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Nuts and bolts of financial inclusion - Outside View by S.S. TARAPORE

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Nuts and bolts of financial inclusion
Jan 27, 2014

The Nachiket Mor panel calls for an overhaul of the system to reach out to the unbanked.

The Committee on Comprehensive Financial Services for Small Businesses and Low Income Households chaired by Nachiket Mor submitted its Report on December 31. The expanse of the Report, its vision and depth of analysis backed up by massive data, is awesome. The instant impression could be summed up as 'wonderful to the point of bewilderment'.

But each of us commenting on the Report are rather like the 'Six Blind Men of Hindustan'. The Mor Report is far too important a document to be consigned to the archives. The Report deserves serious in-depth examination by policymakers and institutions which are likely to implement its recommendations.

Facilitating financial inclusion

The Report highlights that 90 per cent of small businesses have no link with the formal financial sector and 60 per cent of the population does not have a functional bank account. While the bank credit-GDP ratio is around 70 per cent of GDP, there are wide regional and district-wise disparities which confirms that financial inclusion has a long way to go.

The Report stresses that savers have difficulties in accessing institutions and with no instrument providing a positive real rate of return on financial savings, there has been a move away from financial assets to physical assets.

Under the Committee's proposed financial structure, there would be two types of national banks (one with branches and one with agents), besides wholesale consumer banks, wholesale investment banks and payments banks. The entry capital requirements would be Rs 500 crore for national banks and Rs 50 crore for the wholesale banks.

The Report recommends that the cash reserve ratio (CRR) should apply only on demand deposits. It is envisaged that the statutory liquidity ratio ( SLR) will be phased out for national as well as wholesale Banks but this is contingent on government's acceptance of market interest rates on its borrowing.

Wholesale banks would not accept deposits below Rs 5 crore and hence would be heavily dependent on inter-bank borrowing from the national banks. Since inter-bank liabilities are not treated as liabilities for purposes of CRR requirements, the wholesale banks will be subjected to a much lower CRR.

Role of Postal Bank

The Committee envisages the setting up of payments banks which will provide payments services and deposit products to small businesses and low income households with a maximum deposit of Rs. 50,000 per customer. These banks will be subject to reserve requirements. In the case of the SLR, the payments banks will be required to invest in government securities with a duration of not more than three months.

The Postal Bank is proposed by the Committee as a payments bank. It would be a serious error of policy if the Postal Bank is not granted a full-fledged banking licence for which it has applied. Given its vast expanse of offices, unmatched by any other institution, the Postal Bank has to be given a full-fledged banking licence if financial inclusion is to be meaningful.

Financial sector reforms

The Mor recommendations will require a major revamp of the present financial legislative framework. Governor Raghuram Rajan has rightly pointed out that before implementing the recommendations of the Financial Sector Legislative Reforms Commission (FSLRC) it will be necessary to settle on the desired financial structure. As such, the FSLRC Report and the Mor Report have to be examined simultaneously. Eager beavers wanting instant implementation of the FSLRC recommendations need to be reined in until a comprehensive examination is undertaken not only by policymakers, opinion makers and the operational units but more importantly by Parliament. Implementing the recommendations of the FSLRC without Parliamentary approval would be, to say the least, highly irregular.

Inclusion framework

The Mor Committee recommends that every resident Indian over the age of 18 years should have a Universal Electronic Bank Account by January 1, 2016 and every low income household and small business should have 'convenient' access to formally regulated lenders for credit products at an 'affordable' price.

By January 1, 2016, each district should have a credit-deposit ratio of a minimum of 10 per cent, which should be raised rapidly by 10 percentage points each year to reach a minimum of 50 per cent by January 1, 2020. Again, in each district, by January 1, 2016, there should be a minimum total deposits plus investments to GDP ratio of a minimum of 15 per cent which should be increased by 12.5 percentage points each year to reach a minimum of 65 per cent by January 1, 2020.

The January 1, 2020 targets appear excessively ambitious, but the recommendation in a sense underlines the enormity of the task. To ensure that backward districts get preferential treatment, the Committee rightly suggests a weighted district-wise formula in the attainment of the priority sector targets.

The Mor Report could be considered to be excessively ambitious, but given the task one has to dare to be bold. I have on a number of occasions stressed the relevance of the Rajamannar Working Group of the Banking Commission of the 1970s which set out an elaborate legislative framework for linking the organised financial system with the unorganised indigenous financial sector. Not having such a link is a serious error of policy.

Will history repeat itself?

Forty five years ago, the late R.K. Hazari, prepared a path-breaking report on concentration of industrial licensing in the hands of a few industrial houses. The report recommended the nationalisation of banks. Soon after nationalisation of banks in 1969, Hazari was inducted into the RBI as Deputy Governor. Will history repeat itself?

Please Note: This article was first published in The Hindu Business Line on January 26, 2014.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.


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