fin inclusion issues challenges

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AKGEC INTERNATIONAL JOURNAL OF TECHNOLOGY, Vol. 4, No. 2

Financial Inclusion: Issues and Challenges

Abstract -- A vast segment of India's population exists on themargins of India's financial systems. There is growing concernabout people being under-banked. Financial inclusion isimportant priority of the country in terms of economic growthand development of society. It enables to reduce the gap betweenrich and poor. It helps to channelize money-flow to the economy;it ensures people who are unable to access financial system sofar can access it with ease. The paper discusses the role of financialinclusion in the economy and how the different stakeholdersplay an important role in developing the whole initiative.

Keywords: Money-flow in Economy, Banking System, FinancialEducation, Access to Financial Services.

I. INTRODUCTIONFINANCIAL inclusion enhances the economy. In thecontemporary era of running for economic power and selfreliance, it is imperative for any regime to create congenialconditions for individuals, households and private institutionswhich included the availability of Banking services.. Theavailability of banking facilities and strong bank branch networkare the major facilitators of developmental and expansionaryactivities. A strong and sturdy financial system is a pillar ofeconomic growth, development and progress of an economy[1].A financial system, which is inherently strong, functionallydiverse and displays efficiency and flexibility, is critical to ournational objectives of creating a market-driven, productive andcompetitive economy[2] A mature system supports higher levelsof investment and promotes growth in the economy with itscoverage. The economic agents facilitate in growth and one ofthe important facilitator is Financial Inclusion .Financialinclusion is defined as delivery of financial services to thepoor at affordable cost. As per V Leeladhar [6], financialinclusion means delivery of banking services at an affordablecost to the vast section of disadvantaged and low incomegroups [3] .

United Nations defined the main goals of inclusive finance asaccess to a range of financial services such s saving, credit,insurance, remittance, and other banking payment services toall bankable households and enterprise at a reasonable cost.The concept of financial inclusion can be traced back to theyear 1904 when co-operative movement took place in India. It

Akhil DamodaranDepartment of Management Studies, Indian Institute of Technology, New Delhi 110016 India

[email protected]

gained momentum in 1969 when 14 major commercial banks ofthe country were nationalized and lead bank scheme wasintroduced shortly thereafter. Branches were opened in largenumbers across the country and even in the areas which werehitherto being neglected.

Even after all these measures a sizable portion of the populationof the country could not be brought under the fold of bankingsystem.(4) In fact, there is a severe gap in financial access whichneeds special attention.(5) Studies have proved that lack ofinclusion or rather exclusion from the banking system results ina loss of 1% to the GDP(6). Thus, financial inclusion is not justa socio-political imperative but also an economic one. Realisingthe gravity of the problem, Reserve Bank of India in its MidTerm Review of Monetary Policy urged the banks to makefinancial inclusion as one of their prime objectives.

The positive impact of financial inclusion is wide-spread acrossthe globe. Most of the literature on banking sector outreachfocus on its effect through cross-country evidence. World Bankhas also done a study on this subject for rural India and foundthat about 40% of households have deposit accounts, 20%have outstanding loans and only 15% have any insurance.

II. THE ESSENCEFinancial exclusion is broadly defined as the lack of access bycertain segments of the society to suitable, low-cost, fair andsafe financial products and services from mainstream providers.Thus the essence of financial inclusion is to ensure that a rangeof appropriate financial services is available to every individualand enable them to understand and access those services. Apartfrom the regular form of financial intermediation, it may includea basic no frills banking account for making and receivingpayments, a savings product suited to the pattern of cash flowsof a poor household, money transfer facilities, small loans andoverdrafts for productive, personal and other purposes,insurance (life and non-life), etc.

The main reasons for financial exclusion, from the demand sideare lack of awareness, low income, poverty and illiteracy; andfrom the supply side is distance from branch, branch timings,cumbersome documentation and procedures, unsuitable

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FINANCIAL INCLUSION: ISSUES AND CHALLENGES

products, language, staff attitudes, etc. Due to all theseprocedural hassles people feel it easier to take money frominformal credit sources, but it results in compromised standardof living, higher costs, and increased exposure to unethical andunregulated providers and vulnerability to uninsured risks. Thusfinancial inclusion does not mean merely opening of savingbank account but signifies creation of awareness about thefinancial products, education and advice on moneymanagement and offering debt counselling etc. by banks. Everysociety should ensure easy access to public goods. Therefore,banking service being a public good should also be aimed atproviding service to the entire population.

