India Rural Banking_Diamond

8/14/2019 India Rural Banking_Diamond

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insight

Despite recent economic progress and explicit socialist goals, India has

amongst the worlds lowest GDP per capita ($763 USD) and lowest penetratedretail banking systems, with less than 20% of rural India having access toformal nancial services. The reasons for this are complex, as is identifyingpotential solutions. A multi-pronged approach is required to make the Indianretail banking system more inclusive. This will require a concerted effort byseveral stakeholders, including the Government of India, the Reserve Bankof India, and the commercial banks. To bring about this transformation,public and private sector banks will need to play a key role in deningand implementing innovative business models and delivery channels usingappropriate technology solutions.

Building a More InclusiveFinancial System in IndiaThe opportunity to provide rural unbanked communitieswith access to essential banking services.

By Vinod Nair, Andrew Soeld, and Vijay Mulbagal


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Current State of Rural Banking in India. 2

Key Drivers of Financial Exclusionin India Today. . . . . . . . . . . . . 5

The Way Forward. . . . . . . . . . 10

Conclusion . . . . . . . . . . . . . 16

About the Firm . . . . . . . . . . . . 18

About the Author . . . . . . . . . . . 18

table of contents

The Current Stateof Rural Banking

in India

2

The Indian EconomyIndia is the 12th largest economy in theworld in terms of gross domestic product(GDP), and fourth in terms of purchasing

power parity (PPP)1

. The growth of theeconomy is equally impressive with anaverage of over 8.0% during the last threeyears2. However, in terms of GDP percapita, India ranks a lowly 160th amongother nations3.

Within the country, there is a stark dividein the incomes of urban and rural areaswith the average monthly per capitaconsumption expenditure (MPCE) in urban

India being almost double that of ruralIndia. In addition, there are signicantdisparities in urban and rural consumption

expenditure between different states(Figure 1). Jharkhand and Orissa, forexample, have an MPCE of approximatelyRs. 900 in urban areas and Rs. 410 in

rural areas4

. In other states like Punjaband Haryana, the urban rural disparityis signicantly lower.

A fth of the Indian population is belowthe poverty line (BPL) today with a MPCEbelow Rs 340 (Figure 2, see Page 3).In some states like Jharkhand and Orissa,the proportion of BPL is greater than40%. Diamond believes that the segmentsthat are not considered BPL should all be

considered as potentially bankable withgenuine nancial needs that could be metby formal nancial and banking systems.

For more information contact:Vinod Nair

Managing [email protected]

Current State of the Indian Economy and the Urban/Rural Divide

Source: World Bank; National Sample Survey Organisation (NSSO)Household expenditure report 2004.

1. Monthly Per CapitaConsumption Expenditure.

Comparison with Other Countries Economic Status Rural vs Urban India

7,111

GDP/capita ($) 20040 5 Average MPCE 1 (Rs.)

4,072

1,692

763 688414

Mexico Brazil China India Pakistan Bangladesh

10.1%

GDP growth 20040 5

7.5%

6.4% 6.3%

4.9%4.4%

China India Pakistan Bangladesh Brazil Mexico

Urban India 1,060

Rural India 565

Urban and Rural MPCE (Rs.)

Jharkand969

405

Maharashtra1,259

569

Orissa872

414

Manipur797

656

Haryana1,050

879

Punjab1,059

947

H i g h d

i s p a r i t y

L o w

d i s p a r i t y

Urban

Rural

Figure 1


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3

Current State of Indian BankingAn important metric to determinethe level of nancial outreach/inclusionis the ratio of the number of deposit

accounts to population. Figure 3 givesa snapshot of the penetration ofdeposit accounts and credit accountsin India in comparison with a few selectcountries with similar socio-culturaland economic conditions. Even incomparison with other developingeconomies, India has a signicantopportunity for increasing penetrationof both deposit and credit accounts.

Not only is there a large disparitybetween India and other countries inbanking penetration but there is alsoa large variation in banking penetrationwithin urban and rural India. Whileurban India seems to be over-bankedwith more than 100% penetration(many urban Indians have more thanone bank account), rural India lags farbehind with a 19% penetration. Thevariance in rural and urban deposit and

credit account penetration is not restrictedonly to few states but is common acrossall states (Figure 4, see Page 4). Inaddition, the average value of a depositaccount and a credit account is alsoquite low in rural areas as comparedto urban areas (Figure 4). Diamondbelieves that the reasons for lowerpenetration levels are partly economic,as explained by the low GDP per capitain the rural areas of the country, andpartly a result of controllable factorsthat are inherent in formal bankingsystems in India today.

The low deposit and credit accountpenetration and low average values indeposit and credit accounts (Figure 4)demonstrate that banking outreach in ruralIndia is sub-optimal. This low outreachcan be explained by two key parameters:access and usage. Simply dened,access is the availability of nancial

Segmentation of the Rural Market

Source: Diamond analysis; National Sample Survey Organisation (NSSO): Household Consumer Expenditure in India (2004).

1. Based on Monthly Per Capita Consumption Expenditure (MPCE), segments are MPCE ranges of < Rs.340, Rs.341-470,Rs.471-775, >Rs.775. Below Poverty Line (BPL): Individuals with MPCE less than Rs. 340

Segmentation of the Rural Market 1 Average MPCE of States (Rural)

All India Punjab Kerala

Affluent states

Jharkand

N.A.

750

AverageMPCE (Rs.)

