to the poor than Muhammad Yunus, the founder of therameen !ank" #n his autobiography, Yunus described how he came to understand the importance of finance for the poor when he

was a professor of economics in a !angladeshi university" $ppalled by the conse%uences of a recent famine on the poor, he wandered out of the sheltered walls of his university to the neighboring village, Jobra, to find out how the poor made a living" &estarted up a conversation with a young mother, Sufiya !egum, who was making bamboo stools" &e learned that Sufiya needed ''cents to buy raw material for the stools" !ecause she did not have any money, she borrowed it from middlemen and was forced tosell the stools back to them as repayment for the loan" That left her with a profit of only ' cents" Yunus was appalled(

)# watched as she set to work again, her small brown hands plaiting the strands of bamboo as they had every day for months andyears on end*"&ow would her children break the cycle of poverty she had started+ &ow could they go to school when the incomeSugiya earned was barely enough to feed her, let alone shelter her family and clothe them properly+

!ecause Sufiya did not have '' cents, she was forced into the clutches of the middlemen" The middlemen made her accept ameasly pittance of ' cents for a hard day-s labor" .inance would liberate her from the middlemen and enable her to sell directly to

customers" !ut the middlemen would not let her have finance, for then they would lose their hold over her" .or want of '' cents,Sufiya-s labor was captive"

The paucity of finance, which is all too often the normal state of affairs for the poor in much of the world, is rendered even morestark when one contrasts it with the e/traordinary impact of 0ust a few dollars of finance on the lives of the poor" To see this, wemove to an e/ample in Southern #ndia wheremicrofinance the provision of tiny amounts of finance to people with even tinierassets helped lift 2utlibai and her family out of poverty"

The .isherwoman from 3a0pally

1 See Ra-an and Gingha#es (7008)+

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2utlibai came from a fishing community in 3aipally, which lies in an impoverished region of southern #ndia" &er family eked out aliving through fishing in the reservoir" &er husband and two sons went out in the pre4dawn darkness and cast their nets" Theybrought in their daily catch in the morning" Then 2utlibai, along with her daughter and mother4in4law, cleaned and processed the fishin time for 2utlibai to catch the morning bus to various local town markets each day" 2utlibai sold the fish, and the family-s netearnings were about 5'6week, 0ust enough to barely subsist"

2utlibai knew that a few e/tra fishing nets could go a long way in improving her livelihood 7 but she did not have the money to buythe nets" She could not borrow from the bank8 she had heard that others from her community had been turned away by the bank,after several visits, and besides, she did not have any assets to pledge as collateral to the bank" The local moneylender chargede/orbitant rates of interest 9:; per month


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financia# savings +? or eHamp#e% for rura# farmers% savings constitute insurance% to protectthemse#ves against periods of drought or crop fai#ure+ Savings a#so provide a vehic#e for futureeHpenditure needs% hether eHpected (for eHamp#e for specia# fami#y occasions% or for the

purchase of significant assets such as a home) or uneHpected+ Access to finance cou#d a#so have#onger term e#fare imp#ications% permitting peop#e to &orro hen young% for eHamp#e for education or for other physica# or human capita#% and then repay and save for retirement henthey are o#der+

5n 5ndia% since the ear#y nationa# p#ans% successive governments have emphasi>ed the #ink &et een improving access to finance and reducing poverty% a stance that has had inf#uenceg#o&a##y+D F The need to improve financia# access for 5ndias poor% motivated the estaishment of a vast net ork of rura# cooperative credit &anks in the 1B 0s% fo##o ed &y a drive to nationa#i>ecommercia# &anks% #aunched in 1BDB+ This #ed to thousands of ne &ank &ranches in rura# areasacross the country+ The strategy during the 1BF0s and 1B 0s gave the #ead ro#e to the nationa#i>ed(state4o ned) commercia# &anks% ho ere charged ith #oosening the grip of traditiona#informa# sector money#enders through the use of targeted #o 4priced #oans (Reddy% 1BBB)+ The1BB0s sa the partia# deregu#ation of interest rates% increased competition in the &anking sector%and ne microfinance approaches44that com&ine the safety and re#ia&i#ity of formal finance iththe convenience and f#eHi&i#ity of informal finance+ Access to finance for the rura# poor hasimproved some hat over the past decades+ 'ut the vast ma-ority of 5ndias rura# poor sti## do nothave access to either forma# finance or microfinance+ 5nforma# sector #enders thus retain a strong

presence in rura# 5ndia+

Wh! focus on the rural poor? The over he#ming ma-ority of poor peop#e in 5ndia areconcentrated in rura# areas+ =f the estimated 7D0 mi##ion 5ndians (or 7DJ of the popu#ation) ho#ive in poverty% some 1B8 mi##ion (or F?J) #ive in rura# areas+ 5nternationa##y comparae

poverty estimate of a do##ar a day% the num&er of rura# poor is estimated at around 7F0 mi##ion+Another 1 0 mi##ion rura# peop#e are 9near poor:+

5ndias Rura# inance andscape

What are the financial needs of the rural poor?

5ndias rura# poor are over he#ming#y dependent on agricu#ture as their primary source of income< the ma-ority are margina# or sma## farmers% and the poorest househo#ds are #and#ess+ Thefinancia# needs of 5ndias rura# poor ref#ect the vo#ati#e% uncertain and irregu#ar income streamsand eHpenditure patterns of these househo#ds+ The recent#y comp#eted Wor#d 'ank4 *AER Rura#

inance Access Survey (R AS) 7008 B% on hich this Report dra s heavi#y% indicates that% hi#e

? The ro#e of savings and &orro ing in protecting consumption against uneHpected shocks% first discussed &y ,i#tonriedman (1B F) in the Kpermanent income hypothesis has since &een eHtensive#y tested empirica##y% as discussed in

'ond and To nsend (1BBD)+

The K#ife cyc#e hypothesis as an eHp#anation for savings and &orro ing &ehavior% discussed in Ando% ,odig#iani and'rum&erg in a series of artic#es in the 1B 0s and 1BD0s+ See ,ayer (1BF7)% and Romer% (1BBD) for overvie s+D The focus on poverty and finance as articu#ated most famous#y in the 1B ? Reserve 'ank of 5ndia (R'5) report onthe A##45ndia Rura# *redit Survey of 1B 14 7 (R'5% 1B ?)+F or a good discussion on the #ink &et een finance and poverty see Ra-an and Ginga#es (7008)+ or a discussion on themicroeconomic underpinnings of the e#fare imp#ications of improved access to financia# intermediation% see Wor#d'ank (7008a)+ This is &ased on the !#anning *ommission of 5ndias definition of poverty% as the #eve# of per capita consumer

eHpenditure sufficient to provide an average dai#y intake of 7%?00 ca#ories per person in rura# areas and 7%100 ca#ories per person in ur&an areas% p#us a sma## a##ocation for &asic non4food i tems+B This is discussed in detai# in the fo##o ing chapter+

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rura# fami#ies are predominant#y mu#tip#e4income househo#ds% their t o main sources of incomeinc#ude sa#e of agricu#tura# products and of age #a&or+ 5rregu#ar emp#oyment is the mostimportant source of income from age #a&or+ or househo#ds ith more than one source of income% agricu#tura# income is the most important secondary source of income% ith sa#e of farm

produce and sa#e of dairy products &eing the most prominent+ *#ear#y% rura# househo#ds depend onone or &oth of t o types of incomes. seasona# (post harvest sa#e) or high#y irregu#ar due toirregu#ar or part4time age #a&or% ith the dependence on the #atter &eing inverse#y proportiona#to the si>e of #and ho#dings+ The typica# eHpenditure profi#e of the househo#ds is a#so of sma##%dai#y or irregu#ar eHpenses% incurred a## through the month+ ,oreover% the over he#ming ma-orityof rura# househo#ds report having to dea# ith at #east one unusua# eHpense each year% hich theyare forced to finance either from cash at home% or through informa# #oans from fami#y% friends% or money#enders+

Research sho s that poor peop#e va#ue financia# services and ant these to &e re#iae%convenient% continuous and f#eHie10+ They understand that financia# services he#p them spend% atone time% income earned in other times% and &ecause those incomes tend to &e sma##% irregu#ar andunre#iae% they need the fu## armory of intermediating modes 6 saving up for future spending%taking advances against future savings% and &ui#ding cash reserves that can &e ca##ed on at anytime+ The poor need a ide range of financia# services% from sma## advances to tide over consumption needs to #oans for investment purposes and #ong term saving that he#p them manage#ife cyc#e needs+11 3iven the vast popu#ation of the poor in the country% hat has &een the po#icyframe ork and hat eHists in the financia# #andscape to cater to these needsC

Rural finance service providers

5ndia has a range of rura# financia# service providers% inc#uding the forma# sector financia#institutions at one end of the spectrum% informa# providers (most#y money#enders) at the other endof the spectrum% and &et een these t o eHtremes% a num&er of semi4forma#Lmicrofinance

providers+

*ormal providers. 5n terms of sheer si>e and spread of operations% the forma# sector financia#institutions dominate the rura# finance #andscape.

o *ommercia# &anks% most#y puic sector &anks (&ut a#so some private sector &anks) andRegiona# Rura# 'anks (RR's) together have more than 87%000 rura# &ranches+

o 5ndia a#so has a vast net ork of rura# cooperative &anks% ith a three tiered structure atthe state% district and vi##age #eve#+ There are some 1?%000 &ranches of rura# cooperative

&anks and more that B %000 grass roots #eve# retai# out#ets of primary agricu#tura# creditsocieties (!A*S)% hich are used &y the cooperative system as channe#s for funds f#o +

o The post office system 17 adds to the physica# service point net ork of the country ithmore than 1 ?%000 post office &ranches hand#ing more than 110 mi##ion money ordersand administering 11? mi##ion savings accounts+

o 5nsurance companies have a moderate reach in rura# areas% though this is gradua##yincreasing+

