TALKING FINANCIAL

INCLUSION IN
LIBERALISED INDIA

This book presents a set of conversations with five former Governors and the
present serving Governor of the Reserve Bank of India (from 1992 onwards)
on the topic of financial inclusion. Two key aspects are introduced in the con-
versations with each Governor: the initiatives that were undertaken during
their tenure and their responses to some of the current issues. Further, they
examine the reasons and justifications for significant decisions and measures
that were undertaken or withheld. The discussion captures the evolution and
approach of the central bank in addressing a variety of questions pertaining to
financial inclusion.
The volume is an important contribution to the study of India’s continuous
but not entirely successful efforts in increasing the reach of its formal finan-
cial sector. It reconstructs how the policy approach to inclusive banking has
progressed and resisted commercial and market imperatives to safeguard the
deprived and dispossessed sections of society.
With its wide-ranging blend of conversations, documentation, research
and commentary coupled with its engaging style, the book will interest stu-
dents and researchers in the areas of development, banking, macroeconomics,
public administration and governance, as well as academics, analysts, policy-
makers, think tanks, journalists, media and those concerned with the Indian
economic policy.

M. S. Sriram is a member of the faculty at the Centre for Public Policy, Indian
Institute of Management Bangalore, Bengaluru, Karnataka, India. He is also
Distinguished Fellow of the Institute for Development of Research in Banking
Technology, an institute established by the Reserve Bank of India (RBI). In
the past he was the ICICI Bank-Lalita D Gupte Chair Professor of Microfinance
at the Indian Institute of Management Ahmedabad; member of faculty at the
Institute of Rural Management, Anand; and Vice President of Basix. He has
authored the annual Inclusive Finance India Report for 2015, 2016 and 2017.
He has served on the External Advisory Committee of the RBI for granting
licences to Small Finance Banks; chaired an expert committee to examine the
feasibility of establishing an integrated Kerala Co-operative Bank; and was a
member of the Vaidyanathan Committee for co-operative reform.
TALKING FINANCIAL
INCLUSION IN
LIBERALISED INDIA
Conversations With Governors
of the Reserve Bank of India

Edited by M. S. Sriram
First published 2018
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
711 Third Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2018 ACCESS ASSIST, New Delhi.
The right of M. S. Sriram to be identified as the author of the editorial
material, and of the authors for their individual chapters, has been asserted
in accordance with sections 77 and 78 of the Copyright, Designs and Patents
Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or
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without intent to infringe.
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ISBN: 978-1-138-74467-7 (hbk)
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 Dedicated to

Professor A. Vaidyanathan, guide, mentor,

teacher and a friend and to
Usha and Yashwant Thorat, for all the guidance,
conversations, clarifications and passion about
financial inclusion.
 CONTENTS

Preface ix
Acknowledgements xi
Abbreviations xiv
Notes on contributors xvii

Introduction 1

1 Conversations with Dr C. Rangarajan 31

2 Conversations with Dr Bimal Jalan 51

3 Conversations with Dr Y. V. Reddy 63

4 Conversations with Dr Duvvuri Subbarao 86

5 Conversations with Dr Raghuram G. Rajan 113

6 Conversations with Dr Urjit R. Patel 126

Annexure 1 Report of the Committee on the financial

system, 1991 133

Annexure 2 Report of the Committee on banking sector

reforms, 1998 150

Annexure 3 Report of the Committee on financial

inclusion, 2008 173

vii
 CONTENTS

Annexure 4 Report of the sub-committee of the

Central Board of directors of the
Reserve Bank of India to study issues
and concerns in the MFI sector, 2011 215

Annexure 5 Report of the internal working group to

revisit existing priority sector lending
guidelines, 2015 222

viii
 PREFACE

It has been a little over a quarter century since India ushered in eco-
nomic reforms, reflecting a partial withdrawal of the state in favour of
the market forces. The reform process has resulted in ease of doing
business, abolishing the requirement of seeking licences and cutting
out the bureaucratic red tape, thereby unleashing the entrepreneurial
spirit. This spirit is most pronounced in the services sector. While this
process of liberalisation happened faster in the other sectors, the bank-
ing sector has been cautious in opening up. While in many sectors the
government can bring in the reform process, in the financial sector
there are agencies that have to act in concert with the objectives of the
government – institutions like the Reserve Bank of India or the Securi-
ties Exchange Board of India – which represent the larger concerns of
macroeconomic stability. In addition, these agencies not only have a
regulatory function, but an implicit developmental role as well.
In this background, it was felt that it would be interesting to examine
how the landscape for financial inclusion has changed over the years
of reforms and liberalisation. While the Indian financial sector was
accused of being somewhat slow in deepening the financial markets,
it was also hailed for being careful when the global financial crisis hit
the world of finance in 2008. While the archival material and policies
would give a flavour of the official position on how the agenda of
financial inclusion evolved, conversations with the people who were
at the helm of policy making would give an indication into the thought
process. It was in this background that we conducted interviews with
the Governors who held office from 1992 to the present day.
While the interviews give the logic and reasoning and also respond to
the events happening currently, the introductory chapter gives an over-
view of the large initiatives taken by the Reserve Bank of India during
these years. We have also taken care to provide detailed footnotes on

ix
 P R E FA C E

the background of the terminology and the events used in the book.
A set of annexures gives a more detailed sense of the important docu-
ments that informed the policy making.
This is a unique book that tries to look at policy making not only
from an analytical perspective, but also engages with the main per-
sonalities who were involved in setting the policy, and it is hoped that
this approach will throw a new light on how the agenda of financial
inclusion evolved not only from the policy perspective, but also from
the perspective of clients, institutions and markets.

x
 ACKNOWLEDGEMENTS

A book is always a collective effort, with a disproportionate individual

acknowledgement going in favour of the author. There is always a debt
of gratitude owed to the intellectual tradition that inspires the book,
which comes in the form of readings, research, conversations and expe-
riences that is so difficult to pinpoint and acknowledge. However, there
are also direct debts of gratitude that one owes to a specific endeavour.
While human limitations would not permit acknowledging each and
every contribution, we should be in a position to acknowledge the most
significant ones.
The idea of the book was not instantaneous, and it evolved over
a period of time as I was doing the Inclusive Finance India Report
for ACCESS-ASSIST. Friends in ACCESS ASSIST were the ones who
funded the endeavour and provided me all support – logistical, finan-
cial, secretarial and moral – never questioning my judgement and
always supportive. For this I would like to thank the advisory com-
mittee of the Inclusive Finance India Summit, Vipin Sharma and Rad-
hika Agashe of ACCESS ASSIST. Anshu Singh and Keerti Bhandary
were with me in almost all the interviews, helped me with the tran-
scripts and also managed much of the administrative part of the work.
Lalitha Sridharan was ever willing to ensure that I travel well and stay
comfortable. I cannot thank the team of ACCESS ASSIST enough.
The support I have received from each of the Governors was heart-
warming. Each one of them was welcoming, gave more than the time
that was negotiated for, went through the transcripts meticulously and
reverted with their inputs and comments in quick time. I am indeed
thankful to Dr Raghuram Rajan who was in office at the time of the
interview and Vivek Aggarwal who was with Dr Rajan’s office at that
time; Dr Jalan who, apart from having a lively conversation, had also
prepared a set of preliminary answers for the draft set of questions

xi
 ACKNOWLEDGEMENTS

I had sent him; Dr Subbarao who on a hot afternoon at his residence

offered some lovely tea, air-conditioning and quality time when he
himself was in the process of finalising the proofs of his book; Dr
Rangarajan who gave the interview over a crucial hour when results
were declaring that the All India Anna Dravid Munnetra Kazhagam
led by J. Jayalalitha was romping back to power; and Dr Y. V. Reddy
who spent long hours not only talking about the issue, but also going
over the interview multiple times and giving me more insights every
time I met him later. In fact, Dr Reddy, in particular, followed up on
the progress of the work and added new dimensions and ideas as to
how the book could be presented better.
Lastly, I am thankful to Dr Urjit R Patel who readily agreed to speak
to me amidst his very tight and busy schedule; Rajan Goyal in his
office who patiently co-ordinated all the pre- and post-interview inter-
faces needed with the Governor’s office.
I would also like to place on record my deep appreciation for
Prof. M. Govinda Rao, who took much interest in the manuscript
and also helped me with introductions that were so necessary for the
book to bear fruition. How I wish there were many more with his
enthusiasm and passion! I would also like to thank Prof. Ravindra
Dholakia for helping with the necessary interface with RBI and Usha
Thorat with whom I shared much of the thoughts as they were being
crystallised.
At the Indian Institute of Management, my colleagues Arnab
Mukherji and Shabana Mitra were very much a part of this journey,
as we would discuss the aspects that came into the interviews over
cups of coffee in Vasudeva’s Amrit Kalash. My secretary, Namratha,
managed my office and my appointments, and I am ever thankful to
her for the support.
Back home, my wife Gowri, who would wonder why I am always
on the computer, but was always supportive of all my professional
work, and my son Arjun who has turned out to be more a friend with
whom one could share many a joke and also all the frustrations.
A set of friends who always lent a patient ear to this project as
it progressed – Anirudh Krishna of Duke University, Ankur Sarin of
IIM Ahmedabad, M Rajshekhar of Scroll, Vivek Shanbhag my writ-
ing buddy – were all very appreciative and encouraging as the project
progressed.
And of course, Shoma Choudhury of Routledge who was con-
vinced that there was a book in this idea the moment I told her and
the swiftness with which she went through the review process. I am

xii
 ACKNOWLEDGEMENTS

also thankful to two anonymous reviewers – thanks to their inputs

the book is more complete, more academic and possibly has greater
respectability.
Of course, as usual, the failings in this endeavour could only be due
to my own inadequacies of not being able to take all the help and the
good things coming my way.

xiii
 ABBREVIATIONS

AP Andhra Pradesh
ATM Automated Teller Machine
ARF Asset Reconstruction Firm
BC Business Correspondent
BFS Board of Financial Supervision
BFRS Board of Financial Regulation and Supervision
BIS Bank for International Settlements
BSRB Banking Services Recruitment Board
CAB College of Agricultural Banking
CBO Community Based Organisation
CBS Core Banking Solution
CCI Controller of Capital Issues
CD Credit-Deposit
CDR Credit-Deposit Ratios
CESS Centre for Economic and Social Studies
CMD Chairman and Managing Director
CRAR Capital to Risk-weighted Assets Ratio
CRR Cash Reserve Ratio
CSP Customer Service Point
DBT Direct Benefit Transfer
DFI Development Financial Institution
DLCC District Level Credit Committee
GCC General Credit Cards
GFC Global Financial Crisis
GDP Gross Domestic Product
GoI Government of India
IBA Indian Banks’ Association
IDBI Industrial Development Bank of India
IMF International Monetary Fund

xiv
 A B B R E V I AT I O N S

IRDP Integrated Rural Development Programme

IT Information Technology
IWG Internal Working Group
JLG Joint Liability Group
KCC Kisan Credit Card
KYC Know Your Customer
LAB Local Area Bank
MFI Microfinance Institutions
MSME Micro, Small and Medium Enterprises
MUDRA Micro Units Development and Refinance Agency
NABARD National Bank for Agriculture and Rural Development
NBFC Non-Banking Finance Company
NBFC-MFI Non-Banking Finance Company-Microfinance Institution
NER North-Eastern Region
NGO Non-Governmental Organisation
NHB National Housing Bank
NPA Non-Performing Assets
NSDP Net State Domestic Product
OBC Other Backward Castes
PACS Primary Agricultural Co-operative Societies
PB Payments Bank
PDS Public Distribution System
PMJDY Pradhan Mantri Jan Dhan Yojana
PMMY Pradhan Mantri Mudra Yojana
PSL Priority Sector Lending
PSLC Priority Sector Lending Certificates
RBI Reserve Bank of India
RNBFC Residuary Non-Banking Finance Company
RRB Regional Rural Bank
RSCP Rural Sector Credit Plan
SBI State Bank of India
SC Scheduled Castes
SEBI Securities and Exchange Board of India
SFB Small Finance Bank
SFC State Finance Corporation
SFDA Small Farmers’ Development Agency
SGSY Swarna Jayanti Swarozgar Yojana
SHG Self Help Group
SIDBI Small Industries Development Bank of India
SLBC State Level Bankers’ Committee
SLCC State Level Coordination Committee

xv
 A B B R E V I AT I O N S

SLR Statutory Liquidity Ratio

ST Scheduled Tribes
UCB Urban Co-operative Bank
UIDAI Unique Identification Development Authority of India
USP Unique Selling Proposition
UTI Unit Trust of India
VDB Village Development Boards
VRS Voluntary Retirement Scheme

xvi
 CONTRIBUTORS

Bimal Jalan was the Governor of the Reserve Bank of India from 1997
to 2003. Prior to that he was the Chief Economic Advisor, Govern-
ment of India, Banking Secretary and Finance Secretary. He was
also nominated as a member of the Rajya Sabha. He has in the past
also served as Executive Director of the International Monetary
Fund and World Bank, Member Secretary of the Planning Commis-
sion and Chairman of the Expenditure Management Commission
during 2014–2016.
Urjit R. Patel is currently the Governor of the Reserve Bank of India.
He was the Deputy Governor of RBI prior to assuming office as
Governor. In the past, he has served as a Senior Fellow at the Brook-
ings Institute, USA; Executive Director, Infrastructure Development
and Finance Company, India; Advisor to the Boston Consulting
Group, USA; and has also worked with the International Monetary
Fund, USA.
Raghuram G. Rajan was the Governor of the Reserve Bank of India
from 2013 to 2016. Prior to that he was the Chief Economic Advi-
sor, Government of India, Chief Economist at the International
Monetary Fund and Economic Advisor to the Prime Minister of
India. He is currently the Katherine Dusak Miller Distinguished Ser-
vice Professor of Finance at the University of Chicago Booth School
of Business, USA.
C. Rangarajan was the Governor of the Reserve Bank of India from
1992 to 1997, and a Deputy Governor prior to that. He was also
the Governor of Andhra Pradesh, Chairman of the Twelfth Finance
Commission, Chairman of the Prime Minister’s Economic Advi-
sory Council, member of the Rajya Sabha and a professor at the

xvii
 CONTRIBUTORS

Indian Institute of Management Ahmedabad, India. Rangarajan is

currently the Chairman of the Madras School of Economics, India.
Y. V. Reddy was the Governor of the Reserve Bank of India from
2003 to 2008 and was its Deputy Governor from 1996 to 2002.
He served as an Executive Director at the International Monetary
Fund (2002–2003). He was also in the Government of India as Sec-
retary in the Ministry of Finance and in the Government of Andhra
Pradesh as Principal Secretary. He was Chairman of the Fourteenth
Finance Commission (2013–2014). He is currently Honorary Pro-
fessor, Centre for Economic and Social Studies (CESS), Hyderabad.
Duvvuri Subbarao was the Governor of the Reserve Bank of India from
2008 to 2013. Prior to that he was finance secretary to the Govern-
ment of India, and secretary to the Prime Minister’s Economic Advi-
sory Council, India. Subbarao is currently a Distinguished Visiting
Fellow at the National University of Singapore, Singapore.

xviii
 INTRODUCTION

State of financial inclusion in India:

in search of focus
From a supply-driven, state-owned provision of financial services to
the excluded, the country has significantly moved in making finan-
cial inclusion a larger agenda. If we were to look at financial inclu-
sion from the time of independence onwards, we can possibly break
this up into four phases – the first phase of co-operativisation; the
second phase of bank nationalisation; the third phase of institu-
tional tinkering; and the fourth phase of providing a framework for
private sector participation and bank-led initiatives. The fourth
phase is opening up multiple possibilities both in terms of the tech-
nology adopted in the financial inclusion space as well as the insti-
tutional infrastructure. In this introduction, in Part I, we will briefly
describe the earlier phases, and in Part II discuss the post-
liberalisation phase – covered largely in the other chapters of con-
versations – in detail.

Part I
Historically, the efforts of the State to bring the poor into the banking
system has worked at multiple levels, without sharp definitions, and
therefore has resulted in creating opportunities for inclusion rather
than having a focussed and planned approach to inclusion. It is impor-
tant to recognise this continuing fallacy and define the aspect of inclu-
sion sharply if we are to ensure that the institutional and technological
architecture works for the poor.

1
 INTRODUCTION

Phase 1: local institutions; agriculture;

credit is inclusion
The first phase can be seen from independence all the way up to bank
nationalisation. Following the report of the All India Rural Credit Sur-
vey Committee report in 1954, two significant steps were taken – both
to enhance access to credit in the rural areas. First was nationalisation
of the Imperial Bank of India and re-christening it as the State Bank of
India (SBI). Till about 1967, the SBI opened 1,468 branches in the
rural sector, which was partly financed by the development fund cre-
ated by the Reserve Bank of India (RBI). The SBI also had access to
refinance from the RBI (Reserve Bank of India 2014).
In addition, the report suggested a state partnership with co-
operatives. As a result, there was much state support for promotion
of Primary Agricultural Co-operative Societies (PACS) that were
spread across the length and breadth of the country. At its peak, there
were nearly 100,000 rural co-operatives, federated into district co-
operative banks and further federated into a state co-operative bank.
The idea and thrust during that phase was that the state would part-
ner with people in promoting co-operatives. Once the co-operatives
were large enough, it was expected that they would run on their own,
and the state would withdraw from active participation. However, the
State continued the function of refinancing the co-operatives through
the central bank.
The entire paradigm of these institutions was centered on trying
to get the poor out of the clutches of the “evil” moneylender (see
Chapter 3: Conversations with Dr Y. V. Reddy). People’s institutions
would empower them, and they would manage their own institutions.
The focus was (a) rural, (b) agriculture and (c) credit. In a way, these
three buzzwords were used as a proxy for solution to exploitation,
poverty and providing empowerment. It did achieve the overall objec-
tive in some sense. The successive debt and investments surveys showed
that the relative share of co-operatives increased in comparison to the
informal moneylenders as far as rural indebtedness was concerned.
Table 0.1 clearly shows how the co-operative sector rapidly gained
share from the informal market – from a mere 3.1% of the house-
hold credit coming from the co-operatives in 1951, rising to 20.1%
by 1971. This was the era of state partnership with co-operatives. The
growth of the formal credit market acquiring share from the informal
sector continued through till 1991, after which there has been a set-
back and some fluctuation in the share of the co-operatives.

2
 INTRODUCTION

During that period, there was consolidation in the banking sector as

well, with several bank failures and the regulatory architecture matur-
ing. There was control on branch licencing, but with the SBI rapidly
expanding its branches, RBI also permitted expansion of branches by
other banks. While co-operatives were operating in the rural areas, the
absence of the mainstream banking was felt. “While the population
per branch decreased from 136,000 in 1951 to about 75,000 in 1967,
the rural and semi urban centres continued to be unserved and the
private sector, with profit motive was not too willing to venture into
those areas” (Reserve Bank of India 2014).
A major part of the fall in the relative share of co-operatives in
the later decades may be attributed to two changes in the policy
discourse, largely led by the Government of India (GoI). The first
was the nationalisation of banks, which shifted the policy focus on
banking. Later, a second move, a massive debt waiver announced
in 1989 which created a moral hazard for the co-operatives. While
the waiver was applicable to banks as well, the difference was that
the co-operatives had a concentrated portfolio of agricultural loans
while the banks had a diversified portfolio, and the effect of the
waiver was at the margins. The state had been intervening in setting
the terms of the transaction through quotas and targets, but this
was the first time the State had intervened in the transaction between
the institution and the client midway through the contract. That the
state did not compensate the co-operatives immediately was a factor
that led to a strain in liquidity, and we can see its overall effect on
the relative share of the co-operatives in the immediate aftermath
(see Table 0.1).
There is much more to be written about the role of the state and the
rather passive role of the RBI during this phase, but that is a matter for
another paper. This background sets up the large philosophical argu-
ment of the role of the state actively promoting co-operatives and also
looking at the banking system. However, there was a paradigm shift
from co-operatives to social banking in the next phase.

