By Aniket Baksy
Edited by Shambhavi Singh, Senior Editor, The Indian Economist
As with most things associated with India’s new Prime Minister, the Pradhan Mantri Jan Dhan Yojana is a grandiose proposition. The project aims at rapidly achieving universal financial inclusion and boosting access to banking, life insurance and formal sector credit via a massive expansion of Formal Public Banking and Credit. It is currently off to an incredible start. As of August 30, 2014, 15 million accounts had been opened across India, as compared to a targeted 10 million. By the end, 77,852 camps had been held across the nation, with Union Ministers and Chief Ministers alike participating at over 600 programmes. The Prime Minister has revised his targets for the programme, according to which a cumulative of 75 million accounts will be opened by Republic Day, 2015. The targets proposed will require the addition of 50,000 new Bank Correspondents, 7,000 new Branches and 20,000 new ATMs, and this is just in Phase 1. The programme’s specifics are impressive; customers opening an account before January 26 will receive a life cover of INR 30,000, a RuPay Debit card with in-built accident insurance of up to 1 lakh, and an overdraft facility of INR 5,000 subject to “satisfactory operation of the account” for at least 6 months. Additional measures for Financial Inclusion included a mobile banking facility on basic phones, a part of the massive telecom and digitisation drive underway across the Nation[i].
Does India need a massive Financial Inclusion programme? It unambiguously does. The World Bank’s database on financial inclusion for India shows up some rather sobering statistics: in 2011, only 35% of the adult populace had an account at a formal financial institution, a small 8% had an account in which they received their wages, 12% saved in a financial institution (in 2010), and only 8% had taken a loan from a financial institution in 2010[ii]. Credit and Financial Inclusion issues impede the rollout of ambitious Market-based solutions to problems in education (Voucher Schemes) and in direct poverty alleviation (the DBT scheme), thus allowing notoriously leaky in-kind subsidies to proliferate.
In a developing economy, no concerted effort to alleviate poverty can ignore the role of financial inclusion. In the presence of inadequate access to formal credit, an expansion of formal credit from a low base is, in the short term, inequality-increasing[iii]. Access to credit on relatively easy terms allows households to smooth consumption over time. This helps them better deal with income shocks and risk-vitally, which is crucial given the degree of risk involved in Agriculture, the primary activity which individuals engage in. Smoothing consumption can translate into investments in the health of the labour force, raising individual labour productivity. Credit can facilitate for families above a subsistence level, investments in productive technology, and inputs (for instance, better seeds, fertilisers and even machinery). These investments can in turn, boost permanent incomes through the increased productivity of labour they are combined with. A healthier level of income at the bottom of the pyramid will finance more inclusive and rapid consumption and investment-driven growth in India. At higher income levels, boosting financial access can lead to an entrepreneurship-driven boom[iv]. This is particularly relevant to India, given the new Government’s drive to tap into the hitherto latent energies of small enterprises as an attempt at rapidly escaping poverty traps in underdeveloped regions. The Budget in 2014 delivered by the Modi Government has laid down several entrepreneurship promotion schemes[v]; the PMJDY can certainly prove to be the base on which any such scheme can take off. The Financial Inclusion Initiative can also link directly into several other major schemes the Government has launched, including schemes for universal housing[vi].
Certain peculiarities in India’s social structure and savings habits also make a widespread programme of financial inclusion an urgently needed reform measure. India’s populace has traditionally lacked access to developed financial institutions, thus fostering a culture of mistrust towards institutions claiming to keep their wealth in safe storage. Personal relationships developed with local moneylenders and informal lenders are usually thus trusted more than Banks are, when it comes to taking a loan. While many Indian households save adequate amounts, their savings are usually in the form of illiquid assets or in the form of long-term physical investments in fixed assets, land or housing, from which rents can be derived. Financial Inclusion and the expansion of financial institutions offer higher rates of return than the return on small property or on Gold. This will attract the savings of this class of Indians, thus boosting the pool of loan-able funds we need to re-start an investment boom in the Economy.
Before prophesising how the programme will benefit millions through increased accounts for the masses, solve basic adverse selection problems in rural insurance markets, boost household-level productivity-enhancing investments via its Overdraw facility, it’s important to realise the imperfections of the scheme. As with any kind of Government policy, balancing optimism and intent with a hard-headed calculation of Costs and Benefits is usually a good idea. It’s tough to estimate, however, the cost of the scheme. While the Capital infrastructure that will be necessary might exist in large measure, at least for the first phase, the scale of the scheme implies that no assessments can be forthcoming. Setting up 20,000 ATMs and 7,000 new Brick-and-Mortar Bank branches across the nation will not come cheap. Nor will paying a minimum of INR 5,000 a month to the 50,000 new Banking Correspondents who’ll be necessary[vii].
And the costs don’t end here.
There are minor hurdles, such as the fact that rapid account opening conflicts with certain KYC norms established by the RBI to safeguard the stability of the Banking sector (these have, of course, been relaxed by the RBI to an extent[viii]). There isn’t too much clarity on how the PMJDY will fit in with the RBI’s Payment Banks and the rest of the financial infrastructure in India, ranging from MFIs to state-backed local financial institutions to money lending to illegal Chit Funds. A lot is simply indeterminate and will be realised based on complex interactions across different institutions, although some theories on how this will play out have emerged[ix].
