One look at data pertaining to the penetration of formal banking services in India, and the need for financial inclusion becomes crystal clear. That’s why financial inclusion is the cornerstone of the Reserve Bank of India’s (RBI) initiative on new bank licenses. But has the regulator laid down the perfect norms to achieve this goal? This remains a question worth debating.
Also, there are some who believe that the RBI would have been better off approaching financial inclusion as an opportunity, rather than a compulsion enforced through such norms. Let’s take that thought forward.
Firstly, the RBI has retained the stipulation that banks must have at least 25% of their branches in rural areas. Can financial inclusion be achieved only through expansion of branch networks to unbanked areas? Non Banking Finance Companies (NBFCs) that do not have rural branches reach their rural customers through agents and customer relationship associates; hence this stipulation is unfavorable to many such large NBFCs keen on a new banking license. Also, given the fact that many established banks have not found it profitable to open branches in rural areas owing to the high cost of operations, it is unfair for the regulator to demand replication of the same model and force new banks to waste capital. Instead, the RBI should encourage innovative forms of banking and the use of technology on a massive scale to reduce cost. It should also spur innovative distribution solutions and partnerships between established banks and retailers or mobile service providers to enable cost effective reach up to the last mile.
Secondly, in the context of the RBI’s decision to permit entry of corporate houses into private banking, the rationale that this move would favor financial inclusion might not stand true. The guidelines in this regard require new banks to comply with the priority sector lending targets and sub-targets as applicable to existing domestic banks. It is seen that the returns from inclusive sectoral lending tend to be much lower and are occasionally negative since the interest charged to borrowers in the agricultural and small industrial sector has to be considerably lower. Public Sector Banks manage to meet these requirements because their interest cost is partly subsidized by the government, and also because they offset the low returns from the priority sector with the high returns from other businesses. What this means is that profits would have been higher had financial inclusion not been an obligation. To expect Private Banks to settle for a lower profit margin goes against the grain of their core objective of private incentive.
Food for thought – Do we need more banks or do we need to make existing banks more robust through innovative forms of banking and the use of technology to reduce costs and enable financial inclusion?