A PROJECT ON RURAL BANKING

Submitted By: Ravi Pal

Centre Code: 02971

Reg No: 510917520

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RURAL BANKING

INTRODUCTION:

Rural banking in India started since the establishment of banking sector in India. Rural Banks in those days mainly focused upon the agro sector. Today, commercial banks and Regional rural banks in India are penetrating every corner of the country are extending a helping hand in the growth process of the rural sector in the country.

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BANKS: FUNCTIONING FOR THE DEVELOPMENT OF RURAL AREAS.

The area of operation of a majority of the RRBs is limited to a notified area comprising a few districts in a State.SBI have 30 Regional Rural Banks in India known as RRBs. The rural banks of SBI are spread in 13 states extending from Kashmir to Karnataka and Himachal Pradesh to North East. Apart from SBI, there are other few banks which functions for the development of the rural areas in India. Few of them are as follows.

Haryana State Cooperative Apex Bank Limited NABARD

Sindhanur Urban Souharda Co-operative Bank

United Bank of India

Syndicate Bank

Co-operative bank

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CO-OPERATIVE BANKS AND RURAL CREDIT.

The Co-operative bank has a history of almost 100 years. The Co-operative banks are an important constituent of the Indian Financial System, judging by the role assigned to them, the expectations they are supposed to fulfill, their number, and the number of offices they operate.

Their role in rural financing continues to be important even today, and their business in the urban areas also has increased phenomenally in recent years mainly due to the sharp increase in the number of primary co-operative banks.

Co-operative Banks in India are registered under the Co-operative Societies Act. The RBI also regulates the cooperative bank. They are governed by the Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1965.

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Co-operative banks in India finance rural areas under:

Farming Cattle

Milk

Hatchery

Personal finance

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Institutional Arrangements for Rural Credit (Co-operatives)

Short Term Co-operatives Long Term Co-operative

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Primary Agricultural Credit Societies (PACSs)

An agricultural credit society can be started with 10 or more persons normally belonging to a village or a group of villages. The value of each share is generally nominal so as to enable even the poorest farmer to become a member. The members have unlimited liability, that is each member is fully responsible for the entire loss of the society, in the event of failure. Loans are given for short periods, normally for the harvest season, for carrying on agricultural operation, and the rate of interest is fixed. There are now over 92,000 primary agricultural credit societies in the country with a membership of over 100 million.

The primary agricultural credit society was expected to attract deposits from among the well –to-do members and non-members of the village and thus promote thrift and self-help. It should give loans and advances to needy members mainly out of these deposits.

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Central Co-operative Banks (CCBs)

The central co-operative banks are located at the district headquarters or some prominent town of the district. These banks have a few private individuals also who provide both finance and management. The central co-operative banks have three sources of funds,

Their own share capital and reserves Deposits from the public and

Loans from the state co-operative banks

Their main function is to lend to primary credit society apart from that, central cooperative banks have been undertaking normal commercial banking business also, such as attracting deposits from the general public and lending to the needy against proper securities. There are now 367 central co-operative banks.

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State Co-operative Banks (SCBs)

The state Co-operative Banks, now 29 in number, they finance, co-ordinate and control the working of the central Co-operative Banks in each state. They serve as the link between the Reserve bank and the general money market on the one side and the central co-operative and primary societies on the other. They obtain their funds mainly from the general public by way of deposits, loans and advances from the Reserve Bank and they are own share capital and reserves.

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COMMERCIAL BANKS AND RURAL CREDIT

The commercial banks at present provide short term crop loans account for nearly 45 to 47% of the total loans given and disbursed by the commercial banks. Term loans for varying periods are given for purchasing pump sets, tractors and other agricultural machinery, for construction of wells and tube well, for development of fruit and garden crops, for leveling and development of land, for purchase of ploughs, animals, etc. commercial banks also extend loans for allied activities viz., for dairying, poultry, piggery, bee keeping, fisheries and others. These loans come to 15 to 16%.

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Commercial Banks and Small Farmers

The commercial banks identifying the small farmers through Small Farmers Development Agencies (SFDA) set up in various districts and group them into various categories for credit support so as to enable them to become bible cultivators. As regard small cultivators near urban areas and irrigation facilities, commercial banks can help them to go in for vegetable cultivation or combine it with small poultry farming and maintain of one or two milch cattle.

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IRDP and commercial banks

Since October 1980, the Integrated Rural Development Programme (IRDP) has been extended to all the blocks in the country and the commercial banks have been asked by the government of India to finance IRDP. The lead banks have to prepare banking plans and allocate the responsibility of financing the identified beneficiaries among the participating banks. Commercial banks have been asked to finance all economically backward people identified by government agencies.

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REGIONAL RURAL BANKS AND RURAL CREDIT

The Narasimham committee on rural credit recommended the establishment of Regional Rural Banks (RRBs) on the ground that they would be much better suited than the commercial banks or co-operative banks in meeting the needs of rural areas. Accepting the recommendations of the Narasimham committee, the government passed the Regional Rural Banks Act, 1976. The main objective of RRBs is to provide credit and other facilities particularly to the small and marginal farmers, agricultural laborers, artisians and small entrepreneurs and develop agriculture, trade, commerce, industry and other productive activities in the rural areas.

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The progress of RRBs in the initial stage was quite rapid. For instance, the Sixth Five-year plan(1980-85) had envisaged the setting up of 170 RRBs covering 270 districts by the end of march 1985.The target was exceeded. There are now 196 RRBs in 23 states of the country with 14,200 branches.

Structure of regional rural bank

The establishment of the Regional Rural Banks (RRBs) was initiated in 1975 under the provisions of the ordinance promulgated on 26.9.1975 and thereafter Section 3(1) of the RRB Act, 1976. The issued capital of RRBs is shared by Central Government, sponsor bank and the State Government in the proportion of 50%, 35% and 15% respectively.

RRBs established with the explicit objective of:

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1. Bridging the credit gap in rural areas.2. Check the outflow of rural deposits to urban areas.3. Reduce regional imbalances and increase rural employment generation.

ROLE OF RBI IN RURAL CREDIT

Since it was set up in 1934, RBI has been taking keen interest in expanding credit to the rural sector. After NABARD was set up as the apex bank for agriculture and rural development, RBI has been taking a series of steps for providing timely and adequate credit through NABARD.

Scheduled commercial banks excluding foreign banks have been forced to supplement NABARDs efforts-through the stipulation that 40percent of net bank credit should go to the priority sector, out of which at least 18 percent of net bank credit should flow to agriculture. Besides, it is mandatory that any shortfall in fulfilling the 40 percent target or the 18 percent sub-target would have to go to the corpus Rural Infrastructure Development Fund(RIDF).RBI

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has also taken steps in recent years to strengthen institutional mechanisms such as recapitalisation of Regional Rural Banks (RRBs) and setting up of local area banks(LABs).

Micro-Finance

Micro-finance is a novel approach to "banking with poor"as they attempt to combine lower transaction costs and high degree of repayments.The major thrust of these micro-finance initiatives is through the setting up of  Self Help Groups (SHGs),Non-Governmental organizations(NGOs),Credit Unions etc.