>Rs. 775

Rs. 471775

Rs. 340470


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4

services, and usage is the actual use ofthose services. Access is inuenced by

issues such as the basic economic state ofrural India, lack of physical infrastructurefacilities, regulatory constraints, and the

economics of rural banking. Usageis constrained by social issues such as

illiteracy, incomplete service offerings bybanks, and high transaction costs in theformal banking system. Access and usage

are not synonymous, as people may haveaccess to nancial services, but decide

not to use them, either for socio-culturalreasons or because opportunity costsare too high.

Banking in India Rural vs Urban Divide

Source: Census India 2001; BSR 2005Reserve Bank of India; World Bank Sept 2005, Diamond analysis.

1. Percentages above 100 are because some individuals or firms have more than one account.

Deposit Accounts in India

Penetration (% of Population)

Kerala288 1

9

Punjab169

38

Karnataka117

25

Orissa87

19

Jharkand83

18

MadhyaPradesh

80

12

Average Value (Rs. 000s)

28

17

36

25

46

13

39

13

41

18

31

15

Credit Accounts in India

Penetration (% of Population)

47

3

12

4

28

6

16

5

7

3

10

2

Average Value (Rs. 000s)

91

33

245

120

138

42

130

30

149

26

128

48

A f f l u e n t

S t a t e s

L o w I n c o m e

S t a t e s

Urban

Rural

Figure 4


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5

Key Drivers ofFinancial Exclusion

in India Today

According to Diamond estimates,approximately 245 million adults in ruralIndia do not have a bank account today.As depicted in Figure 5, this reects

24% of the total population. While60 million out of 245 million may not needbanking services because they are belowthe poverty line, Diamond believesthat approximately 185 million potentiallybankable people do not use formalbanking services because of reasons likepoor access or usage.

Access Issues for Rural Customers

Access is explained in terms ofinfrastructure, physical distance, limiteddelivery capabilities, regulatory constraintsand the economics of rural banking.

The bankinginfrastructure in rural Indiais not encouraging, with just 7% of villageshousing a bank branch5. Whats more,the poor physical and social infrastructure(Figure 6, see Page 6) also impacts the

access to nancial services, with 23%of villages going without electricity, 67%without a Post Ofce, and an averagerural literacy rate of 59% and secondary

school penetration of 12%. This lackof physical and social infrastructure inrural India is a key issue impacting accessto formal nancial services.

The averagedistance to a branch inIndia is approximately 3.8 Kms (Figure 7,see Page 6). While this comparesfavourably to the average distance to abranch in a developed market like theU.S. (which is 6 Kms6), there are signicant

additional challenges in India in theform of unpaved roads and limited accessto modern transportation. Most ruralcustomers are likely to sacrice an entiredays wage to travel to a bank branchwhich is open between 10:00am and5:00pm. While some banking transactionscould be done over phone, this is rarelyan option in a country with such low ruraltele-density.

Size of Potentially Bankable Market in Rural India

Source: Census India 2001;BSR 2005Reserve Bank of India; World Bank & NCAER (2004).

1. Poverty Line: The cost of average basket of consumption of 2400 calories per capita per day (Rs 328/month as of 2001).2. Population up to 18 years of age.

100%

47%

53% 16%

37% 13%

TotalPopulation

Non-adultPopulation 2

AdultPopulation

Urban AdultPopulation

Rural AdultPopulation

BankedPopulation

24% 6%

18%

UnbankedPopulation

FinanciallyConstrained

PotentiallyBankable

Demand limitation:People below poverty line 1

185 million people are potentiallybankable but unbanked becauseof access and usage constraints

Figure 5


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6

Limiteddelivery capability is asignicant challenge. Much of rural Indiais serviced through branches becauseATM penetration is low and other channels

such as Phone and Internet Bankingare non-existent. Intermediaries likeNon-Governmental Organizations (NGOs),Self-Help Groups, and Micro FinanceInstitutions (MFIs) are being used by banksto improve access to credit and savings.However, these channels, in their currentform, offer limited services (Figure 8 and 9,see Page 7).

There are someregulatory constraints

imposed by the Reserve Bank of India(RBI) which may inadvertently contributefurther to the lack of formal bankingservices in rural areas. For example, theRBI does not allow banks to post anyperson other than a security guardat ATMs.Hence, banks cannot deploymany ATMs in rural areas as many ruralcustomers require in-person support. Asecond regulatory inhibitor is that newbanks planning to establish a branch in

a rural area have to receive approval fromthe Lead Bank and District Collector ofthat district. Hence, banks choose not toopen new branches in certain areas evenwhen it is protable to do so because thereis no certainty of getting approvals.

Many banks view the rural market as aregulatory requirement rather than aneconomic opportunity. Banks have fromtime to time borne the social cost of

lending to the rural economy at ratesbelow their costs. They have also facedcapital erosion because of the write-off of loans, particularly agriculture loans.Banks are required via regulatoryrequirements to open branches in ruralareas to provide loans to agriculture andother priority sectors. These branches areoften unprotable because of low ticketsize, high cost to serve, higher risk ofcredit, information asymmetry, and highproportion of non-performing loans (NPLs):

Current Status of Rural Infrastructure

Source: Census India 2001; BSR 2005Reserve Bank of India; National Sample Survey Organisation (NSSO) report on village facilities2003.

Banking InfrastructurePhysical andSocial Infrastructure

Number of Branches Populationper Branch

Urban India 38,000

Percentage of VillagesHaving Listed Facilities

Post Offices 23%

Irrigation 76%

Electricity 77%

Community TV Centre 7%

Primary School 72%

Secondary School 12%

Self Help Groups 64%

Rural India 31,970

UttarPradesh 4,840

Bihar 2,490

Karnataka 2,160

MadhyaPradesh 1,850

Orissa 1,590

Punjab 1,130

Jharkhand 970

Kerala 340

R u r a l R e g

i o n s

O n l y

Percentage ofPopulation Covered

Tele-density 2%

Literacy 59%

7,500

23,200

27,200

20,900

16,100

24,000

19,700

14,200

21,600

67,900

Figure 6

Current Status of Access to Rural Banking

Source: Census India 2001; BSR 2005Reserve Bank of India; Diamond analysis, National Sample Survey Organisation (NSSO) reporton village facilities2003.

