1

INTRODUCTION:

Rural development occupies a significant place in the overall economic development

of the country. Ghandiji Said India lives in Villages. He stressed a rural character of

economy and the need for re-generation of rural life. Since independence, it has been

constant endower of our policy maker to give adequate trust to rural development as

the sector is directly related to agriculture. Rural banking in India started since the

establishment of banking sector in India. Rural Banks in those days mainly focused

upon the agro sector. Regional rural banks in India penetrated every corner of the

country and extended a helping hand in the growth process of the country. SBI has 30

Regional Rural Banks in India known as RRBs.

The rural bank of SBI is spread in 13 states extending from Kashmir to Karnataka

and Himachal Pradesh to North East. The total number of SBIs Regional Rural Banks

in India branches is 2349 (16%). Till date in rural banking in India, there are 14,475

rural banks in the country of which 2126 (91%) are located in remote rural areas.

Regional Rural Banks (RRB) was established under the provisions of an ordinance

promulgated on the 26th September 1975 and the RRB Act, 1976 with an objective to

ensure sufficient institutional credit for agriculture and other rural sectors.

The RRBs mobilize financial resources from rural / semi-urban areas and grant loans

and advances mostly to small and marginal farmers, agricultural laborers and rural

artisans. The area of operation of RRBs is limited to the area as notified by

Government of India (G.O.I) covering one or more districts in the State.

RRBs are jointly owned by GOI, the concerned State Government and Sponsor Banks

(27 scheduled commercial banks and one State Cooperative Bank); the issued capital

of a RRB is shared by the owners in the proportion of 50%, 15% and

35%respectively.

2

CURRENT STATE OF RURAL BANKING IN INDIA

The Indian Economy

India is the 12th largest economy in the world in terms of gross domestic product

(GDP), and fourth in terms of purchasing power parity (PPP) 1. The growth of the

economy is equally impressive with an average of over 8.0% during the last three

years2. However, in terms of GDP per capita, India ranks a lowly 160th among other

nations. Within the country, there is a stark divide in the incomes of urban and rural

areas with the average monthly per capita consumption expenditure (MPCE) in urban

India being almost double that of rural India.

In addition, there are significant disparities in urban and rural consumption

expenditure between different states. Jharkhand and Orissa, for example, have an

MPCE of approximately Rs. 900 in urban areas and Rs. 410 in rural areas4. In other

states like Punjab and Haryana, the urban rural disparity is significantly lower. A fifth

of the Indian population is below the poverty line (BPL) today with a MPCE below

Rs 340. In some states like Jharkhand and Orissa, the proportion of BPL is greater

than 40%. Diamond believes that the segments that are not considered BPL should all

be considered as potentially bankable with genuine financial needs that could be

met by formal financial and banking systems.

Current State of Indian Banking

An important metric to determine the level of financial outreach/inclusion is the ratio

of the number of deposit accounts to population. It gives a snapshot of the penetration

of deposit accounts and credit accounts in India in comparison with a few select

countries with similar socio-cultural and economic conditions. Even in comparison

with other developing economies, India has a significant opportunity for increasing

penetration of both deposit and credit accounts.

3

Not only is there a large disparity between India and other countries in banking

penetration but there is also a large variation in banking penetration within urban and

rural India. While urban India seems to be over-banked with more than 100%

penetration (many urban Indians have more than one bank account), rural India lags

far behind with a 19% penetration. The variance in rural and urban deposit and credit

account penetration is not restricted only to few states but is common across all states.

In addition, the average value of a deposit account and a credit account is also quite

low in rural areas as compared to urban areas. Diamond believes that the reasons for

lower penetration levels are partly economic, as explained by the low GDP per capita

in the rural areas of the country, and partly a result of controllable factors that are

inherent in formal banking systems in India today. The low deposit and credit account

penetration and low average values in deposit and credit accounts demonstrate that

banking outreach in rural India is sub-optimal. This low outreach can be explained by

two key parameters: access and usage.

Simply defined, access is the availability of financial services, and usage is the actual

use of those services. Access is influenced by issues such as the basic economic state

of rural India, lack of physical infrastructure facilities, regulatory constraints, and the

economics of rural banking.

Usage is constrained by social issues such as illiteracy, incomplete service offerings

by banks, and high transaction costs in the formal banking system. Access and usage

are not synonymous, as people may have access to financial services, but decide not

to use them, either for socio-cultural reasons or because opportunity costs are too

high.

4

List of Rural Banks in India

Rural banking in India started since the establishment of banking sector in India.

Rural Banks in those days mainly focused upon the agro sector. Regional rural banks

in India penetrated every corner of the country and extended a helping hand in the

growth process of the country.