Kisan(Farmers') Credit Card

Another notable development in recent years is the introduction of Kisan Credit Cards(KCC) in 1998-99.The purpose of the Kisan Credit Cards(KCC) scheme is to facilities short term credit to farmers.The scheme has gained popularity and its implementation has been taken up by 27 commercial

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banks, 187 RRBs and 334 Central cooperative banks.

Agricultural Insurance

As Agricultural is highly susceptible to risks such as drought, flood, pests etc.It is necessary to protect the farmers from natural calamities and ensure their credit eligibility from the next season. Towards this purpose, the Government of India introduced a comprehensive crop insurance scheme throught the country in 1985 covering major cereal crops, oilseeds and pulses. Among commercial crops, seven crops viz., sugarcane potato, cotton, ginger, onion, turmeric and chillies are presently covered.

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MARKETING OF MUTUAL FUND UNITS - RRBS 

With a view to expanding the scope of business of RRBs and considering that marketing of Mutual Fund (MF) units provides a profitable avenue for banks, it has been decided by RBI on 17th May 2006 to allow Regional Rural Banks (RRBs) to undertake marketing of units of Mutual Funds, as agents.

Accordingly, RRBs may, with approval of their Board of Directors, enter into agreements with Mutual Funds for marketing their units subject to the following terms and conditions: 

*The bank should only act as an agent of the customers, forwarding applications of the investors for purchase / sale of MF units to the Mutual Fund / Registrar Transfer Agents. 

* The purchase of MF units should be at the risk of customers and without the bank guaranteeing any assured return. 

* The bank should not acquire such units of Mutual

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Fund from the secondary market. 

* The bank should not buy back units of Mutual Funds from their customers. 

* The bank holding custody of MF units on behalf of their customers should ensure that its own investment and investments belonging to their customers are kept distinct from each other. 

* Retailing of units of Mutual Funds may be confined to some select branches of the bank to ensure better control. 

* The bank should comply with the extant KYC/ AML guidelines in respect of the applicants. 

* The RRBs should put in place adequate and effective control mechanisms in consultation with their sponsor banks.

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WHAT IS FINANCIAL EXCLUSIONS?

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WHO ARE FINANCIALLY EXCLUDED

Poor Socially under-privileged Disabled Women Uneducated Ethnic Minorities Un-employed

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Financial inclusion-Definition

“The process of ensuring access to financial services and timely and adequate credit where needed by vulnerable group such as weaker section and low income group at an affordable cost.”-NABARD

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FINANCIAL INCLUSIONS

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Financial Inclusion-Institutionalization miles stones since early 1900’s

1904 - Cooperative Societies Act

1954 - Rural Credit Survey committee

1955 - State Bank of India created for rural penetration

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1969 - 19 Commercial Bank Nationalized, All India rural credit review committee

1970 Lead Bank Scheme –states /districts

1975 Regional Rural Bank – Hybrid banks

1981 6 more commercial banks nationalized

1992 SHG-Bank Linkage Programme

2001 Kishan credit card /Swarojgar Credit card /Garmin Tatkal Card

2006 committee of financial Inclusion Set up

Rural Finance comprise credit, saving and insurance (or insurance substitutes) in rural areas, whether provide through formal or informal mechanisms . The world credit trend to be associated with enterprise development where as rural finance also includes saving and insurance mechanisms used by poor to protect and stabilized their families and livelihoods (not just their businesses).

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An understanding of rural finance helps explain the livelihood strategies and priorities of the poor.

Rural finance is important to the poor.

The poorest group spend the highest proportion of the their income on food –typically more than 60% and sometimes as much as 90% .Under these circumstances , any drop in earning or any additional expenditure has immediate consequence for family welfare –unless saving or loan can be accessed

Financial transactions are therefore an integral part of the livelihood system of the poor.

Rural finance consist of informal or formal sector Example of formal sources of credit includes: banks, project and contractor farmer

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scheme. Reference is often made of micro credit.

Micro underlines the small loan size normally associated with borrowings requirements of the poor rural populations and micro credit schemes used specially developed pro-poor lending methodologies.

Rural populations. However, are much more dependent on informal sources of finance ( including loan from family and friend , the local moneylender and rotating or accumulating saving and credit association)

Rural finance is a set of financial services that are not limited to credit only. Financial services in rural finance include: loans. Savings,

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investments, guarantee funds, remittance services, inventory credit , trader finance and insurance.

SOURCE OF RURAL FINANCE

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Depending upon the requirement and purpose, the funds needed by Indian farmers can be categorized into three types:

Short term loan - 12 to15 months Medium term loan -3 to 5 yearsLong term loan -15 to 20 years

SHORT TERM LOAN are issued to the farmer for the purpose of cultivation or domestics expenses such buying seeds, manure and fodder for cattle, etc.

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MEDIUM TERM LOAN are given to farmer to purchase cattle, agriculture implement and to make improvement on land.

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LOAG TERM LOAN are given to the farmer to purchase land, pay of old debt and purchase useful machinery for long term usage. These loans are for comparative long period since the farmers can repay them gradually over a number of years.

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The two credit sources available to the farmers institutional and private

Institutional sources consist of the co-operative and commercial banks including Regional Rural Banks (RRBS)

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Non institutional or private sources including money lender traders commission agents and landlords

Non –institutional sources or private sources of farms credit refer to credit supplied by money lender landlords and traders.

Money lender is often combined with the farming by the village money lender as they lend to farmer for both the productive and non productive purposes charging high rate of interest.

They enter larger than actually borrowed sums through false pretense by obtaining promissory and give no receipts for repayment and often deny such repayments.

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They commit many other rogueries and have been responsible for many of the ills of Indian agriculture

Their main interest has been exploit the farmers and grab their lands.

Institutional credit has been introduced to stop such activities of the money lenders

CREDIT DELIVERY MECHINISM IN RURAL FINANCE: MULTI

AGENCY APPROACH

In all agriculture development programs agricultural credit is one of the most crucial inputs.

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Private money lenders are the major sources for agricultural finance which is inadequate and highly expenses and exploitative.

Since independence, a multi agency approach consisting of co-operative commercial banks (RRBS) has been adopted to provide timely adequate and relatively cheap to farmer this is known as institutional credit.

The major objective of the credit policy of the government of India is to provide increasingly institutional credit to small and marginal farmer to enable them to adopt modern technology and improved agricultural practices and thus increases agricultural production and productivity.

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INSTITUTIONAL SOURCES OF FINANCE

At present three agency supply institutional finance .they are:

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Co-operativesCommercial banksRRBs

The primary agricultural credit societies (PACSs) provide mainly short term loans, and

Land development banks (LDBs) –these are now called co-operative agricultural and rural development bank (CARDBs) –provide long term and medium term loans to the agriculture sector.

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Agriculture credit to the farmer and refinancing to the above mentioned banks is provided by the National Banks for agriculture and rural development (NABARD), which is apex institution for the agriculture credit at the national level.

RBI is the central bank of the country plays a crucial role by giving overall direction to rural credit and financial support to NABARD for its operations.