Phase 2: rural branches; agriculture;

priority sector; weaker sections
The second phase started with the nationalisation of banks, wherein
the state took over the largest banks in two installments, the first in
1969 and the second installment in 1980. The 1969 nationalisation

3
 INTRODUCTION

Table 0.1 Break-up of institutional and non-institutional rural credit (%)

1951 1961 1971 1981 1991 2002 2012

Institutional 7.2 14.8 29.2 61.2 64.0 57.1 56.0

agencies
Government 3.3 5.3 6.7 4.0 5.7 2.3 1.2
Co-op society/bank 3.1 9.1 20.1 28.6 18.6 27.3 24.8
Commercial bank 0.8 0.4 2.2 28.0 29.0 24.5 25.1
including regional
rural banks
Insurance – – 0.1 0.3 0.5 0.3 0.2
Provident fund – – 0.1 0.3 0.9 0.3 0.1
Other institutional – – – – 9.3 2.4 2.4
agencies*
Self-help groups – – – – – – 2.2
Non-institutional 92.8 85.2 70.8 38.8 36.0 42.9 44.0
agencies
Landlord 1.5 0.9 8.6 4.0 4.0 1.0 0.7
Agricultural 24.9 45.9 23.1 8.6 6.3 10.0 5.0
moneylender
Professional 44.8 14.9 13.8 8.3 9.4 19.6 28.2
moneylender
Traders and 5.5 7.7 8.7 3.4 7.1 2.6 0.1
commission agents
Relatives and 14.2 6.8 13.8 9.0 6.7 7.1 8.0
friends
Others 1.9 8.9 2.8 4.9 2.5 2.6 1.9
Total 100 100 100 100 100 100 100
Source: All India Rural Credit Survey (1954); All India Debt and Investment Survey,
various issues.
Note: Percentage of share of different credit agencies to outstanding cash dues of the
households as of 30th June.
* Includes financial corporation/institution, financial company and other institutional
agencies.
– Denotes not available.

was controversial, large in scale, scope and significant. The later

nationalisation looked like an extension of the 1969 nationalisation
and was relatively low key. In the run-up to the nationalisation there
was much concern expressed about the availability of credit for
both agriculture and small enterprises. While efforts were made to

4
 INTRODUCTION

introduce social controls into banking, it appeared that the political

class had decided the inevitable action of nationalisation.
The actions that followed the nationalisation seem to indicate
that apart from making credit available to the excluded sectors, it
was also aimed at increasing the physical presence. The lead bank
scheme was also instituted in 1969 soon after the nationalisation
of banks, giving the focus of a particular district to a single bank.
In 1989 it was transformed with the service area approach being
dovetailed into the scheme (Thorat 2009). The State thus controlled
not only the policy, but also the operations. Unlike co-operatives
that operated on the principles of mutuality and democracy and
were decentralised and under the control of the state governments,
the banks came under the direct control of the central government.
Thus, the State could not only dictate terms through policy, but
also could control these organisations through the management and
operations as well.
It was a recognition of the fact that possibly co-operatives had
reached their potential and there needed to be a more impactful mea-
sure. The agenda of the union government of looking at the big picture
of financial inclusion could be different from that of the state gov-
ernments. For a good measure, by nationalising the banks, the union
government took direct control of the institutions. This was unlike the
co-operative structure which was under the control of the state govern-
ments – when administrators were appointed intermittently between
elected boards. While there are indications that there were constant
and repeated attempts of the political class at the state level to control
and direct co-operatives, the efforts were sporadic and decentralised.
The banking sector, on the other hand, provided scale, centrality and
operational as well as policy control.
This, added with the introduction of a new institutional structure of
Regional Rural Banks (RRBs) (which we discuss in Phase 3), helped
the State to directly intervene and impact the provision of credit. Irre-
spective of the profitability and operational efficiency of these struc-
tures, the share of the formal sector in the indebtedness of the rural
areas was increasing, and the informal sector and moneylenders saw
a fall in their share all the way up to 2002 when there was a slight
reversal in the process. Most of the credit-based interventions – par-
ticularly the Integrated Rural Development Programme (IRDP) – were
routed through the banks, with the beneficiaries for credit being iden-
tified outside of the banking system. In addition, the focus was also on
improving the reach of the physical infrastructure by controlling the

5
 INTRODUCTION

branch licencing policy and the portfolio by establishing Priority Sec-

tor Lending (PSL) targets.
The initiative yielded results – the relative share of the banking sector
improved and replaced the informal sector. As we can see in Table 0.1,
the relative share of the banks grew smartly in the decades of the ’70s
and ’80s and maintained the share until about the ’90s. It was only
after the liberalisation programme that both the co-operatives and the
banks seemed to have lost steam a bit, only to regain it later. Irrespec-
tive of the operational costs, in retrospect, one has to acknowledge
that this was the most significant phase of using institutional inter-
vention to take banking to unbanked geographies and to unbanked
individuals.

Phase 3: rural focussed institutions;

agriculture; local touch
Phase 3 overlaps with Phase 2 both in the way the thought process
evolved and the ideological underpinnings of the thoughts developed.
While the second round of bank nationalisation came in 1980, the
design of a new type of institution, which distilled the lessons of Phase
1 (co-operatives, local institutions) and Phase 2 (banks, professionally
managed institutions), were put together. This resulted in the design of
a new type of institution – the RRBs. These were smaller in number –
about 196 in all with more than 10,000 branches which later expanded
to around 15,000 branches. The institution was expected to be larger
than a local co-operative but more local than a commercial bank.
They had a higher target for PSL and agriculture and restrictions on
moving to urban areas.
While the institution made more credit available to the people, the
overall structure was never in the best of health. The structure needed
significant doses of recapitalisation and restructuring. One major
contribution of the RRBs was that it addressed the regional skew in
bank branch presence. The importance of RRBs is to be seen from
a different lens. In the second phase, the banking system was seen
as a divide between rural and urban; agriculture, small industry and
large manufacturing; the poor and the rich; and the excluded and the
included. In a way, the social control of the banks was to ensure that
the poor got loans, agriculture got loans and rural areas got branches.
However, one issue that the branch licencing quota did not achieve
is the reduction of regional disparity in banking. The South, which
dominated in the presence of bank branches, continued to dominate

6
 INTRODUCTION

even in opening rural and semi-urban branches. The North-East was

lagging far behind, after the Central and Eastern regions, which were
also relatively under-banked.
As the RRBs were decentralised institutions, their contribution
was that many uncovered districts were covered by this new institu-
tion. With 196 banks, there could only be that much centralisation.
Therefore, the importance of Phase 3 should be flagged more as the
decentralised presence of local institutions which happened to be run
professionally with support from a commercial bank.
The statistics of the RRBs are subsumed in the line item of banking
statistics. While the RRBs contributed to the growth of the portfolio
of the formal banking sector in the credit pie, they disproportionately
contributed to the physical access points in the form of branches.
However, after an initial period of growth, we see that even the physi-
cal touch points plateaued in the decade of the ’90s only to grow later,
after the turn of the century.
During this phase, there was also the hiving off of the refinance
function for agriculture and rural development from the RBI first by
creating the Industrial Development Bank of India (IDBI) and later by
creating the National Bank for Agriculture and Rural Development
(NABARD). This laid out the foundation for the later argument that
RBI completely withdraw from refinancing function – that it would
not create money for development purposes and this should come
through the State’s budgetary process rather than bypassing it. Chap-
ter 3 (Conversations with Dr Y. V. Reddy) alludes to this argument
without directly referring to NABARD.

Part II
Policy on banking: universal banks
The most important change in the intellectual discourse about the role
of the central bank came from the committee set up by the GoI on the
financial sector reform chaired by M. Narasimham, who was the for-
mer Governor of RBI. While there were larger reforms at the level of
the union government followed by the balance of payments crisis that
led to what is famously known as the liberalisation programme, the
tone for the financial sector reform was set by the Narasimham Com-
mittee. There was another committee set up under the same Narasim-
ham in 1998 for the banking sector reform. We shall refer to the 1991
report as the Narasimham I report and the 1998 report as the

7
 INTRODUCTION

Narasimham II report in this book. The continuation of the intellec-

tual argument provided by the Narasimham reports I and II was con-
tinued in the report submitted by the committee on financial sector
reform headed by Raghuram Rajan in 2009 (Rajan 2009).
The tone of the report submitted by the Narasimham I report
(Annexure 1) was clear. This was supposed to be a phase that revisited
the social control on banks, and advocated more and more market-
based steps to put banks in the competitive mode and offer services
to the customers, rather than offer benefits to the beneficiaries. The
agenda laid out by the Narasimham I report was initiated, but is yet to
be completed. It was so prescient in its approach that a fresh reading
of the report seems to make it as contemporary as could be.
The argument was unequivocal – it looked at banks and financial
institutions that needed to maintain integrity and autonomy and the
ownership was not germane, thus laying down the argument for pri-
vate sector participation in the banking and financial sector. It argued
against directed credit, quotas and directed investments. It tried to
clearly delineate between the banking function and the function of
creating a fiscal space within the banking system through the high
levels of statutory liquidity ratios and the cash reserve ratios, which
was an indirect way of funding the sovereign at soft rates. The report
tried to distance the state from the financial institutions not only at
the national level but also at the state level. In general, the tone of the
report was “enough of social banking has been done”; this has had its
positive impacts and it was now time for the state to withdraw and
promote the market forces and prudential regulation to dictate the
financial markets.
In the same tone the committee argued for the disbanding of priority
sector quotas, and most of the recommendations made by the commit-
tee had a timeline. If the report was implemented fully, many of the
questions that are there in the conversations that follow would have
been rendered irrelevant. The most important observations made by
the Narasimham I report about the recommended structure of bank-
ing (without much emphasis on the ownership) were:

1 3 or 4 large banks (including the SBI) which could become inter-

national in character;
2 8 to 10 national banks with a network of branches throughout the
country engaged in ‘universal’ banking;
3 Local banks whose operations would be generally confined to a
specific region;

8
 INTRODUCTION

4 Rural banks (including RRBs) whose operations would be con-

fined to the rural areas and whose business would be predomi-
nantly engaged in financing of agriculture and allied activities.
(Narasimham 1991)

It is clear that we are still considering consolidation of banks. The

merger of the banks within the State Bank group, which now gives it
a size to become international in character, happened only from the
1st April 2017, and there is still discussion going on about the con-
solidation of other banks in the banking system. The recommenda-
tion of local banks and rural banks in the structure has moved in a
different direction, about which we shall discuss later in this
introduction.
One of the first moves after the Narasimham I report was the amend-
ment of the Banking Regulation Act to permit the establishment of new
private sector banks in India. In 1993, the RBI issued guidelines for
opening new private sector banks. As a result of that phase of opening
up, licences were issued and banks were established. These banks were
completely computerised from the day they started and introduced
not only modern technology, but also newer business processes. Some
of these banks failed or merged with other banks, but the space was
opened up for competition. Clearly, even if the policy and the owner-
ship did not imply profitability, the market forces implied that the older
banks had to compete hard to maintain their positions.
This was a significant paradigm shift from the social banking exper-
iment. The Governors whom we have interviewed and the issues that
we have discussed span the period from the opening of the banking
sector and the start of the liberalisation process to a stage where tech-
nology and market innovation are disrupting the way we have been
thinking about banking.
While some of the recommendations of the Narasimham I report
were not considered – removing the quota on priority sector advances –
some recommendations were implemented in phases – withdrawal of
directed credit; removal of administered interest rates; implementation
of prudential norms and adopting modern accounting practices. There
was one element that had a bearing on inclusion that was almost
immediately implemented: removal of the stringent requirements for
branch licencing.
In the case of new banks, while there was some rhetoric on inclu-
siveness, RBI’s policy prescription seemed to be loyal to the spirit
of the recommendations of the Narasimham I report. The policy

9
 INTRODUCTION

architecture did not move towards a great thrust of inclusiveness. For

instance, the policy guideline for new banks in 1993 indicated the
following: “In regard to branch opening, it shall be governed by the
existing policy that banks are free to open branches at various centres
including urban/metropolitan centres without the prior approval of
the RBI once they satisfy the capital adequacy and prudential account-
ing norms. However, to avoid over-concentration of their branches
in metropolitan areas and cities, a new bank will be required to open
rural and semi-urban branches also, as may be laid down by RBI.”1
While it did talk about physical presence more from a point of geo-
graphic diversification, it did not talk about the magnitude or per-
centage of presence required for the bank in rural and semi-urban
areas. During this phase, the RBI kept liberalising the branch licencing
policy, giving more autonomy to the banks. The most important target
that was monitored was the deployment of credit to priority sectors.
The Rajan Committee extended the argument of outreach by recom-
mending a better architecture for business correspondents and use of
technology-based banking.
It is clear from Table 0.2 that once the quota was removed the
growth of the bank branches in the decade that followed, the liber-
alisation moved completely in favour of metropolitan branches. This
was a perfect occasion for generating data to study the impact of
branch licencing policy, which was done effectively. In an interesting
paper, Burgess and Pande argue that the branch licencing policy actu-
ally helped in making a positive impact in the reduction of poverty
(Burgess and Pande 2005).
So, while the RBI went with the intellectual argument of Nara-
simham I, it eventually found out that the growth in rural areas was
not happening without a clear policy directive. It was essential to
open up and liberalise the branch licencing with some checks in place.
Gradually, a less stringent requirement of having to open 25% of all
the incremental branches in unbanked areas was reintroduced when
the new guidelines for private sector banks were released in 2011:
“the new bank will be required to open 25 per cent of its branches
in rural and semi-urban areas to avoid over concentration of their
branches in metropolitan areas and cities.”2 This requirement still
continues, and it is clear from the conversations that the RBI con-
tinues to be engaged with the physical access to the unbanked loca-
tion. There have been debates on whether the economy should pick
up first or the bank should prime the pump of a local economy.
These arguments are found in the conversations of all the chapters

10
Table 0.2 Progress of physical outreach of commercial banking 1991–2000

Important June March March March March March March March March March March Growth rate
indicators 1969 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 from 1991

No. of commercial 89 276 276 276 276 284 293 299 300 303 297
banks
RRBs – 196 196 196 196 196 196 196 196 196 196
No. of bank offices 8262 60220 60570 61669 61803 62367 63026 63550 64218 64939 65412 8.62%
in India
Rural 1833 35206 35269 35389 35329 33004 32995 32915 32878 32857 32734 −7.02%
Semi-urban 3342 11344 11356 11465 11890 13341 13561 13766 13980 14168 14407 27.00%
Urban 1584 8046 8279 8562 8745 8868 9086 9340 9597 9898 10052 24.93%
Metropolitan 1503 5624 5666 5753 5839 7154 7384 7529 7763 8016 8219 46.14%
Source: Banking Statistical Returns of various years. Available at www.rbi.org.in/Scripts/AnnualPublications.aspx?head=Basic+Statistical+
Returns (accessed on 7th May 2017).
Note: Part of the reduction in rural branches may be attributed to reclassification of rural areas as semi-urban areas due to the intervening
census numbers, particularly in the year 1995–1996. However, it is evident that the metropolitan branches really grew disproportionate to the
other categories.
 INTRODUCTION

that follow. While Rajan in Chapter 5 raises questions on whether

banks should be forced to enter an infeasible area even when there
is no business in the foreseeable horizon, the others do believe that
this is a developmental function and mechanisms should be found to
make this happen.
The issue is this: even though the Narasimham I report asked the
financial system to break the shackles and leverage on the past invest-
ments to be more market, profitability and sustainability driven, the
central bank remained committed to its larger developmental role and
could not jettison this to the market forces. This belief continued even
after decades of the recommendations of Narasimham I report. The
instrumentality of achieving the goals had shifted towards the use of
agents, technology and newer channels, but it did not seem to indicate
that the banking system will innovate and find the excluded clients by
themselves.
The report on the lead bank scheme even goes to look at issues of
extension and financial literacy programmes that would bring people
into the banking net (Thorat 2009). Following this report, the RBI
undertook a massive outreach programme by allocating every inhabi-
tation having a population of more than 2,000 to banks and asking
them to ensure a banking outlet within a time frame of three years.
This was an initiative undertaken under the leadership of Subbarao
(Chapter 4). An argument as to why the RBI did not embrace the rec-
ommendations of the Narasimham I report can be found in Chapter 3
where Reddy explains that the governance of RBI was always broad
based and never monetary policy driven. Therefore, there was always
the political argument (of inclusive development) going against the
intellectual argument (of profitable and sustainable banking), and in
most cases the political argument won.
One more significant recommendation made by the Narasimham
I report, which never found favour with the RBI, has been priority
sector allocations. The report argued that these quotas should be
eliminated in a phased manner by first reducing the allocation to the
priority sector from 40% of the net bank credit to 10%, and later to
zero. However, while the RBI addressed this issue multiple times when
the priority sector obligations were reviewed, none of the reviews sug-
gested the abandoning of the priority sector lending. During all these
years the quota has remained at 40% with some smaller changes in
the detail. It is not that the priority sector lending quota did not find
favour with only the RBI. Later in 2009, the committee on financial
sector reform (Rajan 2009) not only recommended the continuance

12
 INTRODUCTION

of the quotas, but also had some further recommendations to make,

including extending the quota to foreign banks.
There was a different dispensation for foreign banks where the
targets were lower and excluded the obligations towards agriculture.
However, this was not applied to the domestic banks. The two recent
committees (Nair 2012; Reserve Bank of India 2015) have not only
reiterated the need to continue the PSL commitments, but also sharp-
ened the definitions on the aspects of inclusion by setting aside harder
targets to reach marginal farmers and micro enterprises. The conver-
sations with the Governors indicated that in the thinking of the RBI,
this would stay.
The Nachiket Mor (Mor 2014) committee report had some signifi-
cant recommendations on the PSL requirements, including deepen-
ing markets for priority sector portfolio, expanding the definition of
priority sector and secondary trading of portfolios. It also suggested
a granular graded weightage for each district – providing a greater
weightage for achieving a rupee of credit in difficult areas. However, it
appears that most of the recommendations of the committee pertain-
ing to PSL did not find favour with the RBI for implementation.
The change in the approach is only evident in the possibility of trad-
ing the excess achievement over a platform through a paper called the
Priority Sector Lending Certificates (PSLCs). While the early recom-
mendation on the tradable notes on priority sector obligations in the
form of PSLCs came from the Committee on Financial Sector Reforms
(Rajan 2009), it was reiterated later by the internal working group of
RBI and was notified only much later. Not only is the PSL retained for
mainstream banks, but also it has been made applicable even to inter-
national banks having significant presence – of more than 20 branches
in India. In addition, there are more stringent PSL norms for the new
niche private sector banks that have been recently licenced – the Small
Finance Banks (SFBs). Therefore, the instrumentality of policy pre-
scription to reach out credit to the excluded and the vulnerable con-
tinues. The RBI seems to believe that normal market forces will not
naturally discover this market, and thus it has to be mandated.
It is also clear in the discourse that while the RBI encouraged other
types of niche players, it saw the banking system as being central to
the cause of inclusion. Right from keeping the PSL targets and ago-
nising about the footprint of where the branches are opened to new
initiatives, they have been most significant in the banking sector. For
instance, a sticky aspect of the banking portfolio has been that of agri-
cultural lending. At the one end, the RBI has been mandating all the

13
 INTRODUCTION

banks to achieve the targets for PSL – these targets were extended even
to foreign banks in the latest amendments to the directions. At the
other end, the government (both at the Union and at the State level)
has been interfering in the contract between the lender and the bor-
rower by announcing waivers, subventions and interest rate caps. This
goes against the overall stance taken by the RBI post liberalisation in
taking the portfolio nearer the market.
In a pointed question on whether it was a good idea to create a
regulatory arbitrage – allowing specialised non-banking finance com-
panies (NBFCs) to lend for agriculture on market terms and allow-
ing banks to claim target achievement under PSL targets for funding
such bulk loans to NBFCs, thereby insulating the interference by the
State – it appears that all the Governors believe that the banks ought
to fulfil these obligations directly. While recommendations to this
effect were made by the Nachiket Mor Committee, it was not accepted
(Mor 2014). This was somewhat contradictory to the stance taken on
microfinance where lightly regulated organisations are lending to the
poor on commercially viable terms and banks funding such microfi-
nance institutions (MFIs) being allowed to take PSL credit.
It appears that agriculture is a holy cow which nobody wants to touch.
Even the somewhat market friendly and liberal Rajan Committee on
financial sector reform just referred to the political imperative of dealing
with agriculture. While it mentioned that there was a need to revisit the
priority sector lending norms, it yielded to the political imperatives of
having norms for agriculture and weaker sections and went on to recom-
mend even more stringent implementation of the norms. The RBI consid-
ered the recommendations of the Rajan Committee and later committees
to allow the banks to trade PSLC (only the obligations under the PSL
targets and not the portfolio) on a platform that is open only to banks.
The overall theme of liberalisation has been applied in the policy
discourse towards extending the physical presence of banking foot-
print – from easing the norms for opening branches to providing an
omnibus permission to open branches in unbanked locations. One
significant policy stance that the RBI has taken is to permit Business
Correspondents (BCs) to provide the last mile transaction facilitation.
While the agent network directions went through multiple flip-flops
on who could be an agent, how they could be selected, the transac-
tions they could do and the viability of the agents in the context of
benefit transfers from the government, the network is there to stay.
There would be policy stability with much experience gained from
years of experimentation.

14
 INTRODUCTION

Policy on banking: niche banks

The policy stance of the RBI vis-à-vis niche banks has not been clear,
and each Governor seemed to have had his own take on how to deal
with regional penetration. While the first initiative of niche banks –
the RRBs – largely came from the State through a separate bill, it
appeared that it was generally welcomed by RBI, or at least there was
not vehement opposition to the proposal. Thus, we saw the emergence
of a hybrid bank – operating in a niche area with a greater target on
priority sector credit and professionally managed.
Rangarajan (Chapter 1) has been a strong advocate of decentralised
growth of banking institutions. Reddy (Chapter 3) has viewed them
with suspicion. Rajan (Chapter 5) has engaged with the question of
viability. However, like the BC model, the RRBs have had their share
of a roller coaster ride, depending on the flavour of the policy. While
Narasimham I recommended that the RRBs should consolidate, the
committee also recommended that all the commercial banks should
have a rural banking subsidiary which takes all the RRB branches and
the rural branches of commercial banks into one entity, and such an
entity specifically takes care of the needs of the rural people. Over a
period of time, the RRBs have consolidated, but have still not reached
the stage where each state has only one RRB.
On the other hand, the concept of a Local Area Bank (LAB) has
had a more chequered run. While it was heavily supported by Ranga-
rajan (Chapter 1) – not only during his tenure as Governor, but also
when he chaired the Committee on Financial Inclusion – the licences
were not forthcoming in the later years. Rajan (Chapter 5) supported
the idea of an evolved LAB, which was not only recommended in the
committee he headed (Rajan 2009), but was also implemented as SFBs
during his tenure. Reddy (Chapter 3), who was opposed to this idea,
feared that these institutions do not have the adequate size to diver-
sify, might not have a great governance structure and may be subject
to capture. He also expressed his discomfort at using these openings
to try and gain a full-fledged universal bank licence. The concept of
private sector regional banks did not gain momentum, not only due
to the regulatory discomfort, but also because of the performance of
the few existing ones which were not brilliant either in terms of profit-
ability, scale or inclusion. However, Reddy (Chapter 3) was open to
the idea of privatising the existing RRBs on an experimental basis to
examine if they would perform better. However, the concept of a niche
bank was possibly always in the policy radar of RBI.

