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Financial Inclusion: Issues and Challenges

Financial inclusion is important for improving the living conditions of poor farmers, rural non-farm enterprises and other vulnerable groups. Financial exclusion, in terms of lack of access to credit from formal institutions, is high for small and marginal farmers and some social groups. Apart from formal banking institutions, which should look at inclusion both as a business opportunity and social responsibility, the role of the self-help group movement and microfinance institutions is important to improve financial inclusion. This requires new regulatory procedures and depoliticisation of the financial system.

HT Parekh finance forum

Financial Inclusion: Issues and Challenges

Financial inclusion is important for improving the living conditions of poor farmers, rural non-farm enterprises and other vulnerable groups. Financial exclusion, in terms of lack of access to credit from formal institutions, is high for small and marginal farmers and some social groups. Apart from formal banking institutions, which should look at inclusion both as a business opportunity and social responsibility, the role of the self-help group movement and microfinance institutions is important to improve financial inclusion. This requires new regulatory procedures and depoliticisation of the financial system.


he nationalisation of banks in 1969 and subsequent developments led to expansion of the geographical and functional reach by commercial banks, regional rural banks (RRBs) and cooperative credit institutions. Public policy aimed at “social” and “development banking” by meeting rural credit needs and reducing the role of informal sector credit. It may be noted that despite the vast expansion, a large number of groups remain excluded from the opportunities and services provided by the financial sector. Such excluded groups include small and marginal farmers, women, unorganised sector workers including artisans, the selfemployed and pensioners.

P Chidambaram, union finance minister, indicated in Budget 2006-07 that “out of the total number of cultivator households only 27 per cent receive credit from formal sources and 22 per cent from informal sources”. The minister proposed appointing a committee on financial inclusion. Based on this announcement, the government of India has set up a committee on financial inclusion under the chairmanship of C Rangarajan to suggest ways and means to extend the reach of the financial sector to cover excluded groups by minimising the barriers to access financial services. The Reserve Bank of India (RBI) and the National Bank for Agriculture and Rural Development (NABARD) are also concerned about financial exclusion of many households.

Against this background, the objective of this note is to bring out issues and challenges for reducing financial exclusion. We concentrate here only on a few selected issues.

Definition of Financial Inclusion

Financial inclusion can be defined as delivery of banking services at an affordable cost to the vast sections of disadvantaged and low-income groups. In the case of credit, the proper definition of the financially excluded would include households who are denied credit in spite of their demand. Although credit is the most important component, financial inclusion covers various other financial services such as savings, insurance, payments and remittance facilities by the formal financial system to those who tend to be excluded.1

In the case of credit, many households are being exploited by moneylenders at very high interest rates (50 to 60 per cent) and, therefore, these households should not be seen as being financially excluded. It may be true that RBI is thinking of using moneylenders as agents. But, the proposal is yet to materialise. Therefore, financial inclusion refers to households accessing institutional credit including commercial banks, cooperative banks, RRBs, NABARD SHG-linkage and other self-help groups, and credible microfinance institutions.

It is possible that in order to fulfil targets of financial inclusion, more bank accounts may be opened in the formal system. However, opening a bank account itself is not sufficient. Financial inclusion also refers to making more efforts towards covering small and marginal farmers and vulnerable social groups. A broader definition of inclusion should also focus not only on credit but also on an increase in productivity and sustainability of farmers and other vulnerable groups.

Farmers’ Indebtedness

Credit to farmer households is one of the important elements of financial inclusion. In order to know the extent of credit inclusion, ideally we should have data on the households who are denied credit in spite of demand. Since we do not have such readily available data, we use here farmers’ indebtedness as a proxy. According to the 59th round survey of NSSO (report no 498) we have nearly 150 million rural households out of which around 90 million are farmer households.

At the all India level around 49 per cent of the farmer households were indebted (col 2 in Table 1). One can say that 51 per cent of the farmer households are financially excluded. These exclusion levels vary from state to state. For example, it can be concluded that Andhra Pradesh has the highest percentage of financial inclusion (82 per cent of farmer households in AP are indebted). On the other hand, Meghalaya has the lowest percentage of financial inclusion (only 4 per cent of farmer households are indebted). These are misleading figures because the indebtedness here covers loans from both formal and informal sources.