10 This dra s on Stuart Rutherford and ;onathan ,orduchs paper for the 'ank+11 or a discussion of ays that #o 4income househo#ds cope ith risk% see ,orduch (1BBBa)+17 Whi#e the posta# system is heavi#y su&sidi>ed% it neverthe#ess adds to the service &ranch outreach of the country and

provides a va#uae and trusted p#ace for sma## investors to deposit their savings+ The potentia# #inkages ith the posta#net ork to de#iver increased and more efficient financia# services is discussed in a Wor#d 'ank study. The Reform of 5ndia !ost. Transforming a !osta# 5nfrastructure to "e#iver ,odern 5nformation and inancia# Services% 7007+


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These forma# rura# finance institutions account for a#most a## institutiona# #oans to rura# areas< the#oan eHposure of commercia# &anks is Rs 88%000 mi##ion (7+DJ of 3"!)< the rura# deposit &ase isRs1%?00%000 mi##ion (D+DJ of 3"!)+ The forma# rura# finance institutions are #arge#y depositfunded (D 4 0J)+

Formal Semi-formal;)icrofinance Informal

ApeH " 5s ,icro finance 5nstitutions (, 5s) ,oney#enders*ommercia# &anks S 34&ank4#inkage program Trade creditorsRegiona# Rura# 'anks (RR's) oca# shopkeepers*ooperative 'anks5nsurance companies!ost office net ork Reserve 'ank of 5ndia

The forma# financia# institutions are regu#ated &y the Reserve 'ank of 5ndia% a#though it hasde#egated to the ationa# 'ank for Agricu#ture and Rura# "eve#opment ( A'AR" 18) the task of supervising rura# cooperative &anks and RR's+ "eve#opment &anks such as A'AR" and theSma## 5ndustries "eve#opment 'ank of 5ndia (S5"'5) provide support to &oth the forma# andsemi forma# segments through fundingLrefinancing arrangements+ A'AR" provides refinancingto &anks #ending in rura# areas% and S5"'5 funds and supports micro finance institutions (, 5s)+

"emi8formal/microfinance sector. Whi#e home to many microfinance innovations% in terms of peop#e reached and the sca#e of financing% microfinance in 5ndia is sti## a drop in the ocean+ 5treaches #ess than J of the rura# poor+

o "ominant among the microfinance mode#s is the Se#f e#p 3roup (S 3) &ank #inkagemode#% here&y omens S 3s are #inked to the rura# &ranches of commercia# &anks%RR's or cooperative &anks+ The S 34&ank #inkage program has reached out to around17 mi##ion fami#ies+ *redit outstanding remains #o < dis&ursements in @ 7007408accounted for on#y 7J of the forma# sector credit outstanding in rura# areas+

o The other mode# is , 5s% hich reach around 1 mi##ion c#ients+ The #oans outstanding of , 5s is around 0+ J of the tota# rura# #oans of the forma# sector &anks+ The tota#

&ranches of , 5s are estimated to &e in the range of a fe thousand compared to the vastnum&ers of &ank &ranches+

o Recent deve#opments have #ed to other inter4#inkages &et een the forma#% &oth puic and private sector &anks% and semi4forma# sector initiatives% particu#ar#y the S 34&ank #inkage program (#ed &y A'AR")% as e## as #ending &y S5"'5 ( hich has &een a

pioneer and takes credit for deve#oping this financia# institutiona# space) and commercia# &anks to , 5s+ ,oreover% a fe private sector commercia# &anks such as 5*5*5 'ank%have tried innovative ays to incorporate the #essons from microfinance into their operations and have made inroads in using microfinance methodo#ogies to de#iver rura#financia# services+ These innovations are detai#ed #ater in the report+

'nformal providers6 5nforma# financiers inc#ude a range of actors. #and#ords% #oca# shopkeepers%traders% professiona# money#enders% etc+ Whi#e there are no definite estimates of the num&er of informa# sector providers% these are spread very ide#y across the country+ Survey data indicatethat poor rura# househo#ds re#y heavi#y on informa# finance to meet a range of financing needs.from consumption and emergency financing to investment #oans+ Around ??J of the househo#dssurveyed &y R AS 7008 report having &orro ed informa##y at #east once in the preceding 17

18 A'AR" is o ned &y the R'5 and the 3overnment of 5ndia and as estaished &y an Act of !ar#iament in 1B 7 asthe apeH &ank for rura# finance+

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months< the interest charged on informa# #oans averages ? J per annum+ ot surprising#y%informa# &orro ing is very important for the poorest (margina# and commercia# categories)% hoare the most deprived of forma# finance+

With a fe notae eHceptions (such as West 'enga#% here #and reforms are the most advancedin the country)% vi##age money#enders and other types of informa# financiers have &een around for as #ong as vi##ages have eHisted+ 5nforma# financiers have the advantage of kno ing their c#ient

&etter than most forma# institutions such as &anks% they have a &etter a&i#ity to enforce contracts%and provide f#eHie products+

Sca#ing4up access to finance for 5ndias rura# poor% to meet their diverse financia# needs (savings%credit% insurance against uneHpected events% etc+) through f#eHie products at competitive prices%

presents a formidae cha##enge in a country as vast and varied as 5ndia+ 'ut the opportunities%too% are p#entifu#% and 3overnment has an important ro#e to p#ay in creating space and a f#eHiearchitecture for sca#e4up+

This report is structured as fo##o s. *hapter 55 revie s the current #eve# and pattern of access tofinance for 5ndias rura# househo#ds% ith a focus on the poor+ 5t high#ights inadeMuacies in rura#access to finance+ *hapter 555 takes a c#oser #ook at hat eHp#ains the #ack of financia# access for 5ndias rura# poor+ *hapter 5/ eHamines recent approaches in 5ndia to improve access to financefor the rura# poor% focusing particu#ar#y on #o 4cost de#ivery mode#s that have invo#ved #inkages

&et een the forma# and informa# sector% &ased on the princip#es of microfinance+ 5t eva#uatessuccesses and fai#ures% and identifies the main cha##enges ahead in improving outreach andsustaina&i#ity+ The conc#uding section provides some suggestions on hat needs to &e done tosca#e4up access to finance for 5ndiaNs rura# poor+ The report dra s heavi#y on a recent#ycomp#eted Wor#d 'ank4 *AER Rura# inance Access Survey (R AS) for 5ndia% conducted in7008 as a &ackground to this report+

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II. ACCESS TO RURAL FINANCE IN INDIA: THE EVIDENCE

Supp#y Side 5ndicators of Access to inance

5ndia has a deep financia# system% attri&utae in #arge part to the countrys vast net ork of &anksand other financia# institutions% inc#uding thousands of &ranches of rura# &anks+ inancia# assetsin 5ndia amount to a&out $SO?80 &i##ion% in nomina# terms% compared to #ess than O7 0 &i##ion inArgentina% $SO880 &i##ion in ,a#aysia% or $SO8 D &i##ion in ,eHico% despite 5ndias significant#y#o er per capita income+ The share of financia# assets in 3"! in 5ndia is a&out B8 percent%compared to 1 percent in Argentina and D percent in ,eHico+ (Tae 1)+

&able 1 Dept+ of Financial )ar ets < India and 't+er $merging $conomies = 777; !!!>

Tota#inancia#

AssetsP($SOm)

EMuity ,arket*apita#i>ation L

3"! (J)

EMuities 4/a#ue

Traded L3"!(J)

"omestic!uic

'onds on5ssue L 3"!

(J)

"omestic!rivate

'onds on5ssue L 3"!

(J)

Tota#inancia#

AssetsP L3"! (J)

3"! per capita 1BBB

At#as ,ethod(curr+ $SO)

!rivate*reditL 3"!

(J)

'ra>i# F 0%F8B 8B+0 1F+0 ?0+B +B 18B+F ?%8 0 0+BArgentina 781%1DD ??+0 7+1 11+ 1+0 1+0 F% 0 7?+7

,QHico 8 D%8DD 7?+F F+B B+7 7+1 D +8 ?%??0 87+8

5ndia ?8F%7B8 8?+7 10?+F 71+ 0+? B7+ ??0 8D+?

*hina 7%1 8%F1F ?7+ DD+ 1B+ + 1BB+? F 0 17 +B

,a#aysia 881%807 1?D+ D + 7B+D 0+0 8F0+B 8%8B0 1??+

2orea 1%0B1%?BB D?+F 788+1 1D+B ? +1 7DF+0 %?B0 1?0+8PSimp#ified definition &ased on aggregate of assets descri&ed in this tae+Sources. Wor#d "eve#opment 5ndicators< 5 S< 5 * 4 Emerging ,arkets "ata&ase< '5S

inancia# depth is attri&utae in #arge part to 5ndias vast net ork of financia# institutions%inc#uding rura# finance institutions+ The 1BF0s and 1B 0s sa a rapid eHpansion of 5ndias

financia# system into rura# areas+ o##o ing 5ndira 3andhis &ank nationa#i>ation drive% #aunchedin 1BDB% commercia# &anks ere reMuired to open rura# &ranches+ 'et een 1BF8 and 1B % &ank

&ranches in rura# areas gre at an average of 1 +7J each year% a&out doue the gro th rate of &ranches in semi4ur&an (D+?J)% ur&an (F+ J) and metropo#itan (F+ J) areas+ Rura# &ranches grefrom 1% 88 in 1BDB to 80%1 D in 1B % an increase of 1% ?FJ (&y comparison% the increase over the same period for semi4ur&an% ur&an and metropo#itan areas as on#y 1B?%81 % an increase of 770J)+ Rura# &ranches continued to eHpand in the 1B 0s% to 8 %000 &y 1BB1% dec#ining s#ight#y to87%?00 in 7001+ Today% 5ndia has over 87%000 rura# &ranches of commercia# &anks1? and regiona#rura# &anks (RR's)% some 1?%000 cooperative &ank &ranches% B %000 primary agricu#tura# creditsocieties% not to speak of the thousands of mutua# fund se##ers% severa# non4&ank financecompanies ( ' *s) and a #arge post office net ork ith 1 ?%000 out#ets that are reMuired tofocus on deposit mo&i#i>ation and money transfers+