15
 INTRODUCTION

Post setting up of NABARD, the RBI has not encouraged the setting
up of Development Financial Institutions (DFI), even though there has
been some clamour for a separate refinance institution for the Self
Help Groups (SHGs) coming on and off from the Ministry of Rural
Development.
However, there was no consistent discomfort in RBI as far as special-
ised banking institutions are concerned. Based on the earlier reports
and discussions, the reintroduction of regional banks was constantly
coming up in the discourse on inclusion. This was first brought up
by the Rajan Committee and reiterated by the Nachiket Mor Com-
mittee, which in its design had a version of a larger LAB with no
access to capital markets. While the Rajan Committee has a much
larger vision for SFBs, where it was more open about the geographi-
cal and functional coverage, its ultimate recommendation suggested a
restricted area much larger than LAB, to be reviewed periodically to
allow for expansion based on performance. In general, both in the rec-
ommendations of the committees and in the discourse of the RBI, the
conception of a Regional Bank appeared to be a refined version of the
RRB and the LAB – possibly with a larger area of operation and bet-
ter governance, but with clear geographical boundaries (Rangarajan
2008; Mor 2014). While there were reservations expressed by Reddy
(Chapter 3), it appeared that the view on this was split.
In 2014, the RBI released its draft guidelines; the guidelines were
called “Draft Guidelines for licencing of ‘Small Banks’ in the private
sector” and indicated that these banks would have a restricted and
contiguous area of operation, somewhat on the lines suggested by the
Rajan and Mor Committees.3 However, the final guidelines led to a
completely different design proposition. The name was changed from
a “Small Bank” to a “Small Finance Bank” wherein, instead of giving
a geographical focus, the guidelines decided to provide a functional
focus.4 The interview with Rajan (Chapter 5) explains the reasons why
this change happened and how the framework was seen differently.
Eventually the RBI in 2016 issued “in-principle” licences to ten
entities to operate as SFB. The functional focus was in defining small
finance as loan sizes of less than Rs.2.5 million – which should com-
prise at least half of the loan book of the bank and a condition that
75% of the portfolio should be in a priority sector portfolio – higher
than the RRBs and the LABs. Moreover, while the SFBs were permit-
ted to sell PSLCs to the extent of over-achievement of target, they were
not permitted to buy PSLCs to make good under achievement, except
when it was for specific “hard” sub-targets like agriculture, finance or

16
 INTRODUCTION

micro-enterprises. These two conditions possibly signalled the devel-

opmental and inclusive role of the new structure.
In addition to the SFBs, the RBI – following the recommendation of
Nachiket Mor Committee – also offered in-principle licences for Pay-
ments Banks (PBs) which would largely offer in remittances, deposit
collection services and sell third-party products. While this is an
untried and untested model, the Governors (Rangarajan, Chapter 1;
Reddy, Chapter 3) looked at these with a little bit of doubt on whether
they indeed had a strong commercial imperative to continue in the
long run.
The question of how the Governors say the developmental role of
the banking system was diverse, and possibly contributed to some lack
of clarity on the institutional stance. For instance, Rajan (Chapter 5)
did ask the question, “Should the banks go to an area where there
are no economic activities, and if so, what should be the type and
structure of subsidy that the state should provide for undertaking this
activity?” Subbarao (Chapter 4) believed that this cannot be an either/
or policy, and the RBI, in collaboration with the government, had to
look at a nuanced carrot and stick policy to get banks to be present
and still undertake commercially viable activities. The final guidelines
on the SFBs seem to indicate the eventual reconciliation of the RBI
that the penetration has to be left to the market forces; pushing the
geographic and regional aspect a bit too hard might result in unviable
institutions, and it would be better to chase a functional strategy that
is commercially appealing to the players on market principles.
Two significant initiatives that came from the government have had
a mixed response. The Pradhan Mantri Jan Dhan Yojana (PMJDY)
was a massive programme of outreach to ensure that every house-
hold had a bank account with certain minimum facilities: a debit card,
an overdraft facility subject to certain performance parameters and
an insurance cover. Based on the structural investments made in the
past in having touch points and the correspondent network, the pro-
gramme aimed at universalising the ownership of bank accounts. This
was a supply side solution with a larger plan of using these accounts
for eventual benefit transfers as well. The RBI participated in the pro-
gramme, while expressing some caution on how the overdraft facility
would pan out.
The second initiative was the Micro Units Development and Refi-
nance Agency (MUDRA) where the RBI seems to have been caught a
bit off guard. The announcement indicated that it would be a financ-
ing, refinancing and a regulatory agency. Rajan (Chapter 5) expressed

17
 INTRODUCTION

his reservations on the regulatory function of MUDRA. However, this

agency, which was enthusiastically welcomed by Subbarao (Chapter
4), fills in a crucial gap in the micro-enterprise finance segment. Reddy
(Chapter 3) was quite skeptical of one more agency being pressed into
the failure of what should originally have been the mandate of the
Small Industries Development Bank of India (SIDBI).

Falling off the radar: rural co-operatives

A review of the policy discourse over the post-liberalisation years is the
conspicuous absence of co-operatives. Following the dip in the share of
co-operatives in the 1991 figures, while there is some semblance that
the co-operatives have regained some share, it does not appear to be on
the top of the mind as a policy choice. The disappointment that the set
of institutions are amenable to political capture (Chapter 4, Subbarao)
indicates the broad thought process. The most significant event in the
period under discussion, where there was a semblance of action, was
the Vaidyanathan Committee Report submitted in 2004. While Reddy
(Chapter 3) seemed to be fully committed to implement the reform
package and bring them back into the reckoning, he lost the drive as
the government announced yet another write-off of agricultural loans,
and the disappointment was evident when he said that there was no
political will to save the co-operatives. There has been neither an initia-
tive from the union government nor from the RBI in even discussing
the set of institutions, which are local, built on a principle of mutuality
and large in number. It appears that the focus towards the turn of the
century shifted to SHG and microfinance, and these two initiatives
seem to have occupied the policy discourse vacated by co-operatives.

Urban co-operative banks: entry point in banking?

On the issue of urban co-operative banks there have been three impor-
tant committees that have looked at the possibility of issuing new
licences and expressing concerns about the governance, duality of con-
trol and other issues. The latest initiative from the RBI has been the
setting up of the Gandhi Committee (Gandhi 2015). The committee
proposes a road map for co-operatives in the urban areas, starting as
a thrift and credit society based on the principle of mutuality and then
moving through the urban co-operative bank phase; it even suggests
that the co-operative could become a mainstream bank by converting
itself into a corporation.

18
 INTRODUCTION

The Gandhi Committee moots the point. Are there size consider-
ations in a co-operative, and does the co-operative reach a stage where
it is too big to be a co-operative? The general belief across the Gover-
nors seems to be that there is nothing holy about being a co-operative,
and if needed, it is okay to convert a co-operative into a corpora-
tion and thus a mainstream universal bank. Rangarajan (Chapter 1)
even cites the example of the Development Co-operative Bank getting
converted as Development Credit Bank (and later as DCB Bank) and
suggests that there is nothing wrong if the situation demands it. One
element that is evident in the discourse – which both Reddy (Chapter 3)
and Subbarao (Chapter 4) subscribe to – is that systemic stability in
the banking system is of a greater concern than the organisational
form. With this as an all-pervading thought process, it is unlikely that
India would see a large multi-service integrated bank which would
remain as a co-operative and gain the same reputation as Rabobank
of the Netherlands.
In the recent past, the Kerala Government has, in principle, decided
to integrate all its district co-operative banks and the state co-operative
bank into one large integrated entity. This would turn out to be a test
on the current view of the RBI on its approach towards co-operation
as a concept.

Self-help groups and microfinance

The phase we are discussing in this introduction is also coincidentally
the phase in which the discourse on microfinance picked up steam. The
story of microfinance can be broken up into two parts, initially start-
ing in two phases, but now running concurrently. In 1992 NABARD
issued the first guidelines for the Self Help Group – Bank Linkage
Programme (SHGBLP). The story of SHGs is somewhat detailed and
interesting, because it challenged the notion on the approach to inclu-
sion. Started in the mid-1980s by some Non-Governmental Organisa-
tions (NGOs), like Myrada in Karnataka, the movement was a mixture
of the principles of co-operation and mutuality applied at a very micro
level, but design principles were drawn from the informal sector. But
there are multiple orthodoxies that the SHG movement broke. See
Harper (2002) and Sriram (2005) for a detailed discussion on both the
models. As it broke orthodoxies, it also started creating its own tem-
plate for the cause of inclusion. This initiative of inclusion was, for the
first time, being driven by forces outside the realm of the policy and
the state.

19
 INTRODUCTION

The first orthodoxy that the SHG movement broke was in mov-
ing away from programmes that centered on men to having a pro-
gramme predominantly women-oriented, resulting in a large number
of women coming into the financial sector. The second orthodoxy it
broke was unlike the past inclusion programmes that were aimed at
agriculture and allied activities in rural India; for the first time, this
programme was tolerant to consumption credit and focussed on
livelihoods. The third orthodoxy it broke was that the programme
was based on a “savings first” principle, followed by intra lending
and then borrowing from the banking system for the residual needs.
The fourth orthodoxy it broke was that from sporadic – walk-in
type of transactions that the banking system had – to regular, stan-
dardised and predictable transactions. The fifth orthodoxy it broke
was that it proved that financial transactions need not necessarily
happen in bank premises but could happen out in the open. The
sixth and most important orthodoxy the movement broke was that
end-use interest rates did not matter as long as the client was will-
ing to accept the contract; it recognised the transaction costs and
the risks involved; and it recognised the arbitrage opportunities
available in the local market and priced the loan product appro-
priately. It brought financial services to the proximity. The seventh
orthodoxy it broke was in shifting from a physical, paper-based
collateral to creating a social pressure group that worked as a soft
collateral.
To the credit of RBI and the other policy makers, this movement
was not only quickly recognised, but encouraged through a benevolent
policy framework that allowed the banks to deal with the groups, and
the RBI also accorded the status of priority sector to these loans. Rec-
ognising SHGs – which were unincorporated group of individuals – as
a legal unit through an interse agreement was one of the most signifi-
cant decisions taken by RBI in 1992 under the leadership of Rangara-
jan. This aspect is discussed in detail in Chapter 1, Conversations with
Dr C. Rangarajan. The promise that the groups hold to the Governors
is evident in all the chapters.
While, apart from the facilitation of dealing with SHGs, classifica-
tion of the loans as PSL and treating group guarantees given by SHG
members as a full collateral for prudential and capital requirement
purposes, RBI did not do any big-bang policy announcements. This
was a recognition that a developmental activity was happening out-
side the initiative of the banking system, and it needed a policy sup-
port, which is exactly what the RBI did.

20
 INTRODUCTION

The growth of the SHGs was slow and focussed on the Southern
states and some states like Rajasthan, Madhya Pradesh, Chattisgarh,
Bihar and Jharkhand. The growth was almost dictated by the presence
of a large NGO which believed in this methodology of intervention.
However, the cause of the SHGs eventually was taken up by the gov-
ernment when it started incorporating some of its flagship rural devel-
opment schemes into the group architecture. While the first attempt
towards this end was made in the Swarnajayanthi Gram Swarojgar
Yojana, the scaling happened more recently with the launching of the
National Rural Livelihoods Mission, which is almost exclusively rid-
ing on the SHG architecture.
When we see the policy response to this movement, it is evident that,
between the State and the RBI, it appears that the SHGs became more
an instrumentality of the State, focussing on developmental aspects
with a financial base, rather than as a tool for banking to have been
promoted by the RBI.
On the other hand, microfinance using the group methodology
propagated by the Grameen Bank of Bangladesh started taking off
from 1996. Basix, the first Microfinance Institution (MFI) started
operations in April 1996 to be followed by many other efforts which
were outside of the mainstream banking sector. Most of the MFIs
used the methodology developed by Grameen Bank, and the growth
in the initial phases was concentrated in the Southern state of Andhra
Pradesh (AP). The large players in the state included – apart from
Basix – Swayam Krushi Sangham (later SKS Microfinance Limited
and now Bharat Financial Inclusion Limited), Spandana (later Span-
dana Sphoorthy Financial Services Limited), Share (later Share Micro-
fin Limited) and Asmitha Microfin Limited.
The methodology adopted by MFIs was partly similar and signifi-
cantly different from the SHGs. While SHGs were stand-alone units,
with their own set of accounts and linked to the banking system
through savings and borrowings, with members of the groups decid-
ing on the loans, and getting benefits from the state system for forma-
tion of the groups and some seed money to prime the pump on the
operations, the MFIs were external agencies offering debt and resort-
ing to collections on a regular basis. Both used groups as a mechanism
to meet and aggregate transactions. Both the models worked predomi-
nantly with women. But beyond that, they were different.
The initial MFIs were operating as not-for-profit enterprises. They
formed the groups and ensured that the groups met regularly and
offered standardised loan products and standardised the collection

21
 INTRODUCTION

mechanism. These organisations grew fast and turned out to be

extremely profitable. Both the growth and the profits catapulted them
to abandon the not-for-profit format and move to the for-profit for-
mat. By around 2004–2005, most of the MFIs had started the process
of transformation to the for-profit format. See Sriram (2010) for a
detailed description of the process of moving from the not-for-profit
to the for-profit format.
While the growth of the SHGs was blessed with a policy frame-
work from the RBI, the growth of MFIs initially happened somewhat
independent of the RBI. In spite of the term “microfinance” being
used extensively, it was not defined in the policy statements. Most of
the for-profit commercial microfinance was happening under the rules
of Non-Banking Finance Companies (NBFCs). These rules applied to
finance companies who were in the business of loaning, including asset
financing, financing of small businesses, automobiles and so forth.
Only housing finance and leasing had a separate and distinct category
of NBFCs and a more nuanced regulation. It is interesting that micro-
finance crept into the discourse of RBI without a clear policy.
However, it appears that RBI was deeply interested in the sector at
that time. In February 2000, there was a communication addressed
to all scheduled commercial banks with the title “Microcredit”.5 This
communication further articulated the RBI support in terms of the
overall policy framework, and its anxiety not to regulate or micro-
manage the sector. The communication firstly carried a definition of
microcredit: “Microcredit is defined as the provision of thrift, credit
and other financial services and products of very small amount to the
poor in rural, semi-urban and urban areas for enabling them to raise
their income levels and improve living standards. Microcredit institu-
tions are those which provide these facilities”.
We can see that the RBI has been either careless or enthusiastic by
reading the above definition. While it is not clear from the notification
itself, it is most likely a definition drawn from elsewhere. By including
savings and thrift, RBI contradicts its notification of January 13th.
However, since this is a broad advisory communication against the
specific communication of January 13th, we can assume that this defi-
nition is more to set the tone and describe the institution to the bank-
ers rather than to stand by each word of the definition. A further
reading of the communication throws up six significant points, some
of which are a reiteration of an earlier statement in the credit policy,
but basically an advisory to the banks to partner with the microcredit
sector. The six points that the notification throws up are:

22
 INTRODUCTION

1 No interest rate cap on loans to MFIs and their loans to clients.

2 Freedom to banks to formulate their own model/conduit/interme-
diary for extending microcredit.
3 No criteria prescribed for selecting MFIs.
4 Banks to formulate their own lending norms.
5 Banks to formulate a simple system, minimum procedures and
documentation for augmenting flow of credit by removing all
operational irritants.
6 The banks were to include microcredit at the branch, block, dis-
trict and state credit plans with quarterly progress to be reported
to the RBI.

To indicate the seriousness of the notification, it was annexed with a

reporting format for the exposure to the microcredit sector, with sepa-
rate sections for reporting progress under SHGs and other microfi-
nance initiatives to be submitted to the RBI every quarter.
From the above, it was clear that the RBI was providing a policy
framework that encouraged private sector microcredit activities
undertaken by for-profits and non-profits. It was agnostic about the
model of delivery. It showed an enthusiasm to remove all bottlenecks
to make the alternative channels open up access to finances. What the
RBI failed to do at this stage is to provide a regulatory framework for
these organisations to operate.
From the time of the transformation of MFIs into for-profit insti-
tutions, they started growing with significant mainstream private
equity investments. The valuations skyrocketed at successive issue of
shares with a pressure for the MFIs to go public. SKS Microfinance
became the first MFI to issue shares in a public offering, and there
were many others waiting in the wings. However, in the quest to grow,
the MFIs were resorting to multiple lending in the same market lead-
ing to overheating. Some clients of MFIs even resorted to suicide due
to over-indebtedness.
At that time, the three most important grievances against the micro-
finance sector was that (a) the interest rates charged on the loans by
the MFIs were usurious, (b) the MFIs resorted to coercive recovery
practices and (c) they were overloading low-income households with
unsustainable debt. This was famously called the AP Microfinance
crisis of 2010 (Sriram 2012). It was only around the time of the crisis
that RBI comprehensively responded – first by setting up a committee
under the leadership of YH Malegam (Malegam 2011) and followed
it up with a regulatory framework for MFIs providing for a separate

23
 INTRODUCTION

category of Non Banking Finance Companies-Microfinance Institu-

tion (NBFC-MFI) regulation. The regulations put forward a client pro-
tection framework, including a cap on the interest rate based on costs
and commercials. Subbarao (Chapter 4) indicates that while the RBI
moved away from its own stand of progressively removing all controls
on business decisions like interest rate caps, this was one sector where
the RBI re-imposed the caps in order to protect the customers. How-
ever, it was the self-regulation and transparency that was more crucial
in the Malegam recommendations. The transparency on pricing the
products and ensuring that the poor are not charged any hidden costs
are the underlying design features of the Malegam Committee. The
basic intellectual argument of ensuring consumer protection through
transparency was made by the Rajan Committee in 2009.
Reddy (Chapter 3) indicates that the RBI was favourable and liberal
towards MFIs because they were all operating as not-for-profit enti-
ties and did not visualise that they would transform into for-profit
enterprises. (Also see Reddy 2011a, 2011b and Sriram 2011 for a
discussion.) Subbarao (Chapter 4) brings out the dichotomy between
allowing an experiment to grow, assess the risk from a systemic per-
spective and also look at the angle of customer protection. He indi-
cates that the RBI possibly overlooked the customer protection angle
as it was possibly predominantly concerned by the issue of systemic
stability.
Thus, SHG and microfinance represent a light-touch model for
financial inclusion from the perspective of the RBI, and the first
instance where the innovation and drive were coming from the market
players and RBI was in a response mode. However, after the regu-
latory framework provided for the NBFC-MFIs based on the Male-
gam recommendations, the RBI has been proactive in this sector with
frameworks for compliance. In fact, as Rajan (Chapter 5) indicates,
the guidelines for issuing licences for SFBs by changing the focus from
“Small” Banks to “Small Finance” Banks was done at the behest of
the microfinance industry. There is little wonder that eight of the ten
licence issues for setting up SFBs were given to MFIs.

Post Bank
If there was one aspect on which the Governors were almost unani-
mous, it was about the concept of a Post Bank. While all of them were
open to the idea of the Post Office network collecting deposits as they
have been doing for years, there was a widespread concern that just a

24
 INTRODUCTION

mere presence and a spread of activities meant nothing. Not only did
it not mean much for a bank, but the network itself was a handicap
because the amount of savings that the Post Office network collected,
and therefore the resources at their command to deploy in the market
itself, posed a systemic risk. The Governors across the board felt that
the Postal Department did not have adequate training and exposure to
modern banking, and collecting deposits was completely different
from dispensing credit and understanding risks. As of now, Post
Offices were in risk-free business where the entire deployment of the
savings collected from the people were to be deployed with the
sovereign.
To that extent, it is just as well that the Postal Department has got a
licence to operate as a PB, which is eligible for doing remittances and
collect savings. There is some appreciation and recognition of the fact
that the network is deep and widespread, and it should be leveraged
for distributional aspects, but they feel that it should be done off the
books. Jalan in particular (Chapter 2) re-emphasised the need for a
strong customer protection framework. Irrespective of the innovation,
unless the framework for protection of the poor and vulnerable – who
form the core of the inclusive market – was in place, the efforts were
incomplete. To this extent, it was clear that the Post Bank was not an
idea that would find favour with the RBI.

