RURAL BANKING AND FINANCIAL

INCLUSION

TERM-4
REFLECTION MEMO NO.1

Date: BY:
16th JUNE MAYANK UPADHYAY
1711031
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Introduction:
Access to timely, affordable and adequate financial resources have been identified as an important
tool through which the objective of inclusive growth could be realized. So, why some individuals are
marginalised from granting loans?

Subprime mortgage crisis was a national banking emergency that explains exclusion of included from
formal banking channels and limitation of mainstream banking channel to include everyone in
banking system.

Exclusion of Included:
Subprime Borrowers: Defined as someone who does not have steady flow of disposable income and
adequate assets, defaulted in past and has bad credit standing.

Excess liquid capital and notion that housing will always be a boom market leads to lending to more
subprime borrowers at lower rates. Overheating of housing market resulted in housing bubble burst
and subprime borrowers defaulted and hence got excluded from banking system because of bad
credit standing.

Too big to Fail:

Banking system works on mutual trust of borrowers and lenders. Banks like ICICI, SBI, HDFC are
considered D-SIB i.e. domestically systematically important. So, when a big size bank like PNB
defaults, it disrupts the entire banking process. Losses from the defaults have to be ultimately born
by taxpayers. When banking system goes through a distress, lenders sell off their portfolio,
borrowers stop borrowing and entire banking system suffers.

Laid back Model:

For bankers, security against the loan and cash flow to operate both are important. Hence a
customer must be able to prove steady source of income, fungible asset possession, good
transaction trails through documentation. Those who can’t is marginalised from mainstream banking
system.

Financial Inclusion:
Mis-selling of product to vulnerable section and building financial superstructure without knowing
the foundation is a bad strategy. In most cases, financial inclusion is considered as social
responsibility rather than market opportunity. (State banks are mandated to have branches in rural
areas)

Problems associated with Financial Inclusion:

1. Establishment of identity of deprived class

2. Transaction trail of deprived class
3. Fungible collateral possession by deprived class

Models, that have/had promised solution:

Money Lending Model:

Informal model based on loan repayment mechanism:

1. Embedded Model: Operates on trust

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 2. Coercive Model

Two types of Coercive model one through physical coercion and second through social coercion.
First one is illegal. Social coercion for loan recovery is used in subsequent models.

High rates of interest and physical coercion are the major shortcomings of the model.

Chit Fund Model:

It is a bridge between mainstream banking and money lending model. Model ensure access to future
savings. A group of borrowers and lenders pool their money at common place on timely basis for a
period and withdraw based on urgency of fund requirement.

Operation without registration, rigging up of bids, stopping contribution of money after winning the
pot are the major drawbacks of the model.

Micro Finance Institutes: “Loan making is easier though recovery is tough”

An opportunistic model, important features:

1. Group lending: Group receives loan which internally ensure self-monitoring of loan
repayment through peer pressure. In case of default, group members can pay on behalf of
others.
2. Progressive Loan: Less information asymmetry as compare to main stream banking model
since loan officer enquire and acquire detailed information about the background of
potential customer before granting. Initially, loan granted on basis of social embeddedness
and subsequent cycle of loan granted based on transaction trail of previous loan.
3. Transaction Size: Small amount and frequent repayment cycle reduces risk of big loss.
4. Loan repayment: No collateral but social coercion for loan repayment. Lean forward
approach to collect loan payments and absolutely no tolerance to default.

Cost saving:

Small loans are often costly for MFIs because of lack of economies of scale. Hence MFIs follow the
lean forward model to reduce cost of operation and efficient collection of loan repayments.

Supply side solution: By standardizing loan amount and aggregating customers based on transaction
type results in reduced operation cost.

History of MFIs:

Gramin Bank:

Differential and additional Features:

1. Customers are divided in to groups and repayment period is fixed.

2. Group dynamics is such that two people with blood relation are avoided within the group.
3. Almost door step service: Lean forward approach to collect loan repayments. Transaction
happens at Village chaupals in front of many people which put social pressure on borrower
to repay.
4. Ritual to recite 16 decisions to ensure loan repayment hygiene.
5. Frequent loan recovery i.e. per week. In turn promote diversity of occupation in agrarian
society and hence encourages women to opt for occupation like Poultry farming and
vegetable vending etc.

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 6. In Gramin 2, ritual of circular seating is followed where credit officer sits in circle with
borrowers which is a symbol of equality where as in Gramin 1, seating arrangement was
rectangular.

When does the group dissolve?

Exclusion of group members because of two reasons 1.) Self exclusion 2.) Defaults

Self-Exclusion:

Unwilling to repay because (s)he doesn’t need the loan any more. To avoid this Gramin bank do
asset test to establish poor financial health of customer in beginning.

Default:

1.) Default due to unavoidable circumstances like natural disaster.

2.) Blood relatives with in the group may result in defaults.

Therefore, diverse loan groups are designed which include customer of age group from 18 to 60 and
no two blood relatives are kept in same group.

In addition, Gramin banks have compulsory saving programme where group has to ensure minimum
saving every week and give group tax. The money is later utilized to write-off loan in case of death of
male member of family and other genuine reasons.

Association for social advancement and Bandhan bank:

Additional features:

1. No groups, but concept of centres.

2. 2 weeks of voluntary default is permitted. (Press points are identified)
3. Absolute level of standardization from size of board to type of chairs in office.
4. Bandhan bank: At the time of loan recovery, credit officer ensures to reset the loan
repayment date if repayment doesn’t happen.

Shortcomings of MFI model:

Excessive standardization:

High level of conceptualization at upper level, hence require under qualified credit officers.

Agrarian society:

Over reliance of farmers on harvesting season and seasonal income source limit their loan paying
capability. Hence weekly repayment of loans become difficult for them. On other hand Gramin bank
encourages women to participate in alternative livelihood options.