1? The tota# num&er of &ank &ranches (rura# and ur&an) is DD% 00+ The &u#k of these &ranches are of puic sector commercia# &anks+


12/60

ot surprising#y% 5ndia comparesfavoray ith other deve#opingcountries in terms of the distri&ution of financia# services+ The average

popu#ation served per commercia# &ank &ranch in 5ndia as around 1 %000 in7007% and inc#uding the &ranches of rura# cooperative &anks% at 17% 00% c#oseto #eve#s in 5ndonesia and ,eHico+ A#soin terms of the average area served per

ranch% 5ndia compares favoray ithother countries% indicating a high degreeof physica# &ranch presence% hich has

&een improving over time+ ( igure 1)+

5ndias performance ith respect toinsurance penetration is a#so &etter thancountries #ike 'ra>i# and *hina+,easured &y insurance premium as a

percentage of 3"!% insurance penetration in 5ndia in 7000 as c#oseto 7+ J% compared to a #itt#e over 1J in5ndonesia% under 7J in *hina and,eHico% and a #itt#e over 7J in 'ra>i#+( igure 7)+

5mprovements in rura# finance notithstanding% the supp#y of forma#

finance appears to &e &iased against therura# popu#ation+ =n average% a rura#

&ank &ranch in 5ndia serves a#most three times the num&er of peop#e served &y a non4rura# &ranch+ (Tae 7)+The vo#ume of deposits and credit in rura# areas is a#so much #o er than inur&an areas+ !er capita deposits in rura# areas stood at Rs7%1 0 ($S"?F) or around 10J of nationa# per capita 3"! in 7001% compared to Rs88%F 0 ($S"F?0) or around 1D0J of per capita3"! in the same year for ur&an areas+ *redit per person in rura# areas stood at RsB00 ($S"70) or around ?J of nationa# per capita 3"! versus a figure of Rs70%D00 ($S"? 0) for ur&an areas

hich is around 100J of nationa# per capita 3"!+ The num er of credit accounts in rural areasrelative to the total rural population amounts to on#y 8+?J against a ratio near#y three timeshigher for ur&an areas+

Rura#4ur&an differentia#s ininsurance are even #arger than the

differentia#s for credit or savings+Whi#e genera# insurance agencieshave a directive to source J of their gross premium ithin threeyears of operations from rura# areas(7J in the first year)% the actua##eve#s for most companies at

present are much #o er+ 5n terms of premium from rura# areas% for

&able 1 #o?erage of ban branc+es

Average population served per ank ranchAverage area per &ranch

@ear =vera## Rura# on4rura# (SM kms)

1BF7 ?0%7?1 B1%1 1 17%8 B 787+?1B 1 1B%18F 7B%D % 70 +F1BB1 1?%0 ? 1F% %F00 7+D7001 1 % 1 77% ?1 %?D1 ?F+

7001P 17% 0D A A 8B+"ources6 RB'% Basic "tatistical Returns% +,,+ and 2and ook of "tatisticson the 'ndian 3conom!% +,, @ABARD statistics &ensus +,,1.

@ote6 C including cooperative ank ranches

B


13/60

@7007408 the share as +8J reducing to on#y 1+?J on eHc#uding the share of ife 5nsurance*orporation of 5ndia ( 5*) thus indicating that most insurance agencies are e## &e#o reMuired#eve#s of rura# eHposure+

The Mua#ity and choice of products and services provided &y rura# &ank &ranches are genera##y#o er than their ur&an counterparts+ Rura# &ranches are typica##y not computeri>ed% do not offer techno#ogy &anking through AT,s or credit and de&it card products+ ,oreover% hi#e ur&an &ank

&ranches have increasing#y started turning into one4stop4shops for a## financia# services(insurance% mutua# funds in addition to &anking products) and a#so provide add4on services interms of payments of net and phone &anking% payment of uti#ity &i##s% ce## phones% etc% rura#

&ranches are unae to offer a comparae servicesLproduct miH+

arge regiona# differences eHist in the distri&ution of financia# services% &oth in terms of thevo#ume of transactions and &ranch density% ith c#ients in 5ndias economica##y eaker regionshaving a disproportionate#y #o er #eve# of financia# access+ The spread of &ranches appears to &ec#ose#y associated ith regiona# shares in popu#ation. the eastern and centra# regions have #arger shares in popu#ation and therefore% despite their #o share in income% occupy the second and third

positions in terms of share in &ranches+ o ever% the presence of &ranches a#one does not ensureaccess to finance< as eHpected% income is a key determinant to financia# access+ Regiona#differences in the vo#ume of financia# services (vo#ume of credit and deposits) are #arge#yeHp#ained &y regiona# income differentia#s 1 . 5ndias #esser deve#oped and #o 4income eastern%centra# and north4eastern regions account for ?J of the popu#ation and ?0+ J of tota# &ranches%

&ut on#y 70J of outstanding credit and 7BJ of deposits+ (Tae 8 and igures 84 ) 1D+

&able @1 Regional Differences in Financial Ser?ices Source. R'5% 'asic Statistica# Returns% 7007< R'5% and&ook of Statistics% 7008< *ensus 7001

RegionS+are in allIndia :DP

S+are inpopulation

Regional per capita :DP;nationalper capita :DP

S+are in all Indiacredit

S+are in allIndia deposits

S+are in all Indiaban branc+es

orthern 1 J 18+ J 1+7 71+ J 77+BJ 1D+1J orth4Eastern 8J 8+FJ 0+FD 1+ J 1+DJ 7+ JEastern 1?J 78+DJ 0+ B+7J 17+BJ 1F+FJ

*entra# 1FJ 7D+DJ 0+D? +BJ 18+DJ 70+8JWestern 77J 1 + J 1+8B 87+7J 7D+?J 1 +DJSouthern 7 J 1D+BJ 1+D8 7D+DJ 77+DJ 7F+?J &otal !! !! .!! !! !! !!

1 The on#y out#ier is the estern region hich has the highest vo#ume of financia# services though on#y the secondhighest contri&ution to 3"! and re#ative#y #o share in tota# &ranches+ This indicates more a deve#oped financia#institutions net ork in this region% that has traditiona##y &een the hu& of &usiness and trading activity in 5ndia+1D The si>e of the circ#e in igures 4 represents the share (or si>e) of 3"! of the region hereas in igure 10 the si>eof the circ#e represents the regiona# share in the countrys popu#ation+

10


14/60

Access to Rura# inance. Evidence from the "emand Side 1F

"eve#opments in 5ndias financia# sector% particu#ar#y after the #ate 1BD0s% resu#ted insu&stantia# achievements in enhancing access tocredit in rura# areas+ The share of rura# credit in tota#credit increased from ?+DJ in 1BF7 to 10+1J in7001< the share of rura# deposits in tota# depositsincreased from + J in 1BF7 to a#most 1 J &y7001+ The gro th of rura# &anking in a&so#ute termsand re#ative to 3"! has a#so &een significant Tae?+

Short#y after independence in 1B?F% the first survey

of rura# inde&tedness (A## 5ndia Rura# *redit Survey%or A5"5S) prepared &y the Reserve 'ank of 5ndia(R'5) documented that money#enders and other informa# #enders met more than B0 percent of rura# credit needs+ The share of &anks in particu#ar

as on#y a&out 1 percent in tota# rura# househo#d de&t+ This ratio remained #o unti# 1BF1 henit as 7+?J% a#though the share of forma# sources of credit in rura# areas increased steadi#y to7BJ due to the rising share of cooperatives+ o##o ing &ank nationa#i>ation% the share of &anksin rura# househo#d de&t increased to a&out 7BJ in 1B 1 and 1BB1 hi#e the share of forma# or institutiona# sources in tota# de&t reached D1+7J &efore dec#ining in 1BB1+ *orresponding#y% theshare of money#enders dec#ined steadi#y over these four decades+ Tae +

&able B1 S+are of rural +ouse+old debt bC source of credit, All India, 7B -7 (percentages)

5nstitutiona# on45nstitutiona#@ear 'anks *ooperatives 3overnment Tota# 5nstn#+ Re#ativeL riends ,oney#enders =thers

1B 1 1+1 ?+D 8+1 + 1?+? D +D +71BD1 0+8 10+? D+D 1F+8 + D0+B 1D

1BF1 7+? 70+1 D+F 7B+7 18+ 8D+B 70+1

1B 1 7 +D 7 +D ? D1+7 B 1D+B 17+B

1BB1 7B 1 +D +F 8+8 D+F 1 +F 7?+8

: thers> includes non8institutional sources other than friends and relatives and mone!lenders% e.g.% traders%agriculturist mone! lender% landlord% etc."ource6 All 'ndia Rural &redit "urve! and All 'ndia De t and 'nvestment "urve!s

Whi#e no officia# survey of rura# accesshas &een conducted since 1BB1% the

1F This chapter dra s on the findings of the R AS 7008+ See AnneH 7 for detai#s on the factors guiding the choice of states covered% and the survey methodo#ogy and samp#ing+ The survey covers D000 househo#ds in t o states% Andhra!radesh% A! (kno n to &e a #eader in the provision of rura# finance) and $ttar !radesh% $! (a #aggard)+ Whi#e theorigina# intention as to contrast the findings of A! and ith $!% in the event% ith a fe eHceptions% such as access tomicrofinance% the findings from the t o states converged on most indicatorsIpossiy &ecause access to finance inrura# A! has &een negative#y affected &y increased poverty resu#ting from years of consecutive drought+ Therefore% theresu#ts ere aggregated and presented as averages+ A &ackground paper on the Survey findings presents the separateresu#ts for A! and $!+

&able "1 Rural ban ing - &rends o?er time Rural Non-rural"eposits (Rs mi##ion)

1BF7 %8BD+B F %1BB+D 7001 1%8B?%818+D %100%01B+8*redit (Rs mi##ion)

1BF7 7% F7+F 8% D +? 7001 ??%817+ ?% ?0%07 +?"eposits to 3"!