The overall ecosystem and looking forward

The overall ecosystem has changed from the time the process of liber-
alisation started. While we have discussed how the paradigm on inclu-
sion has changed over the years on the basis of institutional silos, it is
also important to recognise how the intellectual discourse within the
RBI changed to an accommodative multi-institutional intervention
strategy. Unlike in the past where committees looked at a specific
problem and addressed that specific issue, there was a larger recogni-
tion of the broader agenda of inclusion not to be seen as a pure bank-
ing problem. In 2005, the term “financial inclusion” was used for the
first time in the monetary policy statement (see Chapter 3, Conversa-
tions with Dr Y. V. Reddy). This was followed up by a Committee on
Financial Inclusion set up with Rangarajan as the chair. This commit-
tee set up the institutional architecture for financial inclusion, arguing
not only for state-led interventions, but also for encouraging financial
services to flow through formal sector institutional framework. This
institutional framework not only included embedding SHGs into the

25
 INTRODUCTION

banking more aggressively, but also included promoting decentralised

institutions. In a way, it set up the intellectual argument for what a
regulator could directly do as well as what a regulator could facilitate.
The Nachiket Mor Committee which eventually gave a specifically
designed road map for new institutional structures continued the intel-
lectual argument set up by the committee on financial inclusion.
The fundamental changes have happened in the field of technology,
which makes banking ubiquitous. The Nachiket Mor Committee sug-
gested an aggressive growth plan for banking – where every adult indi-
vidual would have an universal electronic bank account – and this was
to be achieved by 1st January 2016 (Mor 2014). This was based on
the architecture created by the Aadhar platform of the Unique Iden-
tification Development Authority of India (UIDAI). The technology
platform can not only carry out small transactions; these transactions
could be carried out without the presence of cash; and these transac-
tions create a trail which could be used in developing machine learning
on the creditworthiness of the customers. The digitisation of bank-
ing would change the fundamental ways in which the banking would
change.
Way back in 1994, Bill Gates, the then Chairman of Microsoft, is
attributed with the following quote: “Banking is necessary, but banks
are not” (Gandhi 2016). The same aspect was reflected by Subbarao
(Chapter 4) where he talked about the changing ecosystem and how
the banks have to adapt themselves to new opportunities. With tech-
nology and cashless transactions it is possible to break the barrier of
size (small transactions become feasible), and once the fixed costs
of the technology backbone are in place, the variable costs could be
brought down significantly.
With technological solutions available, it is possible that more
transactions are driven through the bank account. One way in which
the traffic could be driven into the inclusive banking segment is by
transferring the benefits and subsidies in the form of cash. Already
large-scale experimentation on transfer of the cooking gas subsidy and
the other subsidies are being routed into bank accounts. With the mas-
sive PMJDY programme, the initial investment in getting people into
the banking system has been achieved to a great extent.
As Patel indicated in the interview (Chapter 6), the role of the RBI
would move from a developmental role to a role of a regulator. The
markets will take over the agenda, as the MFIs have demonstrated,
and innovation would be the key driver. A lesson learned from the
innovation and the aggression of the markets is that the vulnerable

26
 INTRODUCTION

customer could get shortchanged in the process. It is in this context

that the aspect highlighted by Jalan (Chapter 2) of protecting the cus-
tomers through a robust customer protection framework assumes pri-
mary importance.
On the future of the role of the RBI, Patel indicated (Chapter 6)
that apart from the morphing from a developmental role to that of a
regulator, there would be some significant interventions that would be
necessary. The customer protection framework discussed above is the
most important piece. The next piece is tracking the innovations closely,
particularly in areas where there is deployment of technology. In this
particular context, the evolution of digital financial inclusion would
be important. While RBI did put out a draft discussion paper on peer-
to-peer lending (Reserve Bank of India 2016), Patel did not think this
should be seen as an intervention that facilitates only financial inclusion.
He feels that this was distinct, and financial inclusion, if any, should be
seen only as a collateral benefit. Other points that Patel made was of
importance to understand how the RBI as an institution is watching the
future. The first was about the facilitation of moving towards a cashless
environment. There is recognition that cash is a public good and mov-
ing to digital payments would impose private costs; therefore, in cases
where there are non-commercial exchanges of cash, there needs to be
some element of defraying the carrying costs. Another point that was
made was about how smartly subsidies could be designed without com-
promising the essential commercial nature of the exchanges. In essence,
the message given by Patel was that the role of RBI would shift from
the forefront to the background and would move from a predominantly
developmental role to a facilitative and regulatory role.
The customer protection framework should also encompass the
possible digital version of the 2010 crisis – the overzealous finance
companies undertaking aggressive lending programmes, leading to
irresponsible borrowing and the poor and vulnerable slipping into a
debt trap. The pay-day lenders in the West have proved that it is pos-
sible for sophisticated instruments to be used to lure the poor and the
vulnerable into a debt cycle, and therefore, focus should be laid on
consumer protection.
However, the question that continues to open up is whether the
developmental role of RBI is over – has the RBI achieved significant
progress in terms of providing a well-regulated financial services archi-
tecture in an inclusive manner? This is a difficult question to answer,
and we will have to wait to see how the new institutions in the private
sector will grow and how much of the informal sector players they

27
 INTRODUCTION

would replace. We also need to watch if these institutions could be reg-

ulated for ensuring that vulnerable clients are treated fairly and with
dignity. While the numbers of PMJDY, the growth of touch points and
the innovation in the digital space is impressive, meaningful transac-
tions have not happened on a large scale. The levels of indebtedness
to the informal sector seem to be a sticky number and have not moved
significantly. While the hook to get the excluded customers into the
banking system could be through the savings route, unless the other
pillars of exclusion are meaningfully addressed, the agenda will be far
from over.
The design of customer protection framework will have to have two
strategies: first is to open up the space for more competition, thereby
providing multiple alternatives to the customer. While in the microfi-
nance sector we found that this indeed happened, it is important that
the RBI as a regulator has to be vigilant to see if the competitive forces
are working freely to discover price equilibrium or whether there are
disproportionate rents being sought by the players. The AP experi-
ence would provide guidance on this aspect. The second, which is very
important, is to provide a default option to the customers which is
fair, accessible and usually provided by the state. We have to remem-
ber that between an institution and an individual customer – even in
very evolved markets – the institutions have greater powers because
they have the time and the resources to fight their case, while the indi-
vidual customers are vulnerable. It is, therefore, that one argues for a
strong customer protection framework in any institutional arrange-
ment. In the case of customers that are excluded, the framework has
to be so much stronger given that they are more vulnerable than other
customers.
The additional aspect that the RBI may have to take a lead in is
to look at a framework for ensuring that the players in the financial
sector – that are outside the regulatory purview of the RBI – also get
regulated in a manner that does not have a contagion effect. Some of
these are in the securities market, some in the pensions and provident
fund market, but much more in the informal and semi-formal mar-
kets which are governed by the laws of the state governments. It may
be important for the RBI to work with state governments to ensure
that they have independent state financial regulatory authorities that
ensure that the vulnerable customers that fall out of the regulatory
framework of the RBI are protected.
The agenda of inclusion would never be over, as the bar would be
set a bit higher every time there is an achievement to talk about. While

28
 INTRODUCTION

the achievement in bringing the excluded into the formal sector frame-
work is impressive, there will be much more to be done to ensure that
the included customers are meaningfully included and not partially
included. These customers should not just have token accounts, but
should be able to use all the features and the institutional facilities
that come with the entry and access into the institution. While the RBI
might say that the focus would be on harnessing innovation, provid-
ing a customer protection framework and encouraging the markets to
take over, its developmental functions will continue, or will have to
continue.
The challenges as the digital spaces open up and the technology
frontiers open up will have to be faced squarely. If banking is getting
redefined, the RBI will have a big role in the process of redefinition,
and in the process the instrumentality of how it performs its role will
get redefined while its developmental and regulatory role will possibly
continue forever.

Notes
1 See: https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=22965, accessed
on 8 May 2017.
2 https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=4350
3 RBI (2014). https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=2856, accessed
on 20 May 2017.
4 RBI (2014). https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=
32614, accessed on 20 May 2017.
5 RBI (2000). Communication No: RPCD.NO.PL.BC. 62 /04.09.01/99–
2000, dated February 18th. www.rbi.org.in/scripts/NotificationUser.
aspx?Id=127&Mode=0, accessed from the RBI website on 6 February
2011.

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Indian Social Banking Experiment.” The American Economic Review 95
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Gandhi, R. 2015. Report of the High Powered Committee on Urban Co-
operative Banks. Mumbai: Reserve Bank of India.
Gandhi, R. 17 August 2016. New Paradigm in Banking: Banking Is Neces-
sary, Not Banks – Really? Accessed May 14, 2017. www.bis.org/review/
r160822b.htm.
Harper, Malcolm. 2002. “Self Help Groups and Grameen Bank Groups: What
Are the Differences.” In Beyond Microcredit: Putting Development Back

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Into Microfinance, edited by Thomas Fisher and MS Sriram. New Delhi:

Sage Vistaar.
Malegam, YH. 2011. Report of the Sub-Committee of the Central Board of
Directors of of Reserve Bank of India to Study Issues and Concerns in the
MFI Sector. Mumbai: Reserve Bank of India.
Mor, Nachiket. 2014. Report of the Committee on Comprahensive Finan-
cial Services for Small Businesses and Low Income Households. Mumbai:
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Nair, MV. 2012. Report of the Committee to Re-examine the Existing Clas-
sification and Suggest Revised Guidelines With Regard to Priority Sector
Lending Classifications and Related Issues. Mumbai: Reserve Bank of India.
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Delhi: GoI.
Rajan, Raghuram. 2009. A Hundred Small Steps: Report of the Committee
on Financial Sector Reforms. New Delhi: Government of India, Planning
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Rangarajan, C. 2008. Report of the Committee on Financial Inclusion. Com-
mittee Report, New Delhi: Ministry of Finance, Government of India.
Accessed April 22, 2017. www.sidbi.in/files/Rangarajan-Commitee-report-
on-Financial-Inclusion.pdf.
Reddy, YV. 2011a. “A Response.” Economic and Political Weekly (Sameeksha
Trust) XLVI (50): 112.
Reddy, YV. 2011b. “Microfinance Industry in India: Some Thoughts.” Eco-
nomic and Political Weekly 46 (41): 46–49.
Reserve Bank of India. 2014. The Concise History of the Reserve Bank of
India. Mumbai: Reserve Bank of India.
Reserve Bank of India. 2015. Report of the Internal Working Group to Revisit
Existing Priority Sector Lending Guidelines. Mumbai: Reserve Bank of
India.
Reserve Bank of India. 2016. Consultation Paper on Peer to Peer Lending.
Mumbai: RBI. Accessed June 13, 2017. https://rbidocs.rbi.org.in/rdocs/
content/pdfs/CPERR280416.pdf.
Sriram, MS. 2005. “Information Asymmetry and Trust: A Framework for
Studying Microfinance in India.” Vikalpa (Indian Institute of Management
Ahmedabad) 30 (4): 77–85.
Sriram, MS. 2010. “The Commercialisation of Microfinance in India: A
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nomic and Political Weekly (Sameeksha Trust) XLVI (50): 110–112.
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Bank Scheme. Mumbai: Reserve Bank of India.

30
 1
CONVERSATIONS WITH
DR C. RANGARAJAN *

Dimensions of financial inclusion

MSS: You have not only served RBI as a Governor, but also have been
involved with this topic. You have been the Chair of the Committee on
Financial Inclusion. You have later served on the Prime Minister’s Eco-
nomic Advisory Council. The question is about the differing roles of
the RBI and the government on the agenda of financial inclusion. Is
there some congruence given that the government is largely making
policy while the RBI is charged with licencing institutions and ensur-
ing that the institutional architecture works? You have been on either
side and must have straddled with both these views.
CR: The term ‘financial inclusion’ emphasises one aspect of what is
being described as inclusive growth. Inclusive growth is a much broader
concept, in which the economic policy makers will have to ensure that
benefits of growth accrue to all sections of society and that, in particu-
lar, the bottom deciles of the population benefit from growth. In one
sense, financial inclusion is a subset of growth. Financial inclusion has
been interpreted to connote the spread of the organised financial system
to cover the vulnerable groups. It includes the provision of various types
of facilities. As far as the banking system is concerned, it is expected to
provide deposit and payment facilities and credit to the poor.
MSS: Yes, but if we go back in history for a long time, even though
financial inclusion should have been all encompassing; it has mainly
been credit driven.
CR: I see financial inclusion as having three dimensions. One –
spatial, in the sense that the organised financial system must reach out
to all regions and evenly spread. Two – sectoral, financial inclusion
must take care of the credit needs of all the sectors of economy not
only including agriculture and industry, but also sub-classifications of

31
 C O N V E R S AT I O N S W I T H D R C . R A N G A R A J A N

agriculture. And three – the emphasis on the organised financial sys-

tem reaching vulnerable groups and people with low income.
If you look at the evolution of financial inclusion, earlier attempts
were largely on the first two dimensions. The thrust of the branch bank-
ing system was motivated by the desire to see that the banking system
is spread all over the country, and it also reaches out to semi-urban and
rural locations. Then come PSL norms, which looked at provision of
credit for specific sections like agriculture and small-scale industries.
While PSL also had some elements of reaching out to the vulnerable
sections, I would say it was only one element. It is the third dimension
which focuses primarily on the vulnerable groups, in my view, is the
unique dimension of financial inclusion. Therefore, the focus is on how
to get the organised financial systems to reach out to the poor or poorest
of the poor. This is, in fact, the special dimension of financial inclusion.
There has been an evolution of thinking on inclusion, but the lat-
est emphasis is on vulnerable groups. Within the vulnerable groups
the emphasis has been on not only providing credit facilities, but also
providing other savings and payment facilities.
MSS: There have been multiple approaches in trying to achieve the
difficult task of financial inclusion. In your report you had laid out
a road map for financial inclusion with time bound targets and had
also suggested a mission for monitoring this. If you look at the Prime
Minister’s Jan Dhan Yojana (PMJDY)1 it seems to have been rolled out
on a mission mode, though not as a separate mission. Are there dif-
ferences between what your committee2 (Rangarajan 2008) has advo-
cated as a mission and the way PMJDY has rolled out? What do you
think are the achievements and problems in the approach of PMDJY?
CR: Mission mode actually means setting time bound targets, moni-
toring the progress and making midcourse corrections if necessary.
When we suggested a mission mode, the targets set included exten-
sions in relation to both deposit accounts as well as credit. If PMJDY
has similar objectives, the government should come out with periodi-
cal reports on deposit accounts and credit extended. While there is
much reporting on the number of deposit accounts and the amount
collected, there is not adequate information on credit provided.

Local Area Banks

MSS: If we look at this from the perspective of policy makers there
have been two approaches. One is the institutional approach, where
we have specialised institutions like Regional Rural Banks (RRBs) and

32
 C O N V E R S AT I O N S W I T H D R C . R A N G A R A J A N

Local Area Banks (LABs). The other is the policy prescription, which
categorises or allocates a certain portion of portfolio to agriculture,
which you call a sectoral dimension. Do we need to do both or do you
prefer one over the other? Or should these get dovetailed? One
approach looks at the spatial dimension and the works on the sectoral
dimension.
CR: Dimensions of financial inclusions are so vast that I don’t think
that any approach focusing on only one type of instrument or institu-
tion is appropriate. In fact, there is scope for all types of institutions to
play a role. The banks have a role, an important role to play in terms
of all the three dimensions of financial inclusion.
MSS: I would like to take one example on LABs. You were very sup-
portive of LABs during your tenure. You even tried to revive the idea
when you gave the Financial Inclusion Committee report. But after
your tenure, the RBI as an institution has never been comfortable with
a large number of small banks. When the draft guidelines for SFBs
were issued, it was conceived as LABs with restricted areas. But the
final guidelines offered SFBs a national footprint. I spoke to Dr Rajan
about this, and he gave two arguments for the change. One, a large
number of applicants would be MFIs in any case, and they already had
a footprint that was much larger, and it was a valid demand from them.
Second, it was very difficult for the RBI to regulate small institutions.
CR: Well, we have experimented with various types of institutions.
First there was the thrust on bank branching. Then we found that
it was not working completely to meet the objective. Then we set
up RRBs, which are a partial success. But RRBs are government (or
banks) owned. Therefore, we thought that if an institution which is
privately owned can focus on small people and small lending, it could
be great. We have our counterparts in urban areas – the Urban Co-
operative Banks (UCBs), which are extremely small, even compared to
LABs. Some of them are very small and successful.
Therefore, we thought that LABs, like the RRBs, must have some
commitment to a particular area and commitment to people working
in an area. To set up small banks and give them the all India footprint
will not make much impact. If it is going to be a small institution, it
better be confined to one area. But, for some reason or the other, my
successors did not think it was a workable idea.
Institutions survive and grow only if regulators and authorities
provide support. If they have concerns about viability of institutions,
automatically new institutions do not come up. In fact, they did not
invite new applications for LABs after the first round.

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MSS: Yes. They did not. In fact, the RBI set up a committee under
the chairmanship of G. Ramchandran3 (Ramachandran 2002) to
examine the further licences to LABs.4 The report makes a peculiar
conclusion that no further licences to LABS should be given, while
admitting that LABs have not been given the opportunity and that it
is too early to conclude.
CR: Yes . . . We thought it was a good experiment.

Regional Rural Banks

MSS: Let me come back to you regarding the RRB issue. Your report
had suggested that there should be no further consolidation of the
RRBs. Your report came out in 2008 but there has still been some
consolidation, and now we have stabilised it to 56. We don’t know
whether it will be further consolidated. There was this sense that there
should be one RRB per state or two RRBs per state. By doing this are
we looking at only the viability part of it?
CR: What is the concept of RRBs? The concept of RRBs is essen-
tially close to a LAB. The region was not defined in terms of a state;
the region was defined to be much smaller.
MSS: It was, in fact, closer to the village co-operatives.
CR: Being bound with the region was an important dimension
of the concept. And that will create local interest and local initia-
tives. So, if we merge RRBs across districts and create one per state,
I don’t know whether the RRB will be different from a commercial
bank.
MSS: The other thing that has happened with RRBs is an amend-
ment to the act, which allowed a fourth shareholder to come in. State
government, central government, sponsor bank and a private investor
could be shareholders, provided that the combined shareholding of
the state and the central government does not go below 50%. And
along with it there also came a provision that there would be an inde-
pendent director whom they would appoint, who might be outside
the system. Is that a good direction to go? Will that get some dyna-
mism in RRBs?
CR: Basically, we are converting RRBs into ordinary commercial
banks. After this change, will they remain committed to the original
mandate? It is not very clear. Because inclusion of the private sector by
itself is not a bad idea; this we had done with the nationalised banks
and with LABs. But we need to see how this will play out.

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Small Finance Banks5

MSS: There are two differing views on this. If it is an SFB, for instance,
Dr Reddy believes that it should confine to geography and penetrate
deeper, and it should never aspire to become a universal bank. Dr
Rajan, on the other hand, believes that if you are a SFB, then you grow
into a universal bank subject to the qualification requirements.
CR: I suppose that good NBFCs have graduated to become small
banks and even bigger banks.
MSS: Like Bandhan.6
CR: Yes, like Bandhan. We cannot say that small banks should
not become big, but by making area restrictions, we are creating
a situation for greater benefits and greater focus. But without area
restriction small banks could lose focus, and that is my concern.
But, in any case, I am happy that the concept of a small bank has
been accepted.
MSS: But there is a difference in how SFBs are seen (Reserve Bank
of India 2016a) and how you had formulated the idea. Currently, they
are addressing the dimension of vulnerable groups and not the spa-
tial dimension. By putting loan ticket size restrictions and higher PSL
requirements, the design is looking at customer groups rather than
geographies.
CR: Our idea of LAB also was . . .
MSS: Vulnerable groups within spatial dimension.
CR: Right! I mean spatial was only an additional restriction . . .
Were we looking at LABs to provide support to large industries in a
particular area? No! The idea was really to provide support to smaller
industries and agriculture, as they would have a better understanding
of the local situation and provide support. That’s it.
MSS: That brings me to one more aspect. Despite these restrictions
for LABs and RRBs which forces them to go to regions that are under-
banked; despite the policy of encouraging banks to establish branches
in underserved areas, and despite all the work that RBI has proac-
tively done, the disparity still continues. The North-East and Central
regions continue to be under-banked. Eastern and Northern regions7
have picked up in terms of rural branches. The contribution of RRBs
in spatial presence in the North-East and East is significant. When
the LABs were opened, most of the applications were in well-banked
districts. So, are there some areas where people might think it is inher-
ently unviable to do banking? Because if you are talking of banking
being a subsector of inclusive growth and growth itself is not very

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vibrant, then how do we go forward? There isn’t an underlying mon-

etised economy. So how do we deal with this?
CR: Well, you know in the evolution of financial systems, two types
of development are possible: the demand-led development and the
supply-leading approach. In the first case, banks or other institutions
come into existence to meet a demand. In the other case, the institu-
tions are set up by the state or others in advance of demand.
MSS: And they will create the demand . . .
CR: The easy route will be the demand following. LABs and SFBs
will have to come in where the demand has to be created. Here, I think
some special assistance may be needed. Where certain types of institu-
tions are desirable but not coming up for viability reasons, some help
can be given.
MSS: On this the government’s approach has been: if it is a difficult
area, give interest subventions to the SHGs.
CR: I think we should take the approach of supporting the institu-
tions. The better thing is to provide institutional support rather than
interest subvention. Interest rates in some of these institutions are
already low. Some refinance may be provided if an economic activ-
ity is not viable at the rates that are normal in the organised financial
system. We should not have a structure whose viability is seriously in
question. Institutions don’t come up on their own. Even in the case of
SHGs, a lot of spade work had to be done initially to create the insti-
tutions. I think for institutional finance to flow, SFBs, or something
similar, are needed. They may not be coming up on their own and,
therefore, some effort will be needed.
MSS: At least to defray the fixed cost. In fact, the Usha Thorat Com-
mittee (Thorat 2006) that looked at the issues pertaining to banking
in the North-East8 had suggested capital assistance for banks to set up
branches, currency chests and other infrastructural facilities, creating
an ecosystem for institutional finance to flow.
CR: Yes, the state government or somebody can do that. That is
what is required.

