Regulation over the years has only increased the centralisation of financial services organisations, with heftier banking outfits coming into play. Not surprisingly, financial inclusion seems an almost impossible goal.
India has not set the Ganges on fire when it comes to providing access to financial services to low-income households and small businesses.
About 90 per cent of small businesses have no links with formal financial institutions. A good 60 per cent of the rural and urban population do not have a functional bank account. This statistic means that they are heavily dependent on the informal sector for meeting their credit needs. The problem is not the absence of high-quality, formal financial services. The challenge is the ability of the financial system to mount a vigorous supply response.
The RBI Committee’s report on Financial Services for Small Businesses and Low-Income Households pointed out that a credit/economic output ratio of 50 per cent is the minimum that should be the target of the official financial sector policy. MSMEs
generate as much as 20 per cent of the country’s annual economic output which translates into Rs.34,00,000 crore. For that level of production, the bank credit provided to the micro/small businesses is only Rs.9,00,000 crore, whereas if we go by the 50 per cent credit/output norm, they should have credit outstanding Rs.17,00,000 crore from the banking sector!
UNIMPRESSIVE TRACK RECORD
The stats are telling. The long-term performance of the banking sector in meeting the credit and savings needs of the vast MSME and low-income households is sub-par. Another disconcerting fact is that at least four government bodies had flagged this issue. They proceeded to recommend solutions, but sadly all the answers continued to place reliance on the banking sector as the primary credit/savings source. Such an approach won’t wash.
One would have thought that, in the backdrop of the inability of the banking sector to comprehensively meet the financial requirements of the industry, they would have suggested bold measures to recommend fundamental re-ordering of the financial architecture to encourage non-bank financial companies (NBFCs) to complement the activities of the banking sector.
NBFCs take care of last mile delivery
Interestingly, RBI’s committees have, over the years, acknowledged that NBFCs play an instrumental role in extending the reach of the banking system to the more difficult parts of the economy, particularly in last mile credit delivery. This recognition flowed from the fact that till the late 1990s, NBFCs accounted for a good share of both financial savings and credit disbursement in the economy. For example, in 1997, total public deposits with NBFCs were approximately Rs.55,000 crore, and this formed 11 per cent of the then total bank deposits of Rs.5,00,000 crore. NBFCs’ share of total credit was also roughly the same back in 1997. Today, NBFC deposits are Rs.30,000 crore and form merely 0.30 per cent of total bank deposits of Rs.100,50,000 crore. On the credit side, NBFCs are almost out of the picture with their funding base now cut off.
The banking organisation structure, regarding ownership, size, employee orientation, culture, etc., places its constraints on how effectively banks can meet the financial services requirements of the small and micro businesses. I thought that keeping the over-riding objective of deepening and widening financial inclusion in mind, Indian policymakers would recommend some radical solutions in financial sector organisation. Sadly, Indian financial sector policy has not been able to go beyond the hurdle of a bank-centric approach.
RE-ORIENTING FINANCIAL ARCHITECTURE
If the objective is widespread credit availability and financial inclusion, we need numerous small, nimble firms that can provide savings and credit services in India’s vast hinterland. Such firms would have a high regional and local orientation, will be appropriately staffed both in terms of numbers and in the type of people who can relate well to local business and economic conditions and can respond quickly to emerging trends.
A centralised organisation structure with little local affiliation is not the recipe for success in financial inclusion, as is the case now with the big banks centered in the big metros and a branch network that is not tuned into the local environment.
Unfortunately though, regulation over the years has only increased the centralisation of financial services organisations, with heftier banking outfits coming into play, and smaller, localised non-bank entities gradually fading out. Financial inclusion, not surprisingly, seems an almost impossible goal in such an environment.
RBI’s latest report of December 2017 shows that deposit-taking small NBFCs that typically are well placed to cater the credit/savings requirements of India’s vast micro/small business sector and low-income households in the hinterland are just 175 in number now. Their total assets are approximately Rs.1,60,000 crore.
NBFCs bring down lending rates
Mainstream commercial banks are unable to service the MSME efficiently. The annual average incremental credit flow to the MSME sector from the mainstream banks is about the actual requirements, going by the 50 per cent credit/economic output ratio advocated by an RBI committee itself.
But with NBFCs consciously not allowed to grow their business, the small business sector has been forced to rely on local money-lenders in the unorganized sector for their credit needs. Even in today’s market, loan rates of 80 per cent plus are common, whereas, with some encouragement, NBFCs were able to bring down interest rates in some lending sectors to the 18-20 per cent range in the recent past. It is imperative that official financial sector policy encourages this trend rather than shutting out the remaining small, regional, localised NBFCs.
Overall, bringing the MSME sector into the financial mainstream calls for a significant role for non-bank institutions. Even within the organization format of banking, we need to expand further on the concept of small, local area banks rather than rely only on the big, all-service banks currently operating in our country.