1BF7 1+1J 1D+0J 7001 D+DJ 8 + J*redit to 3"!

1BF7 0+ J 10+BJ 7001 7+DJ 78+0J

&able 61 SummarC comparison of AIDIS = 77 > and RFAS= !!@>All India *P AP

*ormal *ormal *ormal

!ercent of househo#ds inde&ted

A5"5S (1BB1) 1 +D 17+ 1D+

R AS (7008) 1B+? 7?+0

Average de&t perhouseho#d

A5"5S (1BB1) 1771+0 1 71+0 1DB1+D

R AS (7008) D8FD+0 ?818+0

"ource6 RB'


15/60

Note: )arginal farming househo#ds #andho#ding 1 acres< Small 1 to ? acres< (argefarmers ?acres< #ommercial househo#ds ith or Lo #and &ut ith income from non4farm sources eHceeding ha#f of tota# househo#d income< 't+ers miHed househo#ds ith#and and non4farm commercia# incomes &ut the #atter &eing #ess than ha#f of their tota#househo#d income+

Wor#d 'ank4 *AER Rura# inance Access Survey (R AS% 7008 6 this covered D%000 househo#dsin the t o states of Andhra !radesh% A!% and $ttar !radesh% $!) a##o s for some ana#ysis of trends &et een 1BB1 and 7008+ Re#ative to the findings of the A5"5S41BB1% the incidence of inde&tedness (i+e+ proportion of househo#ds ith de&t outstanding to a forma# finance institution)had further increased &y 7008% indicating greater access and the a&i#ity to &orro + 1 $nder theassumption that househo#ds Uprefer: forma# &orro ing and ere ear#ier rationed due toinadeMuate supp#y of such de&t% the increase in forma# inde&tedness cou#d &e vie ed as animprovement+ (Tae D)+

5ndias poor househo#ds% ho areconcentrated in rura# areas 1B% have very#itt#e access to forma# finance+ A recent#ycomp#eted Wor#d 'ank4 *AER Rura#

inance Access Survey (R AS 7008) 70

indicates that F0J of margina#L#and#essfarmers do not have a &ank accounted

&y the preponderance of cash transactions+ ouseho#ds ith accounts tend to use them in a#imited ay% accessing them ith #o freMuency and ith #itt#e use of checks (the primary use of deposit accounts is for safekeeping% ith #itt#e ro#e for payment services)+ ouseho#ds ithoutaccounts are presumay too poor to have any eHcess savings to safeguard+

Access to &redit

There is some indication of an increase in Kinde&tedness among rura# househo#ds over the pastdecade 6 ho ever this can a#so mean increased access to credit% and as such may &e a stepfor ard+ According to the A## 5ndia "e&t and 5nvestment Survey (A5"5S) of 1BB1% -ust 1DJ of rura# househo#ds had a forma# #oan outstanding+ 'ased on the Wor#d 'ank Rura# inance AccessSurvey of 7008% the corresponding num&er as 71J+

Some FBJ of rura# househo#ds do not have access to a forma# #oan% and once again% access is particu#ar#y a proem for the margina# farmers and commercia# househo#ds+ (Tae )+

urthermore% some BFJ of househo#ds ithout a forma# #oan report not having app#ied for a #oan

in the past 8 years< the main reason reported for not app#ying is a 9#ack of need:% and the secondmost important reason is 9comp#icated procedures44an indication% perhaps% of the fact that &asedon the eHperience of others% they kno they dont stand a chance of receiving a #oan+

1?


18/60

&able 31 Access to credit from financial institutions, bC +ouse+old categorC = >)arginal Small (arge #ommercial 't+ers &otal

With forma# #oanoutstanding 17+BF 80+FB ??+8D 1D+F 7B+?F 71+01Without forma##oan F+08 DB+71 +D? 8+77 F0+ 8 F +BB Note: )arginal farming househo#ds #andho#ding 1 acres< Small 1 to ? acres< (arge farmers ?acres< #ommercialhouseho#ds ith or Lo #and &ut ith income from non4farm sources eHceeding ha#f of tota# househo#d incomee &ranch infrastructure

77 5ndian &ank managers have found that they can in fact make #arge profits from the trading of 3overnment securitiesin an environment of dec#ining interest rates (and &ankers in 5ndia do not appear to have a fu## appreciation of theinterest rate risk invo#ved in such investment a##ocation decisions% vie ing 34Secs as risk4free assets)+ 5ncome on sa#eof investments has &een rising steadi#y over the past years accounting for around 88J of operating profits in @7007408+ Simu#taneous#y the share in tota# income of interest income on advances has fa##en to #eve#s &e#o ?0J+ R'5%

Trend and !rogress of 'anking in 5ndia% 7008408+78 The S R has dec#ined from 8 + J in 1BB1 to 7 J at present+ Simi#ar#y the *RR has dec#ined from 1 J to ?+ Jover the same period+ o ever% the overa## statutory pre4emption #eve#s are higher than #eve#s in other countries 6South Africa ( J)% ,a#aysia (1 J)% Singapore (1 J)% Sri anka (70J)% $SA (none)+ 7? A f#oorLfiHed rate of 8+ J is set for savings deposits+7 Such difficu#ties can imp#y that sometimes% entire communities% and particu#ar#y the rura# poor% may face #imits oncredit+ Such theories of Kcredit rationing have &een discussed for eHamp#e &y Stig#it> and Weiss (1B 1)% Wi##iamson(1B D)+ 'es#ey (1BB?) and ,urdoch (1BBB) have discussed this specifica##y in the case of communities such as sma##farmers and microfinance providers+

77


26/60

o . Rural ban ing < go?ernments omni-presence

The puic sector (i+e+% ma-ority government4o ned) &anks account for 0J of commercia# &ankassets in 5ndia+ + Some B J of commercia# &ank &ranches in rura# areas are of puic sector

&anks+ And these account for B8J of tota# rura# credit outstanding+ 5n terms of governance% the &oards of a## puic sector &anks have ma-ority representation from the governmentLR'5+

o ever% ith &anking reforms and increasing num&er of puic sector &anks &eing #isted in thecapita# markets (17 of the #arger puic sector &anks are #isted)% governance standards haveimproved significant#y in conformity ith the reMuirements of the capita# markets regu#ator%SE'5+

The Regiona# Rura# 'anks (or RRBs= are a#so ma-ority government4o ned+ The o nershipstructure of these &anks is as fo##o s. 3o5 o ns 0J of the capita# of an RR'% the Ksponsoring

puic sector commercia# &ank o ns 8 J (eHcept for t o RR's that have a private sector &ankKsponsoring the 8 J commercia# &ank stake)% and the state government accounts for theremaining 1 J of the capita#+ our of nine &oard mem&ers are government appointees< inaddition R'5 and A'AR" have one nominee each and the sponsor &ank ( hich are most#y

puic sector &anks) have three representatives+

Rural cooperatives 6 or the state #eve# cooperative &anks (St*'s) the government o nership isaround 10J% hi#e it is around 1 J for the district #eve# cooperative &anks ("**'s)ed+ (AnneH 8 provides more detai#s< igures 17% 18 7 7B )+ AssetMua#ity is Muite poor ( igure 1?80) ith the St*'s reporting an ! ratio of 18+?J% and the"**'s reporting an ! ratio of c#ose to 70J+ Whi#e the "**'s have a reasonae operatingcost ratio of a #itt#e over 7J% staff productivity at Rs 17m is eak (the state #eve# cooperative

&anks performance on these indicators is &etter &ut is rea##y not comparae to retai# &anks since7F *ommercia# &anks rura# operations are not ana#y>ed separate#y as these are su&sumed in their overa## operations+

o ever% as some indicators on asset Mua#ity indicate% their overa## performance disaggregated for the rura# operations%may not &e too different from that of RR's and cooperative &anks+7 3iven the po#itica##y sensitive nature of rura# credit% ith fa##ing interest rates in recent years% announcements &ysuccessive governments% typica##y suggesting interest rate caps on agricu#tura# credit% have not &een uncommon+ The#ast ma-or announcement as made around a year ago and suggested a cap at BJ on farm #oans #ess than Rs 0%000(around O1%700)+ Whi#e these announcements do not get mandated &y R'5 po#icy% such mora# suasion provides the

rong signa#s for rura# &anks and increases the chances that cou#d #ead to rura# &anks &eing forced to adopt such pricing 6 if they do so% the suggested rates ou#d pro&ay #eave an inadeMuate% or even negative financia# margin+7B Whi#e many of the puic sector commercia# &anks are no #isted companies raising capita# from the puic andhaving independent and professiona# &oards and are re#ative#y free of the adverse impacts of government o nership%this is not the case ith the RR's and rura# cooperatives+80 or commercia# &anks% a proHy for rura# asset Mua#ity has &een taken as the ! ratio on the priority sector advancesof puic sector &anks< the puic sector &anks account for more than B0J of the outstanding advances in rura# areas of commercia# &anks+

7?


