PROJECT ON

“ROLE OF PUBLIC SECTOR BANKS IN RURAL BANKING ”

Bachelor of Commerce-Banking & Insurance

Semester V(2008-2009)

Submitted ByFARHIN ANSARI

Roll no- 03

SMT. M.M.K. COLLEGE OF COMMERCE AND ECONOMICS Linking Road, Bandra (w), Mumbai -400050

1

PROJECT ON

“ROLE OF PUBLIC SECTOR BANKS IN RURAL BANKING”

Bachelor of Commerce-Banking & Insurance

Semester V

Submitted In Partial Fulfillment of the requirements

For the award of the Degree of Bachelor of Commerce- Banking & Insurance

By FARHIN ANSARI

Roll no.03

SMT. M.M.K. COLLEGE OF COMMERCE AND ECONOMICS Linking Road, Bandra (w), Mumbai -400050

2

SMT. M.M.K. COLLEGE OF COMMERCE AND ECONOMICS Linking Road, Bandra (w), Mumbai -400050

C E R T I F I C A T E

This is to certify that Miss. FARHIN ANSARI of B.Com - Banking & Insurance Semester V (2008-2009) has successfully completed the project on ROLE OF PUBLIC SECTOR BANKS IN RURAL BANKING under the guidance of A.C. VANJANI.

Project guide

Principal

Course Co-ordinator:

Internal Examiner:

External Examiner:

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Declaration

I FARHIN ANSARI student of B.Com – Banking & Insurance Semester V (2008-2009) hereby declare that I have completed the

Project on ROLE OF PUBLIC SECTOR BANKS IN RURAL BANKING

The information submitted is true and original to the best if my knowledge.

Signature of the student Name of the student

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ACKNOWLEDGEMENT

I would like to thank a lot of people without whom this project would not have been complete. First DR A. C. VANJANI he was of utmost help in guiding me structures this project. He helped me throughout and was always present to help me whenever I had a doubt. Expert opinion is always required to complete the project so it was Mr. DARIRA who has the experience of working in PUNJAB NATIONAL BANK, explained me the concept and helped me structure the project. It wouldn’t have been easy for me to tackle such a topic without his practical guidance

A research can never be over without access to a good library and in this case I was blessed as our college library, is very well stocked with books. And the lending policy made life a lot easier. Also not to forget the library of INDIAN MERCHANT CHAMBER which made it easier to get through to matter that helped me understand concepts wellAnd not to forget the unconditional support provided by my parents and friends.

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“ROLE OF

PUBLIC SECTOR

BANKS IN

RURAL

BANKING”

6

INDEX

SR. NO CONTENTS PAGE NO.

1 EXCUTIVE SUMMARY 8

2 INTRODUCTION 10

3 STRUCTURE OF RURAL BANKING 12

4 HISTORICAL PERSPECTIVE 13

5 NEED FOR RURAL BANKING 20

6 ROLE OF PUBLIC SECTOR BANKS IN

RURAL BANKING SYSTEM

23

7 CHALLENGES AFFECTING

PERFORMANCE

24

8 FUTURE OF PUBLIC SECTOR BANKS IN

RURAL BANKING SYSTEM

31

9 RECENT DEVELOPMENTS 37

10 LATEST INITIATIVES BY REGULATORY

AUTHORITIES

41

11 ISSUUES IN AGRICULTUTAL CREDIT-

DEVELOPING COUNTRIES PERSPECTIVE

44

12 CONCLUSION 47

13 BIBLOGRAPHY 49

EXCUTIVE SUMMARY The Indian national planners have taken up the banking sector as an instrument for accelerating the process of rural development. After

7

nationalization both the Cooperatives and Commercial banks played a significant role in providing credit for the development of agriculture which is classified as a priority sector by the RBI in its credit policy. Due to rapid growth and development of rural areas of the country both the cooperatives and commercial banks could not meet the credit needs of the weaker section of the community. After the introduction of modern technology in agriculture the small marginal

INTODUCTIONEVEN today, a large section of the population of India lives in villages

These people carry out several economic activities like production,

consumption, saving, investment, etc. All these activities are prone to

fluctuations and it is quite likely that there are fluctuations in the level

of income and consumption among many rural people. Therefore,

there is a need for augmenting finances through ways other than the

known and expected incomes of the rural populations. Hence the role

of credit sources is crucial for rural development.

farmers and rural artisans could not crawl out of the

stranglehold moneylenders, therefore came the need for

rural banks who would provide the required credit and also

help in the necessary rural development in the country .This

topic also deals with the PSB as to how they came to rescue

agriculture in the wake of Green Revolution .Their current

role and contribution in the rural banking system and how

successful they have been in helping the rural population so

far

8

INTRODUCTION

ural people have to borrow for a variety of needs. They

need credit to meet short-term requirements of working

capital and for long-term investment in agriculture and

other income-bearing activities. Agricultural and non-agricultural

activities in rural areas typically are seasonal, and households need

credit to smoothen out seasonal fluctuations in earnings and

expenditure. In the Indian context, another important purpose of

borrowing is to meet expenses on a variety of social obligations and

rituals. Similarly, there is tremendous inequality in the distribution of

income too. There are a few individuals who have very high incomes

and there are people with low incomes, such as the labourers and

R

9

marginal farmers. Thus, different people or sections of the population

have different credit needs.

If these credit needs of the poor are to be met, rural households need

access to credit institutions that provide them a range of financial

services, provide credit at reasonable rates of interest and provide

loans that are unencumbered by extra-economic provisions and

obligations. To satisfy these needs in a timely fashion, the state has

taken policy initiatives to provide institutional credit.

