I

n c l u s I v e

n d I a

I n a n c e

r o n t I e r s

RuRal Banking stRategies foR inclusive gRowth

ural sector continues to play an important role in terms of contribution to GDP and employment generation in India, as about 70 percent of Indias population still lives in rural areas. The slow reduction of poverty levels in rural areas against urban areas is an evidence of the sluggish development in rural areas, in spite of new opportunities coming up in rural areas in the post-liberalisation due to better rural-urban linkages and backward and forward linkages of agricultural sector with non-agricultural sector. If the rural population takes advantage of these new opportunities there is a greater scope for reduction in poverty and increase in living standards. However, to fully exploit these opportunities, there is a need to empower rural population with necessary new knowledge, capital and entrepreneurial skills. With abundant knowledge/information flow even in rural areas, the major limiting factor for development of rural poor is the access to capital for both investment and consumption to up grade living standards. As easy and timely availability of capital will act as incentive to wider adoption of productivity enhancing skills / knowledge / technologies by entrepreneurs, farmers and labourers (Reddy and Kumar 2006). To vast majority of rural people, access to capital depends on development of efficient financial service providers (which include credit provision along with other services), as many rural people are poor and having shortage of capital. Provision of services along with credit will not only facilitate borrowers in better utilization of credit but also enhance the credit worthiness of borrowers, which helps in recovery of loans and reduction in non-performing assets of banks. With this background, this paper tries to explore the alternatives, which will enhance the economic and social viability of institutional credit system in rural areas.

paper work as against to the latter, which offer credit at exorbitant interest rates, but credit will be provided whenever, wherever required. Historically, traditionally money-lending business is highly profitable in rural India as many of the moneylenders became rich in the business of money lending. To some extent, their profitability is due to low cost of operation in terms of identifying individuals who are credit worthy, procedures and formalities followed, accessibility, location in densely populated area, individual assessment/pricing based on risk/behavioral assessment. But, due to the high exploitation by moneylenders by levying higher interest rates government discouraged traditional money lending. Since independence, Indian government encouraged many institutions beginning with cooperative credit societies in 1950s followed by social control in 1968, then nationalization of banks in two steps once in 1969 and another in 1980. The establishment of Regional Rural Banks in 1972 is also a step in that direction. Government simultaneously initiated many rural poverty alleviation/ developmental schemes such as community development programmes, service area approach, lead bank scheme, Integrated Rural Development Programme (IRDP) and more recently Swarnajayanti Gram Swarozgar Yojana (SGSY) with a major component of credit with active participation of banks. With all these efforts, the network of branches increased drastically through out rural India, as now for every six villages one-bank branch is there. In the process average population (in 000s) per bank branch came down significantly from 64 in 1969 to 15.2 in 2001. With the main focus on branch expansion and credit expansion without giving adequate attention to the profitability and efficiency, Indian banking system suffered from many typical banking problems such as high NPAs, low profitability, high subsidies and low service quality.

Rural Financial Intermediation

Currently institutional rural credit system comprising of about one lakh primary agricultural credit societies (PACS), 108 regional rural banks (RRBs) with more than 30,000 branches spread through out rural India, about 20,000 branches of commercial banks which provide about 60 percent of rural credit needs. The remaining 40 percent of rural credit needs taken care by non-institutional sources of credit like traditional moneylenders, shopkeepers and relatives. The general distinction between institutional and non-institutional credit sources is former offer credit at low interest rates but with little more

Financial Sector Reforms

The financial sector reforms started in early 1990s to ensure the financial services industry operates on the basis of operational flexibility and functional autonomy with a view to enhance efficiency, productivity and profitability. The impact of these reforms is evident in terms of reduction of average lending rates offered by commercial banks from a peak of about 17 percent in 1996 to about 14 percent by 2002 (Reddy 2005). The increased efficiency also reflected in larger profitability among most of the commercial banks as well as regional rural banks. However, the share of rural sector has been

A. Amarender Reddy
Associate Professor (Public Policy), Administrative Staff College of India, Hyderabad
8
The IIPm ThInk Tank

The IndIa economy RevIew

n c l u s I v e

n d I a

I n a n c e

r o n t I e r s

reduced significantly as banks wants concentrate on more profitable segments of economy to run for profit. Commercial Banks are not willingly participated in lending to rural areas, due to the uncertain character of Indian agriculture, lack of proper accounting of agricultural transactions, small amount of individual loans, inadequate security for loans, and difficulty of collection from farmers, commercial banks in India have largely confined their operations to urban areas, even after nationalization. There has been a shift in even in RRB clientele away from the poorer segments of the population and from areas with low potential to those with better off client groups. Table 1 clearly shows that in the competition for profitability, commercial banks are trying to close remote rural bank branches and opening more branches in urban centers in recent years. So the question arises why the traditional moneylenders are more profitable at least not loss making compared to the all these institutional arrangements even with high technical know-how, scale and scope economies? What causes them to be successful rural moneylender for centuries? What lessons to be learned from the traditional moneylenders to make institutional credit institutions profitable and sustainable?

dishonest local large farmers take all the benefits from cooperatives, thus denying the benefits of co-operation to really needy farmers, have hopelessly wrecked the working of the co-operatives. On the other hand RRBs are suffering from losses since its inception. Some estimated that the RRBs in their present set-up incur losses of about Rs. 5,00,000/- per day - despite their lower costs of operation (Reddy 2006). Highlighting the importance of rural credit reforms RBI (2002) stated that, there is a need to examine the issue of rural credit and its delivery systems in an objective as well as transparent manner and accord it priority in legislative actions and financial allocations.

