Transition and Innovation in Rural Finance in India A Call for Action in this Golden Decade

Abstract

This paper attempts a grand review of rural finance in India since ancient times till 2010 to answer one simple question -- what are the lessons from the past and how can we apply these to redesigning and revitalising the rural financial system (RFS) in this decade – 2010 to 2020? Our review shows that the main purpose of the RFS has been to manage the primary paradox – that of the need to expropriate the rural surplus, and the need to accumulate and re‐invest it. Over different historical periods, either expropriation or reinvestment took precedence, based on the exigencies of the state and the enlightenment of the rulers. As the RFS became more and more institutionalised, a stage came when a secondary paradox emerged – that of the need for ensuring institutional sustainability versus the need for financial inclusion. The secondary paradox was driven by the price (lending interest rates, savings interest rates, insurance premia, etc.) that could be charged to remain in business versus the transaction cost of broadening and deepening inclusion. If prices are lowered below breakeven levels, so as to enhance inclusion, by serving those who cannot afford the higher prices, then it affects the sustainability of financial institutions. On the other hand, if prices are raised in pursuit of profitability and institutional sustainability, it leads to massive exclusion. The breakeven point for a financial institution depends on its cost structure, which is itself a function of regulation, volume and technology. As an increasing proportion of the population is seeing higher income levels, the volumes of financial transactions are going up and costs coming down. On the other hand, improvements in technology such as core banking system software and hardware, tele‐connectivity and biometric identification, are leading to a reduction in transaction costs. Finally, regulation is beginning to state inclusion as a goal. The authors are convinced that these efforts have reached a point where, with concerted action, it will become possible to achieve Universal Financial Inclusion (UFI) -- by 2020. Thus this paper is a call for action and also suggests some details of how to go about achieving that goal. To do all these in a mission mode, we need to establish a Nationwide Electronic Financial Inclusion System (NEFIS), as recommended in the report of the Raghuram Rajan Committee on Financial Sector Reforms, to enable micro‐transactions (below Rs 1000 or Sub‐K), at a convenient distance, less than 1000 metres (Sub‐K) from home or workplace, at an affordable transaction cost, below Rs 10 or 1000 paise (Sub‐K). Only then will the gates of the financial sector open to the poor. We argue that the resources, technologies and regulations are in place and this is the Golden moment pledge to achieve Universal Financial Inclusion – Sub‐K‐Liye! The authors believe that this step will at least resolve the secondary paradox, as financial institutions profitably provide wider and deeper financial inclusion services. They concede that the primary paradox is more refractory, but end with the hope that the urgency of mitigating the effects of climate change will lead to re‐investments in nature, and thus in rural areas, and this may even be done in market friendly ways, such as using carbon credits.