Vijay Kelkar on Financial Inclusion

Last Monday, Dr Vijay Kelkar, Chairman of the 13th Finance Commission and one of the architects behind India’s economic reforms, gave a speech on financial inclusion at the Administrative Staff College in Hyderabad. In the speech, Kelkar provided an extremely thoughtful overview of some of the critical challenges and opportunities in expanding financial inclusion in India and is well worth the read (full text here). The press focused on Kelkar’s proposal for using smartcards to deliver government services (which is not actually new -- the Planning Commission produced a report on the potential for smartcards to be used to deliver government services over a year ago and the census claims to have plans to rollout a national ID system using smartcards) but the speech covered the gamut of issues related to financial inclusion from how to incentive private players to what products the poor really need.

We at the Sector Wide and Policy team of CMF thought that Kelkar’s speech provided an ideal opportunity to summarize our own thinking on the issue of financial inclusion by way of response to Kelkar’s speech. Below are our comments:

1. Financial inclusion is almost universally thought of as broader access to formal financial services ranging from simple products like savings, credit to more complex ones like insurance, pensions etc. In India, there has typically been a greater focus on access to credit in comparison to other financial products. (Admittedly, this has been less true in recent times with the propagation of No Frills Accounts). An example of this is the new debt relief package for farmers recently announced by the government. This sort of measure primarily benefits the better off farmers who have access to bank loans in the first place and raises the expectation that loans are not meant to be repaid. Of course, this is also extremely expensive.
2. One point which Dr. Kelkar raises is that access to products which reduce vulnerability to economic shocks is critical. Given that access to finance is believed to have positive impact on poverty alleviation (Burgess & Pande, 2003; Honohan, 2004) and that some definitions of poverty look at levels of economic vulnerability (Matin & Hulme, 2003), improving access to risk-mitigating products has to be a key part of any policy that seeks to increase financial inclusion. Some examples of such products and what can be done from a policy perspective to improve access to them include:
1. Savings: There is evidence to show that low-income communities value savings almost as much is not more than debt, yet access to safe and secure savings products is low in India. Some ways to rectify this situation from a policy perspective are to promote branchless banking via Business Correspondents and to allow MFIs to collect savings.
1. Insurance: More infrastructures for data collection and sharing of historical data is required for developing index-based products – particularly, weather stations / gauges in underserved locations in the country.
1. Commodities: Develop a micro-commodities / micro derivatives platform within the NCDEX framework – to encourage smaller volumes trade – and consider newer channels (MFIs / Kiosks, etc.) as a platform for disseminating futures prices and for enabling trading.
3. Dr. Kelkar points to the recent initiative by the RBI to encourage banks to provide "no frills" accounts to the poor as an important step toward increased financial inclusion initiative. The "no frills" initiative is certainly an interesting one, but our own research has shown that it has had very little effect in terms of increasing financial inclusion.
4. While the point that financial inclusion can be a quasi public good is an interesting one, it is arguable that many financial products are in fact neither non-rival nor non-excludable (for example: a savings account). However, the broader point that governments must facilitate financial inclusion which happens best through market-based methods is well-taken. We would also argue that any steps taken to improve financial inclusion must be a in a form that is acceptable to the target audience. This point is important to make because there is evidence to show that the extensive banking network in India, which has developed as a result of government intervention, has not succeeded in reaching the poor. Similarly, simply market involvement is unlikely to work either given that the incentive to go to remote underserved areas would be lower.
5. Further, while we share Dr. Kelkar's enthusiasm for the role of the market in increasing financial inclusion, it is necessary to keep in mind that private markets in India are not caste or religion blind.
6. Dr. Kelkar points us towards some useful statistics: almost half of Indian farmer households do not have access to formal finance. In this context, the fact that access does not necessarily imply usage (Beck & De la Torre, 2006; CMF study on financial inclusion drive in Gulbarga) also buttresses Dr. Kelkar’s point that vast sections of the population are excluded from formal finance.
7. As Dr. Kelkar says the SHG-Bank Linkage programme has been an extremely effective way to improve financial inclusion in many parts of this country. It may be time to build some innovations in this model. This year’s State of Sector report, raises the issue of compulsory versus flexible savings. While SHGs require a fixed and compulsory amount of savings on a weekly basis, Dr. Ghate argues that there may be a case to be made for allowing flexible and voluntary savings, with evidence from Bangladesh to show that this does not affect savings discipline. Furthermore, there may be some communities which are so economically disadvantaged that they are unable to save on a weekly basis, but may be able to save on a fortnightly/monthly basis.
8. Finally, Dr. Kelkar suggests an original proposal for promoting financial inclusion by coupling it with the delivery of various government subsidies through a smart card. The establishment of a universal, national ID system based on smartcards holds enormous potential to increase the efficiency of delivery of both government services and financial inclusion. The Centre for Universal Financial Inclusion's recently released working paper which describes how a smartcard based system could be used to simultaneously deliver NREG wage payments while also providing flexible savings accounts to workers illustrates just one way in which this potential could be realized. Furthermore, the case for the government to intervene in this area is a strong one in that an ID system certainly qualifies as a public good -- i.e. the benefits from the establishment of an ID system would be spread across such a wide variety of players and the investment required to set up the system is so large that without government intervention action is unlikely to take place. Countries such as Malaysia and China have shown that it is indeed possible.