28/60

the former are structured as apeH institutions)+ urther% the eighted average cost of funds for thecooperative &anks 4 +8J and +DJ for St*'s and "**'s respective#y ( igure 1 ) 4 is very highand #eads to compressed financia# margins+ =vera## the com&ined effects of mora# suasion fromthe government to keep #ending interest rates #o % poor asset Mua#ity% #o a&i#ity to enforcerecoveries and high cost of funds has #ed to the present tenuous position in the &a#ance sheets of rura# cooperative &anks+

3overnment o nershipLcontro# a#so means that RR's and rura# cooperatives have to operate in#ine ith government diktat and are not ae to take decisions independent#y+ Some eHamp#es of this inc#ude. forced reschedu#ing of agricu#tura# #oans and Kcoerced #ending to unviaegovernment o nedLcontro##ed commodity cooperatives (especia##y% the sugar and teHti#ecooperative sectors)% state governments use of cooperative &anks as channe#s for the de#ivery of various government schemes and de&t or interest aiver schemes 81% and e#ected &oards &eingsuperceded+ Rura# de&t or interest aiver schemes announced &y state governments a#so createadverse incentives for farmers% ho do not service the de&t in a time#y manner on the eHpectationthat% at some point% a aiver i## &e granted+ A## these factors hinder proper management andoperations of rura# &anks and reduce the attractiveness of rura# #ending for these &anks+

*ifth% #aH regu#atory standards for RR's and rura# cooperative &anks% the poor enforcement of prudentia# regu#ations% and regu#atory for&earance% have undermined market discip#ine and addedto the financia# fragi#ity of these &anks% there&y impeding their a&i#ity to perform the task of efficient rura# financia# intermediation+ Whi#e the R'5 is the overa## regu#ator of the rura# financesector% supervision of RR's and rura# cooperatives is de#egated to A'AR"+ o ever% ithregard to the regu#ation of cooperatives% there is dua# contro# 6 the state through the Registrar of *ooperative Societies a#so p#ays a #arge ro#e+ The state government retains significant po ers inrura# cooperative &anks% contro##ing a## matters re#ating to registration% mem&ership% e#ection%financia# assistance% #oaning po ers% &usiness operations% #oan recovery and audit+ This #eads tocross4directives% inadeMuate #eve#s of contro# of the centra# &ank ith respect to &anking functionsand conseMuent eakening of the overa## Mua#ity of regu#ation of the cooperative &anks+

And hi#e regu#atory standards have &een progressive#y tightened for commercia# &anks and &rought in #ine ith &est practices% this has not &een the case for the RR's and rura# cooperative &anks+ !rudentia# regu#ation standards re#ated to capita# adeMuacy have not &een app#ied for RR's and cooperative &anks (there are no minimum capita# adeMuacy ratios prescri&ed) 6 giventhe #arge percentage of rura# &anks that are inadeMuate#y capita#i>ed ( igure 17 a&ove) this meansthat a significant proportion of deposits of rura# &anks is potentia##y at risk+ A#so% assetc#assification standards% and re#ated to this regu#ation on income recognition and provisioning%need to &e upgraded to match up ith that of the commercia# &anking system hich &ases itse#f on ! s on a B04day #eve#+ 3iven these eak regu#atory standards% it is perhaps not surprisingthat e#igi&i#ity norms from A'AR" for avai#ing refinance assistance remain Muite #enient 6 cooperative &anks that have eroded deposits #ess than 0J are e#igie for refinance% as are RR's

hich have a deposit erosion #eve# of #ess than 80J+

A'AR"% in its ro#e as the apeH deve#opment &ank for rura# finance has% in the past% providedsu&sidi>ed refinancing to commercia# &anks% RR's and cooperative &anks+ This cou#d have #edto some cro ding out of market &ased credit to rura# areas and important#y% reduced the incentiveand pressure on rura# &anks to improve financia# performance and move to ards increasedre#iance on market &ased funding+ o ever% ith dec#ining interest rates in the economy% theincrementa# cost of funds for rura# &anks has dec#ined faster than for A'AR"+ The resu#t of this81 ,ost significant#y the Agricu#ture and Rura# "e&t Re#ief Scheme of 1B B4B0 &ut severa# other su&seMuent schemes%inc#uding% most recent#y% thekharif interest aiver in 7007408+

7


29/60

is that A'AR"s typica# refinancing rates of &et een D+7 4D+F J p+a+ are no #onger su&sidi>edand demand for refinancing has dec#ined% especia##y from the more efficient rura# &anks+

Why "o Sma##% Rura# 'orro ers ind Rura# 'anks $nattractiveC

rom the perspective of sma##% rura# &orro ers (the users)% rura# &anks are unattractive for thefo##o ing reasons. Sma##% rura# &orro ers find rura# &anks unattractive for the fo##o ing reasons.

A sence of fle0i le products and services

Rura# &anks do not provide f#eHie products and services to meet the income and eHpenditure patterns of sma## rura# &orro ers+ As noted a&ove% sma## rura# &orro ers have irregu#arLvo#ati#eincome streams and eHpenditure needs% and therefore% prefer to &orro freMuent#y% and repay insma## insta##ments% &ut most &anks do not offer such products+ A#so% hi#e sma## rura# &orro ersseek savings and #ending products% they a#so seek insurance (#ife% hea#th% crop)% hich &anks donot genera##y offer+

)ransactions costs

The transactions costs of dea#ing ith forma# &anks are high+ 5n part% high transactions costs stemfrom distance to the nearest financia# institutions+ According to the R AS% 7008% the mediandistance to the nearest financia# institution ranges from 7 kms (post office &ranches) to kms(commercia# &anks% cooperative &anks)< the median time taken to trave# to the nearest commercia#

&ank% cooperative or RR' is 80 minutes (post offices are avai#ae at c#oser proHimity)+!rocedures for opening an account or seeking a #oan are cum&ersome and cost#y ( ith highre-ection rates)+ 3overnment po#icy dictates that rura# &orro ers current#y need to acMuire a 9nodues certificate: from every other #ender in the vi##age (as defined &y #oca# #enders) that they donot have a #oan outstanding+

urthermore% c#ients have to pay hefty &ri&es (ranging from 10J470J of the #oan amount) toaccess #oans% so that the u#timate cost to &orro ers is very high (despite interest 9caps:)+ =naverage% some 7FJ (and ? J in $!) of samp#e househo#ds in our survey ho &orro ed from anRR' report having to pay a &ri&e to get the #oan% a #itt#e under 7FJ of househo#ds ho &orro edfrom a commercia# &anks paid a &ri&e% and 10J of househo#ds ho &orro ed from a creditcooperative paid a &ri&e+ The &ri&e amounts appear to vary from any here &et een 10J of the#oan amount (in the case of &anks) to 70J (in the case of cooperatives)+ ,oreover% #onger

processing times for #oans% together ith &ri&es% cou#d resu#t in higher effective costs to &orro ers and conseMuent credit rationing+ 5t takes% on average% 88 eeks for a #oan to &eapproved &y a commercia# &ank+87 (Tae 1 )+

87 igh transactions costs of dea#ing ith forma# &anks trans#ate into a #o freMuency of transactions+ According to theR AS% 7008% more than D0J of househo#ds ith &ank accounts report accessing their accounts at a freMuency of #essthan once a month (D7+8J of househo#ds ith accounts in &anks access their accounts #ess than once a month% hi#e thesame percentage amongst househo#ds ith accounts in RR's is F0+ )+

7D


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"ource6 R*A"8+,, .

&ollateral

A third factor that makes forma# &anks unattractive for rura# &orro ers is that &anks demandco##atera#% hich poor rura# &orro ers #ack+ 5ndeed% the ma-ority of #oans eHtended &y commercia#

&anks% RR's and cooperatives are co##atera#i>ed% ith BJ of househo#ds ho &orro ed fromRR's% and FJ of househo#ds ho &orro ed from commercia# &anks% reporting that they had to

provide co##atera# (R AS47008)+ and remains &y far the most predominant form of co##atera#+'ut since this co##atera# is se#dom eHecuted% it is -ust another cost% ith #itt#e &enefit in practice+

7F

an RR #oops Sc+emes 't+ers5nterest rate (median) J p+a+ 17+E 11 11 1? 1?

oan amount received as J of amount app#ied B1+A AA+7 A8+E AD+D B8+!ercentage househo#ds reporting &ri&es 7D+A 7F+0 B+F 7F+7F 78+71

'ri&e as J of amount approved 10+1 1A+7 1B+B ?7+8 A+8Time taken to process a #oan app#ication ( eeks) 88 7A+E 7? A+B 1?+8

&able 6B. Aspects of formal borro ing and its costs


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IV. RECENT EFFORTS IN INDIA TO I,*ROVE RURAL ACCESS TO FINANCE: THEROLE OF FOR,AL-INFOR,AL LIN A/ES AND NE( *RODUCTS 33

5n #ight of the inefficiencies that characteri>e 5ndias rura# finance markets and the re#ative #ack of success of the formal rura# finance institutions in de#ivering finance to the poor% 3=s% financia#institutions% and government have made efforts% in partnership% to deve#op ne financia# de#iveryapproaches to service the financia# needs of the rura# poor+ These approachesIor 9microfinance:

programsIhave &een designed to overcome some of the risks and costs associated ith forma#financing% and a#so to overcome the tyranny of co##atera#+ They invo#ve providing thrift% creditand other financia# services and products of very sma## amounts to the poor% ith the aim to raiseincome #eve#s and improve #iving standards+ 8? They attempt to com&ine the safety and re#ia&i#ityof formal finance ith the convenience and f#eHi&i#ity that are typica##y associated ith informal finance+ Whi#e some of these programs have &een more successfu# than others% their #imitedoutreach% sca#a&i#ity and financia# sustaina&i#ity remain matters of concern+ S 34&ank inkage Approach. inking *ommercia# 'anks to 3rassroots 'orro ers

=ne approach to microfinance that has gained prominence in recent years is the se#f he#p group(S 3)4&ank #inkage program% pioneered &y a fe 3=s such as ,@RA"A in 2arnataka and!RA"A in Ra-asthan (and #ater in Tami# adu and ;harkhand)% ith strong support from

A'AR"% hich has &een instrumenta# in promoting this gro th+ 8 S 34&ank #inkage invo#vesorgani>ing the poor% usua##y 1 470 omen% into se#f4he#p groups (S 3s)% incu#cating in thegroup the ha&it of saving% #inking the group to a &ank (usua##y the rura# &ranch of a commercia#

&ank% &ut a#so RR's% cooperative &anks% etc+)% and rotating the saved and &orro ed funds through#ending ithin the group+ The S 3s thus save% &orro and repay co##ective#y+ The #enders(&anks) are often refinanced &y A'AR" at s#ight#y su&sidi>ed rates a#though% in recent years%high recovery rates have encouraged some &anks to #end to S 3s ithout A'AR" refinancing+The S 3s are not forma##y registered+

The funds may &e distri&uted either to one or more mem&ers of the group 6 ho are persona##yresponsie for repayment (genera##y the group &orro s at a&out 17J per annum) 6 or spentco##ective#y &y the group+ The group is free to decide the interest rate charged to its mem&ers% &uttypica##y% a mem&er &orro s from the group at a&out 7?J per annum+ 8D The groups make their interna# credit decisions% decide on the repayment period% etc+ ,oney is used for &othconsumption (hea#th% marriages% etc+) and% over time% for individua# and group investment

products+ After a #oan is fu##y repaid% the group may &orro again% often a #arger amount+ 'ankstypica##y provide a #oan eMuiva#ent to four times the groups savings &ut% as the group matures%and &ased on the groups track record% &anks are ready to #end more< some of the RR's visitedreported making #oans amounting to 10 times the S 3s savings .