The declared objectives of public policy with regard to rural credit in

the post-Independence period were, “to ensure that sufficient and

timely credit, at reasonable rates of interest, is made available to as

large a segment of the rural population as possible". The policy

instruments to achieve these objectives were to be, first, the

expansion of the institutional structure of formal-sector lending

institutions; secondly, directed lending; and thirdly, concessional or

subsidized credit.

Thus, development of the rural areas has been the major focus of

growth in since long and India is no exception to this. However, owing

to varied development approaches the aim of achieving a speedier

growth in rural sector has been beset with many a bottleneck. Rural

development is basically a micro approach, which has to be entwined

with macro objective depending on the micro perspectives. This study

dwells on a micro region, how different rural development

programmes are being financed by the commercial and cooperative

10

banks, by considering region-wise and sector-wise total deposits,

advances, recovery and loan outstanding. Besides, the macro

analysis of commercial banks provides their various levels of

performance in terms of several indicators. While the contribution of

private banks and foreign banks has been showing a slow growth in

this liberalization era, the public sector banks dominate the current

banking scenario in the country. However, their performance is

subject to fluctuations as and when policy changes are being made

and a steady growth pattern in term is yet to be realized in full.

STRUCTURE OF RURAL

BANKING

bout 75% of the Indian population lives in rural

areas and about 80% of this population is

dependent on agriculture for its livelihood.

Agriculture accounts for about 37% of the national income.

The development of the rural areas and of agriculture and its

allied activities thus becomes vital for the rapid development

of the economy as a whole.

A

In this regard India has succeeded in developing one of the largest

rural banking systems in the world. The National Bank for Agricultural

11

and Rural Development (NABARD) is the apex institution charged

with looking after all matters concerning policy, planning and

operation in the field of credit for agriculture and other economic

activity in rural areas. Public policy was aimed not only at meeting

rural credit needs but also at pushing out the informal sector and the

exploitation to which it subjected borrowers. Rural credit policy in

India envisaged the provision of a range of credit services, including

long-term and short-term credit and large-scale and small-scale loans

to rural households.

Initially, the co-operative form of banking was considered to be most

suitable in the Indian context. However now India has adopted a multi

agency approach for providing credit in the field of agriculture and

allied sectors, the four sets of institutions viz. Commercial banks both

in public and private sector with a large network of rural branches,

Regional Rural Banks (RRBs) and Cooperative credit structure with

State Cooperative Banks (SCBs) at state level, the affiliated District

Cooperative Banks (DCCBs) at district level and Primary Agriculture

Credit Societies (PACSs) at village level, the long term credit through

State Cooperative Agriculture and Rural Development Banks at State

level (SCARDBs) with branches or affiliated Primary Cooperative

Agriculture and Rural Development Banks (PCARDBs) at grassroots

level.

HISTORICAL PERSPECTIVE

12

he Reserve Bank of India has a mandate to be closely

involved in matters relating to rural credit and banking by

virtue of the provisions of Section 54 of the RBI Act. The

major initiative in pursuance of this mandate was taken with

sponsoring of All-India Rural Credit Survey in 1951-52. This

committee had found that cultivators depended on private

moneylenders for about 94% of their credit needs. The All India Rural

Credit Survey Committee (1954) proposed an integrated scheme for

rural credit. It suggested that the RBI should take steps to strengthen

the cooperative movement. An important step towards gearing the

banking system for rural credit was the formation of the State Bank of

India by amalgamating the Imperial Bank of India with other state-

associated banks. It was felt that with the assistance of the RBI, the

State Bank would play a crucial role in providing rural credit.

T

Adoption of a policy of social control over banks in 1967 and the

nationalization of 14 major scheduled commercial banks in 1969 have

proved to be two major turning-points in the history of commercial

banks in India. The period from 1969 to the present can be

characterized as representing, broadly speaking, three phases in

banking policy vis-à-vis the Indian countryside.

The first was the period following the nationalization of India’s 14

major commercial banks in 1969. This was also the early phase of

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the ‘green revolution’ in rural India, and one of the objectives of the

nationalization of banks was for the state to gain access to new

liquidity, particularly among rich farmers, in the countryside. The

declared objectives of the new policy with respect to rural banking-

what came to be known as “social and development banking” – were

(i) to provide banking services in previously unbanked or under-

banked rural areas;

(ii) to provide substantial credit to specific activities, including

agriculture and cottage industries; and

(iii) to provide credit to certain disadvantaged groups such as,

for example, Dalit and Scheduled Tribe households.

(iv) the agricultural sector be included in the category of priority

sectors

The introduction of social and development banking policy entailed a

radical shift from prevalent practice in respect of the objective and

functioning of commercial banks. An important feature of the policy of

social and development banking was that it recast completely the role

of commercial banks in rural banking. The government thought that it

was necessary to ‘control the heights of the economy and to meet

progressively, and serve better, the needs of development of the

economy in conformity with national policy and objectives’.

It was only after 1969 that a multi-institutional approach to credit

provision in the countryside became policy, with commercial banks,

14

Regional Rural Banks and cooperative institutions establishing wide

geographical and functional reach in the Indian countryside.

The Reserve Bank of India (RBI) issued specific directives with

respect to social and development banking. These included setting

targets for the expansion of rural branches, imposing ceilings on

interest rates, and setting guidelines for the sectoral allocation of

credit. Rural credit was an important component of the ‘green

revolution’ package; the first post-nationalization phase of expansion

in rural banking saw a substantial growth in credit advances for

agriculture. Specifically, a target of 40 per cent of advances for the

“priority sectors,” namely agriculture and allied activities, and small-

scale and cottage industries, was set for commercial banks.