Broadly, we can say that financial inclusion is a process ofproviding banking services to the poor at affordable cost, whichimproves their life.

III. THE IMPORTANCEThis can be answered by the given fact that if poor are notconnected to our formal financial system, their growth andimprovement will not take place and as the country grows theywill still be poor without access to basic necessities. Secondlydue to lack of financial system awareness they can be lured toenter in fraud money saving schemes and can be looted. Theylack awareness of investing and will risk the future of theirchildren. That is the reason why financial inclusion is importantfor any country for its growth.

As per the Rangarajan Committee report (2008) FinancialInclusion is defined as the process of ensuring access tofinancial services and timely and adequate credit where neededby vulnerable groups such as the weaker sections and lowincome groups at an affordable cost. Broadly speaking,Financial Inclusion is the delivery of banking services at anaffordable cost to the vast sections of disadvantaged and lowincome groups. Unrestrained access to public goods andservices is the sine qua non of an open and efficient society. Asbanking services are in the nature of public good, it is essentialthat availability of banking and payment services to the entirepopulation without discrimination is the prime objective of thepublic policy.

The goals of financial inclusion can be met largely by initiativeof banking sector to cut across various strata of society, regions,gender and income and encourage the public to embrace bankinghabit. Also, Reserve Bank of India, as the chief regulator hasintervened for the success of financial inclusion by variousenactments, financial literacy drives, leveraging technology etc.

Importance of financial inclusion can be summarised as below:If customer is financially educated, he will make better financialchoices, for example what kind of financial products can fulfilhis individual needs? It will help in improving overall growth ofthe country. Access to financial services at an affordable costwill improve life of the poor.

Financial inclusion is a long term strategy, but to achieve itsobjectives we need to keep in mind what are the key areas itshould address:

z It should provide access to basic financial services likebanking etc.

z The usage of financial services should address needs ofthe poor.

z The financial product should be affordable.z Quality of product and services must be enhanced.

Recent development has shown that technology plays animportant role in improving financial inclusion because of thefollowing reasons:

z It helps to reduce cost of the product.z Reduces transaction cost.z Improves quality of the product.z Helps in increasing choices and flexibility to customer.

All of the above reasons contribute in increasing the utility ofthe financial product.

IV. INTERNATIONAL EXPERIENCEFinancial Inclusion is considered to be the core objective ofmany developing nations since from last decade as manyresearch findings correlate the direct link between the financialexclusion and the poverty prevailing in developing nations.According to World Bank report Financial inclusion, or broadaccess to financial services, is defined as an absence of price ornon price barriers in the use of financial services. The termFinancial Inclusion needs to be interpreted in a relativedimension. Depending on the stage of development, the degreeof Financial Inclusion differs among countries. India rankssecond in the world in terms of financially excluded householdsafter china. For the inclusive growth process of economy thecentral bank has also provided high importance to the financialinclusion.

The weaker sections of the society are generally ignored by theformal financial institutions in the race of making huge profits.Further there are the complexities involved in providing financeto the weaker section. Financial inclusion or inclusive financingis the delivery of financial services, at affordable costs, tosections of disadvantaged and low income segments of society.

There have been many formidable challenges in financialinclusion area such as bringing the gap between the sectionsof society that are financially excluded within the ambit of theformal financial systems in providing financial literacy andstrengthening credit delivery mechanisms so as to improve thefinancial economic growth. Unrestrained access to publicgoods and services is the sine qua non of an open and efficientsociety. It is argued that as banking services are in the nature of

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public good; the availability of banking and payment servicesto the entire population without discrimination is the primeobjective of this public policy. Thus the term Financial Inclusioncan be defined as the process of ensuring access to financialservices and timely and adequate credit where needed byvulnerable groups such as weaker sections and low incomegroups at an affordable cost

India has a historic and well-structured banking system to caterto the financial needs of individuals and households andcontribute towards the improvement and advancement of thenation. Towards these needs, necessary reforms, supervisionand continuous monitoring are envisaged to ensure a modernand up-to-date banking practices, healthy competition, financialinclusion and well calibrated de-regulation. The Indian bankingsector consists of the Reserve Bank of India which is the centralbank, commercial banks and co-operative banks. Banknationalization in India marked a paradigm shift in the focus ofbanking as it was intended to shift the focus from class bankingto mass banking. The rationale for creating Regional Rural Bankswas also to take the banking services to poor people.