SBI has 30 Regional Rural Banks in India known as RRBs. The rural bank of SBI is

spread in 13 states extending from Kashmir to Karnataka and Himachal Pradesh to

North East. The total number of SBIs Regional Rural Banks in India branches is 2349

(16%). Till date in rural banking in India, there are 14,475 rural banks in the country

of which 2126 (91%) are located in remote rural areas.

Apart from SBI, there are many other banks which function for the development of

the rural areas in India. These banks are listed below:

Andhra Pradesh

Bihar

Andhra Pradesh Grameena Vikas

Bank

Andhra Pragathi Grameena Bank

Deccan Grameena Bank

Chaitanya Godavari Grameena Bank

Saptagiri Grameena Bank

Chhattisgarh

Chhattisgarh Gramin Bank

Surguja Kshetriya Gramin Bank

Durg-Rajnandgaon Gramin Bank

Madhya Bihar Gramin Bank

Bihar Kshetriya Gramin Bank

Uttar Bihar Kshetriya Gramin Bank

Kosi Kshetriya Gramin Bank

Samastipur Kshetriya Gramin Bank

Gujarat

Dena Gujarat Gramin Bank

Baroda Gujarat Gramin Bank

Saurashtra Gramin Bank

5

Haryana

Harayana Gramin Bank

Gurgaon Gramin Bank

Jammu & Kashmir

Jammu Rural Bank

Ellaquai Dehati Bank

Kamraz Rural Bank

Assam

Assam Gramin Vikash Bank

Langpi Dehangi Rural Bank

Jharkhand

Jharkhand Gramin Bank

Vananchal Gramin Bank

Madhya Pradesh

Narmada Malwa Gramin Bank

Satpura Kshetriya Gramin Bank

Madhya Bharath Gramin Bank

Chambal-Gwalior Kshetriya Gramin

Bank

Rewa-Sidhi Gramin Bank

Sharda Gramin Bank

Ratlam- Mandsaur Kshetriya Gramin

Bank

Himachal Pradesh

Himachal Gramin Bank

Parvatiya Gramin Bank

Punjab

Punjab Gramin Bank

Faridkot-Bhatinda Kshetriya Gramin Bank

Malwa Gramin Bank

Kerala

Narmada Malwa Gramin Bank

North Malabar Gramin Bank

Tamil Nadu

Pandyan Grama Bank

Pallavan Grama Bank

Maharashtra

Marathwada Gramin Bank

Aurangabad -Jalna Gramin Bank

Wainganga Kshetriya Gramin Bank

Vidharbha Kshetriya Gramin Bank

Solapur Gramin Bank

Thane Gramin Bank

Ratnagiri-Sindhudurg Gramin Bank

6

Vidisha Bhopal Kshetriya Gramin

Bank

Mahakaushal Kshetriya Gramin

Bank

Jhabua Dhar Kshetriya Gramin Bank

Karnataka

Karnataka Vikas Grameena Bank

Pragathi Gramin Bank

Cauvery Kalpatharu Grameena Bank

Krishna Grameena Bank

Chikmagalur-Kodagu Grameena

Bank

Visveshvaraya Gramin Bank

Rajasthan

Baroda Rajasthan Gramin Bank

Marwar Ganganagar Bikaner Gramin Bank

Rajasthan Gramin Bank

Jaipur Thar Gramin Bank

Hodoti Kshetriya Gramin Bank

Mewar Anchalik Gramin Bank

Orissa

Kalinga Gramya Bank

Utkal Gramya Bank

Baitarani Gramya Bank

Neelachal Gramya Bank

Rushikulya Gramya Bank

West Bengal

Bangiya Gramin Vikash Bank

Paschim Banga Gramin Bank

Uttar Banga Kshetriya Gramin Bank

Meghalaya

Ka Bank Nogkyndong Ri Khasi-

Jaintia

Arunachal Pradesh

Arunachal Pradesh Rural Bank

Manipur

Nagaland

7

Nagaland Rural Bank Manipur Rural Bank

Mizoram

Mizoram Rural Bank

Tripura

Tripura Gramin Bank

Uttar Pradesh

Purvanchal Gramin Bank

Kashi Gomti Samyut Gramin Bank

Uttar Pradesh Gramin Bank

Shreyas Gramin Bank

Lucknow Kshetriya Gramin Bank

Ballia Kshetriya Gramin Bank

Triveni Kshetriya Gramin Bank

Uttaranchal

Uttaranchal Gramin Bank

Nainital Almora Kshetriya Gramin Bank

8

KEY DRIVERS OF FINANCIAL EXCLUSION OF RURAL

BANKING

According to Diamond estimates, approximately 245 million adults in rural India do

not have a bank account today. As depicted in Following Table, this reflects 24% of

the total population. While 60 million out of 245 million may not need banking

services because they are below the poverty line, Diamond believes that

approximately 185 million potentially bankable people do not use formal banking

services because of reasons like poor access or usage.