Advances to the countryside increased substantially, although they

were, as was the green revolution itself, biased in respect of regions,

crops and classes.

The Reserve Bank hived off a part of its role in agricultural credit to a

separate national level institution, viz, Agriculture Refinance and

Development Corporation (ARDC) in 1975. Soon thereafter, the

Government established by ordinance and then legislation a new

network of rural financial institutions called the Regional Rural Banks

(RRBs), which were promoted by the Government of India, State

governments and commercial banks. These were created on the

basis of recommendations by a working group on commercial credit,

also called the Narasimham Committee. Subsequently, the ARDC

was converted into NABARD.

15

Where a bank fails to fulfill its commitment towards priority sector

lending, it is currently required to contribute to Rural Infrastructure

Development Fund set up by NABARD. NABARD in turn provides

these funds to State Governments and state owned corporations to

enable them to complete various types of rural infrastructure projects.

It was felt that with the establishment of large network of branches, a

system could be adopted to assign specific areas to each bank

branch in which it can concentrate on focused lending and contribute

to the development of the area. With a view to implementing this

approach, RBI introduced a scheme of "Service Area Approach" for

commercial banks. To further supplement the institutional

mechanism, the concept of Local Area Banks was taken up in 1996-

97.

The second phase, which began in the late 1970s and early 1980s,

was a period when two strategies for employment generation were

envisaged, namely wage- employment through state-sponsored rural

employment schemes and self-employment generation by means of

loans-cum-subsidy schemes targeted at the rural poor. Thus began a

period of directed credit, during which credit was directed towards

“the weaker sections.” The most important new scheme of this phase

was, of course, the Integrated Rural Development Programme or

IRDP, a scheme for the creation of productive income-bearing assets

among the poor through the allocation of subsidized credit. The IRDP

16

was initiated in 1978-79 as a pilot project and extended to all rural

blocks of the country in 1980.

The second phase also involved an expansion and consolidation of

the institutional infrastructure of rural banking. After bank

nationalization, there was “an unprecedented growth of commercial

banking in terms of both geographical spread and functional reach”.

The third and current phase, which began in 1991, is that of

liberalization. The policy objectives of this phase are encapsulated in

the Report of the Committee on the Financial System, which was

chaired by M. Narasimham (RBI, 1991).

The directed credit programmes should cover a redefined

priority sector consisting of small and marginal farmers, the tiny

sector of industry, small business and transport operators,

village and cottage industries, rural artisans and other weaker

sections.

Credit targets for this redefined priority sector should be fixed at

10 per cent of aggregate bank credit.

Stipulations of concessional interest to the redefined priority

sector should be reviewed with a view to its eventual

elimination, in about three years.

A review should be undertaken at the end of three years to see

whether the directed credit programmes need to be continued.

17

The Reserve Bank of India had advised the public sector banks to

prepare Special Agricultural Credit Plans (SACP) in 1994-95. The

SACP mechanism was also made applicable to the private sector

banks in 2005-06. The disbursements by the public sector banks to

agriculture under SACP have increased from Rs 25,654 crores in

2000-01 to Rs 1, 22,215 crores in 2006-07.

More recently, since 2004, vigorous efforts have been made to more

than double the credit flow to agriculture. Emphasis has been laid on

sound credit culture, effective credit delivery and appropriate credit

pricing. New instruments for financial inclusion such as General

Credit Cards and no-frills accounts were initiated. Micro finance

programme was intensified. Use of technology for rural banking is

being encouraged. Special Area Plans for banking in several states

have been formulated to suit the local conditions. In terms of

institutional development, consolidation of the RRBs, revamping of

the urban co-operative banks as per the vision document, revival of

rural co-operative credit structure, a plan for restructuring of long-term

lending institutions for agriculture, and a revisit to the prescriptions

relating to the priority sector lending are underway. While a Working

Group to review the legislations of various States in regard to money

lending has been formed, another Working Group is looking into the

relief measures for the distressed farmers. Above all, as per the

Government of India announcement in 2005, it has been decided to

subsidize the commercial banks and NABARD to enable provision of

short-term credit at 7% interest rate to the major segment of the

18

farmers. In brief, there have been vigorous and determined efforts

towards expansion of rural credit, especially through rural banking.

Keeping the importance of agricultural credit in mind the Tenth Five

Year Plan envisaged a substantial increase in credit flow to

agriculture from a level of Rs 2,29,956 crores achieved during the

Ninth Five Plan to a level of Rs 7,36,570 crores during the Tenth Five

Year Plan.

NEED FOR RURAL BANKING

n the period before the nationalization of banks, key sectors of

the economy including agriculture remained thoroughly neglected

in terms of availability of institutional credit.  Whereas the

industrial sector at that time accounted for about 15 per cent of

national output, it appropriated two-thirds of commercial bank credit,

whereas the agricultural sector contributing about half of national

output was almost completely neglected by the commercial banks.

I

19

The rural population of India has been suffering from a great deal of

indebtedness and is subject to exploitation in the credit market due to

the high interest rates and lack of convenient access to credit. Rural

household need credit for investing in agriculture and smoothening

out of seasonal fluctuations in earnings .Rural household need

access to financial institution that can provide them with credit at a

lower rates and at reasonable terms than the traditional

moneylenders and there by help them avoid debt traps that are

common in rural India

But after the adoption of the New Economic Policy in 1991, the

Indian economy is becoming more and more mature with the

passage of time on account of structural changes undertaken in

different sectors and areas. The GDP growth rate has been much

higher and it has averaged over eight per cent during the past three

years. While there has been acceleration in the industrial sector,

especially manufacturing and services sector, and the country is

graduating from a low-income regime to a middle income regime,

there has been deceleration in agricultural growth, which reflects as a

broad-based slowdown in the productivity growth.