The bureaucratic costs and the potential for corruption and misuse, as well as data misrepresentation, should be evident. Pushing Public Banks to open as many accounts as they can- the missive is, two accounts per household- could very well become a tool in the hands of bureaucrats in order to strengthen their hold on the Indian financial system. Opening accounts arbitrarily, or worse, falsifying account expansion data could be incentivised in a system that promotes quantity in the absence of a solid monitoring mechanism for activity in accounts[x].
It’s not immediately apparent how the PMJDY will target the moral hazard problems an Overdraft facility generates, wherein borrowers can take advantage of high monitoring costs to default on their payments. It isn’t clear either on how incorporating the poor within formal banking can generate benefits if they lack the ability to regularly monitor and operate these accounts, and develop a culture of depositing savings and cash income in Banks.
Much more serious is the potential for a massive adverse shock to the economy from simultaneous agrarian failures: Public sector Banks that already have high Net Non-Performing Asset ratios will find themselves increasingly lending to lenders who are decidedly “subprime”. This implies that India’s largest public sector Banks will be more prone to the systemic risk an adverse monsoon, say would generate. It’s not inconceivable: a bad monsoon could lead to systematic National defaults on loans, leading to a rapid rise in Bank NPAs. To meet prudential capital adequacy norms, banks would impose instant credit rationing. In turn, this would cause a sudden industrial shock as firms fail to get sufficient credit to service their existing debts and immediate capital and operating expenses. India won’t just suffer financial meltdown[xi]; it’ll suffer an overall economic collapse of catastrophic dimensions.
Saving the fragile financial sector while adding over 70 million high-risk households to it, will require some hard choices and smart prudential regulation of Bank lending. While overdraft facilities are welcome, means of alleviating short-term distress for the poor, repayments must be monitored as closely as possible; borrowers with a history of poor repayment capacity must be to an extent excluded from imposing an adverse selection problem on those with good repayment records. Trading off equity and moral prudence over pragmatism is something that needs to be done.
A programme for Financial Inclusion as ambitious as the PMJDY needs to be lauded, if for nothing else, for the scale of its vision. Nonetheless, the true benefits of financial inclusion will accrue to individuals only when a comprehensive financial structure is in place to include the poor in the ambit of the sector ultimately most responsible for the allocation of resources[xii]. The future of the PMJDY will need to include the development of large primary and secondary markets in tailor-made financial products for the poor, something that is woefully lacking in India today. It will depend on its ability to synergise with programmes for entrepreneurship and self-employment in India. It will require, above all, a concerted focus on financial literacy and developing the ability to utilise finance for productive purposes. It needs to be combined with income support that will allow households to take loans for investment purposes, and not just finance consumption over the annual period. This is a tall order.
The World Bank. 2013. “Financial Inclusion Data, Country Dashboard: India.” The World Bank Website. Accessed August 28, 2014. http://datatopics.worldbank.org/financialinclusion/country/india.
 In the presence of Collateral constraints only the relatively wealthy are likely to be able to borrow against adequate collateral. If formal sector interest rates are lower than informal rates, poorer individuals are stuck in a debt trap situation where their debt as a fraction of income rises constantly, while the wealthy can pay lower interest rates and refinance debts repeatedly, eventually accumulating enough capital to engage in productive activity allowing for further human capital accumulation. This exacerbates inequality and tension, especially if initial inequality was along social axes such as caste and religion, and is exemplified in the reaction of AP’s farmers to MFI credit.
 This is seen in the example of China in the late 1980s (although in China, much of this lending was accomplished at state-determined below market clearing interest rates, thus a majority of the eventual financial inclusion achieved occurred in the Shadow Banking Sector).
 These Schemes include Venture Capitalism promotion, schemes to promote entrepreneurship among SC’s and ST’s, Textile clusters and so on.
 Back of the envelope calculations: If it costs around INR 1 lakh per ATM and around 1 crore to establish the necessary infrastructure for a Brick and Mortar Branch, the initial establishment costs work out to over INR 72 billion (INR 7225 crore, as compared to the now infamous “100 crore allocation”). This is the initial cost and a month’s salaries for the Business Correspondents (BC’s). After this, per month, the cost would be nonetheless significant: of the order of 40% of rural revenues for Bank establishments alone, not to mention costs of ATM maintenance and BC salaries.
 KYC Norms involve the provision of customer information and documentation to Banks in order to verify identity and generate credit ratings for riskiness of customers. The RBI relaxed these norms on 27 August. http://timesofindia.indiatimes.com/business/india-business/RBI-simplifies-KYC-norms-ahead-of-Jan-Dhan-Yojana-launch/articleshow/41005593.cms
 A Sub-Prime Crisis may well be in the making; anyone who followed the events of 2008 will recall that the US Government’s decision to “include” minorities in the access to housing finance was in no small way responsible for the boom in subprime lending.
Aniket is a third-year student at St. Stephen’s College, Delhi and an Editor of the Economics Society. His inclinations extend to economic issues, and macro-level socio-economic policies and their possible impacts. He is a prolific reader, with tastes for popular science, economics and policy, science fiction and historical fiction. An inherent urge to argue and avid debating aside, his passions include Economics, Instrumental Hindustani Classical Music, Gastronomy, and writing