100

47 53

16

37

1324

618

0

20

40

60

80

100

120

Tota

l Pop

ulat

ion

Non

Adu

lt Pop

ulat

ion

Adul

t Pop

ulat

ion

Urb

an A

dult Pop

ulat

ion

Rur

al A

dult

Popu

latio

n

Bank

ed P

opul

ation

Unb

anke

d Pop

ulat

ion

Fina

ncia

lly C

onst

raints

Pont

entia

lly B

anka

ble

Series1

Source: Census India; BSR 2008Reserve Bank of India; World Bank & NCAER

(2008).

Access Issues for Rural Customers

Access is explained in terms of infrastructure, physical distance, limited delivery

capabilities, regulatory constraints and the economics of rural banking.

The banking infrastructure in rural India is not encouraging, with just 7% of villages

housing a bank branch. Whats more, the poor physical and social infrastructure also

impacts the access to financial services, with 23% of villages going without

electricity, 67% without a Post Office, and an average rural literacy rate of 59% and

secondary school penetration of 12%. This lack of physical and social infrastructure

in rural India is a key issue impacting access to formal financial services.

9

The average distance to a branch in India is approximately 3.8 Km. While this

compares favorably to the average distance to a branch in a developed market like the

U.S. (which is 6 Kms6), there are significant additional challenges in India in the

form of unpaved roads and limited access to modern transportation. Most rural

customers are likely to sacrifice an entire days wage to travel to a bank branch which

is open between 10:00am and 5:00pm. While some banking transactions could be

done over phone, this is rarely an option in a country with such low rural tele-density.

Limited delivery capability is a significant challenge. Much of rural India is serviced

through branches because ATM penetration is low and other channels such as Phone

and Internet Banking are non-existent. Intermediaries like Non-Governmental

Organizations (NGOs), Self-Help Groups, and Micro Finance Institutions (MFIs) are

being used by banks to improve access to credit and savings. However, these

channels, in their current form, offer limited services.

There are some regulatory constraints imposed by the Reserve Bank of India (RBI)

which may inadvertently contribute further to the lack of formal banking services in

rural areas. For example, the RBI does not allow banks to post any person other than a

security guard at ATMs. Hence, banks cannot deploy many ATMs in rural areas as

many rural customers require in-person support. A second regulatory inhibitor is that

new banks planning to establish a branch in a rural area have to receive approval from

the Lead Bank and District Collector of that district. Hence, banks choose not to open

new branches in certain areas even when it is profitable to do so because there is no

certainty of getting approvals.

Many banks view the rural market as a regulatory requirement rather than an

economic opportunity. Banks have from time to time borne the social cost of lending

to the rural economy at rates below their costs. They have also faced capital erosion

because of the write-off of loans, particularly agriculture loans. Banks are required via

regulatory requirements to open branches in rural areas to provide loans to agriculture

and other priority sectors.

10

CURRENT RURAL BANKING CHANNELS

RURAL FINANCE SERVICE PROVIDERS

India has a range of rural financial service providers, including formal sector financial

institutions at one end of the spectrum, informal providers (mostly moneylenders) at

the other end, and between these two extremes a number of semi-formal/microfinance

providers.

Description Service Provided Remarks

- Fully fledged Branches and - Deposit Accounts - 96% of total deposit and95% Extension Counters of - Credit Accounts of total loans are with schedule Scheduled Commercial Banks - Remittances commercial banks with including Regional Rural Banks - Cards cooperative banks holding Cooperative Banks - Third-Party Products the difference - Has a high cost-to-serve

- NGOs, SHGs, MFIs and - MFIs directly lend to the poor - This channel delivers limited Cooperatives that act as and also act as agents for services in its current form Intermediaries to take financial he banks Services to the rural areas - SHGs borrow from banks and are beneficiaries of loans themselves - Onsite - Cash Withdrawal - Negligible presence of this ATM installed at a branch - Cash Deposit channel in rural areas - Offsite - Money Transfer ATM installed at a remote - Cheque Book Request Location - Bill Payments

-Phone Banking - Cash Withdrawal - Almost non-existent in rural Manual - Cash Deposit - India because of low: Interactive Voice Response - Money Transfer Tele-density - Internet Banking - Cheque Book Request Internet-penetration - Kisan Credit Card - Bill Payments Credit appetite of banks

Provide short-term credit

Branch

Inter-

mediaries

ATM

Others

11

Formal Providers:

In terms of their sheer size and spread of operations, formal-sector financial

institutions dominate the rural finance landscape: Commercial banks, mostly public

sector banks (but also some private- sector banks) and regional rural banks (RRBs)

together have more than 32,000 rural branches India also has a vast network of rural

cooperative banks, with a three tiered structure at the state, district, and village levels.