While growth is important, it is also imperative that growth becomes

more inclusive because if certain regions, sectors or groups of people

are denied economic opportunities for long periods, the spread and

sustainability of growth itself is threatened. Hence, growth, to be

inclusive, must take into account the betterment of every section of

society. Hence, it is imperative to ensure that higher growth is also

more inclusive.

20

In the Draft Approach Paper to the Eleventh Five Year Plan 2007 -

2012, the Planning Commission has emphasized the need for faster

and greater inclusive growth during the Eleventh Plan period. The

banking sector, as the most important financial intermediary to

mobilize the savings leading to increased investments, facilitating

growth would, thus, play the most crucial role in attaining the

stipulated economic objectives through expansion of the coverage of

banking services by reaching the vast unbanked and underbanked

population of the country.

Financial inclusion, or extending the benefits of banking to the have-

nots, is the latest buzzword among bankers. So much so, that it was

the theme for annual top-level bankers’ meet, Bancon 2006. It is

integral to the government efforts to extend the benefits of growth to a

broader section of the population.

According to the Invest India Incomes and Savings Survey of 2007 by

research firm IIMS Data works, just 44.9 per cent of Indian earners

had bank accounts, with coverage rates varying widely in individual

States. Just 38 per cent of paid workers in villages had accounts

compared to 62 per cent of their counterparts in urban areas.

This shows that financial inclusion needs an aggressive push. This

can be achieved by taking banking to underserved areas,

mobilization of household savings, diversification of lending targets,

extension of loans to small farmers and artisans, greater use of

technology to keep transaction costs down, and a bigger role for rural

banks. As a result, a new model of rural banking is being developed

21

with the help of intermediaries such as self-help groups and

microfinance institutions, while banks are exploring new ways to use

technology to lower the cost of delivering rural banking services.

ROLE OF PUBLIC SECTOR

BANKS IN RURAL BANKING

SYSTEM

ublic sector banks continue to have about 75% share in the

banking system. Despite the rapid growth of the new private

sector banks, the share of public sector banks will continue

to remain high. Hence the continued health of Indian banking system

will depend on the performance of public sector banks.

P22

About half the branches of public sector banks (PSBs) are in the rural

sector. These are often regarded as part of the rural community.

Rural branches of PSBs have played a significant role in the past

three decades. They came to the rescue of the agricultural sector in

the wake of the Green Revolution, as the cooperative banks, on

which the agricultural sector had been mainly dependent in the pre-

nationalization period, were proving unequal to the job of meeting

higher credit requirements. Emerging as the focal points for catering

to the localized needs of the rural communities, they helped to

significantly reduce the role of professional moneylenders and

brought about a qualitative transformation in the savings and

investments activities in the rural sector.

PSBs have been able to percolate to the rural areas accompanied by

an increase in priority sector lending, which private banks have not

been able to do. The probable reason is the low level of social

responsibility of business on the part of private and foreign banks.

Another notable thing is that by and large PSBs have been ethical as

compared to their counterparts in private sector.

PSBs are incorporating new technology, reducing manpower and

extending the ambit of customer facilities. While these measures will

reduce the cost overburden in the urban and metropolitan branches,

the relief is not likely to be substantial enough to offset the heavy

administrative and operational burden of running hundreds of rural

branches.

23

CHALLENGES AFFECTING

PERFORMANCE

Banking System :

Historically, there have been four major problems with respect to the

supply of credit to the Indian countryside.

The supply of formal sector credit to the countryside as a whole

has been inadequate.

Rural credit markets in India themselves have been very

imperfect and fragmented.

The distribution of formal sector credit has been unequal,

particularly with respect to region and class, caste and gender

in the countryside. Formal sector credit needs specially to reach

backward areas, income-poor households, people of the

oppressed castes and tribes, and women.

The major source of credit to rural households, particularly

income-poor working households, has been the informal sector.

The huge presence of informal credit has helped moneylenders

charge high rates of interest with complicated terms and

conditions, sometimes accompanied by an element of cruelty.

24

At the time of independence, the rural credit scenario was rife with

these problems.

Since 1991, the policy environment has been dominated by the

liberalization of the banking sector and greater concern for prudential

norms for banks and risk management, most of these efforts have

been concentrated in the urban and metropolitan centres and very

little change has effectively come in the rural areas. Even today,

majority of the rural branches are running in losses, the deposit

mobilization is not up to the desired level, there are problems in

granting advances etc. In their anxiety to reach the target of 40 per

cent to the priority sectors, banks have gone in for indiscriminate

lending. There have been external pressures on the banking sector to

lend to weaker sections. In addition, the priority sector lending has to

be at a low concessional rate of interest.

The deposits collected by banks from rural areas were not totally

deployed there. This indicates that institutional sources of credit such

as banks and co-operative societies are unable to meet the farmers’

needs.

Inadequate branches: The spread of bank branches in rural areas is

quite inadequate. In fact, the number of such branches has declined

in the post-liberalization era. The number of rural bank branches in

the country has come down from 35,000 in early 1990s to as low as

30,572 by March 2006 through mergers and swapping of rural

25

branches. At one time, rural India accounted for 57 per cent of total

bank branches in the country. This share has now come down to 47

per cent. What is more disappointing, they generate only 14 per cent

of deposits and 12 per cent of advances.