Distance to a Bank Branch Rural India Average Distance to a Bank Branch

WithinVillage

10 kms

23%

Adult Population: 541,031,553

Area: 3,287,590 Sq. Kms.

Branches: 69,969

Population per branch: 7,732

Area Covered/Branch: 46 Sq. kms

Average distance to a branch: 3.8 kms

81% of villages donthave a bank branchwithin a 2 km radius

Figure 7


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Low Ticket Size: The average ticketsize of both a deposit transaction anda credit transaction in rural areas issmall (Figure 4). This means that banksneed more customers per branch orchannel to break even. Considering the

small catchment area of a branch inrural areas, generating a customer basewith critical mass is challenging.

High cost to serve: Branches are themost used channel in rural areas. Thisis because many rural people arenot literate and are not comfortable usingtechnology-driven channels such asATMs, phone banking or internet banking.On the other hand, a branch is an

expensive channel for banks (Figure 9).In addition, rural people, whenever theyhave access to banks, have frequentlow ticket and cash-based transactions,which increase the overall transactioncost for their bank.

Higher risk of credit: Rural householdsmay have highly irregular and volatileincome streams. Irregular wage laborand the sale of agricultural products

are the two main sources of income

for rural households. The poor ruralhouseholds (landless and marginalfarmers) are particularly dependenton irregular wage employment. Ruralhouseholds also have irregular expenditurepatterns. The typical expenditure

prole of rural households is small, withdaily or irregular expenses incurredthrough the month. Furthermore, amajority of households incur at least oneunscheduled expenditure per year,with the most frequent reasons beingmedical or social emergency7. In short,the rural customer is generally consideredto be a risky one.

Information Asymmetry: Since many

rural people do not have bank accounts,there is a lack of information on customerbehaviour in rural India. Absence ofa Credit Information Bureau alsocomplicates the problem as banks haveto rely on informal sources to learn thecredit history of rural customers. A lackof reliable information can result in eithermissed opportunities in not approvingotherwise eligible loan candidates, or non-performing loans.

High Non-performing Loans (NPL): Banks have higher non-performingloans in rural areas because ruralhouseholds have irregular income and

expenditure patterns. The issueis compounded by the dependence ofthe rural economy on monsoons,and loan waivers driven by politicalagendas. NPLs from the agriculture sectorare 7.7%, compared to 3.5% acrossnon-agriculture sectors8.

In order for banks to view rural Indiaas a growth opportunity, rather thana regulatory requirement, a combination

of these issues must be addressed.Increasing nancial access to rural areasis contingent upon basic conditionssuch as proper infrastructure and anenabling regulatory framework, aswell as innovative thinking on the partof commercial banks. Access issues,however, explain only one part of theproblem. Usage is an equally importantissue for rural customers.

Current Rural Banking Channels

Source: Reserve Bank of India; Diamond analysis.

Description

Full fledged Branches andExtension Counters of

Scheduled Commercial Banksincluding Regional Rural Banks

Cooperative Banks

Services Provided

Deposit Accounts Credit Accounts

Remittances Cards Third-Party Products

Remarks

96% of total deposit and 95% oftotal loans are with scheduled

commercial banks withcooperative banks holdingthe difference

Has a high cost-to-serve

Branch

NGOs, SHGs, MFIs andCooperatives who act asintermediaries to take financialservices to the rural areas

MFIs directly lend to the poorand also act as agents forthe banks

SHGs borrow from banks andare beneficiaries of loansthemselves

This channel delivers limitedservices in its current form

Intermediaries

Onsite ATM installed at a branch

Offsite ATM installed at a remote

location

Cash Withdrawal Cash Deposit Money Transfer Cheque Book Request Bill Payments

Negligible presence of thischannel in rural areas

ATM

Phone Banking Manual Interactive Voice Response (IVR)

Internet Banking Kisan Credit Card

Provide short-term credit

Cash Withdrawal Cash Deposit Money Transfer

Cheque Book Request Bill Payments

Almost non-existent in ruralIndia because of low: Tele-density

Internet-penetration Credit appetite of banks

Others

Figure 8

Cost Per Transaction in Indian Banks

Source: Reserve Bank of India; CGAP, World Bank.

Cost Per Transaction (Rs) 1

48

25

18

8

4

Branch Phone(Call Centre)

AT M Phone(IVR)

Internet

1. Cost per transaction refers to the operating costthat a bank incurs per customer transaction on aparticular channel.

Figure 9


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8

Usage Issues for Rural CustomersEven if access to formal banking isprovided to rural customers, there is noguarantee that these services will be

used. According to a study conducted bythe World Bank, many households, even indeveloped countries, choose not to havea bank account as they do not engage inmany nancial transactionsthey collectwages in cash, spend in cash and do notwish to be burdened by a bank account9. Tocompound the situation many customers inrural India, who have access to and wouldotherwise choose to use formal nancialservices, do not do so because the product

and service mix do not meet their needs.

The nancial serviceneeds of ruralcustomers are not conned to just savingsand credit, as is usually assumed. Theirnancial needs are linked to their life cycleneeds, ranging from savings to creditto insurance to remittances (Figure 10).In fact, even the savings and creditproducts currently offered to ruralcustomers do not entirely meet their needs.