Payments Banks9
MSS: The other thing is there are two to three new initiatives that the
government has taken in the recent past. One is the SFBs, and we
talked about it. The other set of institutions are PBs (Reserve Bank of
India 2016b). I have not really fully understood how this would work
at scale. Have you seen anything like this? What do you think?

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CR: The emphasis on credit as a significant element of financial

inclusion has been pushed to the background. Our original idea of
financial inclusion started with the desire and intention to provide
credit to the vulnerable groups. I agree financial inclusion encom-
passes facilities for savings, transfer of funds and all that, and these
aspects deserve attention. But much of the new initiatives are not credit
oriented. Nevertheless, they have a role in the context of programs
that have been launched recently, like Direct Benefit Transfer (DBT)
schemes. This is not the whole of financial inclusion. Institutions like
PBs focus only on one aspect, namely deposit and transfers. They have
a partial role in relation to financial inclusion.
MSS: In fact, I have talked to a few people, and I hear that they are
yet to figure out the revenue model for the long run. There does not
seem to be a clear verdict on the viability. Three players have surren-
dered their license.
CR: There are pure fund transfer institutions like Western Union.
Now we have combined it with savings. This combination is not very
clear to me. I would have gone for pure payment systems, in which the
focus is on transfer of funds quickly and efficiently. Something that
could be a close parallel to Western Union.
MSS: In fact, there are institutions that operate prepaid wallets and
possibly they could have been made into two-way wallets?
CR: I think that could have been a better model than combining
it with the savings model. Then the question arises if you are paying
interest for savings, what is the revenue? They could earn on remit-
tances. What else? Are they allowed to invest in government papers?
MSS: Yes! 100% in government paper. Dr Reddy asked how they
were different from residuary NBFCs like Sahara.10 Except that
RNBFCs were initially allowed to keep 20% of their deposits in assets.
Here even that is not allowed.
CR: That is not very convincing.

Post Bank
MSS: The other thing is about the Postal Department. Your committee
had talked about the potential of India Post. I don’t think we have
been imaginative with the network of India Post.
CR: You see, I entirely agree with the proposition that the Post
Office, as it is now, has no expertise in banking. In fact, I was chair-
man of a committee when I was in the Indian Institute of Manage-
ment, Ahmedabad. It had made a recommendation that the savings

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department of the Post Office should be separated from the pure

postal services. What I said at that time was that the postal business
and the savings business have no organic relationship. However, being
co-located gives a natural advantage. I think we recommended to sep-
arate these activities within the Postal Department itself, and we even
said you recruit people separately for this.
If they had accepted this at that time, they would have become the
biggest savings bank in the world. Japan is a good example. Postal
Savings Bank is a big thing there. India Post has a network, and it
has experience in dealing with people. But then they should really
upgrade their infrastructure. Have they been given a Payments Bank
licence?
MSS: They have been given a PB licence. They have spent near about
Rs.50 billion on the Information Technology (IT) modernisation proj-
ect. They have a core banking solution, and they have installed a
thousand Automated Teller Machines (ATMs) across the country. So,
at the back end, there has been lot of work on modernisation and
training. They had an initiative called Project Arrow which looked at
restructuring, reforming and modernising India Post. So, they have
internally prepared to do a whole lot of things.
CR: But I don’t think the RBI is convinced that they can do credit.
MSS: That’s the view that I have heard from anybody whom I talk
to: The postman knows you, yes, he can do a Know Your Customer
(KYC) verification. It does not mean he can do a credit assessment.
The question is: how we use this network? The BC model11 we are
talking about is the established model of Grameen Dak Sevaks. They
are not full-time employees but are representing the Post Office. The
departmental Post Office has around 30,000. The rest of them are
postal outlets which work between two to six hours a day and depend
on the involvement of the Dak Sevaks.
CR: See, once it becomes a bank it cannot use employees of the
Postal Department. It becomes an independent institution.
MSS: Is there a way of leveraging the network?
CR: The Postal Department was able to do much of the things at a
cheaper cost, because they were part of the government system, and
their pay scales were very different. If they get into banking, they will
become exactly like the RRBs. The Supreme Court said there could be
no distinction among banks so their increased costs will affect their
viability.
MSS: The Postal Department set up a committee under TSR Sub-
ramanian12 to look at the reorganisation and new initiatives for India

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Post, which recommended that India Post open a universal bank (Sub-
ramanian 2014). EY13 did a feasibility study for them. But ultimately
the RBI remained unconvinced. They are now working on the PB
license.
CR: I hope the Post Office will continue to receive small savings?
MSS: Yes, they are setting up the PBs as a separate entity, which will
have an independent board and representatives from India Post at the
board level.
CR: What about this National Savings Certificate?
MSS: That will continue to be with the Post Office.
CR: Because the PB has a different mandate?
MSS: Also, the government would be interested in the small savings
bit.
CR: But the key question will be the link between the PB and the
Postal Department. Because so far, the argument for the Post Office
being used is its presence everywhere. Can it be used now? And what
kind of arrangement will there be?
MSS: From what I understand, PB will be a lean organisation, but
they will use the Grameen Dak Sevaks for the last mile delivery. I
don’t know how they will ring-fence the work between the bank and
the Post Office. I am sure they are working on this. In any case, the
rural Post Offices are doing third-party products including selling
gold, so the services to the PB may be one more third-party product
that they will deal with.

MUDRA
MSS: The other institution that is much discussed is MUDRA.14 There
is a bit of confusion: ultimately what is the nature of this institution?
The initial documents indicated that MUDRA would be something
like the National Housing Bank (NHB), in the sense that it will be a
direct lending agency and also a refinance and regulatory agency for
the micro and small enterprises sector.
CR: I think a refinancing agency for MFIs is a good idea. SIDBI is
already there, and it could have been endowed with this responsibil-
ity. The concept of a refinancing agency to support this activity is not
a bad idea. But whether MUDRA can be called a bank, that I do not
know because it does not perform any of the functions of a bank.
Whether as a refinancing agency it should also be given the regula-
tory power depends on how much the RBI is willing to accept it. If it
is too difficult to control and regulate too many of these institutions,

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the RBI would have its reservations. That is why it originally did not
accept our recommendations to create a separate non-bank MFI.

Microfinance Institutions
MSS: That brings us to MFIs; your committee has been positive
towards MFIs?
CR: As you said, we have dealt with MFIs extensively in our report.
Perhaps if the government and the RBI had acted on it, the AP15 inci-
dent might have been avoided, but they did the classification of NBFC-
MFI much later.
Let’s go back. It will be a difficult task to regulate thousands of small
MFIs and the movement has a reasonably good record. We should
really have thousands of MFIs. But to manage them will require some
control which can be indirectly done through the commercial banks. I
mean if banks provide credit to MFIs, then that makes the commercial
banks responsible for the regulation. If a particular bank provides sig-
nificant credit to an MFI, then that bank should be made responsible
for its prudent functioning.
MSS: That’s true, but the current trend is oriented towards creat-
ing more banking institutions, which can be directly managed. In one
sense MFIs have become lightly regulated institutions but still institu-
tions which are regulated. It is extremely difficult to incorporate them
and run them because of the myriad of regulatory requirements. If you
look at the array of institutions needed from banks to informal lend-
ing, they are not coming up in the numbers required.
CR: As I said before, we should experiment with all types of institu-
tions. I don’t think there is any particular institution alone on which
we should focus. But then there is a particular issue of how to reach
out to the extremely small borrowers. That segment is not going to
be met by the banking system. The only route available to the bank-
ing system is through the SHGs. In that case, the loans can become
extremely small. Otherwise, providing credit of that size individually
will become extremely difficult.
MSS: So, that way, microfinance has proven that model.
CR: The MFIs in AP violated a basic principle; namely that the
provision of credit must be for a productive purpose. First of all, they
went ahead and provided a large amount of loans for consumption,
and second, they also violated the principle of multiple lending; the
same borrower borrowed from multiple institutions.

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MSS: What you are saying is that they didn’t do the credit assess-
ment. Simple. Because if you look at the MFI model, as long as my
recovery is coming, the purpose of the loan is secondary. And as long
as MFIs have a mechanism to recover – which is peer pressure and
social coercion – life goes on. But it will boomerang beyond a certain
stage.
CR: Yes, because if the viability is not there, it will go on for a cer-
tain time, but sooner or later it will explode. MFIs as NBFCs cannot
and should not be wished away. There should be effective mechanisms
to supervise. Some broad regulations may be formulated.
The question is who will control these institutions. If RBI thinks
they have the ability and infrastructure to oversee, to supervise this
innumerable number of small institutions, it is well and good. But if
they are not able to do it, then I think we will need another agency to
look after it. Since you raised that issue, we will have to talk about it.
The attitude of RBI towards MFIs has been mixed.
MSS: Yes . . . it has been hot and cold.
CR: Sometimes hostile.
MSS: In fact, it is a very interesting thing, Sir. I was looking at the
old notifications and found that microfinance came into RBI’s dis-
course by stealth. Actually, microfinance was not defined by RBI for
a long period of time, but suddenly that started reporting progress on
microfinance without defining microfinance. There was no classifica-
tion of microfinance, what should be the loan size. So, any NBFC
claimed that they were microfinance, and the RBI started reporting
them as such. During that period, the circulars asked the banks to be
encouraging towards MFIs. There were advisory circulars asking for
quarterly progress reports. And then, after the AP crisis, the RBI sud-
denly became hostile.
CR: The approval for SHGs as an instrument or an institution
through which lending can be given was given during my time.16 In
fact, there was a lot of confusion at that time on whether they should
be registered and if we should frame rules to deal with the groups.
There was an important circular of the NABARD, which we approved
during my time, which paved the way for groups to link with banks
through an inter se agreement.
If we allowed the banks to give credit to NBFCs and put the respon-
sibility on the banks to ensure that they behave properly, it would have
worked. Then the mechanism gets simplified. That is what we should
have done.

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Agricultural co-operatives
MSS: On the agricultural co-operatives what is your take, Sir? Is it a
sunset? Has it has gone dead?
CR: There was an attempt to revive it. I remember Prof. Vaidyana-
than who headed the committee met me also. I was at that time the
Chairman, Economic Advisory Council. Then we did almost every-
thing recommended.
MSS: Dr Reddy also was bullish at that time, but within six months
he said that it was not working out because political will was not
there. That is all!
CR: The basic point is that all this kind of support that one wants to
give will not work unless at ground level things change. The primary
co-operative societies, the village credit societies, must by themselves
be vibrant and active.
MSS: If you go back in time, following the All India Rural Credit
Survey Committee report,17 until the nationalisation of banks it was
the co-operatives that gained the market share from the informal sec-
tor. So that decade of the late ’50s and entire ’60s was the decade of
the co-operatives, very much the way the decade of the ’90s was the
decade of the SHGs.
CR: The one thing rural co-operatives could do is become a BC. I
am really thinking that they should become the BCs of the commercial
banks. One way for the commercial banks to fulfil their mandate and
achieve their objectives is to make the village credit societies as BCs.
This is the way both will gain.

Urban co-operative banks

MSS: What about UCBs? RBI has come out with the Gandhi Commit-
tee (Gandhi 2015) report which is contentious. They say that some of
the UCBs are too big to be co-operatives. They applied the “too big to
fail” concept, said that some of these banks could be “too big to be a
co-operative” and suggested that they be converted into commercial
banks.
The problem is that in co-operatives you cannot distribute accu-
mulated profits on liquidation. You can only distribute dividends/
bonuses out of current income. The moment you go into a company
format you can distribute accumulated profits on liquidation. When
the co-operatives liquidate, the surpluses, if any, will go back either to
another co-operative or to the state. Now, is it fair to change from one

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form of organisation to another? The committee has brushed it away

by saying that they need a legislative amendment.
CR: Well, Development Credit Bank was originally a co-operative.
The fact is that when co-operative institutions become too big, they
cease to be co-operatives, except for the principle that every member
has only one vote, despite one’s shareholding. Therefore, there is noth-
ing wrong in converting it. But the whole issue is that whether all this
conversion and moving into a different form will fulfil the original
purpose and the mandate. Now if the road map for all sorts of institu-
tions is eventually to become commercial banks, then small banks will
graduate into universal banks . . .
MSS: In fact, that is envisaged by the Gandhi Committee. They say
the road map is: first set up a co-operative society; when it becomes big
enough it becomes a co-operative bank; on further growth, it becomes
a SFB; and when they become big they become a universal bank. They
have actually laid out the road map.
CR: Actually the problem is if there is a graduation, then will the
original mandate and the original purpose be retained or not? How
do we do that?
MSS: I personally believe that a co-operative bank itself is an oxy-
moron. The moment you mention banks, they get public deposits,
whereas co-operatives are about member deposits. The moment you
use the word “banks”, it is a non-member transaction.
CR: But the point is they can make every depositor a member also.
MSS: That’s right, but it’s a bank for being in the payment systems
as well. If you look at the Western models, the Rabobank or Desjar-
dins, they continue to be co-operative societies at the member interface
level. They have federal institutions to do specialised functions that
integrate with the lager financial system. A member’s interface is with
the co-operative society. Her insurance is from an insurance company
promoted by the co-operative societies. The governance interface will
be through co-operative societies. That was one of the recommenda-
tions that came into the Gandhi Committee from the National Fed-
eration of State Co-operative Urban Banks, saying that they should
probably be broken down into smaller co-operatives rather than giv-
ing a SFB licence.
CR: I think the point that we will have to make is that the emphasis
on the smaller size is basically to enable the institution to serve better
the small borrowers and vulnerable groups, and these characteristics
should be maintained. This should not be allowed to be dissipated;
otherwise, as institutions they will grow, but they may lose in character.

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Last mile touch points

MSS: You also recommended that BCs could work as agents for prod-
ucts on both sides of the balance sheets. Your committee suggested
that NBFCs could also be the BCs. The RBI was not comfortable with
this proposition. For long, and even now, they are not comfortable
with NBFC BC as agents for deposits. The RBI insists that there is a
conflict of interest.
CR: What have they allowed the BCs to do?
MSS: They have allowed NBFC BC on the credit side but are not
comfortable on collecting the deposits for the banks. To collect depos-
its, you need to be a pure agent with no direct business of your own.
The argument is that you can’t have a portfolio sitting on your books,
on the asset side, when you’re lending and then collecting deposits on
behalf of somebody. That sends confusing signals to the clients.

Agriculture
MSS: That brings me to another sticky issue of credit for agriculture.
You know the problems. There are constant write offs; there are sub-
ventions and interventions in normal commercial transactions that
could happen between a lender and a borrower. There are too many
intervening variables. In that sense, would it be a good idea to look at
agriculture if somebody had to do agriculture like an NBFC-MFI, lend
on commercially viable terms and whatever they achieve can be refi-
nanced by the banks?
CR: There was a recommendation in our report, what we called
Joint Liability Group (JLG) for lending to agriculture. The SHG con-
cept has been applied in a restricted way. But I think if we can extend
that concept, it will be good. One of the problems today in agriculture
is the small size of holding. However productive that land maybe, the
very fact that it is small and restricted cannot give an adequate income.
Therefore, the need for pooling comes in. And that’s why the concept
of SHGs what we call JLGs can be extended to agriculture. That will
have a greater pay off.
MSS: The statistics, in agriculture, shows this paradox: while the
number of holdings are going up, farm sizes are going down; the aver-
age size of an agriculture loan is going up, and the number of agricul-
tural loan accounts are going down. Last year the RBI changed the
detail on the PSL norm to agriculture and introduced a sub-target to
lend to small and marginal farmers.18 While they initially removed

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the direct-indirect break-up, it was re-introduced. Now it has become

a hard target with 8% of the adjusted net bank credit to be given to
small and marginal farmers. Do you think this will help the banks to
look at small and marginal farmers more seriously?
CR: It will, but like all quantitative targets, it may be achieved.
Then they will say that we have achieved in the aggregate but not
achieved the sub-targets. Then all those issues will continue.
MSS: The notification allows trading of the priority sector portfolio
through PSLCs. The portfolio remains where it remains, but if a bank
overachieves the target, it can sell the excess in the form of certificates
for a fee.
CR: Well, it is a way of compensating for doing better, and the
banks earn an income on that. But do you know how many such over-
achievers are there?
MSS: I don’t know. But it’s interesting. If all the SFBs come into
being, all their portfolios as of now is 100% priority sector – may not
really be to small and marginal farmers – there is scope for these SFBs
to trade because they are all large MFIs.
CR: But the point is their mandatory requirements are quite high.
They will have to have to have in excess of 75%. I doubt very much
if they will have excess. But these are all very interesting ideas. The
basic thing is that whether lending to such people is viable. If we can
increase the viability by coming together like a SHG, that is what we
should attempt. I think some attempt has been made somewhere. I
think in Gujarat SHGs focused on agriculture.
MSS: The JLG concept in agriculture has been used widely. Because
the maturity time is common for all the borrowers, and the need for
the next loan is also common. Therefore, JLG concept is ideally suited
for agricultural lending. All of them start together and terminate the
loan together.
CR: That is one way to reach out.

Securitisation and deepening the financial markets

MSS: What about deepening the markets, collateralisation, securitisa-
tion of portfolios, providing liquidity. While I personally don’t think
liquidity is a problem, we need to worry about viability. Much of these
ideas have been floating around. What do you think?
CR: But these are, as you said, essentially means for getting addi-
tional liquidity. But I think that is not the main issue. I mean these are
derivative products and there have been problems with the derivative

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products. All these can be experimented with, but I don’t think they
go to the core of the issue.
MSS: My own assessment of the AP crisis is possibly there is excess
of liquidity through securitisation of derivative products. I mean, I
guess the MFIs grew faster because a large part of what they were
managing was off their balance sheets. So they were much more lever-
aged than they should have been in normal circumstances.
CR: Well, we could do much innovation, but the basic message that
I am trying to give is that if the mandate of financial inclusion is to
be achieved, certain characteristics will have to be retained. The local
character, smaller size and focus on smaller groups and this can be
done not necessarily through one type of institution, and there can
be a diversified set of institutions. And regulation should be done in
a manner in which it can be effective. Regulation becomes difficult
because of the large number of institutions. There should be a de-
centralised way of regulation. And when banks provide credit they
must be held responsible in some ways for regulation.

Conclusions
MSS: The following changes have happened in the ecosystem:

1 Large-scale enrollment of people under UIDAI – with Aadhar

numbers
2 Multiple players willing to do the last mile connectivity, discover-
ing diverse business models
3 Technology roll-out in a much larger and more reliable scale
4 New institutions added to the landscape
5 Almost universal coverage of bank accounts through PMJDY
6 A push towards DBT, first with LPG subsidised, and next with 26
important programmes of the central government

Will all these initiatives, together, fundamentally change the way

financial inclusion is happening in India?
CR: The developments you mention have certainly changed the scene.
The new technology along with Aadhar made it possible to reach out to
the customers in a big way. Certainly, the various subsidy programmes
including the employment guarantee scheme can be better targeted and
leakages can also be plugged. This is indeed a big advance. Also, the
number of depositors of the banking system will increase enormously.
This is an important first step in terms of financial inclusion. But as I

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have repeatedly said, the provision of credit to small borrowers needs

different types of institutional changes. Of course, once credit is granted,
its disbursement and repayment will be greatly facilitated by the new
developments in the field of technology combined with Aadhar.