The banking industry has shown tremendous growth in volumeand complexity over the last decades. Despite making significantimprovements in all the areas relating to financial viability,profitability and competitiveness, there are concerns that muchneeded banking services have not reached a vast segment ofthe population, especially the underprivileged sections of thesociety. Internationally, also efforts are being made to studythe causes of financial exclusion and designing strategies toensure financial inclusion of the poor and disadvantaged. Thereasons may vary from country to country and hence thestrategy could also vary but all out efforts are being made asfinancial inclusion can truly lift the financial condition andstandards of life of the poor and the disadvantaged.

V. RECENT TECHNOLOGICAL INNOVATION INFINANCIAL INCLUSION

Technology plays an important part in improving the financialinclusion efforts. Mobile technology and its large scalepenetration is a fine example. The first product which is popularworldwide is M-Pesa. M-Pesa of Kenya has spread so quicklyand has become one of the most successful mobile basedfinancial service. In 2007 on an average number of registrationto M-Pesa in Kenya exceeded 5000 per day, by2009 around 7.9million M-Pesa accounts are registered.

Customers in Kenya started using M-Pesa for their day to dayactivities, as there was no hard currency involved there wasless risk of theft. Due to increase in M-Pesa outlets demand forbanking agents increased, which ultimately increased jobopportunity in the country. M-pesa is a simple mobile bankingapplication in which customer can send money to any individualor can purchase items by doing transaction with M-Pesaapplication.

One of the main reasons for M-Pesa growth in Kenya is due toincrease in growth of mobile communication in late 2000s.Secondly, the product was simple to use and affordable for thelocals. It provided choices of product which customer canchoose. It facilitated easy cash convertibility due to availabilitylarge number of M-Pesa outlets. Regulators encouraged mobilefinancial services across the world. After success of M-Pesamany countries adapted the idea of branchless banking. As percurrent trend the future of branchless banking looks bright. Alot of technological innovation will be coming in future to boostfinancial inclusion. To support these initiatives, apart fromgovernment , there are some international agencies which alsoworks for financial inclusion, namely World Bank, CGAP, Billand Malinda Gates Foundation.

After the M-Pesa, many companies in Kenya are investing inbranchless banking, recently there are new products have beenlaunched which are similar to M-pesa like IKOPesa also knownas orange money.Other countries have also developed mobilebanking solutions with the help of service providers and banks.Below is the list to name a few

z Easy Paisa-Pakistanz EKO in Indiaz G-Cash in Philippines.

A strong technological innovation in financial services needsto be supported by strong business model. In case of M-pesait was backed by strong agent network which gave customereasy availability to customer support, cash conversion, andbetter quality of service. Also the support of safari.com thelargest telecom operator in Kenya provided them better edgedue to large customer base and highly reliable brand name.

VI. ROLE OF BASIC FINANCIAL EDUCATIONA deep analysis of the trend in mobile banking can easily makeus understand that, having better technology and better productitself is not enough. The customer should have basic financialeducation as well as usage of technology (Imagine a scenariothat if the customer dont know how to operate a mobile phone,will he be interested to go for mobile banking). So basic educationof financial services is important .The customer should knowwhy, long term investments are important for their family. Howcan we ensure that basic needs of poor are provided whichincludes access to services, better financial education. This iswhere role of regulator comes in picture.

Several empirical analysis indicate a negative influence ofpopulation density on deposit penetration. The finding impliesthat although deposit accounts have improved over time, butits growth has not matched with respect to the populationincrease. But, the relationship is not as clear in case of creditpenetration as the coefficient is insignificant. The averagepopulation per branch is having a negative influence on deposit

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penetration. It confirms the beneficial impact of improvementof branch network on financial inclusion drive, which occursdue to greater accessibility and convenience.

The income level is unambiguously having a positive influenceon both penetration proportions. It points to the fact that levelof economic condition is a vital determinant of financial inclusionefforts. The outcome corroborates the phenomenon of higherusage and requirement for financial services with increase inthe standard of living. Both proportion of factories andemployees to population are having a significant and positiveinfluence on deposit penetration. It implies that region'sstructural and environmental setup has a role in determiningthe deposit penetration.

A positive coefficient for the employee proportion indicatesthat employed people seem to be more active, aware, interestedwith regard to banking activities related to both credit anddeposit activities. Using test for convergence it is found thatthe states tend to maintain their respective level of bankingactivity vis--vis the rest. This has an important implication forthe regions performing low in terms financial inclusion. It seemsthat due to certain inherent structural characteristics lowperforming states are unable to close the gap.