Access to savings and investment facilities is critical for the poor. The two criticalneeds for the rural poor aremicro-savingsand frequent withdrawals . These needsfacilitate a customer in building capitalover the long term, as well as coping withincome shocks in the near term.10. However,banks do not offer adequate services toaddress these needs. The lack of services,therefore, leaves the rural poor with little

option than to transact with the informalbanking market. A study conducted byMicroSave also concludes that the poortransact with the informal sector because itwill accept small amounts, provide doorstepservice, and ensure ease of enrolment11.

Rural customers needloans not onlyfor productive purposes but also forconsumption needs (Figure 11). As shownin Figure 10, apart from agricultural

support, rural customers need micro-credit for consumption, education and

emergencies. Though banks offer purpose-free loans (personal loans and credit cards)in urban areas quite liberally, in rural areassanction of such loans is signicantlyrestricted. Therefore, the poor raise these

loans through the informal nancial system(it is worth noting that these loans taken

from the informal system are almostalways repaid or renewed12). In addition,larger households need occasionalhigh value micro-enterprise loans forsmall capital investment. Though

banks offer these loans, they requireexcessive documentation and time-

Financial Needs and Service Requirements

Source: Diamond analysis.

Critical Needs Description

Current Availablity Via FormalBanking

Frequent and dailysurplus savings

To meet contingencies,social functions andworking capital

Rationale

Banks do not offer dailysmall savings depositschemesSavings

Credit

Insurance &

Remittance

Rural banks generally do notgive loans for consumption& emergency purposes

Banks have not targetedthe rural poor for insurance

For consumption,education andemergency purposes

Working capital or smallcapital investmentsrequirements

Asset Protection, Health,Life and SavingsProtection

To Access fundsremitted by relatives

Branch channel is cost-ineffective for ruralcustomers

Banks provide seasonal andlong-term agriculture loansbut there are delays andexcess documentation

Rural branches are notcomputerized and usuallyremittances take morethan 2 weeks to reach thebeneficiary

Micro-savings

Micro-credit

Micro-enterprise Loans

Micro-insurance

Remittance & Transfers

Frequent withdrawals

High Medium Low Negligible

Figure 10

Purpose of Borrowings

Source: AIDIS2003, National Sample Survey Organisation (NSSO); Diamond analysis.

Rural Household Borrowing Bank Lending to Rural Households

OtherBusiness

Loans52%

AgricultureLoans36%

PersonalLoans12%

HouseholdExpenditure

48% AgricultureExpenditure

38%

OtherBusiness

Expenditure14%

A significant percentage of borrowing is toward consumption and other household

expenditure, whereas formal financial institutions in rural India provide loans primarilyfor productive purposes.

Figure 11


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consuming processes which discouragecustomer applications.

Insurance reduces the vulnerabilityof poor households by replacing theuncertain prospect of large losses with thecertainty of payout against small, regularpremium payments. It is integral to acomprehensive risk management strategyfor poor households. This includes life,health, accident and asset (dwelling, crop,and livestock) insurance. Banks and insurancerms do not offer these services in manyrural areas, leading the poor to rely on theinformal nancial system.

There are many rural households whichdepend on weekly or monthlyremittancesfrom their family members who have movedto urban areas. At present, they dependon informal channels to remit the moneyand consequently either risk the lossof money or pay high transaction fees.Banks do not offer seamless remittancefacilities between urban and rural branchesas many of the rural branches are not

computerized and connected to the mainbanks computer systems. This often resultsin the beneciary receiving the amounttwo weeks after it has being transferred.This represents yet another key servicewhich is not provided.

The transaction cost for a rural customerto receive credit primarily constitutes fourattributes: the interest rate, loan amountreceived as a percentage of amount applied,

bribes paid, and the lead time to processthe loan. Though the formal banking systemoffers loans at interest rates lower thaninformal banking systems, the time taken fora loan to be sanctioned (Figure 12) is highwhich increases uncertainty and opportunitycost. In addition, the customer needs to payalmost 10% of the loan amount in bribes andeventually receives an amount that is lessthan what was applied for. Therefore, whilethe interest rates are usurious in the informal

nancing system, rural customers still resortto this channel because the waiting time to

receive the loan is negligible and there areno indirect costs or commission. Banksalso insist on collateral security which manyrural poor cannot afford.

As far as savings are concerned, thoughthe formal banking system providesnancial security, the cost of openingand operating an account is high. Theoverall cost of transacting with the formalnancial system increases for a ruralperson because of additional costs suchas expenses incurred to reach a branchand the opportunity cost of lost wages.Since rural banks are generally not withinan accessible area and do not operateat convenient times, the rural customer

must forgo a days wage to reach a branch.Informal systems, on the other hand,involve a lower transaction cost, butthey are risky and in some cases result inthe loss of ones entire capital. In short,this leaves the rural customer to choosebetween two unfavourable options.

In summary, the services being offeredby the formal banking system do not seemto meet the needs of the rural poor. A

World Bank study suggests that the poorapply a set of criteria to judge the services

being offered by any nancial serviceprovider, including:

ProductsAre nancial servicesavailable and tailored to my needs?

CostWhat is the total cost of the

service (including opportunity cost)?

ConvenienceHow easy is it to accessand use?

EligibilityAm I eligible for nancialservices and can they be accessedrepeatedly?

As explained earlier, the savings productsoffered in the current format do not qualifyas a exible, convenient and cost-efcient

service. Similarly, loan products donot meet product and eligibility criteria.In addition, insurance and remittanceservices are not even available. The costof services, despite lower interest rates, ishigh because of other indirect costs whichmake the banking services cost-inefcient.