There are some 14,000 branches of rural cooperative banks and more that 98,000

grassroots retail outlets of Primary Agricultural Credit Societies (PACS), which are

used by the cooperative system as channels for fund flows.

The post office system adds to the physical service point network of the country with

more than 154,000 post office branches handling more than 110 million money orders

and administering 114 million savings accounts Formal financial institutions are

regulated by the Reserve Bank of India (RBI), although it has delegated the task of

supervising rural cooperative banks and RRBs to the National Bank for Agriculture

and Rural Development (NABARD). 14Development banks such as NABARD and

the Small Industries Development Bank of India (SIDBI) provides support to both

formal and semi-formal segments through funding refinancing arrangements.

NABARD provides refinancing to banks lending in rural areas and SIDBI funds and

supports MFIs.

The semi-formal/microfinance sector

While India is home to many microfinance innovations, in terms of people reached

and the scale of financing, microfinance in India is still a drop in the ocean. It reaches

between 5 and 6 percent of the countrys poor rural households, or about 30 percent of

the rural poor, either directly or indirectly. Dominant among the microfinance models

is Self-Help Group (SHG) Bank linkage, whereby womens SHGs are linked to the

rural branches of commercial banks, RRBs, or cooperative banks, which often benefit

from refinancing by NABARD.

12

SHG-Bank linkage has reached out to around 12 million familys interns of savings

accounts. Credit outstanding remains low; disbursements in FY 200203 accounted

for only 2 percent of the formal-sector credit outstanding in rural areas. The other

model is Specialized Microfinance institutions (MFIs), which reach around 1 million

clients. The total branches of MFIs are estimated to be in the range of a few thousand,

compared to the vast numbers of bank branches.

Recent developments have led to other inter linkages between the formal both public-

and private sector banks and semi-formal sector initiatives, particularly in the context

of SHGBank linkage, as well as through lending by SIDBI and commercial banks to

MFIs. Moreover, a few private-sector commercial banks, such as ICICI Bank, have

tried innovative ways of incorporating lessons from microfinance into their

operations, and have made inroads in using micro finance methodologies to deliver

rural financial services.

Informal providers, Informal financiers include a range of actors-landlords, local

shopkeepers, traders, professional moneylenders, etc. While there are no definite

estimates of the number of informal-sector providers, these are spread very widely

across the country. Survey data indicate that poor rural households rely heavily on

informal finance to meet a range of financing needs: from consumption and

emergency financing to investment loans.

13

REASONS FOR UNPROFITABLE OF RURAL BANKING IN

INDIA

High Non-performing Loans (NPL):

Banks have higher non-performing loans in rural areas because rural households have

irregular income and expenditure patterns. The issue is compounded by the

dependence of the rural economy on monsoons, and loan waivers driven by political

agendas. NPLs from the agriculture sector are 7.7%, compared to 3.5% across non-

agriculture sectors8. In order for banks to view rural India as a growth opportunity,

rather than a regulatory requirement, a combination of these issues must be addressed.

Increasing financial access to rural areas is contingent upon basic conditions such as

proper infrastructure and an enabling regulatory framework, as well as innovative

thinking on the part of commercial banks. Access issues, however, explain only one

part of the problem. Usage is an equally important issue for rural customers.

Low Ticket Size:

The average ticket size of both a deposit transaction and a credit transaction in rural

areas is small. This means that banks need more customers per branch or channel to

break even. Considering the small catchments area of a branch in rural areas,

generating a customer base with critical mass is challenging.

High cost to serve:

Branches are the most used channel in rural areas. This is because many rural people

are not literate and are not comfortable using technology-driven channels such as

ATMs, phone banking or internet banking. On the other hand, a branch is an

expensive channel for banks (Following Table). In addition, rural people, whenever

they have access to banks, have frequent low ticket and cash-based transactions,

which increase the overall transaction cost for their bank.

14

Cost Per Transaction in Indian Banks

48

25

18

84

0

10

20

30

40

50

60

Branch Phone (Call

Centre)

ATM Phone (IVR) Internet

Series1

Source: Reserve Bank of India; CGAP, World Bank.

Higher risk of credit:

Rural households may have highly irregular and volatile income streams. Irregular

wage labor and the sale of agricultural products are the two main sources of income

for rural households. The poor rural households (landless and marginal farmers) are

particularly dependent on irregular wage employment. Rural households also have

irregular expenditure patterns. The typical expenditure profile of rural households is

small, with daily or irregular expenses incurred through the month. Furthermore, a

majority of households incur at least one unscheduled expenditure per year, with the

most frequent reasons being medical or social emergency7. In short, the rural

customer is generally considered to be a risky one.