SUPERIORTY OF INSTITUTIONAL FINANCE

Weakness and inadequacy of private agencies to supply credit to farmer aroused the need of

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institutional credit private finance for example is defective because:

It is based on profit motive and therefore it is always unfair

It is very expensive moneylenders charge very high rates of interest and it is not related to productivity of land and

It does not flow in to the most desirable channel and it is not available to the needy persons.

The motive of the institutional credit is always maximizing the farmer income and raise his productivity.

The rate of interest is relatively low compared to money lenders and can be different for different purposes.

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Institutional also make a clear distinction between short term credit and long term requirement and give long accordingly.

EVOLUTION OF MULTI –AGENCY APPROACH IN INDIA

Much was expected of the cooperative credit movement .as the movement was led by and was for farmers it was expected to cover all the needs of the farmers.

The co-operative were expected to protect the farmer from the clutches of the money lenders.

A survey for the year 1950-51 shows that the co-operative met only 3.3% of the total requirement of the farmers.

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Then State Bank of India was set up in 1955 after taking over the imperial bank of India to show special concern for agriculture credit.

The all rural credit review committee (1969) recommended that the adoption of multi agency approach was necessary to the rural sector as banks and societies alone could not meet the needs of farmers.

SBI’s e-Gram Project in Gujarat

To provide all banking product /services.

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Customers not visit branches personally.

Target more than 5000 rural ICT kiosks.

Villagers to start a bank a/c with Rs 50.

Zero balance also be permitted.

MOU with Indian postal department to act as facilitator for 50 post officers at Surendra nagar anand and bharuch districts.

Also signed with Gujarat agro india to market bank product in 700 out of its 1200 outlets.

So commercial banks have to play an important role in the rural sector also.

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This is one of the main reason for the nationalization of the 14 top commercial banks in 1969.

Later in 1976 the commercial bank were asked to set up RRBs to help the small and marginal farmers and rural artisans.

Thus the multi-agency approach to institutional credit to agriculture co-operative societies and co-operative banks commercial banks and RRB evolved over a number of years.

PROBLEMS OF MULTI AGENCY APPROACH

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The problems were:

There was multiple financing over financing in some area and under financing due to lack of co ordination between the agencies in the same area.

Despite the option of lead bank scheme and districts credit plan, the different agencies often fail to formulate and develop meaningful agriculture programs in given blocks and districts.

Despite guidelines issued by RBI, different agencies adopted different procedures and policies in the matter of providing loans and their recovery.

When different agencies had lent loan to the same person there were some practical problems in the recovery of loans.

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ROLE OF RBI IN RURAL CREDIT

Since it was set up in 1934, RBI has been taking keen interest in expending credit to the rural sector. After NABARD was set up as the apex blank for agriculture and rural development, RBI has been taking a series of steps for providing timely and adequate credit through NABARD.

Schedule commercial bank excluding foreign banks have been forced to supplement NABARD effort through the stipulation that 40% of net banks credit should go the priority sector out of which at least 18 % of net bank credit should flow to agriculture.

Beside it is mandatory that any shortfall in fulfilling the 40% target or the 18% of the target

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would have to go to the corpus Rural Infrastructure Development Fund(RIDF). RBI has also taken step in recent year to strengthen institutional mechanism such as recapitalization of regional rural bank(RRB’s) and setting up of local area banks(LAB’s).

MICRO- FINANCE

Micro finance is a novel approach to “banking with poor” as they attempt to combine lower transaction costs and high degree of repayment. The major trust of these micro finance initiative is through the setting up of Self Help Group (SHG’s) nongovernmental organization (NGO’s), Credit union etc.

KISAN FARMER’S CREDIT CARD47

Another notable development in recent year is the introduction of Kisan credit card (KCC) in 1998-99. The purpose of the Kisan credit card (KCC) scheme is to facilities short term to farmers.

The scheme has been gained popularity and its implementation has been taken up by 27 commercial banks 187 RRB and 334 central cooperative banks.

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AGRICULTURE INSURANCE

As agriculture is highly susceptible to risk such as drought floods pests etc. it is necessary to protect the farmer from natural calamities and ensure their credit eligibilities from the next season. Towards this purpose the government of India introduced a comprehensive crop insurance scheme through the country in 1985 covering major cereal crops oilseed and pulses. Among commercial crops seven corps viz., sugarcane potato, cotton, ginger, onion, turmeric, and chilies are presently covered.

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For development of fruit and garden corps,for leveling and development of land for purchase of ploughs animals etc.

Commercial bank also extended loans for allied activities viz. for dairying poultry piggery bee keeping fisheries and other. These loans comes to 15 to 16%.

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COMMERCIAL BANKS AND SMALL FARMERS

The commercial banks identifying the small farmers through Small Farmers Development Agencies (SFDA) set up in various districts and group them into various categories for credit support so as to enable them to become bible cultivation. As regards small cultivation near urban area and irrigation facilities, Commercial bank can help them to go in for vegetable cultivation or combine it with small poultry farming and maintaining one of or two milk cattle.

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IRDP AND COMMERCIAL BANK

Since October 1980, the Integrated Rural Development Programme (IRDP) has been extended to all the blocks in the country and the commercial banks have been asked by the government of India to finance IRDP.

The lead bank have to prepare banking plan and allocate the responsibilities of financing the identified the beneficiaries among the participating banks.

Commercial banks have been asked to finance all economically backward people identified by government agencies.

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COMMERCIAL BANKS ANG RURAL CREDIT

The commercial banks at present provide short term crop loans account for nearly 45 to 47% of the total loans given and disbursed by the commercial banks.

Terms loans for varying period given for purchasing pumps sets tractors and other agricultural machinery for construction of wells and tube well.

DIRECT FINANCING BY COMMERCIAL BANKS

Commercial banks were expected to vigorously support the farmer’s in general small cultivators In particulars.

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For obvious reason the nationalized banks concentrated their attention on cultivation and other special category farmers such as those engaged in raising high yielding verities of food grain.

Term loans for varying period are given for purchasing pump set tractors and other agricultural machinery for construction of wells and tube wells for development of land for the purchase of plough animals.

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INDIRECT FINANCING BY COMMERCIAL BANKS

Even though the scope of direct financing by commercial banks would be limited for some tears to come. There is a considerable scope for indirect financing by them.

Commercial bank fiancé cooperative societies to enable them to extend their production credit to the farmers. More especially they provide finance increasingly to co-operative engaged in the marketing and processing the agricultural produce or in activities ancillary to such as dairy poultry etc.

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Commercial banks are undertaking indirect provision of production credit through production credit through agencies through engaged in the supply of the marketing or processing of agricultural produce.

They extend credit to manufacturing or distribution firm and agencies and co operative engaged in the supply of pumps set and other agricultural machinery on a hire purchase basis or otherwise.

They finance the operation of the food corporation of India the state govt and other in the procurement storage and distribution of food gains.

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Commercial banks increasingly subscribing to the debenture of the central and development banks and also extend advances to the letter. This enable land development banks to expand their medium and long term advances to the farmer for the purpose of land development.

PROBLEMS OF COMMERCIAL BANKS IN RURAL CREDIT

In the field of financing agriculture the problem concern quantitative and coverage aspect

The RRB have been under serve financial strain on account of higher transaction cost involved in handling of a large no of small size loan account and some what lower interest income as a result of confessional rates of interest on small size loan.