88 This section dra s #arge#y on the &ackground papers &y ,orduch and Rutherford (7008)% ,aha-an and Ramo#a(7008) and ess and 2#apper (7008)+8? Whi#e microfinance typica##y covers the poor in rura#% semi4ur&an and ur&an areas% the focus here is on the rura# poor+8 3uide#ines from the R'5 ere issued in 1BB7% to eHperiment ith a pi#ot of 00 S 3s to #ink ith &anks+ This pi#ot

program as e## the ork of a num&er of 3=s as revie ed &y a Working 3roup on 'ank ending to the !oor through 3=s and S 3s (1BB ) and detai#ed guide#ines ere dra n to encourage &anks to use this method+

A'AR" as given the task of #eading this effort and it took to task ith eHemp#ary di#igence+ 5t invo#ved 3=s%commercia# &anks% regiona# rura# &anks and even cooperative &anks in forming S 3s and then #inking those up ithnear&y &ank &ranches+8D 5n contrast% money #enders ou#d charge annua# interest rates ranging from 8D 4170J p+a+ The average interest ratecharged &y money #enders is ? J+

7


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The success of the S 34&ank #inkage mode# depends critica##y on the tasks of promoting%nurturing% strengthening and monitoring S 3s 6 tasks that are performed &y the Se#f e#p!romoting 5nstitutions (S !5s)+ Traditiona##y% grass4roots #eve# 3=s have performed the tasksof promoting and monitoring S 3s+ ,ore recent#y% rura# &ranches of commercia# &anks%cooperative &anks% RR's% non4&ank finance companies ( ' *s)% etc+ have a## &egun to p#ay thero#e of S !5s+ 'ut% recent eva#uation studies revea# the comparative#y &etter performance of S 3s promoted &y 3=s (as opposed to the other S !5s)+

S 3s reMuire a #arge amount of pre4 and post4#ending monitoring+ ,ost #enders use 9faci#itators:( ho may or may not earn a commission andLor &onus for group repayment and recruiting negroups)+ aci#itators may &e #oca# &usiness peop#e% hea#th orkers% government emp#oyees%teachers% etc+ 'efore a #oan is granted% the group must prove their a&i#ity to save over time% #earn

&ookkeeping ski##s% and sho their commitment to continue as a cohesive group+ 5t often takesover a year &efore an estaished group can &orro + The faci#itator is responsie for introducingthe group to the &ank% imp#ementing savings patterns and teaching &asic accounting practices+(A#though the faci#itator may not accept money on &eha#f of the #ender)+ After the #oan is made%the faci#itator attends month#y meetings (attendance is a good indicator of the continued successof the group) and enforces repayment+

=ver the #ast 10 years% the S 34#inkage mode# has &ecome the dominant mode of micro financein 5ndia% and the mode# has &een successfu# in encouraging significant savings and highrepayment rates+ The num&er of S 3s #inked to &anks has increased from -ust 00 in the ear#y1BB0s% to over 00%000 &y 7008+ The S 34&ank #inkage program today reaches some 17 mi##ion

omen and their househo#ds% cumu#ative#y providing over Rs 70?B *rore ($SO ?? mi##ion) ascredit &et een 1BB7 to ,arch 7008+ (Tae 1D)+

&able 61 :ro t+ in ?olumes of S2:-ban (in age'y ,ar 81 um&er of S 3s #inked to &anks%

cumu#ative nos+*umu#ative &ank #oans (Rs+ mi##ion)

1BBB 87%BB F17000 11?%FF 1%B807001 7D8% 7 ?% 0B7007 ?D1%?F 10%7D87008 F1F%80D 70%? F

There appears to &e idespread enthusiasm in 5ndia a&out the &enefits of the S 34#inkageapproach% notay &ecause. (1) 5t he#ps reduce transactions costs for the &anks (their costs re#atedto credit eva#uation% #oan monitoring and decisions are reduced% since &anks can re#y on the S !5to identify and promote groups and pass4on the #oan appropriation decisions to the group) as e##as the &orro ers (as the group itse#f provides constant atch and fo##o 4up)< (7) 'y using 9peer4

pressure:% the approach increases the #ike#ihood that individua# group mem&ers i## repay as e##as that the group as a ho#e i## not defau#t (other group mem&ers effective#y proHy for co##atera#)< (8) oan defau#t rates are very #o % on average #ess than 1J< (?) 5t empo ers rura#

omen+

7B


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2o- 3ffective 2as "2 Bank $inkage Been in )argeting the oor?A#though data avai#ae to us cannot ans er this Muestion direct#y% e can #ook at some indirectindicators on the re#ationship &et een S 3s and the poor using resu#ts of the R AS% 7008 for thestates of A! and $!+ 8F irst% the ma-ority of the &eneficiaries of S 3 'ank inkage are fromamong the poorer groups+ R AS% 7008 indicates that near#y ?J of S 3 mem&ers are from the

poorest groupsIthe #and#ess and margina# farmers+ o ever% significant differences eHist acrossstates+ Whi#e F8 percent of S 3 mem&ers in $! are from the poorest househo#ds 6 the #and#essand margina# farmers% the corresponding proportion in A! is #o er (?8 percent)+ 5n A!% though%a#most a Muarter of the poorest househo#ds &e#ong to S 3s% &ut the proportion of househo#dsfrom richer categories that &e#ong to S 3s is much higher+ (Tae 1F)+

&able . S2: members+ip bC tCpe of +ouse+olds

)arginal Small )edium (arge 't+ers &otal

Andhra !radesh

S 3 mem&er (J househo#ds) 7 +8 8?+8 81+1 7B 7B+D 7 +7

J of S 3 mem&ers ?8+8 1? 11+? 11+? 1B+B 100

$ttar !radeshS 3 mem&er (J househo#ds) 10+8 +? +8 ?+1 D+F +7

J of S 3 mem&ers F7+ + F+? ?+? D+F 100

7arginal F landholding less than 1 acre% "mall F 18+ acres% 7edium F +84 acres% $arge F more than 4 acres. thersincludes households -ith or -ithout land ut involved in commercial activities."ource6 R*A"8+,,

To eHp#ore further the success ith hich S 3s are targeting the poorest% e used the R AS%7008 data to eHamine the attri&utes of househo#ds that are S 3 mem&ers+ =ur resu#ts indicatethat that S 3 'ank inkage is certain#y Muite effective in targeting poorer househo#ds (in the

particu#ar#y the t o Muinti#es a&ove the poorest househo#ds)+ The re#ationship &et een the poorest househo#ds and S 3 mem&ership is positive too% though not significant statistica##y+ This

on#y further under#ines the cha##enges ahead in eHpanding the outreach of microfinance to the poorest+ ('oH 8)+

8F The R AS targeted rough#y D0 vi##ages in each state% though the actua# num&er of vi##ages samp#ed as higher in $!+"ata from R AS% hich as a househo#d survey% inc#ude responses from those ho ere mem&ers of S 3s% as e## asvi##age4#eve# data+ 'ased on the #atter% a tota# of F8D S 3s ere in operation in the vi##ages covered &y R AS% ith theover he#ming ma-ority in A! as ou#d &e eHpected+ ot on#y does A! have the preponderance of S 3s% these groupsare over he#ming#y comprised of omen on#y+ Womens groups accounted for B percent of a## S 3s in the state+ 'ycontrast% in $! groups comprising on#y men and miHed groups ere a#so e## represented+

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o @. 2o successfullC +as S2: ban (in age targeted t+e poor5

The R AS47008 data a##o for the first time a statistica# ana#ysis of certain aspects of S 3s in 5ndia% hiche have used to #ook at the reach of the S 34&ank #inkage mode# into the poorest househo#ds% ho are

predominant#y amongst those eHc#uded from forma# finance+ We can eHp#ore further the success ith hich

S 3s are targeting the poorest &y eHamining the attri&utes of househo#ds that are S 3 mem&ers% using datafrom A!+ We mode# this in a Kpro&it frame ork using as eHp#anatory variaes househo#ds re#ative incomerank in terms of income Muinti#es are the &ottom Muinti#e%Gint+ the neHt and so on) and thenum&er of S 3s avai#ae in the vi##age ( shgnum )+ =ther eHp#anatory variaes avai#ae in the surveyinc#ude the num&er of other househo#ds in the vi##age that are re#ated to the househo#d ( relatvs )% since this

81


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cou#d indicate the househo#ds access to informa# finance+ 8 We a#so inc#ude as eHp#anatory variae hether or not it has an account ith a forma# financia# institution ( ankac )% as a crude indicator for access to thehouseho#d of forma# finance+ ina##y% e a#so inc#ude a regiona# dummy for vi##ages in coasta# districts(coastal )