Notes
* Dr C. Rangarajan was Governor of Reserve Bank of India between 22
December 1992 and 22 November 1997.
1 The launch of the PMJDY was different in its approach. It took the issue
of inclusion from a supply side to the saturation of the demand side. It was
an ambitious scheme to ensure that every household in the country would
have access to a bank account, which would be bundled with an insurance
cover, a debit card and an overdraft facility. The launch of PMDJY on this
ambitious scale was possible because of the strong foundation laid out on
the architecture that was available for leveraging. The banking architec-
ture laid out until 2014 had taken the physical penetration of brick-and-
mortar branches and touch points (through multiple initiatives) deep into
the countryside. This provided a base for a mission approach to move
beyond the physical infrastructure to the customers and to get the custom-
ers to the formal banking outlet.
2 Rangarajan chaired the Committee on Financial Inclusion set up by the RBI.
The committee submitted its report in 2008. The report defined financial
inclusion, assessed the nature of exclusion and provided 179 recommenda-
tions covering all aspects of financial services. The thrust of the report was
to have decentralised and strong financial institutions and access points, with
innovative products and distribution strategies. The committee advocated
state support to institutional structures and particularly identified vulnerable
groups that have traditionally fallen off the radar of the policy makers. The
executive summary of the report is in Annexure 3.
3 The committee chaired by Mr. G. Ramachandran was set up in 2002 to
examine the concept of LABs. While the committee recommended that no
further licences for LABs should be given until they were reviewed, one
licence, which was purportedly in process, was given after the submission
of the report. However, after that, no further licences were ever given.
One of the LABs has now become a SFB and as of date three LABs exist.
(Ramachandran 2002).
4 For a more detailed discussion on the report as well as the concept of
LABs, see Sriram and Krishna (2015).
5 SFBs are a new type of specialised banking introduced by the RBI in 2015,
and the first in-principle licences were issued to ten entities in 2016. These
banks are different from the universal banks on two significant issues: (1)
that half of the portfolio should be given in loan sizes of not more than
Rs.2.5 million and (2) that 75% of the portfolio should be given to prior-
ity sector as given in the guidelines for such loans for universal banks.
6 Bandhan started its journey as a not-for-profit entity, purveying financial
services to the poor using group lending methodology. Over a period of

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time, as it grew, the portfolio of the not-for-profit entity was transferred

to a for-profit NBFC, licenced by the RBI to undertake microfinance
operations. Recently, when the RBI called for applications for setting up
full-service universal banks, Bandhan Financial Services – the NBFC-MFI –
applied and was awarded a licence. Currently, the entity now known as
Bandhan Bank works as a universal bank, with a significant portion of its
portfolio continuing to be that of small unsecured loans to poor women.
7 North-Eastern Region covers the states of Arunachal Pradesh, Assam,
Manipur, Meghalaya, Mizoram, Nagaland and Tripura. The Central Region
covers the states of Chattisgarh, Madhya Pradesh, Uttarakhand and Uttar
Pradesh. The Eastern region covers the states of Bihar, Jharkhand, Odisha,
Sikkim, West Bengal and Andaman and Nicobar Islands. The Northern
region covers Haryana, Himachal Pradesh, Jammu and Kashmir, Punjab,
Rajasthan, Chandigarh and Delhi. The Western region covers Maharashtra,
Goa, Daman, Diu and Gujrarat. The Southern region covers AP, Karnataka,
Kerala, Tamilnadu and Telangana (Reserve Bank of India 2016).
8 The committee on Financial Sector in the North-Eastern Region (Chair:
Usha Thorat) addressed the issues of carrying out inclusive banking in a
region that has traditionally been underbanked due to terrain, density of
population, infrastructure and other reasons. This committee looked at
the specifics of the region and suggested interesting measures to address
the spatial issues in banking.
9 PBs are a new type of specialised banking introduced by the RBI in 2015,
and the first in-principle licences were issued to 11 operators in 2016.
These banks are expected to perform two significant functions: (1) accept
deposits of less than Rs.100,000 from customers and (2) facilitate remit-
tances. Three of the licencees surrendered their in-principle approval even
before setting up. The other players are at various stages of roll-out.
10 Residuary Non-Banking Finance Companies (RNBFCs) were a recognised
and acceptable set of financial institutions. These institutions were allowed
to collect small and frequent deposits – mostly in the nature of accumulat-
ing deposits – from the customers. They were allowed to use 20% of the
deposits to be invested in any form of assets – financial or non-financial –
and the other 80% were to be deposited in Government securities. This
classification of financial institutions was shut down during the tenure of
Dr Y.V. Reddy. Sahara Group had one large (and systemically important)
entity that operated in this space. An interesting and detailed account of
how the Sahara’s operations were shut down by the RBI, as well as how the
RBI navigated this policy space, can be found in Bandyopadhyay (2014).
11 The BC model was first mooted by the Internal Group to Examine Issues
relating to Rural Credit and Microfinance, famously known as the Khan
Committee (Khan 2005). The committee recommended that the extension of
banking services could be done by BCs – who would be the day-to-day inter-
face between the customers – and the banks as agents and Business Facilita-
tors – who would help in building networks and in expanding business.
12 The committee was set up by the Department of Posts, ostensibly to look
at the entire functioning of the Post Office system, but a significant part of
the report was focussed on the provision of financial services. However,
on the postal network getting into banking, the RBI has been consistently

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opposing, cutting across generations of Governors. The fact that this

study originated from the Postal Department, only to be given a lukewarm
response by the RBI, is a significant issue from a policy perspective.
13 EY is a consulting major. It was formerly known as Ernst and Young.
14 Micro Units Development and Refinance Agency (MUDRA) is an institu-
tion operating as a NBFC. This entity is a wholly owned subsidiary of
SIDBI and is expected to cater to micro-enterprises, refinancing loans of the
ticket size from Rs. 50,000 to Rs. 1 million. Apart from providing loans,
the agency also administers Pradhan Mantri Mudra Yojana (PMMY),
which is a programme undertaken for the same segment directly by the
commercial banks. The initial reports indicated that MUDRA would be a
refinance agency as well as a regulator for the financial institutions operat-
ing in this segment. However, as of now, it remains only a finance company.
15 The well-known “AP crisis” happened in the then undivided state of AP,
which saw a fast-paced growth of MFIs in a concentrated area. As a result of
this quest for growth, the MFIs were seen to be acting without responsibility
towards the clients – resulting in three allegations made against them: (a) mul-
tiple agencies lending to the same family pushing them into debt; (b) charg-
ing usurious interest rates; and (c) resorting to coercive recovery practices.
As a result of all the unrest at the field level, the state passed an ordinance
(later converted into law) to severely restrict the functioning of MFIs. A more
detailed description of the AP crisis can be found in Sriram (2012).
16 The circular letter No.NB.DPD.FS.4631/92-A/91–92, dated 26 February,
1992 by NABARD issued guidelines for the banks for implementation of
the SHG-Bank Linkage programme. This was followed up by the RBI con-
stituting a working group under the chairmanship of Shri S.K. Kalia, Man-
aging Director, NABARD, which advised the scaling up of the programme
and also having SHG lending as a separate category under the PSL norms.
17 The All India Rural Credit Survey Committee was a long-drawn com-
mittee set up in 1951, and the final reports were published in 1956 and
1957. For a critique and timelines, see Thorner (1960). The committee
did a survey of indebtedness of rural households, used the data to assess
the presence of the formal sector in making credit accessible to the poor,
and had far-reaching recommendations for the institutional response to
the access to credit. One of the recommendations was to promote state
partnership with co-operatives – wherein the state would help and pro-
mote co-operatives throughout the country and these would operate as
decentralised autonomous financial institutions working on the principle
of mutuality. The first two decades following the submission of the report,
the share of the co-operatives in the rural credit pie saw a growth.
18 The allocations under the targets for PSL were significantly modified by
the RBI following the reports of the Nair Committee (Nair 2012) and the
Internal Working Group (IWG) report on PSL norms (Reserve Bank of
India 2015). While the Nair Committee provided the architecture for
change, the RBI only acknowledged it when it was presented. Later the
RBI set up an IWG, which largely reiterated the broad recommendations
of the Nair committee, but made its own changes. The report of the IWG
was acted on, and notifications were issued based on its recommendations
(see Annexure 5 for a summary of the IWG report).

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References
Bandyopadhyay, Tamal. 2014. Sahara: The Untold Story. Mumbai: Jaico.
Gandhi, R. 2015. Report of the High Powered Committee on Urban
Co-operative Banks. Mumbai: Reserve Bank of India.
Khan, HR. 2005. Report of the Internal Group to Examine Issues Relating to
Rural Credit and Microfinance. Mumbai: Reserve Bank of India.
Nair, MV. 2012. Report of the Committee to Re-examine the Existing Clas-
sification and Suggest Revised Guidelines with Regard to Priority Sector
Lending Classifications and Related Issues. Mumbai: Reserve Bank of India.
Ramachandran, G. 2002. Report of the Review Group on the Working of the
Local Area Bank Scheme. Committee Report. Mumbai: Reserve Bank of
India. Accessed April 22, 2017. https://rbidocs.rbi.org.in/rdocs/Publication-
Report/Pdfs/32294.pdf.
Rangarajan, C. 2008. Report of the Committee on Financial Inclusion. Com-
mittee Report. New Delhi: Ministry of Finance, Government of India.
Accessed April 22, 2017. www.sidbi.in/files/Rangarajan-Commitee-report-
on-Financial-Inclusion.pdf.
Reserve Bank of India. 2015. Report of the Internal Working Group to Revisit
Existing Priority Sector Lending Guidelines. Mumbai: Reserve Bank of
India.
Reserve Bank of India. 6 October 2016a. Operating Guidelines for Payments Banks.
Mumbai: Reserve Bank of India. Accessed April 23, 2017. http://rbidocs.rbi.org.in/
rdocs/notification/PDFs/NT8012D3D3858D194184981CAF033321AA26.PDF.
Reserve Bank of India. 6 October 2016b. Operating Guidelines for Small
Finance Banks. Mumbai: Reserve Bank of India. Accessed April 23, 2017.
https://rbi.org.in/Scripts/NotificationUser.aspx?ID=10636.
Sriram, MS. 2012. “The AP Microfinance Crisis 2010: Discipline or Death?”
Vikalpa 37 (4): 113–127.
Sriram, MS and Aparna Krishna. 2015. “Review of Local Area Banks and
Policy Implications for Narrow Banks in India.” Economic and Political
Weekly 50 (11): 52–60
Subramanian, TSR. 2014. Report of the Task Force on Leveraging the Post
Office Network. Committee Report. New Delhi: Government of India,
Ministry of Communications and Information Technology.
Thorat, Usha. 2006. Report of the Committee on Financial Sector Plan for the
North Eastern Region. Committee Report. Mumbai: Reserve Bank of India.
Thorner, Daniel. 1960. “The All India Rural Credit Survey: Viewed as a Scien-
tific Enquiry.” Economic Weekly (Special Number): 949–964.

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 2
CONVERSATIONS WITH
DR BIMAL JALAN *

MSS: Dr Jalan, thank you very much for agreeing to speak with us as
a part of the series we are doing with the Governors of the RBI. As you
know, we are talking to the Governors of RBI since 1991, and it col-
lectively should make for an interesting document tracking the evolu-
tion of financial inclusion, with the RBI as a centerpiece.
BJ: Thank you, Sriram, for taking the trouble of coming over for
a chat on financial inclusion initiatives. I understand that ACCESS,
which has organised our meeting, has already done some highly
impressive work, including organising an annual summit on inclusive
finance in the last couple of years.
I have also had the benefit of going through your Inclusive Finance
India Report 2015, which covers all the vital issues concerning
expansion of banking to the remotest part of the country. I do not
have much to add to what you have already covered in your report
as well as what has been extensively discussed at the annual finan-
cial inclusion summit in the past two years. I am glad to have this
opportunity to discuss some of the pending issues in greater depth
with you today.

Stability of the financial sector

MSS: The first aspect I would like to talk about is the overall approach
of the RBI vis-à-vis financial inclusion. We are trying to jog your mem-
ory back to the time when you were at the helm of the RBI. You were
there soon after the liberalisation process started and the initial licences
for new generation private sector banks were handed over. During
your tenure, I do not think a new institution came up; it was more of
a consolidation phase in managing banks. In general, we have seen
that in every four to five years some new institutional initiative would

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have come out of the RBI, either at the behest of the government – like
the RRBs – or at the behest of the RBI – like the LABs. Your tenure
was a phase of consolidation. The RBI has been responding with ini-
tiatives based on what the policy directions from the government are,
as well as considering the ground realities. When you look back, do
you see a sense of continuity in how it has all evolved?
BJ: Yes. You see evolution of the financial system, including inclu-
sive finance, is feasible when the financial system as a whole expands.
I refer to the formal financial system here. But the most important
thing is that the evolution is also a function of the events in the larger
financial market, and it is a function of what is happening in the econ-
omy as a whole. What is the use of opening bank accounts with no
deposits? We need to recognise that inclusion is an integral part of the
larger economy. When you talk about my tenure from 1997–2003, the
major problem that the country faced at that time, as you remember,
was the impact of the Asian Crisis.
MSS: Right. And I think when you took over in the domestic market
there was the CRB scam that led to a change in the regulatory frame-
work for NBFCs . . .
BJ: Yes, we will come to the NBFCs later. But the second important
issue was while the financial sector expanded, how do we expand the
banking network? We already had the public sector banks; we opened
the door to the private sector banks as well. But it was important to
make sure that the private sector banks that get licensed meet, what
you might say, the strictest criteria of supervision – capital adequacy,
Statutory Liquidity Ratio (SLR) so that they can take deposits and
deposits are safe and subject to guidelines. We were creating a strong
architecture of banking that could be stable and also reach out to the
excluded.
This process takes time. We managed the Asian crisis successfully
by taking measures which required action to ensure that there was
no balance of payments crisis in India. Then we took certain initia-
tives at that point of time, which have now become a very normal
part of the banking structure globally. For example, take the managed
exchange rate. The orthodox view led by the International Monetary
Fund (IMF) was that the exchange rate should either be free or fixed.
We had moved from a fixed to a managed rate. Based on our experi-
ence, we said that we would need the exchange rate to be neither fully
free nor fixed. We had to manage the Balance of Payments crisis, and
therefore manage the exchange rate and intervene in the markets. And
that has now become the international practice also.

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New initiatives had to wait for the crisis to blow over. Towards the
end of my tenure we processed licences for two more new private sec-
tor banks, and during my time we laid a lot of emphasis on creating
MFIs.
But let me reiterate. The first priority was to manage the balance of
payments crisis. The second most important priority was opening the
frontier to the banks, and the third most important thing was launch-
ing MFIs.
Please remember that during those days India was one of the very
few countries, developing country if you like, which did not default
or postpone payments on any foreign loans. This was also a base we
created for more investments to flow in, particularly in the financial
sector. So we managed to establish that we were a robust economy, an
economy which didn’t have a high debt to Gross Domestic Product
(GDP) ratio. So capital inflows started happening.

New institutional initiatives

MSS: In addition to the three issues that you highlighted, the licences
for a new form of institution – the LABs – were issued to a few
players.
BJ: Yes, we issued the licences, but you have to remember that it was
started in Dr Rangarajan’s time. All these are a part of the process.
It was not my time or his time, it was the country’s time . . . But as I
mentioned, we were working on the ground, and our most important
objective at that time was to balance the macro situation and still
open up the domestic banking sector. How do you liberalise, in terms
of your comfort zone? So, we did what we thought was within our
capacity.
You see, the RRBs also have an important role in the expansion
of banking services, but again these have to be carefully regulated
because what they lend has to be compatible with how many deposits
they have attracted from rural areas.
MSS: The question I wanted to ask was whether the concept of
the LABs was flawed. We had four LABs, of which one has become
a SFB and we are now left with three. There were, over a period, ten
in-principle licences issued. But they did not take off in a way the RBI
probably expected them to take off.
BJ: No, I don’t think it was a flawed idea, though I do not recall
the details. But let us look at the principles. If you have an institu-
tion confined to one region, with branches expanding within the

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confines, it is a great advantage for families residing in that region

because the institution becomes more accessible. However, if mem-
bers of the family are working outside the area then how to inte-
grate the other financial services like, say, remittance? So, you need
a combination of all these initiatives. It is not choosing one or the
other alternative, and we should see LABs as one of the alternatives
that was tried.
In the recent initiatives, along with government, I am glad that the
RBI has also taken several steps. As you are aware, in addition to two
new universal banks, in-principle licenses have also been awarded to
ten SFBs and eleven Payments Banks (PBs). These new differentiated
banks are expected to significantly impact the outreach and further
advance financial inclusion. This is where I suggest that there has to
be a multiplicity of initiatives.
MSS: If we were to move to other initiatives that have been taken in
the recent past beyond what you have already spoken about like SFBs,
PBs, the other initiatives by the RBI during the last year . . .
BJ: No, instead of getting into the details, let me make a general
point. I think that all these suggestions are worthwhile. All. And let
me repeat one point, the most important thing is safety of deposits. So,
everything that we do, for example, BCs is an extremely good idea; PB
is a new innovation and is an extremely good idea; non-bank financial
institutions, MFIs, etc. are all worthwhile. But just keep in mind that
when we are running these institutions and regulating these institu-
tions, the most important thing to remember is that we are dealing
with other people’s money.

Approach to financial inclusion

MSS: If you are looking at it as a central banker’s perspective, one is
to encourage institutional innovation, new banks, SFBs, PBs, etc.
which are coming together. The second is the policy push, say, I’ll give
you one license in metropolitan you have to open four elsewhere. And
third is to mandate, like priority sector portion of your portfolio will
go . . . so these are a combination of things that one needs to do or is
there a preferred . . .
BJ: No. In our situation, we have adopted all these canons; namely,
that access to government finances or network banking should not be
dominated only by the better-off sections, but it must have outreach.
But the other part to it is that the outreach cannot be at the cost of
depositors who are also relatively less well-off.

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MSS: Yes, of course it is not an either/or situation. But, if we look

back at the regional spread, we have seen that the South and West
have been more banked than the Central, Eastern and North-Eastern
sectors. Is there a way in which an institution like the RBI can try and
achieve some regional balance?
BJ: The RBI is trying to do that by encouraging setting up banks in
the North-Eastern sector and giving a certain amount of support and
opening their own offices, but we must remember that, ultimately, we
are dealing with other people’s money.
MSS: Right, you are indicating that the aggressive measures should
not be at the cost of safety.
BJ: Yes, safety becomes very important, and the process has to be
such that these institutions are viable over the long term and are there
to serve the cause.
MSS: You are indicating that access should be coupled with safety
and viability.
BJ: Yes, these have to be balanced, and one can’t be impatient with
that part. Where you need to transfer funds, then the state has to step
in and transfer funds like subsidies, and this has already happened,
with PMJDY.
MSS: If you look at it historically, the state has looked at this entire
inclusion with a credit perspective; how do you make non-usurious
credit available to the poorer sections of the society? Whether it’s IRDP1
or all other old government schemes, all are driven more towards
access to credit, including agriculture. It’s only the SHG movement,
the Swabhimaan scheme, as well as PMJDY, which turned it around to
focus on an account where people could save and transact.
BJ: As you are aware, both the RBI and the government have already
undertaken some important initiatives last year which should con-
tribute substantially to expand financial inclusion in India. The most
important financial inclusion initiative by the present government
is, of course, the launch of PMJDY, which was launched in August
2014. Within a short period since its launch, this new initiative has
already played an enormous role in expanding financial inclusion. I
understand that under PMJDY, 20 crore bank accounts have already
been opened and people have deposited nearly Rs.30,000 crores in
these accounts. The trend of “zero” balance accounts share in the total
number of accounts is also declining, thereby implying that the rural
population has already started doing transactions through the bank-
ing system. The share of rural accounts in total is as high as 70%. This
is most welcome.

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In the current year’s budget, a further initiative has been taken to

launch the Jan Suraksha initiative, which provides several social secu-
rity measures and, particularly, Insurance and Pension penetration in
the country.
With all these initiatives, what we are trying is to make the transfer
of subsidies to the poor easier. Then the other most important thing
is the reduction in administrative costs, which makes it possible to
deliver what you are actually spending. In the Public Distribution
System (PDS), for every rupee that we transfer, we spend Rs.2.65 in
administrative costs. I am talking about findings of a study in 2002.
But you see the DBT technology has changed that completely. But it’ll
take time for this to expand. And we should be prepared to accept
that, because we want not only the means of transfer, but also means
of safe transfer.
MSS: I am a bit curious. In the pre-liberalisation era, the rhetoric
of inclusion was dominated by making credit accessible and provid-
ing physical outreach. But if you go back and look at the Credit-
Deposit Ratios (CDRs) of rural branches, you would find that these
branches are deposit dominated. Now we are focusing on savings
accounts which are also deposit oriented. So, is the access to credit
getting pushed aside?
BJ: No, it’ll take time. Earlier, it was mainly cash, kept at home.
Now, you have a branch, if you have a co-operative society, you deposit
whatever cash you have, whatever money you have for the monthly
expenses, whatever it is, and you get a small interest. The credit sys-
tem requires a little more paperwork, the assessment of credit worthi-
ness, so on and so forth. Depositing your own money is easier. If you
want to deposit your money, nobody is asking for credit appraisal. But
with credit there has to be an appraisal or you will be financing debt.
Therefore, you need to see deposits as the first step in inclusion and
wait for credit growth to naturally happen.

Microfinance institutions
MSS: It was during your tenure that the MFI sector opened up, for the
private sector to participate.
BJ: Yes, there was private sector participation, but initially there
was no foreign capital coming into microfinance.
MSS: That’s right; the foreign investments started flowing in at a
later stage, as you said after the recovery from the Asian crisis and
some stability was achieved.

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BJ: Yes, that was at a later stage. The whole thing was to make sure
that India conformed to the best traditions of meeting all its obliga-
tions before we opened up our markets for foreign investments.
MSS: So in a sense we would be right to say that the first-generation
private sector banks were all homegrown, came from the local capital,
from the local entrepreneurs.
BJ: FDI was allowed in banks, if I remember it correctly. In the his-
torical perspective, in addition to financial expansion, we were able
to fulfil the obligations and kept our debt ratio under control. With
a strong financial sector, eventually we were able to reach out to the
poor.
MSS: MFI sector, that started off in 1997–1998 and has grown sig-
nificantly. MFIs have made inroads in terms of credit market. And in
fact, if you look at the last year’s statistics, it shows that they have
gone to areas where banks have traditionally not gone. North-East,
East; Orissa, UP and so on. So, in one sense they have a very good
network and touch point in remote areas as well. They have been ask-
ing for a positive regulatory framework that allows them to take thrift
deposits from their borrowers at least. But rightly, the regulation has
not evolved to allow them to take thrift because depositor protection
is a concern, and on paper you cannot distinguish between a genuine
MFI dealing with the poor and others who possibly pretend to be
lending but only takes deposits. Should this window evolve as a pos-
sibility to . . .?
BJ: Of course. This will evolve. But again, I keep on repeating it that
when you are dealing with other people’s money you have to make
sure that the institution that is dealing with them conforms to viable
safety standards.
MSS: But when we look at the RBI regulations, the only framework
where the depositor protection is really available is in the banking
system. That, too, because of deposit insurance . . .
BJ: As you said, the NBFCs and MFIs are also being supervised.
MSS: They are being supervised but not on the depositors’ side.
BJ: Yes. What I am saying is that it is a process and the process is
improving,
MSS: So, going forward, you would see a multiplicity of institutions
that are doing this.
BJ: Yes, you cannot be too conservative. If you have SHGs, then you
don’t have to get into all this. The SHGs are mutually regulated. Even
with the MFIs the Andhra crisis happened, but that was handled. Over
a period of time, the regulatory system has become quite effective.