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REGIONAL RURAL BANKS

Rural banking of India started since establishment of banking sector in india.Rural banks those mainly focused upon the agro sector. Regional rural bank in India penetrated every corner of the country and extended a helping hand in the growth process of the country.

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WEAKNESSESS OF RRBS

NARSIMHAM COMMITTEE (1991) ON RRBS

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SERVICE AREA APPROACH (SSA)

Public sector bank adopted a new strategy for lending on the basis of a study on the impact of blank credit in the rural sector viz., ‘sevice area approach’ under which each semi urban and rural branch of commercial banks was assigned a specific area comprising a cluster of villages with in which it would operate adopting a planned approach. It was to avoid duplication of efforts and scattered lending over wider areas.

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The implementation was:

Identification of service area.

Survey of service area for accessing the potential for lending.

Preparation of credit plans on annual basis.

Coordination on continuing basis, and

A continuous system of monitoring the implementation plan.

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Some of the advantages claimed of SSA are as follows:

Attention to the development of the service area for each branch.

Avoidance of duplication of efforts.

Organized and planned lending.

Easier and effective monitoring of the end ise of credit.

Assessment of its impact on production level.

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The problem during implementation of SAA were with respect to:

Allocation of villagers

Organizational issue

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FUTURE OF RURAL BANKING IN INDIA

The Reserve Bank of India has a mandate to be closely involved in matters relating to ruralcredit and banking by virtue of the provisions of Section 54 of the RBI Act. The major initiativein pursuance of this mandate was taken with sponsoring of All-India Rural Credit Survey in1951-52. This study made agency-wise estimates of rural indebtedness and observed thatcooperation has failed but it must succeed. The Report of the Committee on Directions is stillconsidered a classic on the subject, and two of the four members were, incidentally, from AndhraPradesh. This is the origin of the policy of extending formal credit through institutions whileviewing local, traditional and informal agencies as usurious. In the first stage, therefore, effortswere concentrated on developing and strengthening cooperative credit structures. The Reserve

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Bank of India has also been making financial contributions to the cooperative institutionsthrough evolving institutional arrangements, especially for refinancing of credit to agriculture.

While enacting the State Bank of India Act in 1955, the objective was stated to be the extensionof banking facilities on a large scale, more particularly, in rural and semi-urban areas. SBI,therefore, became an important instrument of extending rural credit to supplement the efforts ofcooperative institutions. In 1969, 14 major commercial banks were nationalised and theobjective, inter alia, was "to control the heights of economy". The nationalised banks thusbecame important instruments for advancement of rural banking in addition to cooperatives andState Bank of India. The next step to supplement the efforts of cooperatives and commercialbanks was the establishment of Regional Rural Banks in 1975 in different states with equityparticipation from commercial banks, Central and State Governments.By 1982, to consolidate the various arrangements made by the RBI to promote/ supervise

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institutions and channel credit to rural areas, NABARD was established. Though several effortswere made to increase the flow of institutional credit for agricultural and rural lending, there

were mismatches in credit and production. Field studies conducted to determine the reason,revealed that it was due to absence of effective local level planning. It was felt that with theestablishment of large network of branches, a system could be adopted to assign specific areas toeach bank branch in which it can concentrate on focussed lending and contribute to thedevelopment of the area. With a view to implementing this approach, RBI introduced a schemeof "Service Area Approach" for commercial banks. To further supplement the institutionalmechanism, the concept of Local Area Banks was taken up in 1996-97 and in-principle approvalhas been given for 8 Local Area Banks.As regards cost of credit, for most of the period, the administered interest rate regime wasapplicable for bank lending and this included concessional terms for priority sector. Currently,

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all interest rates on bank advances including in rural areas are deregulated and there is no linkbetween priority sector and interest rate, though there are some regulations on interest rates by

size of advance i.e. below Rs. 2 lakh in respect of commercial banks.As regards policy measures to enhance flow of credit to rural areas, apart from availability ofcredit lines from the Reserve Bank of India, the concept of priority sector was evolved to ensuredirected credit. Currently, the stipulation is that domestic commercial banks should extend creditto the extent of 40 per cent of the total net bank credit to priority sector as a whole, of which 18per cent should be specifically for agriculture. Out of the target of 18 per cent for agriculture, atleast 13.5 per cent should be by way of direct loans to agriculture and remaining could be in theform of indirect loans.Where a bank fails to fulfil its commitment towards priority sector lending, it is currentlyrequired to contribute to Rural Infrastructure Development Fund set up by NABARD. NABARDin turn provides these funds to State Governments and state owned corporations to enable them

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to complete various types of rural infrastructure projects.It is pertinent to recognise that there are a large number of credit linked programmes sponsored

by the Government for direct assault on poverty. In programmes relating to self-employment andwomen welfare, the multiplicity of programmes has been reduced by having a comprehensiveand consolidated programme named Swaranjayanti Gram Swarojgar Yojna.The financial sector reforms, which were introduced from 1991 onwards were aimed attransforming the credit institutions into organisationally strong, financially viable andoperationally efficient units. The measures introduced include reduction in budgetary supportand concessionality of resources, preparation of Development Action Plans and signing ofMemoranda of Understanding with the major controllers, and introduction of prudential normsrelating to income recognition and asset classification for RRBs and cooperative banks. Thelending rates for these institutions have also been deregulated. Other measures of liberalisation

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include allowing non-target group financing for RRBs, direct financing for SCBs and CCBs, andliberalisation in investment policies and non-fund business.

These measures have contributed to many RRBs turning around and becoming more vibrantinstitutions. In the case of cooperative banks, there is greater awareness of the problems ofofficialisation and politicisation and initiatives in this regard include legislative actions oncooperative banks in Andhra Pradesh.Recently, several policy initiatives have been taken to advance rural banking. These includadditional capital contribution to NABARD by the RBI and the Government of India,recapitalisation and restructuring of RRBs, simplification of lending procedures as per the GuptaCommittee recommendations, preparation of a special credit plans by public sector banks andlaunching of Kisan Credit Cards. Finally, a scheme linking self-help groups with banks has beenlaunched under the aegis of NABARD to augment the resources of micro credit institutions. A

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Committee has gone into various measures for developing micro credit, and has submitted itsreport, which is under the consideration of the RBI. In respect of cooperatives, a Task Force

under the chairmanship of my esteemed and affectionate colleague Shri Jagdish Capoor, DeputyGovernor has been constituted to review the status and make recommendations for improvement.Undeniably, these initiatives have enabled a very wide network of rural financial institutions,development of banking culture, penetration of formal credit to rural areas and a counter to thedominance of moneylenders. These initiatives have also financed modernisation of ruraleconomies and implementation of anti-poverty and self-employment programmes. However, forthe purpose of focussing on the future, generalisation on some concerns regarding the currentapproach to rural credit and banking would be appropriate.Firstly, the cooperative banks have different layers and many of them have significantly largenon-performing assets (NPAs). Many cooperatives are undercapitalised. The public sector

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banking system also exhibits NPAs, and some of them have so far been provided withrecapitalised funds. The RRBs also exhibit NPAs and these have been recapitalised from the

Government of India so far, which would imply a total recapitalisation of double the amountprovided by Government of India.Secondly, according to the All-India Debt and Investment Survey, 1991-92, the share of debt toinstitutional agencies in the case of rural households has increased marginally from 61.2 per centto 64 per cent between 1981 and 1991. However, it must be noted that this figure relates to debtoutstanding and the overall share of the institutional credit in the total debt market is likely to besmaller than what this figure indicates.Thirdly, the cost of financial intermediation by the various rural financial institutions isconsidered to be on the high side. The difference between the cost of resources made available toNABARD by Reserve Bank of India and the commercial rates of interest at which thecooperative banks lend for agriculture in the deregulated interest rate regime is also considered

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to be on the high side.Fourthly, empirical studies indicate that institutional credit is more likely to be available for wellto do among the rural community.