The access and usage issues need to beaddressed to improve nancial inclusion.The next segment of the paper looks

at some changes that the government,RBI and banks need to make.

Aspects of Credit and Deposit in Rural India

Source: State Bank of India; World Bank.

Aspects of BankingTransactions

CredIt

Deposit

Interest rate (median) % p.a.

Loan amount received as % ofamount applied

Bribe as % of amount approved

Time taken to process a loanapplication

Cost of opening & operatinga deposit account

Interest earned

Associated risk

Cost ofFormal Financing

9.5%

92%

10%

33 Weeks

10%

3.5%

Low

Cost ofInformal Financing

24%120%(Varies from state to state)

100%

0%

1 Week

02%

010%

Medium to High(In extreme cases,

deposit facility providermay abscond)

Figure 12


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In building an inclusive nancial system,each of the three key stakeholdersthegovernment, RBI and commercial bankshas a role to play. The following chapter

briey examines the desired actions to betaken by the government and RBI, and thenprovides more in-depth recommendationsfor banks. We focus on the actions to betaken by banks because they are ableto more rapidly implement change thanthe government or RBI, even withinthe current regulatory environment.

Stakeholders

The Government: As noted, weakinfrastructure is an important factor limitingaccess to rural branches even in areas whereit would seem that customers are withina reasonable distance of a bank branch.The government has initiated the BharatNirman plan13 to improve infrastructuralconditions in rural India, but there is a needto ensure rapid implementation. The twocritical elements of rural infrastructure whichhave a direct impact on the accessibility of

banking channels are road and transportationinfrastructure and electricity and powerinfrastructure.

Similarly, high levels of illiteracy deter ruralcustomers from actively engaging in formalnancial channels. Hence, the government

has an additional responsibility to improvesocial infrastructure by improving literacyrates and education facilities. In addition,the government should educate rural

people about the negative effects ofdebt-trap and the benets of using formalbanking channels. Finally, to regulatethe informal credit market, the governmentcan not only enact laws such as theMoneylenders Act, but also needs tosuccessfully implement them.

Reserve Bank of India: The ReserveBank of India, as the regulator of theformal banking system, has a critical

role in improving rural access and usage.Changes in technology, banking systems,and market conditions may requirethat the RBI revisit some of its guidelinesgoverning the licensing of new branches,operations of ATMs, and use of technology.The following are a few suggestionsto address each of these three issues.

First, with improvements in bankingtechnology, it may not be essential to have

a bank branch to reach rural customers.The RBI need not require banks to open abranch in rural areas as a requirementto grant licenses for urban branches.Instead, banks should be allowed toexplore alternative, more economicalchannels to reach the rural customers.

The Way Forward

Stakeholders Involved in Improving Access and Usage


Issues Stakeholder Involvement

Access

Government

Usage

Role Description Government to play an important role

in building basic infrastructure RBI to bring necessary changes in

regulation Banks to innovate and use technology

to improve the banking outlets

RBI Banks

High Medium Low Negligible

RBI to relax guidelines to permit banksimprove services & operations

Banks to introduce new products, improveprocesses, establish new partnerships andmanage pricing to improve usage of bankingservices

Figure 13


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Second, ATMs are an effective channelto deliver many services at signicantlylower cost than a branch. However, ATMsare not effective in rural areas if they

are unattended, as required by the currentRBI guidelines. The RBI should considerthe option of allowing banks to appointcustomer service agents in rural ATMkiosks subject to some stringent rules toprevent fraud.

Last, the RBI should examine thepotential impact of allowing bank businesscorrespondents to use point-of-saletechnologies such as Palmtops to deliver

nancial services in rural areas.While there are additional regulatoryreforms which would enhance bankingaccess and usage for rural customers,Diamond believes that addressing thesethree points would be a signicant start.

Banks: Even within the sub-optimalinfrastructure and regulatory frameworklaid out by the government and RBI,there is an opportunity for banks toimprove the rural customers access andusage. Access can be enhanced throughnew and innovative channels whichthe RBI already permits, and by leveragingcost-effective technology in existingchannels. Usage can also be improvedif banks revise their product and serviceofferings to meet the needs of therural customer.

Market OpportunityAt present, a rapidly growing urbanIndia is the focus of the banking sector;however, as the deposit penetrationnumbers suggest (Figure 3 & 4), themarket is highly competitive and over-banked. Despite this, most banksare still not shifting their focus to the ruralopportunity, as they are apprehensiveabout the total market potential ofthe rural market and the protabilityof rural banking channels.

Contrary to the widely held notion,however, the rural market is attractivefrom both a credit and deposit perspective.The credit demand in rural areas isapproximately Rs 1,330 billion (based on

an estimate by World Bank). There areother studies by the Planning Commissionand ICICI Bank which put the gure evenhigher at Rs 1,440 billion and Rs 1,500billion respectively. Similarly, on thedeposit side, a large segment of the ruralpopulation does not save with formalbanking channels because banksare not accessible and do not providethe appropriate products and service,leaving a signicant opportunity to growthe deposit base.

At present, the penetration of bankingin rural areas is sub-optimal with a largemarket remaining untapped in boththe liability (~ Rs 215 billion) and asset(~ Rs 1,204 billion) sides of the business(Figure 14). These estimates clearlysuggest that there is sufcient demandin the rural market to encourage banksto think seriously about rural areasas an alternative growth opportunity.

As we identied earlier, access and usageare two broad concerns which explainwhy the potentially bankable are unbanked.With regard to access, the challenge forbanks is to identify protable channels that

meet the needs of rural customers. Withregard to usage, banks need to understandthe requirements of the rural customerand customize products and servicesaccordingly (Figure 15).