Information Asymmetry:

Since many rural people do not have bank accounts, there is a lack of information on

customer behavior in rural India. Absence of a Credit Information Bureau also

complicates the problem as banks have to rely on informal sources to learn the credit

history of rural customers. A lack of reliable information can result in either missed

opportunities in not approving otherwise eligible loan candidates, or nonperforming

loans.

15

USAGE ISSUES FOR RURAL CUSTOMERS

Even if access to formal banking is provided to rural customers, there is no guarantee

that these services will be used. According to a study conducted by the World Bank,

many households, even in developed countries, choose not to have a bank account as

they do not engage in many financial transactionsthey collect wages in cash, spend

in cash and do not wish to be burdened by a bank account9. To compound the

situation many customers in rural India, who have access to and would otherwise

choose to use formal financial services, do not do so because the product and service

mixes do not meet their needs.

The financial service needs of rural customers are not confined to just savings and

credit, as is usually assumed. Their financial needs are linked to their life cycle needs,

ranging from savings to credit to insurance to remittances. In fact, even the savings

and credit products currently offered to rural customers do not entirely meet their

needs.

Access to savings and investment facilities is critical for the poor. The two critical

needs for the rural poor are micro-savings and frequent withdrawals. These needs

facilitate a customer in building capital over the long term, as well as coping with

income shocks in the near term. However, banks do not offer adequate services to

address these needs. The lack of services, therefore, leaves the rural poor with little

option than to transact with the informal banking market. A study conducted by Micro

Save also concludes that the poor transact with the informal sector because it will

accept small amounts, provide doorstep service, and ensure ease of enrolment.

Rural customers need loans not only for productive purposes but also for consumption

needs (Following Table). A part from agricultural support, rural customers need micro

credit for consumption, education and emergencies. Though banks offer purpose free

loans (personal loans and credit cards) in urban areas quite liberally, in rural areas

16

sanction of such loans is significantly restricted. Therefore, the poor raise these loans

through the informal financial system (it is worth noting that these loans taken from

the informal system are almost always repaid or renewed12). In addition, larger

households need occasional high value micro-enterprise loans for small capital

investment. Though banks offer these loans, they require excessive documentation

and time-consuming processes which discourage customer applications.

Purpose of Borrowing

Rural Household Borrowing

Other business

expenditure, 14%

Household

expenditure, 48%

Agriculture

expenditure, 38%

Other business

expenditure

Household

expenditure

Agriculture

expenditure

Bank Lending to Rural Households

Personel Loans, 12%

Agriculture Loan, 36%

Other Business Loan,

52%

Personel Loans

Agriculture Loan

Other Business Loan

Source: AIDIS2008, National Sample Survey Organization (NSSO); Diamond

analysis.

17

A significant percentage of borrowing is toward consumption and other household

expenditure, whereas formal financial institutions in rural India provide loans

primarily for productive purposes.

Insurance reduces the vulnerability of poor households by replacing the uncertain

prospect of large losses with the certainty of payout against small, regular premium

payments. It is integral to a comprehensive risk management strategy for poor

households. This includes life, health, accident and asset (dwelling, crop, and

livestock) insurance. Banks and insurance firms do not offer these services in many

rural areas, leading the poor to rely on the informal financial system.

There are many rural households which depend on weekly or monthly remittances

from their family members who have moved to urban areas. At present, they depend

on informal channels to remit the money and consequently either risk the loss of

money or pay high transaction fees. Banks do not offer seamless remittance facilities

between urban and rural branches as many of the rural branches are not computerized

and connected to the main banks computer systems. This often results in the

beneficiary receiving the amount two weeks after it has being transferred. This

represents yet another key service which is not provided.

The transaction cost for a rural customer to receive credit primarily constitutes four

attributes: the interest rate, loan amount received as a percentage of amount applied,

bribes paid, and the lead time to process the loan. Though the formal banking system

offers loans at interest rates lower than informal banking systems, the time taken for a

loan to be sanctioned is high which increases uncertainty and opportunity cost. In

addition, the customer needs to pay almost 10% of the loan amount in bribes and

eventually receives an amount that is less than what was applied for. Therefore, while

the interest rates are usurious in the informal financing system, rural customers still

resort to this channel because the waiting time to receive the loan is negligible and

there are no indirect costs or commission. Banks also insist on collateral security

which many rural poor cannot afford.

18

As far as savings are concerned, though the formal banking system provides financial

security, the cost of opening and operating an account is high. The overall cost of

transacting with the formal financial system increases for a rural person because of

additional costs such as expenses incurred to reach a branch and the opportunity cost

of lost wages. Since rural banks are generally not within an accessible area and do not

operate at convenient times, the rural customer must forgo a days wage to reach a

branch. Informal systems, on the other hand, involve a lower transaction cost, but they

are risky and in some cases result in the loss of ones entire capital. In short, this

leaves the rural customer to choose between two unfavorable options.