Financial exclusion: The main problem is the lack of access to

banking. More than half of the Indian population suffers from financial

exclusion, 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. Such a high level of

financial exclusion obviously imposes social costs.

Poor Financial Viability: Banks may not find operations economical,

as sometimes the transaction and follow up costs are more than the

amount of credit. Rural banks and rural branches that are compelled

to operate in this milieu do so unprofitably.

Non consumption loans: Another problem is that banks generally

do not give loans for consumption. In cases where day-to-day living

itself is at question, banks, their strict conditions on the use of money

borrowed and the numerous delays are avoided.

Nature of transactions: Rural transactions are cash based. Majority

of the rural populiace has the capacity to engage in micro-savings

and would require depositions and withdrawals at their convenience.

Moreover, the timing of the transaction does not necessarily coincide

with the bank branch timings. Since most transactions are cash

26

based, this increases the total cost of transactions because of the

cost of idle cash, and the cost of handling infrastructure, that is

branch setup, manpower and the cost of cash security.

Education and Awareness level of the people: Rural India at 59

percent rate of literacy is behind urban India. It affects the acceptance

of formal banking by villagers as they feel a natural hesitation towards

a structured and rigid environment. They also find it difficult to fulfill

the formalities required for carrying out banking transactions. Hence,

they need a higher level of guidance and support which requires

deploying more manpower; again a cost escalating factor. Lower

education and awareness also act as an impediment in effective

utilization of proposed and existing ATMs.

Tough competition from unorganized financers: Unorganized

financers like village money-lenders, traders, shopkeepers and

commission agents are a major source of finance for rural folks.

These informal sources of finance have distinct advantages over the

formal banking system in terms of location, service- delivery at the

door-step, flexible working hours, customized terms of transactions,

of element of familiarity and personal touch in services.

Manpower problems: Rural banking has emerged as a niche

wherein special skills and sensitivity are required. Since the

education level is poor, it is difficult to find employees locally to man

the rural branches while the urban employees are generally

disinterested in working in these areas. It results in lesser number of

employees per branch in rural areas, absenteeism among

27

employees, and disproportionate work load on existing employees,

plummeting their morale, and deteriorating the quality of services

offered.

Difficulty in meeting demand: The credit-system in rural areas finds

it difficult to cope with the rising demands of commercialized

agriculture and in any case, there are few credible risk-mitigation

measures for the borrowers resulting in greater distress to the

farmers in areas with significant presence of commercial crops. In

addition, while there has been significant growth in rural credit in the

recent years, its medium-term sustainability is contingent upon

growth in agriculture and improvements in the institutional settings.

Public Sector Banks:

Public sector banks follow government and RBI guidelines/directions

by having branches in rural areas that are very expensive to maintain

and service. These branches also lend to farmers, rural artisans and

people involved in allied activities. They service segments that are

commercially unviable but require banking most. The crux of the

matter is that the bulk of the public sector bank branches across the

length and breadth of the country undertake the massive task of

financing areas that are of top priority for development.

Further, as the priority sector loans have been of small amounts, the

public sector banks not been able to adequately monitor the

28

distribution, follow-up and recovery of loans, resulting in squeezing of

profitability and increase in non-performing assets.

The official compulsions of keeping a high proportion of their deposits

in liquid form and subsidization of credit added fuel to fire. Over the

years, there has been growth in staff, resulting in increased operating

expenses—although in the recent past this ratio has gone down on

account of compulsions of increased competition from private sector

and foreign banks. Moreover, very few programmes focused on

micro-enterprises or encouraged diversification away from

agriculture. This led to a focus merely on geographical expansion of

the rural areas, where the banks’ branches offered credit in sizes

which were too large to be made use by the very poor. These

practices led to a high default.

The difficulty is that, faced with the demands made on them by the

advocates of liberalization and the effects of competition from the

private sector banks, banks in the public sector are also being forced

to change. They are trying to trim operating expenses, by reducing

the wage bill by reducing employment through retrenchment under

the VRS scheme and computerization. They are also seeking to

reduce costs by limiting branch expansion and reducing the number

of bank branches.

The latter, which affects the rural areas first, reduces access to credit

in rural areas that were well-served by the post-nationalization branch

29

expansion drive, and worsens the tendency towards reduced

provision of credit to the agricultural sector.

What is however worrying the PSB management is the structural drag

of these branches on the profitability of the banks. Costs had been no

consideration when these branches were established at breakneck

speed in the Seventies. But today the exact benchmarks for

profitability and viability have put the PSBs in an unenviable position.

The big challenge in promoting rural banking is to keep the costs low

in view of the fact that while the number of transactions in such areas

may be high, they are mostly small-value transactions. However,

technology can play an important role in keeping the costs of such

transactions low. Unfortunately, public sector banks (PSBs), which

account for 70 per cent of assets, have been slow in making use of

modern technology to bring down transaction costs.

While public sector banks have the potential, with their spread and

reach, to enable financial inclusion, they also have to face difficult

challenges in human resource development. Public sector banks

need to invest significantly in skill enhancement at all levels, for

delivering new service modes in the face of greater competition. They

will also face new recruitment challenges in the face of adverse

compensation structures in comparison with the private sector banks.

30

FUTURE OF PUBLIC SECTOR

BANKS IN RURAL BANKING

SYSTEM

he future of banking in rural areas depends on several

factors, namely, how the current concerns are addressed

taking into 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 as

technological progress on the systems of financial intermediation.

Consequently, public policy will have to address several issues to

ensure a sound and efficient banking system in the service of rural

areas.