Rural India has a Large Untapped Credit and Deposit Market

Source: BSR 2005Reserve Bank of India, RBI; World Bank 2003.

Total Market

Credit

Deposit

Current Coverage ofScheduled Commercial Banks

1. Consumption or Working Capital Rs. 6,000 per household for all Households

2. Capital Investment Rs. 30,000 per household for 10% of

Households91%

9%

Total Credit Market= ~ Rs. 1,330 Billion

+

Savings Per HouseholdRs. 7,800

Financial SavingsPer HouseholdRs. 2,800

Non-Financial SavingsPer HouseholdRs. 5,000

Total Deposit Market

= ~ Rs. 400 Billion

54%46%

Untapped Market Size= Rs. 1,204 Billion

Untapped Market Size= Rs. 215 Billion

Note: No. of Rural Households148 Million

Figure 14

Proposed Approach to TapPotentially Bankable Population

Source: Diamond analysis

ConvertPotentiallyBankable

ImproveAccessfor Rural

Customers

AddressAccess Needs

of RuralCustomers

EnsureChannel

Profitability

EncourageUsage ofServices

AddressUsage Needs

of RuralCustomers

Bank Initiativesto Improve

Usage

Figure 15


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Improving AccessToday, branches are the primary deliverychannel in rural areas. Though there are32,000 commercial bank branches in India,

they cover less than 7% of total villages14

.Opening more branches is not necessarilyprotable as many pockets of rural areasdo not have business enough to justifyan expensive branch channel. Therefore,to improve access in rural areas, banksneed to modify existing channels,introduce new channels and identifyinnovative ways to integrate the two.

Modify Existing ChannelsFortunately there are a variety of optionsavailable for banks looking to modifytheir existing channels.

To reduce the costs imposed by branches,banks should consider the option ofsharing their branch infrastructure .This would not be too dissimilar tothe example of the telecom industrysharing network infrastructure or

the fast food industry sharing food courtsin urban areas. Though infrastructuresharing may raise concerns over clientcondentiality and data leakage, in thelong run banks will only benet fromsuch collaboration.

ATMs are an effective channel which candeliver many of the services frequentlyused by a branch customer. However,ATMs, in their current form, are not

suitable for rural areas as the literacy leveland transaction ticket amount is too low. ATMs can, however, be designed tomeet the needs of rural customers.For example, ICICI Bank is working with IITChennai to develop an ATM that hasa biometric ngerprint login, accepts soilednotes, and lower value denominations.In addition to modifying the design of themachines, banks should also hold discussionswith the RBI to allow an attendant to

be posted at ATMs. This will enhance theusability of ATMs.

Thoughphone banking and internetbanking are cost-effective channels, givenvery low tele-density and low internetpenetration in rural areas, the ability to use

these channels to reach the rural customeris low. However, phone and internet bankingshould be considered once infrastructureand literacy levels improve in rural India.A business correspondent could then runan e-kiosk to assist customers to transactover these channels. For example,Centenary Bank in Uganda uses internetand phone banking to provide bill payments,money transfers and loan repayments.

Business correspondents can be providedwithpoint-of-sale (POS) functionalityto allow customers to deposit and withdrawcash from their accounts. Combining POSwith a smart card is one way to improveaccess. Brazil has successfully usedbanking correspondents who use POS andcard readers to provide current accounts,loans, and insurance, accept bill payments,and perform other transactions.

Introduce New ChannelsThe RBI allows banks to appointbusinesscorrespondents and facilitators tobe used as intermediaries in providingbanking services. NGOs, MFIs, Societies,Section 25 companies, registered NBFCsnot accepting public deposits, andPost Ofces can be appointed as BusinessCorrespondents.

Business Correspondents can provideseveral services which are not currentlyoffered by SHGs and MFIs, including:(i) identication of borrowers and tmentof activities; (ii) collection and preliminaryprocessing of loan applications includingverication of primary information/data;(iii) creating awareness about savingsand other products and education andadvice on managing money and debtcounseling; (iv) processing and submission

of applications to banks; (v) promotion andnurturing Self Help Groups/Joint Liability

Groups; (vi) post-sanction monitoring;(vii) monitoring and handholding of SelfHelp Groups/Joint Liability Groups/CreditGroups/others; and (viii) follow-up for

recovery; (ix) disbursal of small valuecredit, (x) recovery of principal/collectionof interest (xi) collection of small valuedeposits (xii) sale of micro-insurance/mutual fund products/ pension products/other third-party products and (xiii) receiptand delivery of small value remittances/other payment instruments.

The introduction of Business Correspondentsmay face some challenges from labour

unions. However, Diamond believes thatthere may be some options to addressthe concerns of the current workforce whileusing Business Correspondents to capturemore value from rural customers.

Caixa Economica, a state-owned bankin Brazil, manages the countrys lotterynetwork and distributes governmentbenets. To increase the access of itsservices, Caixa extensively utilizes the

Banking Correspondent channel, with14,000 banking correspondents covering allof Brazils 5,500 municipalities. In lessthan 2 years, Caixa opened about 2.8 millionnew accounts and estimates that 40% ofits banking transactions are handledthrough the banking correspondent channel.

Satellite ofces are a cost-effectivealternative to branches. These ofcescan be established at xed premises in

villages and are controlled and operatedfrom a base branch located at a blockheadquarters. All types of bankingtransactions may be conducted at theseofces. Banks have, however, not used thischannel actively, despite the argumentthat this channel is relatively less expensive,as it can draw personnel from the mainbranch and can remain open for just twodays a week. This channel, therefore,is appropriate in blocks and districts

which are densely populated. In the urbanareas, most Indian banks opt for an


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extension counter where the business doesnot justify a full-edged branch. Similarly,satellite branches can cater to rural areaswhich do not justify a large branch.