VII. IMPACT OF REGULATIONRegulation defines the business rules of a country. In case ofbranchless banking, regulation can play key role in enhancingcustomer satisfaction, ensuring proper service given to endusers, to create an environment which should be a win-winsituation for both business entities and customer.

Below are some basic observations on regulation in branchlessbanking implemented around the world:

z Regulators should be open to experiment, learn andimplement.

z They should work on enhancing public-privatepartnership.

z Relaxed KYC requirements for smooth customer sign-up.z Focus on customer security and protection.

A vast segment of India's population exists on the margins ofIndia's financial systems. Whilst the per-capita savings of thisclass may not be very high their sheer number means that takentogether their savings are of a considerable amount. If theirentry in the formal financial sector is made easier these savingscan be channelized for an inclusive growth with a distributivejustice. Also savings cum risk products that are their primaryneed can be structured for them once they are part of the formalbanking system.

Among the developed nations, UK was one of the earliest torealize the importance of financial inclusion. Around 8 per centof the households lacked any kind of deposit account. Accountholding is lowest for people aged under 20 and over 80 years.Reasons for exclusion vary from low credit scoring, legislationto prevent bank accounts for 'money laundering', mistrust bypeople , terms and condition of the banks, physical accessproblems among others. In Australia, the prevalence of un-banked adults is much lower than in other developed nations,with estimates of just 3% of adults lacking a bank account.There is however growing concern about people being under-banked.

Financial inclusion is not a short term goal: it is a big initiativeand will itself evolve as the time progresses. The stake holderswho are involved are government, regulators, public and privateentity and the People of the country. To enhance financialinclusion initiative all stockholders have to work together tocreate a better business model which not only serves the needof the current economy but also it should build foundation forfuture financial inclusion plans .In this regards it is worth tomention that the technology plays a vital role. It helps to reducetransaction cost, enhances customer accessibility, products aremore affordable.

Figure 1. Product ecosystem.

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Access to financial services for people, especially poor anddeprived, is critical. Also, access to finance by micro-entrepreneurs is imperative for inclusive and overall growth ofthe economy. The Indian legislature has been conscious of thisfact since early. Bank nationalization in India gave the firstvigorous focus of banking to mass banking. The rationale forcreating Regional Rural Banks was also to take the bankingservices to poor people. The branches of commercial banksand the RRBs have increased from 8321 in the year 1969 to84,504 branches as at the end of March 2010. The averagepopulation per branch office has decreased from around 64,000to less than 14,000 during the same period.

The number of No frill accounts has also registered a growthover the last few years. In view of their vast branch network,public sector banks and the regional rural banks have beenable to scale up their efforts by merely leveraging on the existingcapacity. However, there are still many areas under-banked,particularly in Bihar, Orissa, Rajasthan, Uttar Pradesh, WestBengal and a large number of North-Eastern states, where theaverage population per branch office continues to be quitehigh compared to the national average. In this respect, the newbranch authorization policy of Reserve Bank of India encouragesbanks to open branches in the under banked regions. The newpolicy also places a lot of emphasis on the efforts made by RBIto achieve, inter alia, financial inclusion and other policyobjectives.

To measure financial inclusion, a multidimensional Index ofFinancial Inclusion (IFI) has been proposed. The IFI is an indexthat captures information on various dimensions of financialinclusion in one single digit lying between 0 and 1. It capturesthe penetration of the banking system, its availability to usersand its actual usage. Axiomatic measurement approach isemployed for the measurement of financial inclusion. It improvesupon the IFI proposed such that the index can be utilized todetermine the percentage contributions by the various factors.

Standing out on a global platform India has to look upon theprogress in inclusive growth and financial inclusion is the keyfor inclusive growth. There is a long way to go for the financialinclusion to reach to the core poor. According to K.C.Chakrabarty RBI Deputy Governor Even today the fact remainsthat nearly half of the Indian population doesnt have accessto formal financial services and are largely dependent on moneylenders. Mere opening of no-frill bank accounts is not thepurpose or the end of financial inclusion while formal financialinstitutions must gain the trust and goodwill of the poor throughdeveloping strong linkages with community-based financialventures and cooperative. Financial Inclusion has not yieldedthe desired results and there is long road ahead but no doubt itis playing a significant role and is working on the positive side.