T

The move towards inclusive growth is a big challenge for the financial

system of the country, including Public sector banks. They need to

adopt an innovative, customer-friendly approach to increase their

effective reach so that the share of organized 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,

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relationship banking, dependency on IT systems and competitive

pricing would be the driving forces. Public sector banks needs 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.

It is against this background that we position a technology based

solution for improving the speed efficiency and effectiveness of the

credit delivery of the rural people through the application of

information technology tools and systems. A model for using

Information Technology for improving rural credit delivery system by

reducing the cost, increasing the speed of delivery and also

increasing the value addition in the service delivery and improving the

accountability is needed.

E.g.: It is important to mention that the Union Bank has launched a

New initiative called ‘Village Knowledge Centre’s. Here, technology

is used to help the farmer improve his productivity. The Bank’s staff at

this village knowledge centre’s act as relationship managers, liaising

between local authorities and farmers, facilitating the opening of

accounts and ensuring that credit is provided to the needy.

Public sector banks should mobilize deposits from the agricultural sector itself to finance its own credit requirements. Such a move will entail two steps—curtailment of unproductive expenditure and deposit

32

of savings by the agriculturists in banks. Their outlook needs to be changed with the help of banking staff and utilizing the services of the mass media. Villagers must be convinced that they themselves would gain in the long run if they would save and invest.

In order to mobilize the savings of the villagers, the services of the

moneylenders—both professional and agricultural—must be utilized

by the public sector banks. The public sector 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 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.

Priority sector lending’s should be restricted only to the core sector.

Public sector banks should provide credit not merely on the basis of

collateral security such as land and buildings but they should also

advance loans to the agriculturists after assessing the ‘absorptive

capacity’ and the increase in productivity that is feasible with the help

of such loans. Crops should also be accepted on a loan of security.

To assess the ‘absorptive capacity’ of the farmers commercial banks

should maintain a staff of agricultural experts.

The public sector banks must also provide credit to the agriculturists

on the basis of ‘joint guarantee’ given by the village panchayat or by a

few well-known farmers of the village. The acceptance of such a

basis will greatly help the farmers, particularly small farmers, in

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securing loans. This will also result in more purposeful advent of the

commercial banks in the rural sector and will bring them into

relationship with cooperative institutions. It will also ensure a fair

understanding between them and encourage commercial banks to

operate on the principle of collective service for a collective need.

The geographical and functional reach of public sector banking must

be restored and extended, differential interest policies reinstated, and

special loans-cum-subsidy schemes reintroduced on a large scale for

all landless and poor and middle peasant households, scheduled

caste and tribe households and other vulnerable sections of the rural

population.

Public sector banks must open new branches/ extension counters in

unbanked locations. These branches should focus on providing direct

banking services to the people living in the immediate neighborhood

and the rural rich, besides they should also act as processing /

coordinating centres for providing banking services to other smaller

villages. The cost of operations in such branches can be reduced by

deputing muti-skilled employees and adopting technology. Revenue

generation can be enhanced by incorporating other activities into the

branch like agricultural tension services, backward and forward agri-

linkages, crop, live-stock, life and general insurance and other allied

activities.

There are many non-banking entities that are operating in rural India

and have a high reach, low cost and higher flexibility in terms of

34

operations, for example- Non Banking Finance Companies, Non

Government Organizations (NGO), agricultural cooperatives and Self-

Help Groups (SHGs). Apart from these, there are nearly 1,39,000

post offices in rural areas which mobilize small savings to the tune of

thousands of crores. By collaborating with such partners for providing

banking services in unbanked locations, the cost of services can be

brought down significantly.

Public sector banks can find a new productive and useful role if the

institutional configuration for the channeling of savings and

investment activities in the rural sector is reformed and redesigned.

They can productively operate as a source of refinance for rural

institutions while acting as a conduit for passing on the benefits of

different kinds of financial services appropriate for the rural sector.

Further, the public sector banks could provide a catalytic role for

extending modernizing influences and systems. In the performance of

this newly-carried responsibility, they would not need to carry the

heavy cost burden of maintaining an extensive network of branches.

Public sector banks success must be able to forge partnerships and

work for collective benefit from a long term perspective with

innovative use of existing infrastructure.

Rural Banking in Public sector banks should be a powerful ‘business

enabler’ to plug the gaps in information, communication, &

transportation infrastructure. Hence one has to look at the holistic

needs of customer and offer access to banking without time, place,

and access limitations.

35

Finally, it needs to be remembered that stray attempts would not

solve the problem of agricultural credit. The credit system as a whole

—government, commercial and cooperative—must 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 still is

the key to India’s prosperity in future.

RECENT DEVELOPMENTS

New Policy Directions:

The most recent policy directions are as follows:

The National Development Council approved, “An Approach to the

11th Five Year plan” which contains extensive references to the

future policy directions. Some extracts from the document are as

follow:

On objectives and challenges

36

One of the major challenges of the 11th Plan will be to reverse the

deceleration in agricultural growth from 3.2% observed between 1980

and 1996-97 to a trend average of around 2.0% subsequently.

To reverse this trend, corrective policies must not only focus on the

small and marginal farmers who continue to deserve special

attention, but also on middle and large farmers who suffer from

productivity stagnation arising from a variety of constraints.

A second green revolution is urgently needed to raise the growth rate

of agricultural GDP to around 4%

On financing development

The 11th Plan must ensure that our policies are sufficiently flexible to

support the development of micro finance. Interest rates in the micro

finance sector have to be significantly higher than in the banking

sector reflecting the much higher cost of doing business. It is

important to remember that most micro-finance institutions charge

rates which are much lower than rates charged by money lenders.