In summary, the services being offered by the formal banking system do not seem to

meet the needs of the rural poor. A World Bank study suggests that the poor apply a

set of criteria to judge the services being offered by any financial service provider,

including:

Productsare financial services available and tailored to my needs?

Costwhat is the total cost of the service (including opportunity cost)?

Conveniencehow easy is it to access and use?

EligibilityAm I eligible for financial services and can they be accessed

repeatedly?

As explained earlier, the savings products offered in the current format do not qualify

as a flexible, convenient and cost-efficient service. Similarly, loan products do not

meet product and eligibility criteria. In addition, insurance and remittance services are

not even available. The cost of services, despite lower interest rates, is high because

of other indirect costs which make the banking services cost-inefficient.

19

MARKET OPPORTUNITY OF RURAL BANKING

At present, a rapidly growing urban India is the focus of the banking sector; however,

as the deposit penetration numbers suggest (Figure 3 & 4), the market is highly

competitive and over banked. Despite this, most banks are still not shifting their focus

to the rural opportunity, as they are apprehensive about the total market potential of

the rural market and the profitability of rural banking channels. Contrary to the widely

held notion, however, the rural market is attractive from both a credit and deposit

perspective.

The credit demand in rural areas is approximately Rs 1,330 billion (based on an

estimate by World Bank). There are other studies by the Planning Commission and

ICICI Bank which put the figure even higher at Rs 1,440 billion and Rs 1,500 billion

respectively. Similarly, on the deposit side, a large segment of the rural population

does not save with formal banking channels because banks are not accessible and do

not provide the appropriate products and service, leaving a significant opportunity to

grow the deposit base.

At present, the penetration of banking in rural areas is sub-optimal with a large market

remaining untapped in both the liability (~ Rs 215 billion) and asset (~ Rs 1,204

billion) sides of the business. These estimates clearly suggest that there is sufficient

demand in the rural market to encourage banks to think seriously about rural areas as

an alternative growth opportunity.

As we identified earlier, access and usage are two broad concerns which explain why

the potentially bankable are unbanked. With regard to access, the challenge for banks

is to identify profitable channels that meet the needs of rural customers. With regard

to usage, banks need to understand the requirements of the rural customer and

customize products and services

20

Accordingly (Following Table).

Proposed Approach to Tap Potentially Bankable Population

Source: Diamond analysis

Convert

Potentially

Bankable

Address

Access Needs

Of Rural

Customers

Ensure

Channel

Profitability

Address

Usage Needs

Of Rural

Customers

Improve

Access

For Rural

Customers

Bank

Initiatives

To Improve

Usage

Encourage

Usage of

Services

21

IMPROVING ACCESS FOR RURAL BANKING

Today, branches are the primary delivery channel in rural areas. Though there are

32,000 commercial bank branches in India, they cover less than 7% of total villages.

Opening more branches is not necessarily profitable as many pockets of rural areas do

not have business enough to justify an expensive branch channel. Therefore, to

improve access in rural areas, banks need to modify existing channels, introduce new

channels and identify innovative ways to integrate the two.

Modify Existing Channels

Fortunately there are a variety of options available for banks looking to modify their

existing channels. To reduce the costs imposed by branches, banks should consider

the option of sharing their branch infrastructure. This would not be too dissimilar to

the example of the telecom industry sharing network infrastructure or the fast food

industry sharing food courts in urban areas. Though infrastructure sharing may raise

concerns over client confidentiality and data leakage, in the long run banks will only

benefit from such collaboration.

ATMs are an effective channel which can deliver many of the services frequently

used by a branch customer. However, ATMs, in their current form, are not suitable for

rural areas as the literacy level and transaction ticket amount is too low. ATMs can,

however, be designed to meet the needs of rural customers. For example, ICICI Bank

is working with IIT Chennai to develop an ATM that has a biometric fingerprint

login, accepts soiled notes, and lower value denominations. In addition to modifying

the design of the machines, banks should also hold discussions with the RBI to allow

an attendant to be posted at ATMs. This will enhance the usability of ATMs.

Though phone banking and internet banking are cost-effective channels, given very

low tele-density and low internet penetration in rural areas, the ability to use these

22

channels to reach the rural customer is low. However, phone and internet banking

should be considered once infrastructure and literacy levels improve in rural India. A

business correspondent could then run an e-kiosk to assist customers to transact over

these channels. For example, Centenary Bank in Uganda uses internet and phone

banking to provide bill payments, money transfers and loan repayments.