The percentage of indebted farmer households by source of loan (cols 3 and 4 in Table 1) shows 56 per cent of indebted farmer households obtain loans from formal sources and 64 per cent from informal sources. The total percentage is

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Economic and Political Weekly October 14, 2006

more than 100 (120 per cent) because farmers take loans from multiple sources. Approximately, we can say that only 56 per cent of the indebted farmer households are financially included as they are getting loans from formal sources. The shares in formal and informal sources vary from state to state. In AP, 54 per cent of the indebted farmer households obtain loans from formal and 77 per cent from informal sources (total is 130 per cent).

Table 1 also gives another distribution by formal and informal sources (cols 5 and 6). This gives distribution of outstanding loans by sources. The table indicates that if a farmer’s outstanding loan is Rs 100, around Rs 57.7 is from formal sources and Rs 42.4 is from informal sources. These percentages provide interesting information at the state level. For example, the percentage of loans from formal sources in Chhattisgarh, Jharkhand, Orissa and Uttar Pradesh is more than 60 per cent and higher than that of all India. On the other hand, only 31 per cent of loan is obtained from formal sources in Andhra Pradesh. Therefore, the source of loan is important for examining the extent of financial inclusion.

Another issue is the inclusion of credit for small and marginal farmers. Table 2 shows that the share of formal loan sources increases with the size of land. At the all India level, the share of loans from formal sources varies from 22.6 per cent to 58 per cent for small and marginal farmers, while it varies from 65 to 68 per cent for medium to large farmers. Dependence of small and marginal farmers on informal sources is high even in states like Andhra Pradesh, Punjab and Tamil Nadu. For example, small and marginal farmers of AP obtain 73 per cent to 83 per cent of their loans from informal sources. This indicates very low financial inclusion for Andhra Pradesh. The NSS data also shows that across social groups, indebtedness through formal sources is lower for scheduled tribes as compared to others.

Similarly, there are many financially excluded households such as unorganised workers, self-employed, artisans and other vulnerable groups in both rural and urban areas.2 Finance for housing is another area where many poor are excluded.

Supply and Demand Side Issues

It is being increasingly recognised that addressing financial inclusion requires a holistic approach addressing both supply and demand side aspects. Although there network in rural areas; (b) fall in credithas been significant expansion in banking deposit ratios in rural areas; (c) disproin the last few decades, there are many portionate decline in agriculture credit to supply side problems for commercial banks, small and marginal farmers; (d) worsening RRBs and cooperative banks. Some of the of regional inequalities in rural banking criticisms on the trends in rural credit in – steepest decline in credit-deposit ratio the 1990s are: (a) narrowing of the branch in eastern and north-eastern states; and

Table 1: Percentage of Indebted Farming Households by All Sources of Loans,by Source of Loan and Distribution of Outstanding Loans by Source, 2003

State Percentage of Percentage of Indebted Percentage Distribution Indebted Farming Farmer Households of Outstanding Loan Households in Total by Source of Loan by Sources Rural Households (All Sources) Formal Informal Formal Informal 1 234 56

Andhra Pradesh 82 54 77 31.4 68.5 Arunachal Pradesh 6 14 103 26.9 73.1 Assam 18 15 88 37.5 62.6 Bihar 33 23 84 41.7 58.5 Chhattisgarh 40 66 56 72.4 27.7 Gujarat 52 63 49 69.5 30.5 Haryana 53 76 50 67.6 32.5 Himachal Pradesh 33 57 65 65.3 34.7 Jammu and Kashmir 32 9 94 67.6 32.3 Jharkhand 21 44 60 64.1 35.9 Karnataka 62 57 55 68.9 31.2 Kerala 64 96 40 82.3 17.6 Madhya Pradesh 51 64 66 56.9 43.0 Maharashtra 55 92 30 83.8 16.2 Manipur 25 6 99 18.2 81.9 Meghalaya 4 2 97 6.0 94.0 Mizoram 24 33 67 77.3 22.6 Nagaland 37 20 79 68.8 31.1 Orissa 48 68 46 74.8 25.1 Punjab 65 58 70 47.9 52.1 Rajasthan 52 38 81 34.2 65.8 Sikkim 39 18 89 57.8 42.2 Tamil Nadu 75 59 67 53.4 46.5 Tripura 49 46 55 79.7 20.3 Uttar Pradesh 40 47 70 60.3 39.7 Uttaranchal 7 65 44 76.1 23.9 West Bengal 50 51 73 58.0 42.1 Group of UTs 51 42 71 59.0 41.0 All India 49 56 64 57.7 42.4