The issue of financial inclusion has received large importancein India during the recent years. India had invested considerable

amount of resources in expanding its banking network with theobjective of reaching to the people. During the last 40 yearshuge infrastructure has been created in the banking sector.However, this large infrastructure that has penetrated evenremote rural areas has been able to serve only a small part of thepotential customers. While India is on a very high growth path,almost at the two-digit level, majority of the people are out ofthe growth process. This is neither desirable nor sustainablefor the nation. We also know that one of most important drivingforces of growth is institutional finance. Therefore, it is nowrealised that unless all the people of the society are broughtunder the ambit of institutional finance, the benefit of highgrowth will not percolate down and by that process majority ofthe population will be deprived of the benefits of high growth.Thus financial inclusion is not only socio-political imperativebut also an economic issue.

VIII. RECOMMENDATIONSFinancial inclusion is still a long road ahead. Innovations in thefield of branchless banking and banking business model aremaking their way towards this goal. Recent exploration suggeststhat product plays a very important role in creating a financiallyinclusive ecosystem. If we observe the innovations happenedaround the world in financial inclusion, we can easily say thatbelow factors are main criteria for making financial inclusion asuccess:

Following suggestions are to be implemented in India forenhancing the Financial Inclusion:z Government should increase number of banks branches

in remote areas.z Banks should focus more on products which should be

simple, affordable , and should have high utility.z RBI should frequently check whether the financial

products are actually utilized by customer effectively, ifnot it should analyse the reasons.

z Banks should do regular surveys in villages forunderstanding the financial needs of the people.

z NGOs and other not for profit organisation/ socialorganisations / Non Governmental organisations etc. maybe involved more to propagate the financial services tothe remote and non accessible areas.

z Banks should allow customers to provide feedback aboutthe product services.

z R B I should allow service providers to provide bettermobile banking products at affordable price.

z Micro Finance Organisations/ Non Banking Financialorganisations may be given permissions to do limitedfinancial services in remote areas.

z Enlist many intermediaries/ agents with incentives tofacilitate popularising Financial products in remote areas.

z Opening of Bank Accounts without minimum balancecondition should be allowed at all branches and places.

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Also simplify the procedure of opening the bank account.No introduction/security to be insisted.

z Opening Bank Branches in remote and rural areas shouldbe liberalised by RBI.

z Institutionalise the agency system that can bring the bankservices at the door step of customer on a commissionbasis like commission agents/ daily collectors etc.authorised by Banks.

z Telecom Service providers and Banks should togetherworkout and implement Mobile Banking simple solutions.

z RBI should allow entrepreneurs to invest in new productinnovation in financial innovation.

z Mobile Banking should be encouraged/incentivised as asmart way of sending and depositing money in Ruralareas.

z There should be special discounted charges for Bankingservices in Rural areas like Telephone calls originating inRural Telephones. For example the interest charges inRural areas should be less than that of Urban .Similarlythe saving Bank account in Rural can be given moreinterest than in Urban. The additional burden on accountof this should be met from a separate fund like USO fundin Telecom.

Financial inclusion enhances the economy. It will grow fasterand will be more stable. It will increase the quality of life of thepeople of the country and also ensure an orderly growth. It willalso reduce the gap between the rich and the poor. This is whatMahatma Gandhi visualised our India should be.

IX. ACKNOWLEDGMENTI am duty bound to acknowledge the great contribution of myProfessor Dr. Mahim Sagar who moulded my imagination intothis study. I must acknowledge that he has been a source ofguidance throughout this study.

IX. REFERENCES[1]. Nitin Kumar, Financial Inclusion and its Determinants: Evidence

from State Level Empirical Analysis in India.[2]. Rohit Sarkar, Vision 2020 for India: The Financial Sector

(Planning Commission Report).[3]. Sadhan Kumar Chattopadhyay, Financial Inclusion in India: A

Case-Study of West Bengal.[4]. S. Nagaraja, Dr. Pallavi and S. Kusugal, Financial Inclusion and

Rural Development.[5]. R Pradhan, Evaluation Of Micro Finance in Harda and

Hoshangabad Districts of MP.[6] V. Leeladhar, Taking Banking Services to the Common Man

Financial Inclusion, 2005.[7]. Anupama Sharma and Sumita Kukreja, An Analytical Study:

Relevance of Financial Inclusion for Developing Nations.

Akhil Damodaran (b. 1986) is a final yearstudent of MBA (Technology management)majoring in strategy and finance from IndianInstitute of Technology, New Delhi. He hasexperience in IT service industry in diversedisciplines ranging from service operation, ISO-27K auditing, and six sigma project management.He holds a bachelor of engineering in Electronicsand Instrumentation from Rajeev GandhiTechnical University, Bhopal.

fin inclusion issues challenges

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