WHY HAS THE SOCIAL BANKING REVOLUTION BEEN A FAILURE?

India has seen a number of experiments in social banking which had good intentions but were plagued by political myopia. Most of them started off ambitiously but ended in failure .The new initiatives beginning in the second decade of the twenty first century have made finance more inclusive and equitable. 

The increased availability of a wide range of financial choices has deepened financial inclusion, and have been a core element of recent financial developments. The overriding objective behind most of the government’s subsidized credit schemes since the 1950s has also been to provide alternatives to usurious moneylenders.  

The overriding objective behind most of the government’s subsidized credit schemes since the 1950s has also been to provide alternatives to usurious moneylenders. But most of them were unsustainable for financial institutions. All these attempts to deliver credit, through state-run banks collapsed in the face of widespread corruption and default. It is now well recognized that financial needs of the ‘excluded’ segments of the economy go beyond access to credit. Improved access to various formal financial services includes safe instruments for savings, easy-to-understand insurance instruments, and pension and transfer facilities, among others. 

In the period following the nationalization, the banks were given a mandate for rural expansion. The declared objectives of the new policy that came  to  be  known  as  “social  and  development  banking”  were  (i)  to  provide  banking  services  in  previously unbanked or under‐banked rural areas; (ii)  to provide substantial credit  to specific  activities,  including  agriculture  and  cottage  industries;  and  (iii)  to  provide  credit  to  certain  disadvantaged groups such as, Scheduled Caste and Scheduled Tribe households2.

The social banking revolution has helped banking expand its outreach. The Indian government launched an ambitious social banking programme which sought to improve access of the rural poor to formal credit and saving opportunities. A key feature of this programme was expansion of bank branches in hitherto unserved rural locations (i.e. rural areas without any formal credit or saving opportunities). 

It was public banks that revolutionised rural India in the social banking era of the 1970s. It was the emphasis on those excluded from the formal financial stream that led to a slew of measures in the field of finance, and drove so many bankers into the arena of the battle against poverty.

State-owned banks in developing countries have an important socio-economic objective – to meet the needs of the most vulnerable sections of the economy. Apart from being   required to lend 40% of their loanable funds at a concessional rate to the priority sector (particularly agriculture); state-run banks have to shoulder the main burden of the government’s development policies—from rural lending to infrastructure development.

To further promote banking facilities in such locations, the RBI announced a new branch licensing policy in 1977 which operated until 1990. Under this policy, in order to obtain a license for opening a new branch in a location with one or more branches (i.e. in a banked location); it was mandatory for a bank to open four branches in an unbanked location (referred to as the 1:4 licensing policy). To ensure that this expansion translated into greater credit and saving opportunities for the rural population, the RBI introduced additional policy changes. During 1969–90, the rural lending rates were kept lower than urban rates, with the converse being true of savings rates. Besides, lending targets for the so-called “priority sectors” were imposed. The latter comprised small businesses/ entrepreneurs, and agriculture. 

There was a marked shift in savings mobilization and credit disbursement in rural India1. These shifts were associated with a significant reduction in rural poverty. Between 1969 and 1990, bank branches were opened in roughly 30,000 rural locations with no prior formal credit and savings institutions (unbanked locations). The figure rose from 8,261 in the year 1969 to a whopping 65,521 in the year 2000. The share of households accessing institutional credit rose from 32% to 61.2% between 1971 and 1981. During the early years of state ownership of major banks (1969 to 1991), the government, as the owner and policy maker, and the RBI, as the monetary authority, laid emphasis on making banks accessible to the masses, both geographically and socially. Bank offices were opened in remote parts of the country; credit was made cheaper and available to the vulnerable sections of society.

However, social banking had its own inherent flaws. The additional burden arising out of the mass opening of rural bank branches adversely affected the resilience and viability of banks. The extension of commercial bank branches was inspired by the need to fill credit gaps in the rural economy which the uneven and inadequate development of the cooperative movement had left. The politicians believe banks can bring economic revolution through rural credit, which is just like expecting a midwife to deliver a baby. In a developing country, it is not enough just to provide credit for production. Production itself must be increased with the adopting of improved technology.

The branches mushroomed and there was an exponential increase of rural branches of banks. Villages began to be courted by bankers. This phenomenon gave rise to a popular adage: “A village could be known as uninhabitable only if it did not have a branch of a bank.” Such was the explosion of rural banking. The depth and outreach of the banking network in the late seventies grew at a sizzling pace on account of tough government mandates. This was at a time when the transport and communication infrastructure in the country was abysmally weak, unlike today when mobile phones, email, SMS and Skype enable you to communicate anywhere any time.

While the positive social and economic impacts of nationalization were quite evident, the experiment was also an eye-opening lesson in the disaster that mindless bureaucratic programmes can become. Nationalization initially spurred financial development and channeled unprecedented amounts of credit to flow to agriculture, but it came at a cost of lower quality intermediation. Most development programmes are a grim reminder of how mechanically trying to meet targets can completely undermine the integrity of a veritable economic and social revolution to such an extent that a counter-revolution can be set into motion. But we refuse to learn lessons particularly because populist politicians consider it a sure way to burnish their electoral fortunes.

This agenda was largely driven through quotas, allocations and incentive/disincentive schemes. They were meant to address addressed all the three components risky activities, risky geographies and risky customers all at one go. The official mandates have certainly helped banks penetrate remote, unreached populations but have in the process dented their sustainability 

in the post –bank nationalization era, there was a plethora of baffling questions that confronted planners, a section of which felt that subsidies were distorting the economic climate and retarding the efforts of the poor for fighting poverty. Some of the pertinent questions were directed mostly at the relevance of the State’s continued aid to poverty alleviation programmes. When and where is intervention at the bottom end of the financial market justified? Of what kind: direct intervention, subsidy, regulation or something else? The literature of that time, which consisted more of polemic and counter-polemic than of empirical investigation, did not answer all these questions. All we could do was to get a flavour of the aggressive debate in the hope that it might stimulate us to forge solutions that might at least have validity within our own local working environment.

As in other areas of development, the use of public funds is easy to justify in the interest of improving access and thereby promoting pro-poor growth. Such subsidies of course need to be evaluated against the many alternative uses of the donor or scarce public funds involved, not least of which are alternative subsidies to meet education, health, and other priority needs for the poor themselves. In practice, such a cost-benefit calculation is rarely made. Indeed, the scale of subsidy is often unmeasured.

But an even more serious problem is the possible chilling effect of subsidies on the commercial provision of competing and potentially better services to the poor. Subsidizing finance is likely to undermine the motivation and incentive for market-driven financial firms to innovate and deliver. It is this danger—that subsidies will inhibit the viability of sustainable financial innovation—that can be the decisive argument against some forms of subsidy. 

It is not subsidization of the poor that should be questioned: the poor need help and subsidies in many dimensions. Subsidies to cover fixed costs (for example, in payments systems, especially when these generate network externalities) may be less subject to this chilling effect than those that operate to subsidize marginal costs. But every case must be assessed on its own merits.

It is clear that the principles of viability and sustainability should not be compromised. Financial inclusion has to be inclusive and equitable but it must stand on the legs of robust banking principles. Credit discipline must be ensured and we should not allow political ideologies to contaminate credit culture and dilute the principles of robust discipline in banking.