BENGALURU: What are the economic impediments to greater financial inclusion? Perhaps the most important is the economic condition of the excluded. World over, the poor, the small, and the remote are excluded. It is not just because the financial system is underdeveloped, but because they are hard to service profitably. Nevertheless, this is not a reason to abandon hope, but to ask how we can overcome the impediments in the way of inclusion. The best way to characterize the impediments are through the acronym IIT: Information, Incentives, and Transaction Costs.
IIT
The excluded may live in remote areas or may belong to communities or segments of society that undertake economic activity informally – they do not maintain records or have signed contracts or documentation. They often do not own property or have regular established sources of income. As a result, a banker, especially if as is typical, he is not from the local region, will have difficulty getting sufficient information to offer financial products. A second concern is incentives. For example, loans are easily available only if the lender thinks he will be repaid. When the legal system does not enforce repayment quickly or cheaply, and when the borrower does not have any collateral to pledge, the lender might believe that he will find it difficult to get repaid.
The third impediment is transactions costs. Since the size of transactions by the poor, or by micro farmers or enterprises is small, the fixed costs in transacting are relatively high. It takes as much time helping a client fill out the forms and to provide the necessary documentation if he is applying for a loan for `10,000 as it takes to help another one borrow `10 lakhs. A banker who is conscious of the bottom line would naturally focus on the large client in preference to the tiny one.
How does the moneylender manage?
One of the primary motivations for the country to push financial inclusion is to free the excluded from the clutches of the moneylender. How does the moneylender boldly lend where no banker dares to lend? Because he does not suffer the same impediments! Coming from the local community, the sahukar is well informed on what everyone’s sources of income and wealth are, and how much they can repay. He is quite capable of using ruthless methods to enforce repayment.
Moreover, the borrower knows that if he defaults on the sahukar, he loses his lender of last resort. So the borrower has strong incentives to pay. Finally, because the sahukar lives nearby and uses minimal documentation – after all, he is not going to use the courts to force repayment – loans are easily and quickly obtained. In an emergency or if the poor need to borrow on a daily basis, there are few more readily available alternatives than the moneylender. No wonder he has so many in his clutches.
How then should public policy approach this problem? I will now describe three approaches: mandates and subventions, transforming institutions, and moving away from credit.
The Changing Paradigm for Financial Inclusion excerpted from I Do What I Do by Raghuram G Rajan, with permission from HarperCollins India. The book is now out in paperback.