Business correspondents can be provided with point-of-sale (POS) functionality to

allow customers to deposit and withdraw cash from their accounts. Combining POS

with a smart card is one way to improve access. Brazil has successfully used banking

correspondents who use POS and card readers to provide current accounts, loans, and

insurance, accept bill payments, and perform other transactions.

Introduce New Channels

The RBI allows banks to appoint business correspondents and facilitators to be used

as intermediaries in providing banking services. NGOs, MFIs, Societies, Section 25

companies, registered NBFCs not accepting public deposits, and Post Offices can be

appointed as Business Correspondents. Business Correspondents can provide several

services which are not currently offered by SHGs and MFIs, including:

1. Identification of borrowers and fitment of activities;

2. Collection and preliminary processing of loan applications including

verification of primary information/data;

3. Creating awareness about savings and other products and education and advice

on managing money and debt counseling;

4. Processing and submission of applications to banks;

5. Promotion and nurturing Self Help Groups/Joint Liability Groups;

6. Post-sanction monitoring;

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7. Monitoring and handholding of Self Help Groups/Joint Liability

Groups/Credit Groups/others;

8. Follow-up for recovery;

9. Disbursal of small value credit,

10. Recovery of principal/collection of interest

11. Collection of small value deposits

12. Sale of micro-insurance/ mutual fund products/ pension products/ other third-

party products

13. Receipt and delivery of small value remittances/ other payment instruments.

The introduction of Business Correspondents may face some challenges from labor

unions. However, Diamond believes that there may be some options to address the

concerns of the current workforce while using Business Correspondents to capture

more value from rural customers.

Caxias Economical, a state-owned bank in Brazil, manages the countrys lottery

network and distributes government benefits. To increase the access of its services,

Caixa extensively utilizes the Banking Correspondent channel, with 14,000 banking

correspondents covering all of Brazils 5,500 municipalities. In less than 2 years,

Caixa opened about 2.8 million new accounts and estimates that 40% of its banking

transactions are handled through the banking correspondent channel.

Satellite offices are a cost-effective alternative to branches. These offices can be

established at fixed premises in villages and are controlled and operated from a base

branch located at a block headquarters. All types of banking transactions may be

conducted at these offices. Banks have, however, not used this channel actively,

despite the argument that this channel is relatively less expensive, as it can draw

personnel from the main branch and can remain open for just two days a week. This

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channel, therefore, is appropriate in blocks and districts which are densely populated.

In the urban areas, most Indian banks opt for an extension counter where the business

does not justify a full-fl edged branch. Similarly, satellite branches can cater to rural

areas which do not justify a large branch.

Where banks do not find it economical to open full-fl edged branches of satellite

offices, mobile offices may be more appropriate. Mobile offices extend banking

facilities through a well-protected truck or van. The mobile unit visits villages on

specified days/ hours. The mobile office would be affiliated with a branch of the bank,

and serve areas which have a large concentration of villages. This will not be

dissimilar to the mobile ATMs implemented by some of the Indian banks in the urban

areas.

Determine the Combination of Channels

There is no one right channel or solution to improve access in rural areas. Banks have

to evaluate the trade-offs between those channels that are most convenient to

customers and those that are the most profitable. Banks are not comfortable opening

new rural branches because many of those that already exist are unprofitable.

Therefore, determining the right combination of channels is critical to improving

access in profitable ways. An innovative approach to improving access will consider a

combination of these channels. For example:

Branches and Satellite Branches

In addition to providing regular banking operations, providing backend support to

manage and audit the operations of business correspondents.

A low-cost, custom-made ATM

Managed by a business correspondent to bring down the operating cost and scales the

channel.

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An e-kiosk

Managed by a business correspondent with internet banking, ATM and POS terminal

in relatively large rural areas.

A business correspondent

Using manual ledgers or POS/Palmtop to act as deposit collector and remitting agent

in smaller rural areas.

While this list is not exhaustive, it highlights the need for creative solutions that apply

the right channel to the right market and transaction. In South Africa, Capital has

combined convenient branches along transportation routes (for example, train and bus

stations, and taxi stops). In addition, it has rolled-out debit cards and automatic teller

machines across 200 of these branches to stimulate savings among low-income

earners. Between February and August 2007, the number of customers jumped from

around 30,000 to more than 90,000

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SUGGESTIONS

ENHANCING the growth rate in agriculture to 4.1 per cent, as envisaged in the

Approach Paper to the Eleventh Five Year Plan, and improving its robustness would

require substantial investment in irrigation and water management technologies,

diversification and boosting productivity of different crops through improved seeds

and plant-care practices. The move towards inclusive growth is a big challenge for the

financial system of the country, including commercial banks. Banks would need to

adopt an innovative, customer-friendly approach to increase their effective reach so

that the share of organised finance increases. A participatory and partnership-based

model for financial inclusion, coupled with community-linked financial initiatives is

the need of the hour. In the near future customer-friendly products, delivery channels,

relationship banking, dependency on IT systems and competitive pricing would be the

driving forces. Banks will to move to high-tech banking. The Internet would be the

engine of the banking revolution in the decades to come and e-commerce would be its

fuel. Therefore, the key to survival of banks in future will be the retention of customer

loyalty by providing value-added services tailored to their needs.