On agriculture sector policy

The failure of the organized credit system in extending credit has led

to excessive dependence on informal sources usually at exorbitant

interest rates. This is at the root of farmer distress reflected in

excessive indebtedness.

37

There is evidence that farm debt is increasing much faster than farm

Incomes and the larger issue of the overhanging debt stock, as

distinct from credit flow, have not even been on the agenda except

of a few State governments. Admittedly, there are limits to the extent

that banks can be expected to play a purely social role in today’s

more competitive environment. However, too conservative an

approach on settling debt that has turned bad, due to contingencies

of poor weather or prices, is not even prudential banking if this serves

only to show bank balance sheets to be better than they are, and

prevents profitable new lending. There are several suggestions,

ranging from a Stabilization Fund to be run by the Centre for

automatic write-off under some specified conditions, to the setting up

by States of standing professional Debt Commissions to examine

individual debt (including to non-institutional sources) on a case-by-

case basis for one time settlement

The 11th Plan will examine in detail the impediments which now stand

in the way of social and developmental banking and suggest

innovations that can improve access and speed up one-time

settlements while maintaining credit discipline and financial prudence.

As farmers adopt new and untried technology, and increase input

intensities, they also face larger risks. These and related issues of

risk management are again largely non-plan areas but need to be

addressed during the 11th Plan. This should ideally be done by

concentrating on innovations in design which could help expand

38

insurance in a manner that is financially viable without excessive

subsidy.

The 11th Plan gives top priority to redressing the weaknesses in the

agricultural sector. Growth in the agricultural sector has been less

than 2% per annum since the middle of the 1990s. With about half of

the rural population still dependent on it for most of their income

inclusive growth cannot be expected if agriculture is not revitalized. It

is important to recognize that the problem is not distributional, with

the better off farmers doing well while the small farmers and the

landless face hardships. Though the weaker groups clearly face more

difficulties and need special attention, agriculture as a whole is in

crisis. Therefore, there should be focus on achieving higher

productivity and incomes for all farmers in both crop and non-crop

agriculture.

The Approach Paper calls for corrective action in several dimensions

of agriculture. Water is a critical input for agriculture and we need to

re-examine all aspects of the water economy. We are not spending

enough on irrigation and what we are is not being utilized efficiently.

In addition to investment in irrigation, steps to conserve water

and promote artificial recharge in rain fed areas must be taken.

Other issues on the agriculture agenda identified in the Approach

Paper relate to the need for focused research in specific crops,

39

farming systems and dry land farming practices, improved extension

work to close the knowledge deficit affecting farm productivity; better

seeds and inputs; enhanced facilities for credit, including revamping

the co-operative credit system; initiatives to support agricultural

diversification with effective marketing solutions; and completing the

unfinished agenda of land reforms etc.

LATEST INITIATIVES BY

REGULATORY AUTHORITIES

uring the Ninth Plan period, the total amount of

agriculture/rural credit was to the extent of Rs. 229956

crore. This is sought to be increased to Rs. 736570 crore.

For this to happen, the Government has directed that:

D40

Commercial Banks, cooperative banks and RRBs should

double the credit to agriculture in the next three years.

Periodic review and enhancement of credit delivery in rural

areas should be undertaken.

Stepping up of rural infrastructure for long term sustainable

growth should be made.

Innovative way of providing finance e.g. micro-finance, Kisan

Credit Card should be evolved on an ongoing basis.

Self-Helf-Group (SHG) micro-finance programme through

NABARD should be encouraged.

Banks should prepare and submit Special Agricultural Credit

Plans (SACPS) every year with the focus on financing Small

and Marginal Farmers.

Banks should waive margin/ security requirements as under:

For agricultural loans up to Rs.50,000/-

For loans for agribusiness and agriclinic up to Rs.5/-

lakhs.

Allowing Private Banks in rural areas to service farm and non-

farm sector.

Besides the above specific policy directions in place, RBI had since

constituted two expert groups for suggestions for increasing flow of

credit to agriculture, rural finance, microfinance and other means of

rural development.

The group led by Mr. YSP Thorat submitted its report in June 2005

highlighting, inter alia–

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For focus on entire supply chain management of agricultural

products, management of agricultural infrastructure.

To lay emphasis on computerization of land records, legal

support for recovery, improving extension network and

developing marketing banks.

Water management policies and investment water conservation

be appropriately designed.

Short-term credit is integrated with term credit, outsourcing

monitoring activities to be made and to provide loan support for

diversified agriculture etc.

To initiate risk mitigation measures by developing suitable

financial products and commodity exchange, allowing banks

(on behalf of farmers) to participate in commodity futures,

designing special risk mitigation packages for low asset-based

borrowers, using warehousing receipts with price hedging

instrument, adopting technology for dissemination of market

intelligence, sharing borrower information, etc.

In July 2005, the other expert group headed by Mr. H. R. Khan

submitted its report on rural credit and micro-finance. Their

recommendations inter alia are as under were:

Banks to use civil society organisations for support services

such as –

(i) Borrower identification

(ii) Collection, processing and submission of credit

applications.

(iii) Preliminary appraisals

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(iv) Post-sanction monitoring

(v) Follow up for recovery.

NGOs, farmer clubs, agriclinics etc. to function as business

facilitators.

Institutional agents/others may support banks extending

financial services such as disbursement of small volume credit,

recovery of loans, etc.

Registered NBFCs with significant rural presence, NGO–micro

finance institution (MFI) may act as Business Correspondents

(RBI has already allowed NGOs engaged in micro-finance

activities to access External Commercial Borrowing up to

approximately Rs. 23 crore during a financial year.