The estimated coefficients are reportedin terms of the incrementa# impact onthe pro&a&i#ity of the househo#d &eingan S 3 mem&er due to a sma## changein the eHp#anatory variae+ Thus% anincrease in the num&er of S 3s in thevi##age &y 1 increases the pro&a&i#ity of a househo#d &eing in an S 3 &y 0+7

percent+ Simi#ar#y% househo#ds in thesecond Muinti#e have a F+ percenthigher #ike#ihood of &eing in S 3scompared to househo#ds in the richestMuinti#e+ A#though the overa## fit of theregression is #o % suggesting other variaes (not avai#ae in the survey data) are a#so important% thecoefficients of a## variaes inc#uded are statistica##y significant at J #eve# of significance% eHceptthe poorest and Muint?+ The three variaes ith statistica##y insignificant coefficients are poorest%Muint? and eHpnd+ )his suggests that households in the t-o Guintiles a ove the poorest householdsare more likel! to e "2 mem ers% -hile the poorest and those in the top t-o income Guintiles areless likel! to e in "2 s + ote though that the coefficient for poorest Muinti#e is positive even if insignificant% and that the second Muinti#e may sti## inc#ude househo#ds that are Muite poor% even if notamong the poorest+ (Tae 1 )+

We can a#so use the R AS47008 data to ans er a re#ated Muestion using vi##ages and S 3s in A!%here S 3s ere found in a## vi##ages. Are poorer villages more likel! to have a larger num er of

"2 s? What eHp#ains inter4vi##age variations in S 3sC =ne approach is to use the standard!oisson mode# for count data to ana#y>e the num&er of S 3s in a given vi##age+ Specifica##y% #et y idenote the num&er of S 3s in vi##age i and #et y i &e distri&uted as a !oisson ith mean i here

i eHp ( i )

and i is a vector of eHp#anatory variaes+ o ever% a pre#iminary #ook at the data sho s an over dispersion in num&er of S 3s re#ative to the !oisson% ith the variance su&stantia##y higher than themean+ To account for the over dispersion% e use a negative &inomia# distri&ution that can &evie ed as modifying the eMuation a&ove to

i eHp ( i X u i) here u i denotes some omitted variae(s) such that e ui fo##o s a 3ammadistri&ution ith mean 1 and variance + arger va#ues of imp#y greater dispersion in the data+

Resu#ts of the negative &inomia# regression are provided &e#o using a num&er of eHp#anatoryvariaes re#ated to poverty in the vi##age 6 vi##age average per capita income (avpcy)%ineMua#ity in #and ho#dings (gini#and)% andconnectivity of the vi##age measured &y distanceto nearest rai# ay station and nearest meta# road(rai# Y road respective#y)+ !oorer vi##ages i##have #o er per capita incomes% hi#e greater

8 riends and fami#y are a ma-or source of informa# &orro ings+

&able 3. Probit estimates of li eli+ood of a +ouse+oldbeing a member of an S2:

d LdH s+e+ GShgnum 0+007 0+001 7+7F*oasta# 40+0? 0+01F 47+!oorest 0+08B 0+080 1+87Zuint7 0+0F7 0+07 7+DFZuint8 0+107 0+08? 8+18Zuint? 0+08B 0+07 1+?1'ankac 40+0?7 0+01B 47+78re#atvs 40+00F 0+007 48+?D

7B10 !seudoR7 0+011

&able 7. Negati?e inomial Regression $stimates forS2:s in a ?illage, AP

*oef+ > ! >*onstant +BD 8+B 0Si>e 0+007 D+1 05##iterate 40+0? 47+7 0+07?!rimary 40+0F 48+ 0Avpcy 0+00 0+0F 0+B?83ini#and 41+?F 40+B? 0+8?

go 40+88 41+D0 0+11Rai# 0+01 1+?8 0+1 ?Road 40+0D 41+B 0+0 7RR' 40+08 47+01 0+0?*oop 0+07 7+7B 0+077A#pha 0+77 0+0D 8+?B

B !seudo R 7 0+17 $ikelihood ratio test of alphaF,6 chi +


36/60

ineMua#ity for any given per capita income ou#d indicate more poor peop#e in the vi##age+ /i##ages farther a ay from access to rai# and road% and hence markets% may &e re#ative#y poorer+ The percentage of i##iteratehouseho#ds in the vi##age is a#so #ike#y to &e corre#ated ith vi##age poverty and is inc#uded+ 5n addition% ea#so inc#ude an indeH of educationa# attainment for vi##agers ho are not i##iterate in the form of percentagehaving primary education+ =ther variaes inc#uded are tota# vi##age si>e in terms of num&er of househo#ds(si>e) and hether or not 3=s are active in the vi##age ( 3=)+ ina##y% since rura# institutions #ike RR'sand cooperatives can a#so assist ith S 3 formation% e a#so inc#uded their distance from the vi##age (RR'and coop respective#y)+ (Tae 1B)+

The resu#ts suggest a&sence of a strong re#ationship &et een village8level indicators of poverty and thenum&er of S 3s+ The si>e of the vi##age is significant indicating the #arger the vi##age% greater the num&er of S 3s found+ igher rates of i##iteracy% presumed corre#ated to poorer vi##ages% are associated ith fe er S 3s in the vi##age+ 8B Simi#ar#y% the negative sign for (distance to) meta# road imp#ies vi##ages in theinterior% a ay from good roads% have fe er S 3s+ oticeay% neither vi##age per capita income nor ineMua#ity ithin the vi##age is significant% again under#ining the eak #ink &et een poverty and presenceof S 3s+ The coefficient for 3=s is negative &ut insignificant% imp#ying no significant re#ationship

&et een presence of 3=s and num&er of S 3s in the vi##age+

'mpact on vulnera ilit! of poor households

Recent ana#yses indicate that access to #oans under S 3 &ank inkage has contri&uted to thereduction in vu#nera&i#ity of poor househo#ds+ ?0 This reduction in vu#nera&i#ity takes the form of.(1) 'mprovement in asset position . the program significant#y improved the asset position(comprising #ivestock and consumer duraes) of samp#e househo#ds+ The average increase inassets as a&out F7 percent% from Rs D% ?8 to Rs 11%FB8 in rea# terms (in one to three years)+A&out B percent of househo#ds sa assets increase after groups ere formed+ 'efore the groups

ere formed% one in three househo#ds had no assets< after the groups ere formed that changed toone in siH< (7) 'ncrease in savings . the average savings per mem&er more than trip#ed% from Rs?D0 &efore the group to Rs 1%??? after< (8) &hanges in orro-ing patterns and activities

financed . average &orro ing per househo#d increased from Rs ?%7 7 to Rs %8?1+ A shift aso&served in the activities of the se#f4he#p groups% ith a #o er share of consumption andcu#tivation #oans after the groups formed and a #arger share of a##ied agricu#tura# activities andsma## &usinesses< (?) 'ncrease in emplo!ment . emp#oyment per househo#d ent from an averageof 81 days a year to 8F days+ The proportion of emp#oyment generated through nonfarm andoff4farm activities increased< ( ) 'ncrease in consumption e0penditure . consumption eHpenditure

per househo#d per month increased from Rs FBB to Rs BB8+ !er capita consumption increasedfrom Rs 1BF per month to Rs 7?B< (D) 'mpact on income . the average net income per househo#dincreased from Rs 70%1FF to Rs 7D% B+ A&out ?8 percent of the incrementa# income generated

as from nonfarm activities< (F) 'mpact on povert! . a&out 78? househo#ds ere &e#o the poverty #ine &efore groups ere formed% compared ith 177 after< ( ) "ocial impact . B percentof mem&ers reported that% as a resu#t of the groups activities% they cou#d meet officia#s from thegovernment or from &anks% hi#e a&out FF percent had never had that opportunity &efore+*hanges ere a#so reported regarding attitudes to ard omen+

urther ork shou#d &e conducted on the performance of the program from the point of vie of the financia# institutions that provide the #inkage+ This ou#d provide #essons on the costs and

&enefits associated ith the se#f4he#p group mode#% inc#uding hich entity in the #inkage covershat costs% hat financia# &enefits &anks get from the se#f4he#p group program% potentia#

8B o ever% this ou#d a#so &e consistent ith the notion that greater i##iteracy makes more difficu#t the formation of S 3s+?0 See% for eHamp#e% !uha>hendhi and Satyasai (7000) and Wor#d 'ank (7008)+

88


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ad-ustments and innovations &anks have made to the se#f4he#p group mode#% and incentives thatmotivate them to &e invo#ved in the program and in microfinance in genera#+ 5t i## &e

particu#ar#y important to ana#y>e private &anks to dra on their eHperiences and assess their potentia# to p#ay a #arger ro#e in microfinance in 5ndia+

"ome $essons from "2 Bank $inkage5n #arge part% the success of S 3 'ank inkage may &e attri&utae to the fact that it is e##a#igned ith 5ndian history and circumstances% and capita#i>es on the countrys vast net ork of rura# &ank &ranches+ The idea of #oca# savings4and4#oan c#u&s en-oying access to forma# financia#services &y &ecoming corporate customers of &anks is a good one and is practiced in a sma## ayin many countries+ A e##4run c#u& can keep its reserves at the &ank and take &u#k #oans hich itcan on4#end to its mem&ers at a premium% covering its costs and re arding its savers in the

process+ 5n 5ndia% this practice seems particu#ar#y appropriate on t o counts. irst% the countryhas active 3=s that have &een >ea#ous in their efforts to ards group formation< 3=s vieS 3s as having many &enefits (such as omens empo erment) &eyond microfinance+ Second%and perhaps even more important% S 3 'ank inkage seems particu#ar#y suited to 5ndia &ecausethe mode# capita#i>es on the countrys vast (and uniMue) net ork of rura# &anks that are other iseunae to reach out to the poor+ o ever% as the ana#ysis a&ove indicates% the S 3 'ank inkage

program faces important cha##enges in eHpanding outreach and reaching the poorest Muinti#es of rura# househo#ds+