Where banks do not nd it economical toopen full-edged branches of satellite ofces,mobile ofces may be more appropriate.Mobile ofces extend banking facilitiesthrough a well-protected truck or van. Themobile unit visits villages on specied days/hours. The mobile ofce would be afliatedwith a branch of the bank, and serve areaswhich have a large concentration of villages.This will not be dissimilar to the mobile

ATMs implemented by some of the Indianbanks in the urban areas.

Determine the Combination of ChannelsThere is no one right channel or solutionto improve access in rural areas.Banks have to evaluate the trade-offsbetween those channels that are mostconvenient to customers and thosethat are the most protable. Banks are not

comfortable opening new rural branches

because many of those that already existare unprotable. Therefore, determiningthe right combination of channels is criticalto improving access in protable ways.

An innovative approach to improvingaccess will consider a combination ofthese channels. For example:

Branches and Satellite Branches

In addition to providing regular bankingoperations, providing backend supportto manage and audit the operations ofbusiness correspondents.

A low-cost, custom-made ATM

Managed by a business correspondentto bring down the operating costand scale the channel.

An e-kioskManaged by a businesscorrespondent with internet banking,ATM and POS terminal in relativelylarge rural areas.

A business correspondentUsingmanual ledgers or POS/Palmtop to actas deposit collector and remitting

agent in smaller rural areas.

While this list is not exhaustive, ithighlights the need for creative solutionsthat apply the right channel to theright market and transaction.

In South Africa, Capitec has combinedconvenient branches along transportationroutes (for example, train and bus stations,and taxi stops). In addition, it hasrolled-out debit cards and automatic tellermachines across 200 of these branchesto stimulate savings among low-incomeearners. Between February and August2004, the number of customers jumped fromaround 18,000 to more than 60,000.

Encouraging UsageThe presence of a banking channel doesnot guarantee that the rural customer willactually use that channel. In additionto access issues there are usage issues.To stimulate usage, banks need to improvetheir product mix, reduce total transactioncost, provide convenience, and clearlyoutline the eligibility criteria for products

and services (Figure 17, see Page 14).

Multi-Channel Approach to Meet Customer Needs and Ensure Channel Profitability


BusinesFacilitatorsCorrespondents

Satllite/Mobile Office Branch

High Medium Very High Low Negligible

ATM

InternetBanking/PhoneBanking/POS

AddressAccess Needs

of RuralCustomers

ImproveAccess

for RuralCustomers

EnsureChannel

Profitability

AccessCost

Ease ofAccess

RevenuePotential

Cost toServe

Figure 16


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With regard toproducts , rural customershave some critical needs, such asmicro-savings, micro-credit, remittancesand others which will require banks

to develop some innovative offerings.For micro-savings, banks could develop aexible savings product with daily depositcollection and withdrawal facilities. Abusiness correspondent carrying a manualledger or POS can facilitate such a product.For micro-credit needs, consumption loansneed to be designed. This is not entirelydifferent from giving purpose-free personalloans and credit cards in urban areas.Rather than not offering these loans at

all, banks should focus on managing creditrisk. For instance, banks may give suchloans only under the Joint Liability Groups(JLGs) format. Similarly, for remittances,banks need to accelerate the remittancesbetween various channels by improvingtechnology and connectivity.

SafeSave in Bangladesh is an exampleof how well-designed nancial servicesproducts can quickly become popular

amongst rural populations. SafeSavehas designed savings products whichallow the poor to save on a daily basis,withdraw as needed at their doorstep,and access credit products with exiblerepayment options.

Rural customers are concerned not onlyabout the interest rate, but also aboutindirectcosts (bribes, commissions,etc.) and expenses associated with

banking transactions. While interestrates of the formal banking system arenot high, the total transaction cost fora rural customer is. The government andRBI can relax rules around interest ratesfor loans less than Rs 200,00015 to allowbanks to manage the cost of credit risk.To reduce indirect costs to the customer,banks have to adopt simpler processesand documentation, and transparentand clearly dened norms. By allowingrural borrowers to use their approved

credit limits through credit cards, bankscan reduce their visits to branches andintervention by a bank ofcer. This will notonly reduce the cost of bank operations

but also reduce the burden of commissions/bribery at every stage of the process.

In South Africa, cell phone companiesare developing low-cost, cell phone-basedbanking services using short messageservice technology, often connected tomobile banking. Transactions, whichare being used mainly by poor customers,include balance inquiries, bill payments,money transfer, transaction alerts, and

account servicing.The primaryconvenience needs ofrural customers are bank operating hours,ease of transaction, and customer service.

Operating hours need to be tailored tobetter meet the needs of rural customers.In agricultural communities, for example,opening the branch in the morningand evening would allow farmers anddaily wage earners to bank withoutlosing a days work or wage. Alternativeoperating hours have, in fact, already

been implemented in urban areas wherebanks are open from 8:00am to 8:00pmor four hours in the morning and four hoursin the evening.

To improve the ease of operating anaccount, banks can print signature-readypay-in slips and withdrawal slips, whereinthe illiterate rural customer is requiredonly to tick the amount of deposit orwithdrawal and place a thumb impression.

Finally, to improve customer service,banks can recruit staff locally. Bankingcorrespondent channels have beensuccessful in some countries becausethey recruit local staff who betterunderstand the local customer.