Fifthly, empirical studies also indicate that relatively backward regions have less access toinstitutional credit than others do.Sixthly, the non-availability of timely credit and the cumbersome procedures for obtaining creditare also attributed to the functioning of the financial institutions, though this is equally valid forrural and urban banking.Finally in regard to Government sponsored schemes, there has been overlap in accountability inas much as the beneficiaries are identified on a joint basis. Banks have been indicating thatNPAs are proportionately more due to this overlapping.An important development in the formal segment of the rural financial markets is the growingsignificance of non-banking financial companies, in particular, in hire purchase and leasingoperations. They also finance traders of agricultural inputs and output. The NBFCs have only

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recently been brought under the regulatory regime of RBI. While their importance is recognisedin financing diversified rural agriculture, its extent and scope of operations has not been

adequately researched.

Dynamics of Rural Economy

Problems, prospects and solutions to many of the issues mentioned have been researched anddebated, primarily with a view to strengthening, revamping or re-orienting rural financialinstitutions. However, there is merit in viewing the problems of rural credit and rural banking ina wider context. In this regard, it will be useful to recognise some dynamics of rural economy.First, services sector is getting increasing importance in the rural areas also -from coffee shops tocable television operators. Assessing and meeting of credit needs of this sector is important.Second, the integration between rural and urban areas has increased significantly, with the result,mobility of labour, capital, products and even credit between the two is increasing.

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Third, commercialisation of agriculture, particularly the increasing role of cash crops like cottonhas resulted in substantial role for suppliers' and buyers' credit. Thus, fertiliser and pesticide aresupplied to farmers on credit, often on deferred payment basis. In such deferred payment

arrangements, credit terms are built into price and hence it is difficult to isolate terms. Similarly,the commission-agents advance money towards purchase of output from farmers, which amountsto providing credit and includes an element of forward trading. These arrangements are oftenentered into on a voluntary basis. The present banking system does not generally encouragefinancing the transactions of this nature. However, a few non-banking financial companies doprovide indirect finance for such purpose.Fourth, compared to cereal production, other food items, including poultry and fish are growingat a faster pace. In other words, rural agriculture is getting increasingly diversified in terms ofproducts and processes.Fifth, in areas where commercialisation of agriculture has reached significant levels, the

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traditional landlord-based tenancy is replaced with commercial-based tenancy. Where intensivecultivation of cash crops such as cotton is called for, this has become quite common. However,the present credit and banking procedures do not cater to the working capital needs of suchcommercial based tenancy relationship.

Sixth, given the diversified activities, and large work force in rural areas, there is increasingrecourse to multiple occupations to earn a decent livelihood. For example, a small farmer is alsoa petty trader and may also be a satellite based cable television operator in the village. The end48use specification and monitoring of credit is more difficult in such circumstances.Seventh, to the extent employment and indeed incomes could be seasonal, especially foragricultural labour, there is reason to seek and obtain consumption loans. Such assurance ispossible with prosperity in rural employment. Present arrangements in formal credit markets areinadequate to meet such requirements.Eighth, while there is significant commercialisation and diversification of rural economies,

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progress is very uneven in different parts of the country. So, there are still many areas, whereexploitation of tribals by money lenders or of agricultural labourers by landlord-money lenders,still persists. Norms and procedures of credit, therefore, need to be different to meet varyingcircumstances.Ninth, from the data on credit deposit ratios, it is clear that the banking system is a conduit for

net transfer of financial savings from rural to non-rural sectors. On the other hand, a major partof informal markets would be local and hence savings would be locally deployed, within therural areas.

Rural Credit Markets : New Realities

As mentioned earlier in the approach to rural banking, the basic thrust of our policy has been topromote institutional credit and eliminate or ignore informal finance. However, in reality, whileformal credit has expanded its share, informal finance continues to be significant. The idea ofpromotion of Self-Help Groups and micro financing is an indirect admission of necessity of

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informal finance. The future of rural banking cannot be appreciated without fully understandingboth formal and informal rural credit markets, especially their linkages. Since in the earliersections, organisation and functioning of the formal credit system in the rural areas has beenexplained, in this section nature of informal markets and the linkages will be explored.

The informal financial market which is legal but officially unrecorded comprises unregulatedfinancial activities i.e., outside the orbit of officially regulated financial intermediaries. In theinformal financial transactions, one could treat borrowing and lending among friends andrelatives as occasional and not part of such an informal market. Consequently, there are threebroad types of informal financial transactions, viz., well-defined group, tied-lending/borrowing;and untied lending/borrowing activities. In the literature on well-defined groups, there are threebroad types namely Rotating Savings and Credit Associations (ROSCA); Accumulated Savingsand Credit Associations (ASCRA) and hybrid forms of both. There are some variations under

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each category. Basic characteristics of these groups are that they are voluntary in nature, usuallyamong equals, with little or no outside support or interference. Often, members have somespecial bonds based on religion, caste, status, neighbourhood, etc. In brief, there is no patronclientframework. In essence, therefore, these arrangements among well-defined groups, thoughimportant, should not in my view be included in the concept of informal financial markets. In the

recent past, there have been efforts to provide a bridge between formal financial markets andthese well-defined groups in the form of ‘micro-finance' initiatives. However, these initiatives donot constitute marketisation of activities of well-defined groups. Thus, the informal financialmarkets are those which are outside the orbit of officially regulated institutions. These informaldebt transactions may involve tied debt transactions and untied debt transactions.The general approach, at least at the policy level, to informal market whether tied or untied, hasnot been positive since informal debt market has been historically equated with either landlord ormoneylender. The transactions are considered to be expensive, especially in view of what is held

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to be of usurious nature of interest rates. It is considered to be financing unproductiveexpenditures since consumption needs are financed. Sometimes, it is said that there are oftenunequal and exploitative arrangements, say, between the landlord and the tenant or theagricultural labourer. Finally, it is held that, since these are unregulated, they are prima facie notdesirable.