First, traditionally banks have viewed rural areas as a segment purely in need of up

liftment. This was based on the underlying philosophy of a social obligation.

However, the future lays with those who see the poor as their customers, namely,

financial inclusion. By financial inclusion is meant the provision by the financial

system, of financial products and services at an affordable price, to those who have

been financially excluded. As banking services are in the nature of a public utility

service, it is essential that banking and payment services are provided to the entire

population without discrimination. The harsh reality is that the spread of banking

facilities in India is uneven, with a substantial portion of the households, especially in

the rural areas, still outside the coverage of the formal banking system. Almost 40 per

cent of the adult population of the country is unable to access mainstream financial

products.3 The Reserve Bank of India has recently adopted a decentralised approach

in this regard with close involvement of State Governments and banks and has used

multiple channels to expand the outreach of banks. It is important to mention that the

Union Bank has launched a new initiative called Village Knowledge Centres. Here,

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technology is used to help the farmer improve his productivity. The Banks staff at

these village knowledge centres act as relationship managers, liaising between local

authorities and farmers, facilitating the opening of accounts and ensuring that credit is

provided to the needy. Such examples need to be followed by other banks.

Secondly, commercial banks should change their marketing concept. Under the new

concept of marketing, the task of management should not so much be skill in making

the customer do what suits the rest of the business, as to be skilful in conceiving and

making business do what suits the interest of the customers.

Thirdly, stress should be laid on deposit mobilisation from the agricultural sector

itself to finance its own credit requirements. Such a move will entail two steps

curtailment of unproductive expenditure and deposit of savings by the agriculturists in

banks. It is common knowledge that villagers spend huge sums on unproductive

social ceremonies, drinking, litigation, etc. Their outlook needs to be changed with the

help of banking staff and utilising the services of the mass media. Villagers must be

convinced that money spent on such social obligations is a waste and they themselves

would gain in the long run if they would save and invest. The services of officers and

staff of the community development projects may also be utilised for this purpose.

Fourthly, the more important aspect of the whole drive is the deposit of savings by the

agriculturist in the banks. Vast sums of money are lying idle even today in rural areas.

We think that, in spite of different agencies engaged in providing agricultural finance,

the village moneylender continues to be a necessary evil. These moneylenders have

great influence on the villagers. To mobilise the savings of the villagers, the services

of these moneylendersboth professional and agriculturalcan be utilised. The

nationalised banks may appoint them as their agents. The banks should then ask them

to encourage the villagers to deposit their money in the banks and approach the banks

for loans through them. The banks may give them a sort of del credere commission,

depending upon the quantum of business done by them, as is done in the case of

agents of the Life Insurance Corporation, General Insurance Corporation, National

28

Savings Organisation, etc. Such a step would help in mobilising savings. The

appointment of moneylenders as agents has an added advantage. These moneylenders

have been living in villages for a long time and are, therefore, accustomed to the rural

way of life. They know the local language and can, therefore, mix well with the

villagers.4 This is not the case with the qualified, educated and sophisticated bank

staff. Many a time, superiority complex on the part of the bank employees drives

away the villagers. As a corollary to this, it is also suggested that, as far as possible,

the staff to be deputed in the rural branches, should be drawn from the villages or

semi-urban areas themselves and better living conditions be assured for the bank

employees.

.

Finally, it needs to be remembered that stray attempts would not solve the problem of

agricultural credit. The credit system as a wholegovernment, commercial and

cooperativemust be so knit together that it does not suffer either from a gap or an

overlap. It is only then that the real fruits of credit facilities will be enjoyed by the

country at large in the form of agricultural development which stills the key to Indias

prosperity in future.

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CONCLUSION

There are 185 million bankable adults in rural India who are unbanked because of

access and usage issues. This presents a significant opportunity for commercial banks.

However, to reach this market and subsequently build an inclusive financial system,

there must be a coordinated and concerted effort by the three key stakeholders: the

Government of India, the Reserve Bank of India and the commercial banks.

In addition, a partnership between banks and business correspondents, and

collaboration amongst banks is critical.

Furthermore, banks should tailor their product and service mix to meet rural

Needs, and adapt their delivery models to ensure commercial viability of their rural

banking operations.

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BIBLIOGRAPHY

www.cia.gov

Census

Access to and Usage of Financial Services, World Bank

www.rbi.org.in