Prodem in Bolivia is a successfulexample of how banks can increasecustomer usage by improving convenience.Prodem installed ATMs that incorporatebiometric ngerprint readers and voiceinstructions in three languages. TheseATMs, along with smart cards, can supportmany banking transactions and giventheir convenience, have been popularwith customers.

Improving Usage Desired Initiatives from Banks


AddressUsage Needs

of RuralCustomers

EncourageUsage ofServices

Bank Initiatives to

ImproveUsage

Product

Micro-savings Micro-credit Micro-insurance Remittances

Cost

Interest Rates Indirect costs

Bribes Commissions Documentation

expenses

Convenience

Banking Hours Ease of deposit

and withdrawal Friendly bank

officials

EligibilityCriteria

Eligibility foraccount opening,loans, and otherservices

Flexible savingsaccount

Bancassurance E-remittances Credit Cards and

personal loans Joint Liability

Group basedloans

Differential interestrate based oncredit history

Minimaldocumentation

Loan deliverythrough creditcards

Usage of palmtopsand POS for depositsand withdrawals

Flexible workinghours

Simpler pay-inslips andwithdrawal forms

Employeessensitive to localculture

Define eligibilityclearly invernacular

New credit scoringmodels to suitrural customers

New methods forsharing creditinformation

Note: Usage Needs are Not Exhaustive

Figure 17


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Uncertaineligibility criteria traditionallyhave been a barrier to usage. The processand guidelines to apply for loans areneither clear nor concrete. Rural customers

are never certain what is required toapply for a loan or whether they qualify fora certain product. In order to encourageconsumption banks need to clearlydene the loan qualication criteria in thelocal language. In addition, banks shouldensure that otherwise qualied candidates

are not denied credit. This can be achievedthrough proper credit scoring systemsthat assess credit risk of farmers andothers who have irregular cash ows, and

processes and systems which allow banksto share information. Most importantly,developing and enforcing clearly denedrules and educating the customers willhelp them to see the merits of the formalbanking system.

CECAM in Madagascar and Prizma inBosnia present two examples whereinnovative methods in developing creditproducts and credit methods helped

to include the poor in their clientele.CECAM developed credit products wherethe repayment of loans matches thecash ows of the borrower, and Prizmadeveloped customized credit scoremodels which help it keep track ofcustomers credit histories.


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There are 185 million bankable adultsin rural India who are unbanked becauseof access and usage issues. This presentsa signicant opportunity for commercial

banks. However, to reach this market andsubsequently build an inclusive nancialsystem, there must be a coordinatedand concerted effort by the three keystakeholders: the Government of India, the

Reserve Bank of India and the commercialbanks. In addition, partnerships betweenbanks and business correspondents, andcollaboration amongst banks is critical.

Furthermore, banks should tailor theirproduct and service mix to meet ruralneeds, and adapt their delivery modelsto ensure commercial viabiility of theirrural banking operations.

Conclusion


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End Notes

1. World Bank 2005

2. Reserve Bank of India 2005

3. w ww.cia.gov

4. National Sample Survey Organization (NSSO), Household Consumer Expenditure in India (2004)

5. Census 2001

6. Access to and Usage of Financial Services, World Bank 2003

7. RFAS, 2003, World Bank & NCAER

8. Reserve Bank of India, www.rbi.org.in

9. Access to Financial Services by Stijin Claessens, World Bank 2005

10. Rutherford Stuart, The Poor and their Money, January 2000

11. www.microsave-africa.com

12. RFAS 2003, World Bank

13. Bharat Nirman is a four year business plan of the Government of India to improve rural infrastructure

14. National Sample Survey Organization (NSSO) 2003

15. At present interest rates on loans less than Rs 200,000 are regulated.


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About the Firm Diamond (NASDAQ: DTPI) is a premier global management consulting rm that helpsleading organizations develop and implement growth strategies, improve operations,and capitalize on technology. Mobilizing multidisciplinary teams from our highlyskilled strategy, technology, and operations professionals worldwide, Diamond works

collaboratively with clients, unleashing the power within their own organizations toachieve sustainable business advantage. Diamond is headquartered in Chicago, withofces in Washington, D.C., New York, Hartford, London and Mumbai. To learn more,visit www.diamondconsultants.com.

.

About the Authors Vinod Nair is a Partner at Diamond and leads the rms India practice. He has workedwith clients in India, Europe, the Middle East, U.S. and South Africa on a range ofstrategic and operational issues. Vinod has focused on issues such as successful marketentry strategies, proposition development and marketing planning, analytical marketingtechniques to improve customer lifetime values, and operational improvement effortsto reduce costs and streamline processes. His clients include leading corporations in thetelecommunications, nancial services, media, automotive and manufacturing sectors.In nancial services, he has worked with retail banks and credit card issuers on deningnew payment solutions and exploring partnerships between retail banks and mobileoperators. He has also advised leading private equity houses on potential transactionsin Europe and in India.

Andrew Soeld is a Manager in Diamonds Financial Services practice. Andy has experiencein retail nancial services organization, product, marketing and communication strategy,process and policy reengineering, competitive analysis, and operations management.He has also worked as a strategy, operations, and change management consultant inthe telecommunications, health care and product sectors. Throughout his consulting careerAndy has gained extensive international experience, having lived, worked, or travelledin more than 50 countries on six continents. His most recent international initiative hasbeen helping open Diamonds ofce in Mumbai, India.

Vijay Mulbagal is a Senior Associate in Diamonds Financial Services practice. Vijayhas nine years of experience working in commercial banking in India. He has workedacross multiple segments, including retail banking, operations, trade services, micronanceand corporate banking, in both domestic and multinational banks. He has signicantexperience in client relationship management, due diligence, structured problems analysis,and project management.


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