Yet, the fact remains that informal debt markets do prevail, and studies have shown that in someareas in our country, they account for 70 to 80 per cent of debt transactions. Studies have alsoshown that many poor people have no access to institutional credit. The arrangements ininformal debt markets are said to be flexible, and sometimes have in-built risk sharingarrangements. These credit arrangements do provide for smoothening of consumption andproduction requirements. Transaction costs in terms of certainty, timeliness, proceduralrequirements, number of trips, etc. are somewhat negligible although there may be hidden costsin tied lending. Moreover, while formal markets tend to cater to less risky borrowings, informal

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markets provide for the more risky borrowings and thus serve a purpose. Finally, it has beenstated in the literature that financial repression like directed credit, high reserve ratios, interestrate ceilings, branch licensing, etc. make informal financial markets relatively attractive andpopular.Perhaps, one way of reconciling the conflicting views on usefulness of informal credit is to

recognise some emerging realities of both formal and informal markets. This would also help arethink on approaches to rural credit and rural banking.First, it is no longer the case that the money lender and informal financing are alwayssynonymous, in view of the dynamics of rural economy already described involving supplierscredit, buyers credit and credit for services sector.Second, informal markets are less significant now than before, and have to face competition or atleast accept benchmarking of formal credit. The concept of monopoly of moneylender in ruralareas is not true in many areas now.Third, when informal financial market is linked to socially undesirable activities, there is

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certainly a cause for concern though the available evidence shows that such a link is more ametropolitan or urban phenomenon rather than a rural one.Fourth, bank credit is really not severely restricted to what can be officially determined asproductive, since most of the credit-card financing by the banks is, in fact, financing ofconsumption and at interest rates comparable to those prevailing in the rural informal debt

markets. In other words, it is no longer unethical for banks to finance consumption creditthrough the credit card route. Credit card business, so far, is an essentially urban phenomenon.Hence, the financing of consumption by informal markets in rural areas cannot be frowned uponwhen it is being done by banks through their credit card business.Fifth, the real extent of informal markets is grossly understated in any survey that views data onoutstanding debt since the turnover of debt is admittedly much lower for public institutions thanfor private lending. The turnover-differential is on account of several factors, includingpreference for short term finance and better recovery-performance in informal markets.

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Sixth, the social significance of informal credit is more than its proportion in financial termssince the poorer sections draw far larger amounts from informal than formal markets.Seventh, a significant part of informal market is through leasing, hire purchase, deferredpayment, etc. with finance often provided by NBFCs. The informal market is providing a range

of financial products, which the formal banking system is not able to.Eighth, studies have demonstrated that expansion of literacy and education tends to increase theaccess of rural folk to formal credit, reduce the informal transaction costs in dealings with formalcredit institutions and improves their resistance to malpractices attributable to landlord ormoneylender. The exploitative nature of informal markets is more pronounced in tribal or lessdeveloped areas while productive nature of informal markets is more pronounced in prosperousvillages. Indeed, one can argue that in many areas, the formal credit structure has provided apositive institutional alternative to the moneylenders and thus marginalising his role in providingcredit to rural masses.

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Linkages in Rural Debt Markets

Having recognised that one cannot wish away informal markets, some tentative generalisationson the relative roles of formal and informal markets and on the linkages between them would

also be necessary to capture the emerging but complex realities. Such generalisations arepossible on the basis of empirical studies.First, the formal credit has a tendency to flow more easily to agriculturally developed regionsand to relatively larger farmers leaving the backward regions and small farmers to be largelyserved by the informal market. This phenomenon is generally explained by four factors viz.,poor-resource endowment features of the borrower, poor personal factors (education, socialcontact etc), underdevelopment of a region and higher transaction costs.Second, as per empirical studies, transaction costs associated with formal credit include fees forprocuring necessary certificates (open), travel and related expenses including loss of wages etc.,

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and informal or unofficial commissions (hidden). The transaction costs vary with type of creditagency involved, the type of borrower and farm-size.Third, uncertainties and delays usually associated with formal credit can also be treated asadditions to the transaction costs.Fourth, the true cost of borrowing from the formal credit system is thus higher than nominal cost

if the above informal transaction costs are also included. To the extent some transaction costs arefixed, the effective cost of borrowings for smaller loans tends to be relatively higher than for alarger loan.Fifth, there are usually hidden costs or concealed interest rates in respect of informal credit also,which have to be added to the nominal costs to arrive at the true cost. These hidden costsgenerally relate to tied lending, tied to land, labour, input or output. The tied advance in respectof labour is particularly relevant for migratory labour. The hidden costs are usually in the formof undervaluation of labour and output of borrowers and overvaluation of inputs supplied bylender.

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Sixth, the choice between formal and informal credit depends on both the access and relative truecosts. Thus, recourse to informal credit, admittedly at far higher nominal costs, is to be explainedpartly in terms of effective costs and the extent of supply of formal credit.Seventh, in assessing relative roles, both supply and demand side bottlenecks of formal credit

need to be appreciated. The former relate to asset-based lending policies and complex formalitiesand procedures, while the latter relate to poor endowment, lower education and social-contact,usually caste-based in backward regions. Viewed differently, a larger role for informal creditmay arise due to low level of commercialisation and monopoly power of moneylender; and itmay also arise due to high level of commercialisation of agriculture when supply from formalchannel cannot match significant demand for credit.Eighth, it is also necessary to recognise that, to the extent informal markets tend to lend toborrowers who are relatively less creditworthy, risk-premium is bound to be higher. This would

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also get reflected in higher nominal interest rates in informal markets and indeed higher truecost, though it may not be so high if it is net of risk premium.It is clear that the critical issue in respect of informal credit is the manner in which the linkagesamong the participants in the market operate and result in varying degrees of hidden costs. It ispossible to make some exploratory postulates here. First, trader-lenders are likely to provide

most of production - credit, while farmer-lender or moneylender is likely to provide most ofconsumption - credit. It is, of course, possible that some individuals combine the functions offarmer, trader and moneylender. Second, informal markets are unlikely to finance credit forinvestment purposes, given the time preference. Third, the levels of education are likely toreduce the scope for gross overvaluation or undervaluation in linked-transactions. Fourth, theinter-linked transactions among parties with equal bargaining power are likely to minimise thehidden costs. Fifth, from the supply side, farmer-lenders may tend to be associated with land andlabour market linkages while trader-lender is likely to be associated with input-output markets.

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On the demand side, agricultural labour may be associated with land and labour markets whilethe farmer-cultivator with input-output linkages. In the process, it is likely that a farmer wouldbe a borrower from a trader and a lender to agricultural labour, a common phenomenon invillages. It will, therefore, be over simplification to divide the rural population into lenders andborrowers or exploiters and exploited. Sixth, similarly it is necessary to appreciate the role of

linkages in credit-risk-mitigation. In fact, the risk reducing element of linkages are not built intoformal credit-channels. Incidentally to the extent the transaction costs are front loaded in respectof formal credit, there is no incentive to repay while the true costs of informal credit are spreadout. Seventh, in terms of bargaining power among the class of borrowers, the agricultural labourand migratory labour appear to be weakest except in agriculturally prosperous areas wherlabour-shortage is acute to cater to agricultural and other operations. Similarly, the differential inbargaining power between large and small borrowers is similar to that between large corporatesand small-industrialists in urban areas.

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In brief, the linkages between formal and informal markets are complex, contextual anddynamic. The two markets appear to compete with and also supplement each other.