Micro-credit portfolio of regulated MFIs to be eligible for direct

finance from NABARD.

NABARD to set up Rural Kiosks/Village Knowledge Centres.

ISSUES IN AGRICULTURAL

CREDIT – DEVELOPING

COUNTRIES PERSPECTIVE

(INDIA)

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griculture plays an essential role in developing economies,

especially because the large proportion of the population is

engaged in agriculture in developing countries as also for

strategic reasons of ensuring food security. The variety in farming

activities ands farm management poses challenges and opportunities

to agriculture and rural lenders. It is common that policy makers,

particularly in developing countries, have been confronted with the

task of resolving a number of issues in agriculture lending

A

The basic challenge faced is that providing finance to agriculture

and rural development is not seen as a commercial and business

opportunity by banks or for that matter by the formal financial

systems. Unlike in the past, the present day agriculture has become

increasingly capital intensive which require access to working capital

and seasonal loans along with medium and long term credit for –on

farm investments and cannot modernise without the support of strong

financial system. Significantly even small farmers generally have no

access to formal credit because the financial system is not innovative

or sufficiently efficiently to reduce transaction cost and to provide

tailor made products to small clients at affordable cost.

Two major factors that hamper the smooth flow of credit to

agriculture are the absence of effective credit delivery systems and

the lack adequate credit absorptive capacity of the rural populace.

In agriculture lending, the cost for delivering and monitoring of credit

is found to very high and the banks have not yet found an easy

solution to manage the cost of credit delivery and supervision in the

agriculture sector within the discipline of balance sheet numbers.

44

Distances between clients and financial intermediaries, transport and

communication difficulties, and the risky nature of agriculture that is

vulnerable to natural diasters, boost these cost. The challenge still is

to design and deliver the provision of loan products to better suit the

farming community. Weak land titling and cumbersome and cost

court procedures also compound problems of providing conventional

collateral for loan in rural areas, thereby further increasing the risk of

rural lending. Another major issue confronting agriculture and rural

credit is that standard credit programmes are not suited to the

heterogenous need of small farmers. Subsidised interest rates

blocked these emergences of vigorous and competitive rural financial

markets, fostered loan repayment indiscipline, prevented banks from

covering cost, and discouraged local saving mobilization.

Complexity of various out dated procedures and related paper work

involved in provision of credit is another issue in agriculture lending

Rural financial markets cannot thrive and grow if their clients lack

credit worthiness. The low absorption capacity of farmers, inability to

repay loans, and the inability to save because their incomes are

depressed, all results in low credit worthiness. Notwithstanding

improvements in information technology, backs lack the essential

information on the credit history of potential clients, the viability of on-

farm investments, the self financing capacity of farmers and their

repayment capacity. Lack of these vital pieces of information

hampers the timely credit reach for agriculture and rural development

As most of the farmers are either small or marginal in the developing

countries, they lack the absorbtative capacity both in terms of cost

45

and the size of loan and advances which are of cost effective size to

be handled by the banks. Since many of the financial transaction in

the rural areas are small both for loans and for deposits-the

transaction cost per unit of money involved is necessarily high as

compared to larger transactions. Most of the banks either lack risk

management system or they feel it is not necessary to have one,

especially when it comes to financing agriculture

CONCLUSION

ublic sector banks, entrenched as they are in rural banking

for over three decades appear to be holding on their

business. When the banking industry is surging ahead the

world over, they find that nearly one half of their branches generate

less than 15 per cent of their business. About 17 per cent of their staff

is deployed for handling this business.

PBanking sector being on the threshold of major technological

innovation, public sector banks are at the cross-roads: whether to

shed the historical baggage and adopt sophisticated banking.

A plea is made for functional specialization and structural

reorganization of rural banking business, with a view to strengthen

46

the competitive edge of the banking sector to be in tune with the fast

changing banking scenario. While the new banks prefer to flourish in

cities, gramin banks are directed to operate in rural areas and public

sector banks struggle to remain in both the worlds. They have done

this balancing act for over three decades. Hiving of the rural business

into a subsidiary and amalgamating the gramin banks into it is a

radical suggestion made.

The process of partial privatization is changing drastically the

perceptions of the state owned banks. The increasing stress on

transparency is pushing them towards reducing NPA and improving

the bottom line. This shift in emphasis is slowly resulting in the

elimination of less remunerative business. They have virtually

stopped rural branch expansion. As a part of the rationalization of the

branch network, some rural branches are being shifted the semi

urban centre or closed, unlamented.

Reorganization of rural business, however, should not result in

creating monolithic, impersonal banking giants. Rural India needs

user-friendly, rural oriented banks, an amalgam of the rustic simplicity

of gramin banks and business concentricity of commercial banks.

Finally, it can be said that rural India provides ample opportunities for

profitable banking and the public sector banks should take advantage

of these latent opportunities and expand rural credit by repositioning

themselves and delivering better services in the financial system.

Only then can PSBs meet the expectations of becoming vibrant rural

47

financial institutions capable of meeting the growing requirements of

rural India.

BIBLIOGRAPHY

Books:

Man & Development: June 2007

Restructuring of Indian Banks – Falguni C. Shastri

Nationalization of Banks – G.S. Monga, R.K. Sinha

Rural Banking and Economic Development—Rais Ahmad

Report on Currency & Finance 2006-2007

Websites:

www.rbi.org.in

www.mainstreamweekly.net

www.thehindubusinessline.com

www.india.smetoolkit.org

www.business.mapsofindia.com

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www.hinduonnet.com

www.financialexpress.com

www.indiatogether.org

www.economictimes.indiatimes.com

www.businessworld.in

www.geocities.com

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