Note: Formal and Informal is more than 100 per cent because farmers borrow from multiple sources. Source: Calculated from NSSO (2005).

Table 2: Percentage Distribution of Outstanding Loans by Formal and Informal Sourceacross Size Classes of Land in Selected States, 2003

State Size Class of Land Owned

<0.01 0.0 I-0.40-1.01-2.0 I-4.01-10.00+ All Sizes

0.40 1.00 2.00 4.00 10.00

Formal sources

AP 16.9 19.3 25.1 26.6 41.5 48.6 49.5 31.4 Bihar 36.5 20.8 47.0 66.1 63.4 19.6 70.1 39.2 Maharashtra 58.3 83.2 80.2 78.8 83.8 88.7 91.1 83.8 Orissa 64.7 62.4 77.1 72.1 88.4 96.9 13.2 74.8 Punjab 24.8 29.2 65.6 49.1 61.2 47.5 30.1 47.9 Tamil Nadu 19.1 37.4 46.0 61.5 65.2 74.3 82.9 53.4 All India 22.6 43.3 52.8 57.6 65.1 68.8 67.6 57.7

Informal sources

AP 83.2 80.9 75.0 73.4 58.4 51.4 50.5 68.5 Bihar 63.5 79.2 53.0 33.8 36.6 80.4 29.9 58.5 Maharashtra 41.6 16.8 19.8 21.1 16.2 11.3 8.9 16.2 Orissa 35.4 37.5 22.8 27.9 11.7 3.2 86.8 25.1 Punjab 75.2 71.0 34.5 50.9 38.8 52.4 70.0 52.1 Tamil Nadu 80.9 62.5 53.9 38.6 34.7 25.7 17.2 46.5 All India 77.4 56.7 47.2 42.4 34.0 31.2 32.8 42.3

Source: Calculated from NSSO (2005).

Economic and Political Weekly October 14, 2006 (e) crippling of the RRBs.3 Political interference including loan waivers and writeoffs also resulted in unviability and sickness in some of the formal rural credit institutions.

One issue is whether we need separate institutions for promoting financial inclusion. Existing formal institutions may be sufficient for this purpose. It is true that commercial banks have their own problems such as manpower shortage, an unfavourable attitude towards rural services, infrastructure and technology problems in rural areas, etc. Rural banking has to be friendly to small and marginal farmers and other vulnerable groups. It requires a specific type of organisational ethos, culture and attitude [Rangarajan 2005]. The cadre of officers in rural branches has to develop this attitude and promote financial inclusion of low income groups treating it both as a business opportunity as well as social responsibility. There is a need to address the supply side problems in commercial banks, RRBs and cooperative banks. As the last year’s union budget admits, “the cooperative banks, with few exceptions, are in shambles”. This institution has to be revived as many farmers are dependent on the credit from these banks. The Vaidyanathan Committee’s recommendations may be helpful to revive cooperative sector.

So far we have been discussing mainly the issues relating to credit. Savings, insurance and other financial services are also important. NSS data shows that around 88 per cent of rural households in 2002 reported one or the other form of financial assets under “deposits” which include deposit accounts with banks, government, certificates, post office deposit accounts, private deposits, insurance policy and cash in hand. However, it may be noted that only 6.82 crore households out of a total of 19.9 crore households (around 36 per cent) availed of banking services to have a deposit account in 2001. Therefore, there is a lot of scope for business opportunities for banks to include deposit-excluded households.