Technology and Rural Banking

We should recognise that the role of banks, which is central to formal credit in rural areas, is fast

changing. Many non-banks are providing avenues for savers and funds for investment purposes.Banks themselves are undertaking non-traditional activities. Banks are also becoming what arecalled universal banks and are already providing a range of financial services such asinvestments, merchant banking and even insurance products. Similarly, non banks are alsoundertaking bank like activities. At present in India, these are mostly confined to urban areas, butthey will sooner than later spread to rural areas.Another development relates to the gradual undermining of the importance of branches of banks.The emergence of new technology allows access to banking and banking services without

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physical direct recourse to the bank premise by the customer. The concept of Automated TellerMachines (ATMs) is the best example. At present, ATMs are city oriented in our country. It isinevitable that ATMs will be widely used, in semi-urban and rural areas.The technology-led process is leading us to what has been described as virtual banking. Thebenefits of such virtual banking services are manifold. Firstly, it confers the advantage of lower

cost of handling a transaction. Secondly, the increased speed of response to customerrequirements under virtual banking vis-à-vis branch banking can enhance customer satisfaction.Thirdly, the lower cost of operating branch network along with reduced staff costs leads to costefficiency. Fourthly, it allows the possibility of improved quality and an enlarged range ofservices being available to the customer more rapidly and accurately at his convenience. It maynot be possible to deny these facilities to rural areas in our country since, if banks do not providethem, some non-banks will do it.Another development relates to the increasing popularity of credit cards, which are bound to

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reach rural areas. Many Public Sector Banks are already in credit card business. In fact, multipurposecards could be a facility that IT could usher in for rural population. The potential can beillustrated with SMART cards. SMART cards – which are basically cards using computercircuits in them thereby making them ‘intelligent' – would serve as multipurpose cards. SMARTcards are essentially a technologically improved version of credit and debit cards and could be

used also as ATM cards. They could be used for credit facilities at different locations by theholders. SMART cards could also be used for personal identification and incidentally formonitoring credit usage.For the spread of virtual-banking and SMART cards to rural areas, it is essential that electricpower and telecom connectivity are continuous and supplies do not drop especially during thehours when a bank's transactional activity is at relatively high levels. The banks could, undersuch assured supply conditions acquire the required banking software and also put in place thenecessary networking for providing anywhere banking facilities in rural and semi-urban areas

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also.Like banks in other parts of the world, Indian banks will have to get interested in providingdiversified range of financial products and services along with those that they are alreadyproviding, by using technological advances. As the level of education in rural areas rises andaffluence spreads, customers will start seeking efficient, quicker and low cost services. As the

financial system diversifies and other types of financial intermediaries become active, in ruralareas, savers would turn towards mutual funds or the savers themselves decide to deploy part oftheir financial surpluses into equities and debentures as also other fixed income securities. Thebulk of bank deposits in the rural areas are currently longer term deposits and as these comedown, there would be a distinct shortening of the average maturity structure of bank depositswith an increase in asset liability mismatches. The spreads that the banks now enjoy willprogressively shrink making it more difficult for them to survive. As more and moreintermediaries enter rural areas with greater level of technology, traditional banking business

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will come under pressure. In order to face the competitive pressures being exerted by therecently set up market savvy banks, banks which have extensive branch network in most of theexisting and potential rich rural and semi-urban areas may have to provide such services.

Issues

It is clear that significant progress has been made, since independence, in expanding bankbranches and banking habits in the rural areas, through a variety of institutional innovations. Animpressive segment of rural economy has been brought into the ambit of formal financialintermediation, mainly through the public sector banking system, and to some extent, throughcooperatives and RRBs. The future of banking in rural areas would, however, depend on severalfactors that have been described, namely, how the current concerns are addressed taking into

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account the dynamics of transformation in rural economies, the new realities in credit markets,the linkages between formal and informal markets, and the impact of financial as well astechnological progress on the systems of financial intermediation.Consequently, public policy will have to address several issues to ensure a sound and efficientbanking system in the service of rural areas. The more important of such issues relate to the

approach, institutions, supply, cost, and related policies

Approach

In the past, the major instruments of public policy were cooperatives and public-sector bankingsystem. However, with the diversification of ownership of public sector banks and the overallthrust of financial-sector reform, a review of institutional arrangements, mainly in the incentiveframeworkfor credit-delivery appears necessary. Similarly, in the area of cooperatives also, a

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reduced role for Government including in providing refinance is being advocated. This desirableapproach would also need a review of institutional arrangements, in particular in delayering anddebureaucratising the cooperatives.Further, there are new institutions and new forms of financial intermediation that are emerging –be it mutual funds or more important for rural areas, non-banking financial companies. Anyapproach to rural-development should consider capturing, at least the activities of non-banking

financial companies as part of formal rural financial markets.Moreover, in many parts of the country, growth of literacy and diversification of the economyhave brought about new characteristics and linkages between formal and informal financialmarkets in rural areas. The latter does play a significant part in rural economy. Hence, the twomarkets should be treated as competing and co-existing, and in fact the policy should seek toutilise informal markets also for public interest. A small beginning has been made in thisdirection, through initiatives on micro finance. A policy of analysing and monitoring of rural

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financial markets as a whole is critical for the future and devoting attention only to banks andcooperatives may not suffice. I would hasten to add that a policy-focus on informal markets doesnot at all imply extending regulation to informal markets. In fact, the Report of Task Force onmicro-finance of NABARD (1999) has recommended extending regulatory framework formicro-finance institutions, and in my view this recommendation is fraught with difficulties.Funding by banks and regulated NBFCs of micro-finance institutions should be encouraged and

guidelines provided, but regulation of micro-finance institutions may not be prima facie wise.In any case, research and micro studies encompassing both formal and informal segments wouldhelp the policy makers appreciate relative roles and linkages in rural financial markets as awhole. In other words, policy analysis should perhaps consider expanding its attention from ruralbanking to rural financial markets.Enhancing effective supply of credit in such rural financial markets would be a logical objectiveof policy, thus enlarging the current attention to include both directly disbursed credit by the

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banking or cooperative sectors and indirect supply. Similarly, reducing the true cost of creditavailabilityto rural areas would be yet another objective, expanding the attention of policy toinclude both nominal cost of credit from banking or cooperative sector and true cost in formaland informal markets. In an increasingly deregulated environment, this objective would implyattention to competitive efficiency involving procedural-simplification also, in respect of banksand cooperatives.

Finally, the approach may expand from delivery of credit to rural areas to making availablefinancial services and products to savers, investors and consumers in the rural areas. In otherwords, it should be recognised that rural financial markets comprise both depositors or saversand borrowers or investors.

Institutions

Among the institutions involved in rural credit, cooperatives have a special place in the RBI.