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MSS: Yes, that’s right. You have consistently maintained that deposi-
tor money is the most supreme thing and that has to be the touchstone
of anything that we do. So in that sense, not allowing MFIs which are
NBFCs to take deposits is also a valid thing, because they are not as
regulated as banks.
BJ: But it is a process. Whether it is valid or not valid, I do not want
to comment on that, but what I am saying is you have to look at the
process. If we have licenced a NBFC, if we are regulating a NBFC,
then certainly we can permit them to give credit, but the most impor-
tant point that I keep on making is the safety part. NBFC regulation
is also a part of the mandate of the RBI. If NBFCs are taking deposits
from public, then the amount of money that you can create from those
deposits has to be proportional and weighted by the risk.

Post Bank
MSS: Can we discuss the Post Offices? Since we are talking about
institutions, Post Offices have been collecting small savings through
the National Savings Scheme, Kisan Vikas Patra, Postal Office savings
bank accounts. They have been dealing with deposits of the poor
because the amount that they can collect from a depositor is capped at
Rs.450,000. They also have a formidable network. But when it came
to a banking licence, the RBI somehow thought that they were not
ready for a universal bank license yet, even though they were dealing
with deposit money . . .
BJ: So far as Post Offices are concerned, it is extremely desirable
to use the vast postal network for transfer of deposits and funds to
the people. However, a full-fledged banking system through the Post
Offices is not feasible. Of course, the Postal Department can use the
vast expansion of Post Offices by creating a special subsidiary which
is managed and regulated by the Postal Department under the supervi-
sion of the RBI.
When I look at them in terms of financial services, there is a lot
that they can do. Transfer of funds from the government to the peo-
ple. We must give an opportunity for people to be able to deposit, to
have access to the banking system, or the financial institution struc-
ture. However, on the matter of credit, it has to be ensured that the
appraisal system for credit is in place. It takes time to establish an
appropriate institutional structure.
MSS: Now with these differentiated PBs that the Postal Depart-
ment will set up, and the postal network that is available, it would

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be a formidable network, much more deeply penetrated than the

banking system. And also through their Grameen Dak Sevaks, they
have something equivalent to the BC, which is time tested, you know.
So, payments could happen through that, the government payments,
DBT, etc. But my question is whether we are creating multiple parallel
systems, one for just remittances and small savings and another for
credit and other banking services and not using the full potential of
the postal network.
BJ: The two are not to be seen as exclusive. They are additional.
This transfer mechanism is extremely important, but if we can create a
vast infrastructure of deposit taking institutions which are transferring
funds to credit-worthy individuals, that is the thing to do. That is why
we are expanding the banking system also; RRBs, SFBs, PBs, so on.
MSS: In fact, in the last three to four years the expansion of the
banking system in the rural areas has been much more.
BJ: Yes, you should look at that fact also. Both sides of the equation
are equally important. If you have to attach weights, the depositor’s
side of the equation, the depositors’ safety is of utmost importance,
particularly in the rural areas.
MSS: Because they are much more vulnerable
BJ: Yes. And the second part of the equation is credit.

Agriculture
MSS: Just a couple of things on agriculture. That’s one sticky area
where we have constantly had some sort of problem because there is
too much of intervention from outside, either there is a waiver, there is
a cap on interest rate or there is a subvention. So how can we deal with
this part of the portfolio, is there is a . . .
BJ: You see the agricultural population, by and large, is farmers.
They are relatively less well-off. And so the expansion of the agricul-
tural lending, both institutional and in terms of credit, is difficult. So
we have agricultural schemes, schemes for providing finance, fertil-
izers, subsidies and so on. So we have to keep in mind that if one has
small agricultural land then the banking system’s role there cannot be
as big as would be feasible in other sectors. We have compulsory PSL
as a proportion of total net banking, and that is good. We have to
expand the banking system to the agricultural sector without doubt.
MSS: In this sense, would you think of something like a special-
ised thing, like microfinance, allowing them to do agricultural lending
would be a good idea?

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BJ: There is no bar on microfinance to lend to agriculture.

MSS: But there is this arbitrage; bank interest rates are capped at a
certain percentage so, therefore, it’s not a very competitive thing for a
non-bank to go in.
BJ: And, therefore, we have PSL, which has lower interest rates. So
there are always trade-offs. If our formal banking system is regulated,
supervised and created by public authorities, then we don’t want the
poor to pay a rate of interest which is higher. In fact, we subsidise it
through what is termed as PSL.

MUDRA
MSS: MUDRA is one thing we have not talked about. You would
know that this institution will target their loans at less than a million
rupees . . .
BJ: The government has also launched a MUDRA to help at the
ground level with a relatively simple regulatory mechanism for small
loans.
MSS: So you think this is also a good idea?
BJ: Yes . . . The main point is that in our country we have talked
about regional disparities; we have talked about sectoral issues, indus-
tries, agriculture, consumer financing and so on. We need institutions
which can meet these needs, but the primary focus also has to be that
the depositor’s money is safe. And in any area where we need to pro-
vide funds to the poor or funds to the agricultural area, which are of
utmost importance, then the much better way is to directly transfer
these through the government schemes. We can try and do it through
technology, and we can create MFIs.
MSS: So what I hear from you is basically don’t play around with
depositor money, don’t put the banks into risk whenever there is a
risky proposition which the government wants to . . ., that has to
be done more towards DBT rather than interfering in the people’s
deposit . . .
BJ: What I am saying, essentially, is that the focus has to be that
banks deal with depositor’s money, and depositors in different seg-
ments of our society are also as varied as income classes.
So, we have to make sure that the regulatory system and the credit
appraisal system is such that the banking system, as a whole, is not
playing around with other people’s money. That’s the basic point, par-
ticularly in rural areas.

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Hybrid financial instruments

MSS: Now there’s also a movement towards having Collateralised
Debt Obligations, Securitisation and selling the portfolio of which the
banks originate the poor into the secondary market. So, instead of
deposit money you get to directly raise money from the market. Is it a
good idea to integrate the poor with the market? They also tend to be
volatile.
BJ: No, but you cannot say to the poor that I am lending to you at
your risk, that I am lending this money and generating this security at
your risk. Risk is with the bank.
MSS: No, but when you do securitisation, naturally it gets transferred.
BJ: If the banks fail then it is a risk. That’s why we have the regula-
tor. It is the responsibility of the regulatory system to make sure that
what the regulated banking institutions or the financial system or the
MFIs are doing is not using credit at depositors’ risk. Financial insti-
tutions are using credit in terms of a mechanism with limits on CDR,
adequate liquidity and, where necessary, securitisation.
MSS: Right . . . CRR.
BJ: All these are very important. So, the basic point that I am mak-
ing is that securitisation and other things should not be at the cost of
the depositors.
MSS: The issue is when you do securitisation; in essence, you are
over-leveraging because the portfolio gets out of your balance sheet.

Concluding comments
MSS: Sir, do you have any concluding comments?
BJ: In this effort of Financial Inclusion, technology is likely to play
an important role; for example, the initiative in respect of DBT in
strengthening the financial inclusion system. A whole new ecosystem
is being designed to enable future positive outcomes from the schemes
that have been launched to expand financial inclusion.
I should also emphasise that financial inclusion of the non-banking
population, particularly in remote rural areas, is absolutely essential.
The pace of progress in this respect is to be closely monitored to ensure
the safety of deposits made in the banking system. As we all know,
banks are transfer channels and not creators of money. In their lend-
ing process and providing credit, they are actually dealing with “other
people’s money” where safety of public money is equally important.

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In principle, it is also a good idea to expand the reach of UCBs and

MFIs to provide banking services and to improve supervisory mech-
anism to ensure that only the members of the Co-operative Society
or shareholders of MFIs are not the primary beneficiaries of funds
deposited by non-members. As such, the expansion of lending services
through the decentralised system of co-operatives and MFIs also has
to be very carefully regulated.

Notes
* Dr Bimal Jalan was Governor of Reserve Bank of India between 22
November 1997 and 5 September 2003.
1 IRDP was a programme launched by the union government in 1978. The
programme was aimed at encouraging self-employment schemes for poor
communities, with varying degrees of subsidies for small and marginal
farmers, landless people, scheduled castes and tribes and so on. The loans
were all routed through public sector commercial banks, with the benefi-
ciaries of the loans being identified through a state government apparatus
and not through an appraisal by the banks. The programme resulted in
significant default. A later improved scheme was launched under the name
Swarna Jayanti Swarozgar Yojana (SGSY) where the subsidy amounts
were backended as against the front-ending of subsidies in IRDP. In a way,
the banks were mandated through a government scheme to participate in
the scheme, with little autonomy in decision-making.

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 3
CONVERSATIONS WITH
DR Y. V. REDDY *

Overall vision
MSS: How has the RBI’s overall vision on financial inclusion evolved
over a period of time?
YVR: The RBI has a very unique board. The RBI board has repre-
sentatives from agriculture, social services and even scientists. Most
central banks are monetary authorities packed with economists. The
RBI is not just a monetary authority worried exclusively about issues
of inflation, but much beyond. I think we have to accept the context
and people’s expectations.
Since inception the RBI as an institution was expected to be involved
in the issue of credit.
The RBI was also an originator of DFIs like Unit Trust of India
(UTI) and IDBI; it has an intellectual and cultural tradition of being
sensitive to the issues of society. For instance, UTI became indepen-
dent and so did IDBI. The stakes in SBI have been shed. But in keeping
with modern times, it is also shedding some of its functions.
Historically, the basic thrust of public policy in India has been in the
discourse that money lending is bad; informal credit is bad; we must
get rid of it; and, therefore, we should extend more formal credit. As a
philosophy, it believed that you have to improve the credit essentially
through the banking system. So, in a way it was a mandate to the RBI
to see that banking expands to virtually replace the (evil) moneylender.
In 1969, banks became direct instruments of policies in regard to
the financial sector, as dictated by the government. The role of the
RBI in the 1970s and ’80s was virtually to support or accept what
the government wanted in the financial sector, and it doubled up as
the regulator.
MSS: So, it was largely credit oriented?

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YVR: Yes, even after nationalisation, the thrust was to open more
bank branches and give more credit until the early 1990s.
The Narasimham Committee report on Financial System, 1991
(Narasimham I), was not in favour of the PSL.1 The Narasimham
Committee report of Banking Sector Reforms, 1998 (Narasimham II),
also suggested that the RBI should ensure competition, have a good
regulation and keep off from the developmental business. That was
the intellectual argument, but the political argument seemed to be
going against the intellectual one. The government was not keen to
give up control over banking business and was encouraging the RBI
to finance development. So, there is a sort of continuing dualism in
banking and credit allocation.
MSS: Was this the argument for hiving off NABARD as well, though
this happened before the Narasimham Committee reports?
YVR: Narasimham I was appointed in 1991, and NABARD was
formed in the early ’80s. Before that it was called the Agriculture Refi-
nance Development Corporation as a separate agency. Rural Credit
was initially a department in the RBI, and later it was hived off into
a separate institution. After 1991, there were two forces in RBI – the
intellectual forces, led by the Narasimham I, advocated RBI’s with-
drawal of PSL, focused on regulations, ensured competition and
geared up the financial sector to let the market play. We also had mon-
etary reform which meant that we created money only for monetary
conditions – there was no question of refinancing, no question of the
RBI creating money for development financing. The RBI will create
money in the context of monetary conditions. This view meant that
the intellectual framework of the reform no longer justified the RBI’s
involvement in credit directly.
This was at variance with the socio-political forces and their com-
pulsions. Broader considerations ensured that the developmental
financing role could not go out of the RBI’s radar. Dr Rangarajan
more or less went along with this dilemma. That was the position
when I joined the RBI as Deputy Governor. Perhaps it continues to
be so.
MSS: You had two stints with the RBI, as a Deputy Governor
working with both Dr Rangarajan and Dr Jalan, and later as a Gover-
nor. How do you think the RBI’s overall vision of financial inclusion
evolved during the years that you were at the helm?
YVR: Dr Rangarajan was supportive of rural credit. Dr Jalan had
sympathy for something to be done directly by the RBI on the devel-
opmental side. Even then it was not much about inclusion per se; it

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was on development, depositor protection and quality of services to

the customer. The focus was on consumer protection and prudential
regulation and also credit. Finance for growth, or credit to finance
productive activity, was emphasised.
MSS: You are said to have used the term “financial inclusion”
for the first time. So, were you looking at financial services beyond
credit?
YVR: We used the term “financial inclusion” for the first time in
a monetary policy statement in 2005. But measures in that direction
were initiated as soon as I joined as Governor, and these, in aggre-
gate, were described under the phrase “financial inclusion” in 2005.
Initially in my statements, I referred to financial exclusion and how
that was not good. Then, we thought we should be more positive, and
I coined the term. This was to encompass initiatives taken through
opening no frills accounts and zero balance accounts, in general, and
access to all banking services, not just credit. The BC model was also
a part of this.
The government noticed that financial inclusion was an attractive
concept. The Rangarajan Committee was announced in 2006 (see
Annexure 3) as per the budget announcement by the Finance Minister.
When the committee was set up, we suggested that the committee not
equate financial inclusion with credit. The committee defined “finan-
cial inclusion” with emphasis on credit, but recognised the significance
of access in the concept of financial inclusion.
Essentially there were these considerations that led us to this con-
cept of financial inclusion. The organised sector cannot easily replace
the informal sector. If you have an unorganised sector, you cannot
regulate it in a centralised manner. So, we have to have something
in the nature of multiple channels of supply, and some may involve
semi-organised channels. We had lucky breaks. Indian Bank opened
a branch in Dharavi slum, and it mobilized a large number of small
deposits, and the total amount was big. Banking on the slum dwellers
appeared a good banking practice! Our belief that the poor are keen
to have a safe place like a bank to keep their money was confirmed.

Institutional architecture
MSS: You have believed that the Central Bank should proactively
bring people into the banking fold, and have advocated that the best
way to mainstream them is through regulated financial institutions.
You have been a strong advocate of bank-led financial inclusion. Can

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you explain why it is important for financial inclusion to be bank-led,

rather than through other less-regulated institutions?
YVR: When I became Governor, I re-emphasised what Rangarajan
and Jalan were doing. I wanted institutional consciousness about the
customer services. If you are a bank, your emphasis should be on the
customer services specially oriented to the common person.
That was also the time that technology was being introduced in the
financial sector. The first DBT experiment was introduced in Warangal
in AP just when I joined as a governor (2003–2004). AP Government
told us that they were interested in use of technology in their benefit
transfer. So, the government’s objective of efficient payments was iden-
tified as an advantage to push the RBI’s agenda for financial inclusion.
It was about financial service in general and not about credit alone.
Finance Minister Yashwant Sinha popularised Kisan Credit Card
(KCC). In addition, we also had a survey done on the status of finan-
cial inclusion, followed by an evaluation of zero balance account and
its limitations in Pondicherry by Indian Bank. The most important
issue for the middle class and the lower strata of the people was safety
of their deposits, the security of the little money they save. In addition,
the concern was to help in consumption smoothening since work in
the organised sector is not continuous, but expenditure is. So, my pri-
ority was that the RBI should treat finance as a service, and this service
should be accessible to everybody who wants it. And if we have to go
to the door, go to the door to ensure access.
Credit is always a tricky business. So, I differentiated these two:
credit and financial service. I wanted to continue the emphasis on cus-
tomer service from Jalan’s legacy and introduce change by using the
words “common person” and moved to the basic agenda of “finan-
cial inclusion”. The word “the common persons” was used before the
word “financial inclusion”.

RNBFCs
MSS: Are you uncomfortable with the diversity of institutional
infrastructure?
YVR: No, I think diversity of institutions is very important. Multiple
institutions, multiple channels should still be the preferred approach.
That’s why I always say multiple channels of credit and multiple chan-
nels of financial services, definitely.
MSS: You were also extremely uncomfortable with RNBFCs (includ-
ing Sahara) and ensured that they ceased operations. Was it that the

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players were not engaged in practices that were good and safe for the
poor, or was your concern about the architecture around RNBFCs
themselves? In fact, in his book on Sahara (Bandyopadhyay 2014), the
author says you were on a mission to shut down that channel.
YVR: The limited point was that the regulatory framework for
RNBFCs was not as strong as that for the banks, but they were tak-
ing public, retail deposits, on a large scale, some of them expanding
too rapidly for the comfort of the regulator. I had nothing against the
NBFC sector as such, but was convinced that the RNBFC model was
non-viable unless questionable practices were resorted to. I introduced
this category of asset based NBFCs, and I was comfortable with that
and not with non-asset based NBFCs, in particular RNBFCs.
MSS: Yes, and by the time you joined the 1997 CRB crisis had hap-
pened, and there was some stability in the NBFC sector.2
YVR: But RNBFCs were a problem. They could collect deposits.
There was only one safeguard for the depositors: 80% of their assets
had to be in government securities. Now the question was, if 80% is
invested in government securities, how can you give attractive inter-
est rate to depositors without incurring losses? Government securities
cannot give you more than 6%. So interest was inconceivable that
the RNBFCs could be viable and grow without a mystery behind it.
Secondly, if you went into the details, the unpaid unclaimed deposits
were high. There was no transparency on who their customers were.
On the face of it, if the business was conducted exactly according to
regulatory framework, the model could not work. Once we came to
that conclusion, we suggested that RNBFC category should go, and
the RNBFCs would be given time to transit out of the model.

Payments Banks
MSS: In the light of your discomfort with RNBFCs, what do you think
of the new guidelines and in-principle licences accorded to the PBs?
Recently in a speech you said that PBs are like RNBFCs, but since they
are banks, they are better (Reddy 2015). Yes, the scope of the PBs are
wider – in that they have scope for remittances and selling of third
party products – but the basic savings collection function, which is the
financial inclusion part of the business, looks very similar to RNBFCs.
So do you still think there is a cause for worry?
YVR: The RNBFCs did not have revenue stream from transac-
tions which PBs may have. Vulnerability of PBs is that they are in
two separate businesses, and capital adequacy becomes little more

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problematic because of the combination of businesses. My own

inclination would be to have a separate regulatory framework and
deposit insurance window for PBs with stronger and instant relief for
their customers.
MSS: When we look at the 11 in-principle licenses that were given
for PBs, we find 5 of them are telcos and two operate in the pre-paid
wallet space. So where do you think these players would go?
YVR: Having this institutional choice is good. We should allow
multiple models; those who are good will thrive, and others will inno-
vate. There may be risks, but they are worth taking. We have to take
advantage of technology. The institutional structures are important,
and at this stage we should allow institutional innovation. But it also
means that we are in multiple unfamiliar territories. We should be
alert. We should insist on reporting, monitoring information and
evolve a robust system as soon as possible.
MSS: So, you think this is better than RNBFC because it is better
regulated?
YVR: No, all I am saying is RNBFC is not entirely comparable to
PB. For RNBFCs, mobilising deposits is their main business; for PBs,
people’s transactions are their main business. The RBI cannot simply
afford to take chances in regard to payment systems.
MSS: Yes, it is a totally new animal. Are you aware of anything
similar anywhere else in the world?
YVR: No, actually, the Postal Office was that.

Post bank
MSS: The Postal Department is already collecting savings through the
small savings window . . .
YVR: I am saying that the Postal Department should not go into
things that they are unfamiliar with. Huge effort would be needed to
establish sound and efficient banking. The Postal Department can do
KYC; it has a network. So computerise the payment systems and rec-
ognise them as a part of the payment system. That is the business they
can do well. If necessary, subsidise initial investments.
MSS: Yes, that is one question I was asking Dr Rajan also, saying
that the Postal Department is getting a PB license, but they are already
a PB.
YVR: But, it is good that the Postal Department becomes so more
formally.

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MSS: Right, so they can ring fence that business from the rest of the
business.
YVR: In fact, I would not even put it under the RBI licencing regula-
tions because it is too large. I would tell the government: “You have
established banks by law; I don’t have to license your bank. Similarly,
have your own PB. The Postal Department is huge and so you better
pass a separate law and make a legal provision that it is authorised to
be in this space of payments.”
MSS: What is your take on the Post Bank of India? The RBI was
uncomfortable in giving them a full-fledged licence, and they have a
PB licence. Given the reach of India Post, would it be a good idea to
still consider them for a universal bank licence? Would that change the
financial inclusion landscape significantly?
YVR: The Postal Department as a universal bank is totally undesir-
able on the current assessment of their skills, even potentially for a
long time.
MSS: Why do you think so?
YVR: Banking is a very difficult business. It requires expertise and
they don’t have it. The Postal Department should exploit their com-
parative agenda. Let the private sector do what they want to do.
MSS: See, but on the deposit side, after SBI they are the second larg-
est collector of deposits.
YVR: All I am saying is that the Postal Department knows how to
collect deposits. The risky, the tricky, the complex part of banking is
investing depositor’s money. Risks, rewards, temptations, influence-
peddling are part of lending or investing. It will take a lot of time and
effort to learn about investing money gathered from depositors. What
is the strength of the Postal Department to assess the risk? Does it have
the capability to price the risk while lending?

MUDRA
MSS: What do you think of MUDRA? This is something that was
announced in the budget last time, but it’s now been established as a
subsidiary of SIDBI, but the ultimate objective is to have a statute
passed, get the MUDRA Bill passed.
YVR: What is the difference between MUDRA and SIDBI?
MSS: The difference between MUDRA and SIDBI will be that
MUDRA can give loans up to Rs.1 million. SIDBI is a small industries
thing, so it has no limitation . . .