The poor face many individual and covariate risks such as droughts, floods, cyclones, fires, theft, pest attacks, sharp falls in prices, health problems, accident, death of a family member, etc. They need some kind of insurance to cope with these risks. The supply of insurance mechanisms has increased in the last decade. With the opening up of insurance to the private sector, the pricing of insurance services will see some changes. Too much under-pricing of these schemes by the government may not be sustainable for both the public and private sectors.

On the demand side, some of the constraining factors for financial inclusion in rural and urban areas are low productivity and risk and vulnerability of small and marginal farmers, low skill and poor market linkages for rural non-farm and urban workers, vulnerability to risk for rural landless and urban poor, inadequate awareness and low financial literacy. In order to improve demand, the suitability of existing financial products for the farmers/poor must be assessed. For example, the rural poor do not even have a safe place to keep their savings, let alone thinking about the demand for credit. Suitable mechanisms have to be explored for addressing the risks faced by farmers and other poor, risks such as weather, price, yields, technology, etc. Moreover, financial instruments have to be developed in such a way that they promote economically viable activities. The financial institutions have to educate the poor and vulnerable by giving wide publicity to their financial instruments, e g, no frills bank accounts.

Role of Self-Help Groups

The RBI recognised the problem of financial exclusion in the annual policy statement in 2005 and since then has initiated several policies aimed at promoting financial inclusion of especially pensioners, the self-employed and those employed in the unorganised sector.4 Some of these include “no frills” banking accounts, a simplified general purpose credit card (GCC), introduction of a pilot project for 100 per cent financial inclusion, etc.

NABARD has also taken several initiatives that have significantly contributed to financial inclusion. The self-help group (SHG)-bank linkage programme of NABARD is an innovative programme. It started as a pilot programme in 1992. We now have 22 lakh SHGs under this programme, comprising more than three crore poor households who are accessing credit through commercial and cooperative banks. Every year six lakh SHGs are added. The programme is no longer confined to southern states. The nonsouthern states have 46 per cent of the groups. Thus, the SHG movement is now a national movement.

There have been several institutional innovations in financial services by including civil society. Followed by the

Economic and Political Weekly October 14, 2006

success of SHG-bank linkage programme and the Bangladesh Gramin Bank model, many of the NGOs have taken to financial intermediation by adopting innovative delivery approaches. Following the RBI guidelines in 2000, commercial banks including RRBs have been providing funds to microfinance institutions (MFIs) for on-lending to poor clients. Though initially only a handful of NGOs were into financial intermediation using a variety of delivery methods, their numbers have increased considerably. A large majority of MFIs operate on much smaller scales with clients, with the latter number ranging from 500 to 1500 per MFI. However, a few non-banking financial company (NBFC) MFIs have an outreach of more than one lakh. MFIs have been playing an important role in substituting moneylenders and reducing the burden on formal financial institutions.5 The competition created in the form of developing several nonbanking financial institutions in rural areas and the SHG movement has also reduced the interest rates in the informal credit market.6

With the objective of ensuring greater financial inclusion and increasing the outreach of the banking sector, banks have been allowed to use the services of NGOs, self-help groups, MFIs and other civil society organisations as intermediaries in providing financial and banking services through the use of business facilitator and correspondent models. Provisions for this kind of financial intermediation have opened new and diverse avenues to address the issue of financial inclusion by banks. NABARD also has some other initiatives like the joint liability group approach, Rytu Mitra Groups in AP.

One can also learn lessons from successful experiences in and outside India. Within India, we have good and successful practices for credit like the Kudumbasree programme in Kerala and the Velugu (Indira Kranti Padhakam) SHG programme in Andhra Pradesh. We also have good practices in SEWA (health) and BASIX (livelihoods) for insurance, while the Pondicherry pilot project offers lessons for bank accounts. We can also learn from the successful practices in countries like Bangladesh, Thailand, Indonesia, Mexico and Brazil.