EMua##y important% the success of S 3 'ank inkage underscores -ust ho important a ro#eski##fu# #eadership% good po#icy% and a conducive #ega# and regu#atory frame ork can p#ay+5ndeed% the ro#e of government in estaishing the necessary po#icy and #ega# frame ork% and the#eadership ro#e assumed &y A'AR" in championing the movement% cannot &e underestimated+3overnment recogni>ed the potentia# of S 3 &anking very ear#y on in the movements historying meetings% training the mem&ers)+ The estimate of this cost is

controversia#% ith A'AR" c#aiming it to &e as #o as Rs 1000 per group and 3=s saying ittakes as much Rs 17%000+ The ,inistry of Rura# "eve#opment has estaished a norm of Rs10%000 per group% hich eHperts c#aim is rea#istic+ Thus% reaching A'AR"s interna# target of forming an additiona# one mi##ion groups &y 700 % ou#d reMuire an estimated Rs 10 &i##ion+Where these funds i## &e sourced from remains unc#ear+ ,oreover% even after a group has &een

promoted% continuous efforts are needed to monitor these groups and strengthen their interna#capacity to undertake administrative tasks (accounting% meeting minutes% correspondence% andnegotiations ith &ankers) and commercia# activities (&usiness start4ups% marketing% and re4investment)+ Efforts are a#so needed to ensure the groups remain financia##y sustainae and havethe a&i#ity to eather persona# #osses (accidents% sickness% death)% and natura# disasters+ eading

3=s that have &een engaged in this activity indicate that it takes a minimum of three years of nurturing &efore a group is ready to &e #inked to a &ank+

Third% issues concerning the mode#s financial sustaina ilit! in the face of pressures on &anks to#end to S 3s at su&sidi>ed interest rates cou#d constrain the further gro th of S 3 'ank

inkage+ 'anks have &een #ending to S 3s at interest rates of &et een 17J and 17+ J+

?1 These tasks inc#ude incu#cating in the groups a cu#ture of savings and repayment% teaching them &ookkeeping ski##s%strengthening their interna# capacity to undertake administrative tasks (accounting% meeting minutes% correspondence%and negotiations ith &ankers) and commercia# activities (&usiness start4ups% marketing% and re4investment)% ensuringthe groups remain financia##y sustainae and have the a&i#ity to eather persona# #osses (accidents% sickness% death)%and natura# disasters% etc+

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Recent#y% t o state4o ned &anks% the State 'ank of 5ndia and Andhra 'ank% have announced their intention to #end at BJ per annum% vie ing S 3 #ending as a high#y profitae &usiness+ Recentstudies% ho ever% indicate that the a## inc#usive costs of #ending to S 3s are in fact much higher than hat state4o ned &anks seem to think% and cou#d range any here &et een 1 J ( hich is

hat private &anks #ike 5*5*5 'ank charge hen they #end to S 3s) to 7 J+ 5n a study of fiveRR' &ranches% Sinha (7008) sho s that the a## inc#usive costs of #ending to S 3s (taking intoaccount the re#ative#y high transactions costs of dea#ing ith S 3s as e## the costs of groupformation% hich &ank are increasing &eginning to &ear) ou#d trans#ate into interest rates of any here &et een 77J and 7 J per year% and in one case% here the RR' as #ocated in a #odensity% forested district% the costs trans#ated into interest rates as high as ? J per annum+ TheS 3 portfo#io is a sma## part of the tota# &ank #ending% portfo#io Mua#ity is good% and it may &e

possie to cross su&sidi>e this% &ut un#ess &anks charge interest rates to recover costs% themode#s financia# via&i#ity and #onger term sustaina&i#ity may &e -eopardi>ed+

As the S 3 program has caught the attention of government officia#s and po#iticians% Muantitativetargets on the num&er of groups to &e promoted each year are overriding concerns a&out theGualit! of the groups promoted% and this cou#d discredit the entire mode#+ ,any of the groups are

&eing promoted &y S !5s that are driven &y short term monetary incentives (such as those under the government se#f4emp#oyment program% S3S@) andLor #ack adeMuate ski##s in group

promotion+ ,any groups have come together on an ad hoc &asis% on#y &ecause they ant a #oan+The emphasis on targets ithout adeMuate attention to nurturing and strengthening the S 3scou#d #ead to a genera# deterioration in the Mua#ity of groups promoted% threatening the #onger term credi&i#ity and via&i#ity of the entire program+ 5ndeed% recent evidence suggests that theMua#ity of groups is a#ready &eginning to suffer+ A survey &y A!,AS in 7007 indicated that on#y1F percent of a## groups ere of adeMuate Mua#ity for &ank #inkage and this as in a state hich isconsidered the #eader in the movement+

,icrofinance 5nstitutions (, 5s)

A second approach to microfinance invo#ves de#ivery of finance to the poor through the creation

of specia#i>ed microfinance institutions (, 5s)+ This effort has &een #ed &y the Sma## 5ndustries"eve#opment 'ank of 5ndia (S5"'5) oundation for ,icro4*redit (S ,*) and other apeH#ending institutions% inc#uding the Rashtriya ,ahi#a 2osh (R,2) and riends of Womens Wor#d'anking+ ,uch of the credit of the gro th of the sector has &een pioneered &y these institutions+S ,*% as the #argest p#ayer% #ed a num&er of innovations inc#uding mainstreaming themicrofinance sector% faci#itating #inks to commercia# &anks and #enders% promoting &etter

practices amongst , 5s through its capacity &ui#ding program% pioneering support to ratinginitiatives and ne instruments inc#uding the recent#y #aunched transformation #oanLMuasi4eMuity

product+ As a resu#t of such initiatives the , 5 sector has gro n at a fast rate over the #ast siHyears or so+ Some of these , 5s are &ased on the 3rameen mode#+ =thers promote and estaishfinancia# #inks ith S 3s+ The , 5s offer some of the features of the informa# sector such asf#eHie products% customer friend#y practices &ut at a higher interest rate ?7 than forma# sector%

hi#e &ringing in some features of the forma# institutions 6 such as documented #oan contracts%detai#ed &ooks of accounts% ,5S% staff% and some degree of supervision &y a regu#atory authority+

?7 ,4*R5 s 7008 ,icro inance Revie presents the A!R of rated 5ndian , 5s as 7?+8J+ There are signs that ithcompetition and gro ing efficiency in operations% interest rates of , 5s can reduce over time< Spandana% a #eading , 5in A!% amongst the #argest in the country% reduced its #ending rate from 1 470J pa f#at to 1741 J pa f#at and has p#ansto reduce it further on account of operationa# efficiency gains ith gro ing sca#e of operations< ASA% a #eading , 5 inTami# adu a#so reduced its interest rate from a high 7?J pa f#at to 1 41DJ pa f#at that is c#ose to the rates that S 3sthemse#ves charge each other for interna# #ending+ =ther eHamp#es can &e found particu#ar#y from these t o states%

here the degree of competition &et een , 5s is strongest+

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=ver the past decade% the num&er of , 5s in 5ndia has gro n+ o ever% ith a fe eHceptions%most , 5s in 5ndia are very region specific% sma## in si>eIthe #argest &eing S ARE ,icrofin

td ith #oans outstanding of a&out Rs 0 crore and 'AS5 of Rs 8 crore in ,arch% 7008Iandtheir co##ective outreach has &een #imited+ 5n ,arch 7008% the , 5s sector as a ho#e hadoutstandings of Rs 7?0 crore (O 7 mi##ion) reaching #ess than one mi##ion &orro ers+

=ne estimate indicates that the average #oans dis&ursed &y the top 10 , 5s amounted to -ust Rs1D crore per , 5+ Another estimate% &ased on DB rated , 5s ( hich are among 5ndias top 100, 5s)% sho s that these , 5s had a&out D 00 &orro ers and Rs 7+8 crore #oan outstanding% per , 5+ (Sinha% 7008)+ 5n comparison% , 5s in 'ang#adesh are estimated to reach more than D0Jof the poor in the country ith the #arger programs such as 3rameen 'ank% 'RA*% !roshika andASA a## reaching e## over one mi##ion c#ients each+ 3rameen 'anks #oan portfo#io a#oneeHceeds that of the entire microfinance sector in 5ndia &y a factor of five hereas 'RA*s

portfo#io is more than three times that of a## , 5s in 5ndia< &oth ASAs and !roshikas portfo#io isa#so greater than that of the entire microfinance sector in 5ndia+

5n addition to the re#ative#y sma## sca#e of their operations% 5ndian , 5s a#so tend to have a#imited scope+ "ue to regu#atory reasons% on#y a handfu# of , 5s% such as /SS$ (West 'enga#)offer savings as a service+ Apart from promoting mutua# savings among groups (S 3 or 3rameen type)% a fe 3= , 5s offer savings services &y taking deposits from their mem&ers+=thers have had to use mutua# &enefit trusts or mutua##y aided cooperative societies (,A*S)+=n#y the SEWA 'ank% Ahmeda&ad and the 'AS5 #oca# area &ank 2'S A' (in three districts of A! and 2arnataka) offer savings as R'5 regu#ated entities+

What has constrained the outreach and scale of 7*'s?The #imited outreach and sca#e of 5ndian , 5s% re#ative to the , 5 giants in 5ndonesia and'ang#adesh% ref#ects% at #east in part% the a&sence of an enaing po#icy% #ega# and regu#atoryframe ork+ , 5s suffer from the fact that their regu#atory oversight is fragmented across manygovernment agencies+ , 5s are not a##o ed to mo&i#i>e deposits (even from their o n mem&ers)

un#ess they convert themse#ves into a non4&ank finance company ( ' *)+ And even as ' *s%an Kinvestment grade rating from corporate rating agencies is reMuired for mo&i#i>ing deposits+This is difficu#t for most , 54 ' *s< &ased on past eHa

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