Table 1: Population Group wise Number of Commercial Banks Closed/Opened Between 2000 & 2002 (Number of Branches)
Population Group Year Closed 1999-2000 2000-2001 2001-2002 127 206 129 Rural Opened 65 45 46 Closed 136 384 147 Urban Opened 647 541 514 Closed 263 590 276 Total Offices Opened 712 586 560

Banks Traditional Business Segments and Economic Viability

Based on an in depth study of RRBs functioning at microlevel, the paper developed a chart showing trade-off between outreach and viability of different commonly provided credit channels. The chart is reproduced in Figure 1, based on this one can conclude that all individual based credit delivery are profitable, but credit delivery though self-help groups are making loss due to high cost involving in nurturing, maintain and sustaining group operations. The key for efficient credit delivery system in rural areas lies in reducing operation and overhead costs. Keeping in cost reduction as main focus, this study proposed an improved credit delivery system within the existing framework of coexistence of commercial banks and RRBs simultaneously and encouraging healthy competition between them. With the reduced government support there is greater need to develop efficient credit delivery mechanism, based on the experience of past studies. The problem with rural banking is high cost of reaching to the remote areas and small account holders. To make operations of regional rural banks more cost competitive, these banks should become lean, technologically capable and organizationally flexible to suite to local population.

Need For Rural Banking to be Competitive

Generally in rural areas, demand surpasses supply of credit (as it is widely assumed that credit rationing is widely practiced both by institutional and non-institutional moneylenders), in surplus demand conditions, banks can become economically unviable only if there are high non-performing assets, controlled credit rates and high operating costs. Inefficiency of rural credit institutions was attributed to the directed and pre-approved nature of loans sanctioned under sponsored programmes, absence of any security, lack of effective follow up due to large number of accounts, legal recovery measures being considered not cost effective, riddance of repayment culture consequent to loan waiver schemes, etc. While in general the rates of interest have come down, they are available more to highly rated borrowers than to the rural sector and small and medium enterprises. Commenting on functioning of cooperatives Datt and Sundharam (2004) stated that, in many places, unscrupulous and

The problem with rural banking is the high cost of reaching to the remote areas and small account holders

reduce bank branches and build other alternate sources to reach out to widely spread rural population. This will reduce operating and overhead costs. Establishing one bank branch for every 40 to 50 villages according to the geographical area, population size is enough to cater to the needs of rural population. The main purpose of reducing bank branches is to have small number of banks with necessary infrastructure. The bank branch should be lean and slim it terms of number of employees, but with high level of computerization and other technical facilities and expertise.

Reaching Out through Mobile-Banks and Agents/Representatives

To reach to vast majority of rural population bank branches should organize mobile banks and take help of bank agents/ representatives. These banks can recruit their own field assistants/representatives to make frequent filed visits to villages and help banks to acquire new customers, loans/ deposits. These representatives may be village traditional moneylender/village fertilizer shop owner/general stores person or uneducated youth/LIC agent/UTI agent who does have local knowledge, know local people and having confidence by local people. The dates of these mobile-banks to be coincide with the weekly traditional melas (mandis) that will be convenient to the village people, as most of the villagers come to melas either to purchase/sell their farm inputs/outputs and also household consumables. The basic function of mobile banks is to do normal business of taking deposits/loans and other service provisions. The representatives should work on commission basis, as it makes them self-motivated and cost effective. New information technology greatly improves efficiency of even rural banking system if banks adopt them by recruiting skilled persons and installing necessary software and hardware by acquiring simple computers with minimum cost. The banks should be free to evolve and implement their own policies on personnel, including recruitment, training, and incentive systems. Proper training is to be given to representatives/agents in handling new customers. This will greatly reduce overhead costs.

Figure 1: RRB Product and the Outreach/Viability Trade-Off

Outreach-Low-Income Families SHG-linkage
1

NPS4

ISB2

KCC3

-Ve

+Ve Viability

Regional Banks - Flexible Multi-Service Providers

With the changing scenario of flexible operations, emphasis to be placed more on priority setting in terms of which agroindustries/crops to be encouraged rather than emphasis on

Bank Branches-Lean Banks with Skilled Manpower

Large number of bank branches, will not make economic sense in cost competitive banking system. There is an urgent need to
1. SHG-linkage (Credit Delivery Through Self-Help Groups-Unsecured) 2. ISB (Industry, Service, Business Loans Unsecured) 3. KCC (Kisan Credit Cards-Credit limit for three years based on land or other assets) 4. NPS (Non-Priority Sector Advances secured through gold etc.)