There are some issues, which have to be sorted out regarding the SHG movement and MFIs. Some of these are: Are the SHGs really self-help groups or are they receiving lot of subsidies from the government or donors? What will happen if the subsidies are removed? Are the interest rates of 24 per cent to 36 per cent charged by MFIs justified? What types of terms and conditions are needed for better functioning of MFIs?

Productivity of Small Farmers and Other Vulnerable Groups

Ultimately, financial inclusion will be successful only if the productivity of the small and marginal farmers, rural nonfarm enterprises and other vulnerable groups is sustained with viable economic activities. We have to recognise that financial inclusion for farmers cannot be sustained by the banking system alone as there is a need for other measures like public investment in irrigation, research and extension, infrastructure in rural areas, proper seeds and fertilisers, a good marketing system for better price, etc. Small and marginal farmers face many risks in cultivation. Financial inclusion should take into account the risk elements experienced by farmers while framing policies. Banks should provide credit plus services to the farmers and the rural non-farm sector. The agricultural officers must provide “farm advisory” services that will help in making agriculture an integrated activity with appropriate backward and forward linkages [Rangarajan 2005]. Rural banking has to be restructured so that credit will be supplemented with farm and non-farm advisory services.


The purpose of this note is to flag the importance of financial inclusion in improving the living conditions of poor farmers, rural non-farm enterprises and other vulnerable groups and discuss a few important issues and challenges. It does not cover all the issues due to space constraints. The concept of financial inclusion covers wider financial services such as credit, savings, insurance, etc. We have noted that financial exclusion in terms of access to credit from formal institutions is high for small and marginal farmers and some social groups. For example, even in a state like Andhra Pradesh, 73 per cent to 83 per cent of outstanding loan for small and marginal farmers is from informal sources such as moneylenders and traders. Supply and demand problems have to be solved with appropriate policies. Banks should look at financial inclusion both as a business opportunity and as a social responsibility. Apart from formal banking institutions, the role of the self-help group movement and MFIs is important to improve financial inclusion of people. However, some regulatory procedures for MFIs may have to be evolved by having consultations with MFIs, consumers and the government. Depoliticisation of the financial system is needed for maintaining the viability of formal financial institutions. The risk elements of small and marginal farmers and other vulnerable groups have to be taken into account in framing policies for financial inclusion. For improving the productivity of small and marginal farmers and improving the skills of rural non-farm workers, the banking system may have to undertake credit plus advisory services.




[These are the personal views of the author.]

1 For more on the definition of financial inclusion see Thorat (2006).

2 On household indebtedness see NSS report no 501, All India Debt and Investment Survey published in 2005.

3 More on this see Shetty (2003) and articles in Ramachandran and Swaminathan (2004). 4 More on the initiatives of RBI on financial

inclusion, see Usha Thorat (2006). 5 On the approach of RBI on micro finance, see Reddy (2005). 6 See Mahajan (2004).


GoI (2006): ‘Union Budget, 2006-07’, Ministry of Finance, Government of India. Mahajan, Vijay (2004): ‘Deregulating the Rural Credit’, Seminar, September.

NSSO (2005): Indebtedness of Farmer Households 2003, NSS Report no 498, Central Statistical Organisation, Government of India.

Ramachandran, V K and M Swaminathan (2005):

Financial Liberalisation and Rural Credit in India, Tulika Publications, New Delhi.

Rangarajan, C (2005): ‘Agricultural Credit: Reaching the Marginalised Farmers’, lecture delivered at the Bankers’ conference (BANCON) 2005, Kolkata, November 12.

Reddy, Y V (2005): ‘Micro Finance: Reserve Bank’s Approach’, RBI Bulletin, September. Shetty, S L (2003): ‘Credit Flows to Rural Poor’, mimeo, EPW Research Foundation, Mumbai.

Thorat, Y S P (2006): ‘Indian Banking: Shaping an Economic Power House’, lecture delivered at Banking Conclave 2006 organised by FICCI at Kolkota, July 31.

Thorat, Usha (2006): ‘Financial Inclusion and Millennium Development Goals’, RBI Bulletin, February.

Economic and Political Weekly October 14, 2006

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