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There is full appreciation of the problems and efforts are underway to workout a package forrevival and may be, rebirth of rural cooperative banks by a Committee headed by DeputyGovernor Shri Jagdish Capoor. The Committee would naturally address issues relating to legalframework, and incurring costs of addressing problems related to overhang of the past. Inaddition, the Committee, I trust, would consider desirability of cooperative banks' foray intonon-fund-based activities, such as fee-based financial services on behalf of mutual funds or

insurance-products. The cooperatives could, in fact help, retail Treasury Bills and GovernmentSecurities in rural areas. Diversified financial products will be increasingly demanded andsupplied in the rural areas, and co-operatives should not be left out of this trend of providing55multiple-products through a single window. This would also imply, going beyond the somewhatclosed loop of preferred financial relations within cooperative system into a multiple contactsbetween cooperative banks and other financial intermediaries, largely utilising technological

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improvement.Commercial banks are being reformed in accordance with recommenations of the NarasimhamCommittee. The RRBs are being recapitalised. These efforts in regard to banks wouldpresumably recognise the trends in providing financial services to enable them to exercisenecessary flexibility and dynamism that is warranted by fast changing world. Similarly, thefuture role of NABARD could be addressed because the organisational setup, funding andactivities will have to reflect the basic logic of financial sector reform viz. changing roles of

owner, regulator, refinancing, subsidised credit, government-funding and cooperatives.

Enhancing Effective Supply

Some analysts argue that supply-led strategy in regard to rural credit has not been successful,since institutional spread and directed-lending have not had the desired impact. While acceptingthat demand has to play its role, and real-demand also implies negotiating strength of the

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borrower in respect of financial institutions, it will be inappropriate to conclude that supplyshould necessarily follow demand. Mere presence of rural credit institutions, does not amount toavailability of supply. Similarly, mere prescriptions of priority lending would not ensure supply.For example, prescription of priority-sector lending relates to percentage of credit outstandingrather than advances. Further, there is no reward for overshooting the target and undershooting isnot really penalised since amounts of shortfall need to be placed in a fund administered byNABARD with a totally risk-free return of 11.5 percent for a five-year advance. These funds are

actually lent to State Governments, thus to an extent replacing rural credit to agriculture withcredit to State Government for rural development. While as a transient measure during a periodconspicuous for incomplete projects, such an arrangement was justifiable, this should notbecome a permanent feature as it would have obviously perverse effects. The coverage ofdefinition of priority sector also leads to some difference between apparent supply and effectivesupply. Thus, the base for calculating priority sector excludes commercial banks' investments,

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which are expanding rapidly. The procedural bottlenecks resulting in delayed supply also, insome ways, amount to erosion of effective supply.At the same time, there may be some effective supplies which are not reckoned for supply underpriority-sector. There may be funds channeled by banks to rural area through urban-branches orthrough other intermediaries such as NBFCs.There is perhaps a case for some research and studies on policy of directed lending so that wecould improve on the incentive and policy framework to enhance effective supply. For example,

the definition and coverage of priority sector for agriculture could be revisited and lending toagriculture by banks through NBFC's could be considered for inclusion in priority-sector, as hasbeen done to ensure flow of credit to truck operators.Yet another area in effective supply relates to lending by banks under government sponsoredprogrammes, which has significant non-commercial considerations. Several issues relating toboth supply and accountability arise due to involvement of both Government and banks. A more

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transparent approach, for example, by separately accounting for them as policy-induced lendingwould help isolate and monitor this supply, apart from isolating the non-performing assets onthis account in the balance sheets of banks.An important bottleneck in the delivery of credit has been the negligible use of bill-discountingfor services sector. Current policies and procedures restrict this instrument to goods. It has beendecided by the RBI to constitute a Committee to explore ways by which bank finance can bemade available to service sector. The Committee, with representation from public, private sector

and foreign banks also is expected to study international experience, our policies and proceduresand make recommendations in two months. This important step recognises that about half of ourGross Domestic Product is in services sector and would also help flow of bank finance to thegrowing services sector in rural areas.

Reducing True Cost

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The major reasons for the true cost of credit from rural financial institutions being higher thannominal costs are mainly scarcity of supply and transaction costs. Enhancing effective supplywould be an important strategy of reducing the true cost. Encouraging competition would be yetanother strategy. A review of procedural requirements, such as eliminating mandatory forms andreplacing them with locally determined procedures, could also be considered. All non-verifieddocumentation could, for instance, be replaced with self-declaration by the borrower. Repeatedvisits and consequent transaction costs can be avoided by several procedural simplifications -

going beyond Gupta Committee recommendation. In particular, growth of informationtechnology and its application in banking would warrant a thorough review of products,procedures and linkages among rural financial institutions.Arbitrage in financial markets is inevitable and prevalence of such operations cannot be ignored.Arbitrage between formal and informal markets, and between production loans and consumption

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needs is also common. Thus, keeping the true cost artificially low in formal markets, the ruralfinancial institutions would encourage arbitrage and erode the clear potential for profit. Indeed,an appropriate strategy may be to reduce the difference between nominal and true cost andensure that true cost reflects market conditions, including premium for credit risk.As already mentioned, provision of diverse financial products and services in the rural areaswould enhance income to banks and help reduce the admittedly large spreads in interest rates.Thus, among the efforts to reduce nominal and true costs of credit in rural areas would beprovision of multiplicity of financial services by rural financial institutions, taking advantage ofdevelopments in technology and financial markets.

Related Policies

There is increasing recognition that, the spread of literacy and generation of growth impulses inthe rural sector would be very significant factors in enhancing effective supply and reducing truecost of rural credit. More specifically, the desired spread of technology and trickledown of urban

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financial products to rural areas would require concerted action in four areas. First and foremost,insurance, especially of crops, should penetrate the rural areas to mitigate the risks to bothfarmer and lender. The lack of penetration of insurance is perhaps an important reason forlenders seeking tied and other risk-mitigation arrangements through informal markets. Second,there should be assured supply of electric power so that functioning of systems is not disrupted.Third, telecommunication network needs to be dependable and financial sector needs to ensure anetwork. We, in the RBI, have already launched INFINET. Fourth, the institutional and

regulatory framework should enable rural financial institutions to operate in diverse financialproducts and services. We, in the RBI are currently engaged in a number of initiatives andstudies. We hope to continue the process, and focus on rural credit, as mandated by the RBI Act.We would seek advice and guidance in this endeavour.

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CONCLUSIONRRBs' performance in respect of some important indicators was certainly better than that of commercial banks or even cooperatives. RRBs have also performed better in terms of providing loans to small and retail traders and petty non-farm rural

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activities. In recent years, they have taken a leading role in financing Self-Help Groups (SHGs) and other micro-credit institutions and linking such groups with the formal credit sector.

RRBs should really be strengthened and provided with more resources with which they can undertake more of these important activities. And most certainly they should be kept apart from a profit-oriented corporate motivation that would reduce their capacity to provide much needed financial services to the rural areas, including to agriculture. Ideally, the best use of the resources raised by RRBs through deposits would be through extensive cross-subsidisation. This, in turn, really requires an apex body that would cover and oversee all the RRBs,

something like a National Rural Bank of India (NRBI).

The number of rural branches should be increased rather than reduced; they should be encouraged to develop more sophisticated methods of credit delivery to meet the changing needs of farming; and most of all, there should be greater coordination

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between district planning authorities, panchayati raj institutions and the banks operating in rural areas. Only then will the RRBs fulfill the promise that is so essential for rural development.

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THANK YOU

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