10

The IIPm ThInk Tank

The IndIa economy RevIew

11

n c l u s I v e

n d I a

I n a n c e

r o n t I e r s

target setting at district level. This approach gives a directive based on social goals to the regional rural banks, without compromising freedom of operations. All the banks operating in a region/district are free to set their own targets. The priority setting at district level is only a kind of direction and knowledge enhancing exercise but not a compulsion to banks to follow. This kind of exercise gives an idea about the general development outlook/government priorities/policy objectives. The basic strategic advantage of proposed rural banks lies in their local knowledge compared to other national level commercial banks. On this premise, banks should take advantage of this local knowledge by providing as many services as possible which satisfy/ provide competitively to the local people. For example, banks may provide information on weekly prices of inputs and outputs to farmers, advice on crop/ weather insurance, assist in procuring/ storing local farm inputs/outputs with the help of non-governmental organizations/government/local administration. As these will not require much over head costs, but facilitate farmers/local traders to come to bank branches/ mobile-banks more frequently and add value to the main banking operations.

The priority setting at district level is only a kind of direction and extra knowledge enhancing intervention

credit in late 1993. The number of such accounts with the same credit limit has steadily fallen to 37.32 million and their share to total bank credit to just 5.9 percent by the end of March 2002. To provide credit to small borrowers, small farmers and village artisans, banks incurs additional costs, which have to be compensated by government in terms of subsidy. Some studies point out that, more exposure to rural areas/below poverty line population by regional rural banks will adversely affect the profitability of the banks by raising the cash-deposit ratio, operating costs (reaching of these areas are costly as these regions lack necessary infrastructure) and lowering the amount per loan account. To compensate for higher operational costs government subsidy/support to be given, based on the region/district of operation and number of small accounts with that bank. This kind of support targets the source of market imperfection and enhances the overall efficiency of banking system at the same time.

Non-Market Distorting Government Support to Rural Banks

Government Support/Subsidy at the Source

The objective of encouraging rural banking by government is firstly, to reduce rural-urban and agricultural workers-industrial worker differences in poverty levels. In the post-liberalisation these differences are widening both among rural-urban and agricultureindustry (includes services). There was 60 percent credit-deposit ratio prescribed for rural branches, this was fulfilled by until 1990s at least in rural branches, however, since 1995-96 credit-deposit ratio of both rural and semi-urban braches declined to 40-45 and 34-35 percent respectively. The share of agriculture in total bank credit had touched near 18 percent in the late 1980s thus fulfilling the target set, bur recently its share decreased, like wise, the share of smallscale industries in total bank credit has steadily slipped. There were 62.55 million small borrower accounts at the end of March 1993 having credit limits of Rs.25,000 or less. Such accounts form about 22 percent of outstanding total bank

The government assistance should be based on some index of rural development and banking development in terms of people below poverty line and on the basis of bank credit to population ratio. Firstly emphasis on people below poverty line rather than direct credit to people below poverty line gives freedom to banks to lend money based on market principles, which will not create any market distortions. And the same will also create employment opportunities in proportion to poverty in that locality there by creating income-earning opportunities to households below poverty line. In this way probably short supply credit may go to economically viable projects in the region without distorting credit allocation mechanism. In the current atmosphere, bank employees does not have right incentives for recovery of loans, most of the times employees may find it profitable by collision with loan takers, facilitate the farmer in defaulting the loan. It is also important to see that the every rural bank should be responsible for all its financial affairs, without access to government funds. Subsidies are not entirely ruled out, but the subsidies should not be linked with efficiency of banks, and they should be fixed in advance on a pro-rata basis.

Conclusions
The regional rural banks should adopt innovative methods to make the banks economically viable at the same time not compromising with outreach to the rural people and priority sector and less developed regions and poor people. The paper specifically suggests reduction of number of bank branches to make individual banks economically viable and reach many villages through setting up of mobile banks/bank agents/ representatives. The incentive structure for agents/representatives should be based on commission of business generated. The agents may be recruited from traditional money lenders/ LIC agents/UTI agents/unemployed youth and trained properly. The banks will not provide any refinance to these agents, but use their services to reach in remote areas. In this way cost incurred in setting up of many branches are avoided, operations become incentive driven and costs of operation will reduce.

References and Additional Thinking

RBI (2002) Summary of The Report of The Central Board of Directors on the Working of The Reserve Bank Of India For The Year Ended June 2002 Reddy, A. A. 2006. Productivity growth in regional rural banks, Economic and Political Weekly, Vol.XLI, No.11, March 18th, 2006 pp. 1079-1086. Reddy, A. A. 2005. Banking Sector Deregulation and Productivity Change Decomposition of Indian Banks, Finance India, Vol.XIX No.3, September, 2005 Pages 983-1001. Reddy, A. A. and Praduman Kumar 2006. Occupational Structure of workers in Rural Andhra Pradesh Journal of Indian School of Political Economy, pp. 180-195 Jan-July 2006 (The views expressed in the write-up are personal and do not reect the official policy or position of the organization.)

12

The IIPm ThInk Tank

The IndIa economy RevIew

13