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YVR: When originally the “small industry” was defined as units

within a particular level of capital, SIDBI was supposed to cater to
those “small” industries. Subsequently, the definition of small indus-
tries was changed. You could always achieve the focus on small or
tiny industry by a policy decision. We can do that by indicating that a
certain percentage of the financing should be reserved for units below
the defined threshold size. As a concept, a design and a strategy, how
is MUDRA different from SIDBI?
MSS: But as you know, this is a new institution. It has already been
set up. Though, it is true that there was not much of a discussion or
indication before the announcement was made.
YVR: So, really how different is it from SIDBI? Let me tell you a
mystery to me, when I was in government and the RBI. SIDBI, which
finances small units, was always making profits, while small industry
segment had many sick units.
MSS: From the announcements we know that the ultimate intention,
at least when they announced it, was to have it similar to National
Housing Bank – that it will not only do refinance but also regulate the
microfinance sector.
YVR: Plus direct lending, as I understand. Is that true?
MSS: Yes, plus direct lending. Dr Rajan said that the RBI has
made it very clear to the government that regulation is out of ques-
tion, and it should only be the RBI. But we don’t know ultimately
when the act comes what would be the detail. So this is much more
a design question: Is it good to have a re-financing agency regulat-
ing a sector?
YVR: First let’s look at the experience of National Housing Bank
and its functions. What is its record of refinancing and regulation?
Actually they say that the relative share of housing finance companies
in the housing finance market has been coming down.
MSS: Because the banks have taken over.
YVR: So, formulation number one: share of NHB, an institution
that is supposed to lead the financing of housing sector, is coming
down in total housing finance. What does it imply – success or failure?
Formulation number two: NHB is having a concentration ratio which
will be unacceptable to any institution.
MSS: Also because of a mismatch.
YVR: Incidentally, I was the Chairman of NHB at one stage
when I was the Secretary, (Banking). At that time, three institutions
accounted for 80% of the housing finance provided by NHB. The

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third formulation, therefore, is that to the extent that housing finance

is being done by somebody else, what is the coverage of regulatory
framework that NHB was having?
I am talking of NHB, not of MUDRA Bank. NHB’s functioning
in housing finance is not exactly a model that is increasing housing
finance. Perhaps, it is profitable because it is tax free. If I am not
mistaken, SIDBI is being taxed. So therefore, which model are you
proposing for MUDRA? NHB, SIDBI or a new one? My point is, for
MUDRA to succeed neither NHB nor SIDBI model is good. Either you
overhaul SIDBI or create a new model. And then, of course, there is
the issue of how the institution itself raises money.
MSS: Nothing, unless the government keeps giving budgetary sup-
port in capital.
YVR: Yes. So in essence a refinancing institution should have a con-
cessional finance from the government. In refinancing, the primary
financing unit assumes risks. In MUDRA, which is the primary financ-
ing unit that assumes the risks in lending?
What is the regulation that you are trying to make, of whom and
for what? What is the objective of the regulation? So here, if MUDRA
Bank is collecting deposits, then it is a deposit-taking institution. Does
it regulate itself in terms of depositor protection?
MSS: No, the idea is they will also regulate MFIs and allow MFIs
to take deposits.
YVR: Then we are talking of MFIs and regulation of MFIs. That is
a matter on which there is no agreed view.
What is the role of state governments in the work of MUDRA?
Possibly the RBI should encourage, promote and help the state-level
financial regulatory institutions and enable them to regulate. Jalan
proposed this for UCBs in 2001. All these MFIs could be regulated
at the state level. And we have to have a national deposit insurance
which it is able to enforce. Something like that can work.
MSS: Is it because they have the intelligence and coordinating
mechanism?
YVR: They have knowledge of local conditions. They have huge
administrative machinery at the local level. Strengthening the capa-
bilities of the state government for regulating MFIs is important. That
can include chit fund, anything that involves deposit, small deposits or
which jurisdiction should be confined to the state. Some states will do
a good job; some states will do badly. And those states that do good
will learn over a period of time. We must create strengths of state level

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institutions for regulation of financial intermediaries with localised

operations.

Local Area Banks

MSS: The concept of a Local Area Bank (LAB) was first introduced
when you were a Deputy Governor, but after the initial licencing, it
appeared that there was a great discomfort in the institutional struc-
ture. During your time at the helm of the RBI we got a sense that you
would rather not have LABs, no new licences were accorded, neither
was there a policy push to look at growing the existing LABs.
Let’s take the LAB. One way to look at it was that it was a private
sector RRB, but you could have used it to encourage LABs in certain
regions, concentration risks notwithstanding. But having given those
four to five licenses, one gets the sense that – and I also read the Ram-
achandran committee report (Ramachandran 2002) – that there was
a sense of discomfort within RBI which is very evident when you read
the reports of that time.
YVR: The interesting thing was, I guess there was only one success-
ful LAB, and others had issues.
MSS: I have looked closely at the Capital Local Area Bank in Pun-
jab. I got the sense that it was very family-oriented and clannish. I also
felt that it defies all the conventional wisdom of banking.
YVR: See, they are banking on the social network.
MSS: Right, and the social network. In fact, of course now the RBI
has given them a license to become a SFB, but my gut feeling says that
this would be a challenge for them because they will have to change
the culture.
YVR: It is trust-based.
MSS: Right now it is trust-based, and if they have to shift to systems-
based they will have to be able to handle it.
YVR: I recall that the concept of LAB was announced by Minis-
ter Chidambaram, when Rangarajan was Governor. I was the Secre-
tary (Banking). We all thought it was a very good idea. That was in
1996, I recall. After we observed the performance of LABs in the RBI,
I became uncomfortable. Secondly, the political pressure for giving
licences to LAB was high. So I was among those who argued against
the LABs after gaining experience. I realised that the governance could
be an issue. It would be impossible for us to ensure the governance
was up to the mark. Regulation of a large number of LABs may also
pose problems.

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Regional Rural Banks

MSS: So my next questions are on SFB and RRB.
YVR: RRB was conceptually right, but it failed.
MSS: But now with consolidation . . .
YVR: I don’t know how the consolidation process is going, but
when I was there the proposal was to have one RRB for one sponsor
bank in one state.
MSS: More or less in that direction. There are 56 banks now.
YVR: My point originally also was, you are talking of privatising
nationalised banks, etc.; you can just as well privatise RRBs.
MSS: Actually the first step towards that happened last year. There
was an RRB act that was amended, allowing the fourth investor to
come in, and the bill says the government’s and sponsor bank’s total
shareholding will be 51%. But they have said that in recognition of
this you could have an independent director, etc. So the concept of
private participation has started creeping in.
YVR: That doesn’t help. As long as RRB is under a separate statute,
it cannot change. You have to convert these into banking companies,
and then privatise.
MSS: That is to reduce government ownership below 50%.
YVR: No, no. The percentage is irrelevant when an institution is
under a statute, and not under the Companies Act.
MSS: But the Nayak Committee suggested that because it will be
less than 50% ownership, the public sector banks will be out of CVC,
RTI and other things, and therefore . . .
YVR: No, I am not sure if it is the case. Again, I may be wrong.
Legally, when it is under a statute, it is under CVC. When it is under
company law, the definition of a government company applies to it.
All I am saying is that RRBs were established under the RRB Act;
once you covert it to a company, then company law will apply. Then
the definition of a government company comes, and the share of the
government becomes relevant.

Small Finance Banks

MSS: Ok, yes I see the point. Do you think the SFBs will further the
cause of inclusion in any way? As you know, the draft guidelines were
very much like LABs with restricted area of operation, but final guide-
lines gave a nationwide footprint. They can open branches anywhere
in the country. The restriction is that 75% of their portfolio will be

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under the priority sector (instead of 40%), and half of their portfolio
will be represented by loans under Rs.2.5 million ticket size.3 They
will have a higher Capital Adequacy Ratio. These three things are dif-
ferent from a universal bank. Ownership structure is the same. So does
it look like it will further the cause of inclusion because of these
restrictions?
YVR: See, here again you are equating inclusion with lending. The
moment you say lending I will say there are risks involved; wherever
the resources come from, there are risks involved.
MSS: Yes, but since this is a bank this will also open up deposits.
YVR: See, deposit taking or lending is a standard banking busi-
ness. All you are saying is that SFBs cannot lend to big fellows. It’s
like a bank that lends only to small industry. If I recall, there were
specialised small industry branches of banks, some time ago all over
the country, in hundreds. Perhaps one should commission a study
on their functioning and learn how their performance was, etc. Let
us use the empirical evidence we have on bank branches devoted to
small industries.

Regional spread
MSS: When you were heading the RBI, it was evident that you were
concerned about the regional disparity, and you appointed a commit-
tee under Usha Thorat (Thorat 2006) to look into how the concerns of
regional disparity in the North-East could be addressed to ensure the
spread of banking. But the problem of regional disparity continues. Is
there something that the central bank can do?
YVR: There are two things. Is there empirical evidence to show that
finance will lead to development? Finance enables, perhaps helps, but
does it trigger or lead?
MSS: Dr Rajan also said the same thing last year when I talked to
him.
YVR: And the second thing is perhaps finance is associated with,
but may not cause, growth. Where did the MFIs first go?
MSS: To the South . . .
YVR: Yes. What happens is that the market takes time to catch up
with the reality. So what you can do is, if the region is developing and
the banks are not opening branches, you catalyse it. Policy can try to
ensure that finance is not a bottleneck. Finance can be encouraged to
go if there is potential for growth. There should be potential at least
for development and profitability.

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MSS: Though you see the argument given by Burgess and Pande in
a paper called “Do Rural Banks Matter?” (Burgess and Pande 2005)
where they very strongly defend the RBI’s policy of 1:4 licensing.4
Their broad argument is this: Because the banks went into rural areas,
which they would not naturally go to unless they were forced to, they
started lending to the non-farm sector in those areas, and, therefore, it
had a positive effect on reduction of poverty.
YVR: I agree; but the 1:4 policy gives the choice to banks to decide
which village to go to. As far as credit is concerned, in the ultimate
analysis, the credit is based on economic activity now or potentially.
There is scope for such policies, but the limits to their effectiveness are
set by economic factors.
MSS: Not only were you concerned about the North-East, your
attention to detail was also evident in the fact that you appointed the
YSP Thorat Committee to look into the disparity of Credit Deposit
Ratios (CDR). Were there measures taken based on the committee’s
recommendations? Do you have a view on it now?
YVR: I can say that I can provide an institutional mechanism to
facilitate credit, but I cannot ensure the flow of credit. In fact, I was
never fascinated by CDR. If you just see from the macro picture,
35% of the deposits are pre-empted through SLR, CRR and liquidity
requirements. From the rest, a significant chunk goes to the organised
sector.
MSS: You mean the approach was not necessarily concentrated on
credit, but the entire gamut of financial services.
YVR: Yes, because credit can follow economic activity and also
facilitate economic activity, provided there is potential. So unless you
combine economic activity and credit, it will not work. But, as the
RBI we do not have the capacity to combine these. Only the fiscal
system or the government would have to do that. So if the govern-
ment is able to fund programmes which are viable, then the bank
can lend the money. Therefore, you will find me rarely talking much
about CDR.
Financial inclusion should not be confused with political inclusion,
economic inclusion and social inclusion. They are different things.
There can be social inclusion even if society is kept out of virtually
any economic activity, but finance cannot reach there. Finance cannot
handle bigger issues. Similarly, political exclusion creates problems.
These exclusions are definitely related. But finance alone cannot by
itself produce results. Finance can operate basically within the totality
of social, political and economic inclusion.

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Let me give an example. Government payments to millions of citi-

zens and disbursements were a political decision to get them included
in economic activity through budgets. Getting the direct benefit trans-
fer through the banking system or financial inclusion was enabled by
such economic inclusion.

Last mile delivery

MSS: Apart from the institutional structures, you also tried alterna-
tives of extending the reach of the existing institutions to address the
last mile problem. However, it seems to have had a limited success. Is
there one big idea to achieve the last mile connectivity or are we only
looking at institutional innovations in the hope that they would find
some solutions?
YVR: Let us take the issue of credit. I came into a conclusion that
whatever you do, the cost of credit for an individual is not an inter-
est rate alone but the “all in cost” that includes transaction costs –
you have to get documents, you have to go a number of times to the
branch. The daily wage earner loses his wage if the bank is located
elsewhere. The all-in cost of borrowing from a moneylender may not
be very much more than a bank.
In terms of the credit system, my preference was to increase supply,
have multiple channels of supply and eliminate subsidies. As long as
we give subsidies, there is a shortage of resources and there is arbi-
trage. And in remote areas, we cannot control or monitor how subsi-
dies are used and misused.
For instance, under FERA, if you wanted foreign exchange you had
to go to the RBI; that was the procedure. We introduced the bank as
the RBI representative. The bank has access to the customer’s credit
history of the past. So we can say that all the power of giving foreign
exchange was delegated to the bank but on behalf of, or as an agent
of, the RBI. And if banks commit a mistake, the RBI catches it. It is
with that experience that we introduced the BC model, where BC is
the agent, the bank is the principal and the RBI held the bank respon-
sible for all actions of BC.
So BC is an extension of the bank, as far as financial services are
concerned. I was also aware that it is quite possible that BC could
also become a lender. In a way, a BC is a bridge between informal
and formal money lending. My conception was that BC is like an
accredited agency of a bank. In fact, we said the BC should be linked

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to the branch. If BC is not linked to a branch, accountability prob-

lems arise.
But we were also aware that a BC by itself may not be enough; we
need multiple channels. So, we encouraged MFIs; at that time MFIs
were mostly not-for-profit organisations. We encouraged MFIs because
of the nature of ownership. The problem, which we didn’t visualise,
was that the not-for-profits could transit into for-profit organisations.
They started as a non- profit but became for-profit after they became
very profitable. Ostensibly this was done to scale up.

Deepening financial markets;

addressing agriculture
MSS: The other thing was about deepening the markets. Let’s look at
the agricultural credit. The credit culture is impaired because of waiv-
ers and subsidies. Is it a good idea to allow private sector NBFCs to do
PSL? And incorporate them into the banking system through
securitisation?
YVR: There are two things there. One, of course, is the simple trad-
ing of PSL which was done in East Asian countries; that is one part.
You do not mean that, do you?
MSS: No, it isn’t. The question is more about engineering a regula-
tory arbitrage.
YVR: Risk in lending does not disappear because you create instru-
ments or institutions. It gets transferred or diversified. My impression
is that securitisation served the purpose of saving on equity required
for lending by banks. If there is a situation where the traditional
instruments themselves are not able to penetrate, are we expecting a
non-traditional instrument to penetrate, say lending to an unworthy
customer?
MSS: No, the argument is just this. We have now demolished the
credit culture, as far as agriculture is concerned, having successive
waivers.
YVR: Having done that, how do you think your proposal is going
to change the credit culture?
MSS: . . . because that is possibly insulated from political interfer-
ence at the client level.
YVR: Is the credit culture bad only because of political interference?
Isn’t it institutional?
MSS: Yes, it ultimately will be a banker through an intermediary.

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YVR: What did the MFIs do? They borrowed from the bank, but
they also took money from somewhere else. All that happens through
securitisation is that their base equity gets diluted, that’s all.
MSS: So, therefore, there is no skin in the game, and it is risky.
YVR: It is all leverage, and we should be aware where the ultimate
risk lies. If the market culture doesn’t exist, if the market institutions
do not exist, if they are not able to penetrate, how will sophisticated
instruments improve the market efficiency?

Agricultural co-operatives
MSS: You were enthusiastically supporting the recommendations of
the Vaidyanathan Committee on agricultural co-operatives,5 and pos-
sibly that was a good chance to get them on track.
YVR: Yes, there was the co-operative system. One major area where
I thought we could push reforms in the co-operative institutions was
through the recommendations of the Vaidyanathan Committee. This
started in my first year as Governor.
MSS: Now that nothing much has happened, do you see co-
operatives as sunset institutions – particularly given the political econ-
omy of interest rate caps on loans, subventions and write-offs? Is there
a way in which we could save these institutions that provide decentral-
ised financial services to the farming class?
YVR: I was really hopeful about the co-operative system. After
agreeing to chair the implementation committee, I saw that the politi-
cal will to implement it disappear. I could see the non-cooperation
from the state governments – they wanted to dilute the conditions for
GoI to give money to the states. Then it became clear that the most
powerful instrument for providing rural credit was impossible politi-
cally. So that was a failure.
The other failure was in loan waivers, which, naturally, I opposed. The
only thing which we could do at that point of time was to say this time
the government should bear the burden, and I made it a condition that
some of the losses due to these waivers were to be absorbed by the banks.
But this also had another effect – the banks found it easy to clean
up their balance sheets, so they entered into a phase which we did not
visualise where there was a convergence of interests between the bank-
ers and the government. It is a short-term solution with a huge long-
term cost, and now the GoI has a problem in disciplining the states.
So, we lost the moral authority to impose the credit culture.

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Urban Co-operative Banks

MSS: Let us talk about Urban Co-operative Banks (UCBs). The latest
approach of the RBI seems to be to convert UCBs to SFBs. They want
UCBs to be under mainstream regulation.
YVR: Even now, are they not under mainstream regulation?
MSS: Yes, but it involves a state government MoU.
YVR: As far as the regulation of the financial operations is con-
cerned, they are with the RBI. There is no issue there.
MSS: The Gandhi Committee suggests something interesting, and
being a student of co-operation I am personally uncomfortable with it.
They are saying that there should be a path – you set up a co-operative
society; when it is of a decent size we will convert you to an UCB; and
when that becomes larger we’ll convert it to a SFB. Now personally,
I am even uncomfortable with the UCB concept because co-operative
society operates on the principle of mutuality. The moment you bring
the word “bank” you are dealing with public at large.
YVR: Exactly! That is the issue. In essence you are absolutely right.
Either it is a co-operative society or it is a bank. Co-operative bank is
a misnomer. We inherited it. We should have clarified it long ago.
Second, what is the problem that you are trying to solve? Are you
trying to solve the problems of UCBs and if yes, what is the problem
you are facing in UCBs now?
MSS: What they are saying is that they are not very well-regulated,
they are growing in size, and once they grow it is better that they . . .
YVR: But are they a problem now?
MSS: I don’t think they are a problem right now, neither do I see a
simmering problem.
YVR: If it is a bank, is the institutional structure compatible with
the governance of a bank?
MSS: Correct, that is the most significant problem.
YVR: Second problem is who regulates the governance aspects.
What is the difference between the public sector and private sector
banks in terms of regulation?
MSS: The governance structure is . . .
YVR: The government decides governance for public sector banks.
For private sector, though it is under company law, the governance
aspect has to be cleared by the RBI under the act. The RBI has to be
satisfied with the standards of governance. In the case of UCBs, the
governance aspects are with the state government.

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MSS: No, but my own discomfort is with co-operatives being con-

verted to corporations. They are under different incorporations right?
As a one-time measure it may be okay, but as a continuing policy,
where you start as a co-operative . . .
YVR: If you have a standard procedure for conversion of a
co-operative society into a bank, and pre-conditions for conversion
are set; I see no problem. As long as everybody knows a co-operative
society can potentially become a bank, provided you increase to this
size, I see no issue.
I totally agree that a co-operative society is based on the principle
of mutuality. If it is not mutual, then you are a separate body; you are
financial intermediary. I think the fundamental difference is when a
mutual is also an intermediary. A co-operative society is mutual, and
so the risk is totally internal.

Global trends in financial inclusion

and the role of Central Banks
MSS: Are you pleased that financial inclusion, to which you were
committed as Governor, is now top of the policy agenda?
YVR: Of course, yes. But the real reason for the spread of financial
inclusion like a good contagion is the Global Financial Crisis (GFC).
Financial inclusion gave a positive twist to the package of policy
responses to the financial crisis. The GFC warranted massive coordi-
nated policy intervention, both by governments and Central Bankers
to save the world economy from depression and misery. The financial
sector was viewed as a villain by many, and governments and Central
Banks were often accused of bailing them out at great expense to the
exchequer. Policy makers must have felt a need to demonstrate that
they were equally concerned with people as much as finance.
The policy makers had to create a direct stake in the financial sector to
bail-out larger segments of the population in the financial sector that
they were intending to build for the future. That explains explosion of
interest in financial inclusion recently. Of course, it is true that devel-
oping countries were concerned for quite some time with the issue of
connecting people with finance. For the global community, it became an
issue only as a consequence of the GFC. Before the GFC, the focus was
on extending credit to those without assets and making a good business.
You know the work of De Sotto and Prahlad.
The G20 statement and subsequent follow-up actions by various
multilateral institutions on financial inclusion have to be viewed in the

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context of the GFC. It was put in the G20 agenda in November 2008,
and in 2010 it became one of the pillars of the global development
agenda. We now have the Financial Inclusion Action Plan and Global
Partnership for Financial Inclusion, apart from follow-up work by
IMF, World Bank, BIS, etc.
MSS: So, what you are saying is that recent emphasis on financial
inclusion is for political compulsions after the GFC. So, there is noth-
ing new. Is that so?
YVR: Actually, there are many new things about the way financial
inclusion can be approached now. I was referring to the trigger for
global activism in it.
There are a lot of new things. Central Banks before the GFC were
required to focus on monetary policy with a single objective or at least
one primary objective – namely, Price Stability – are now urged to
add financial stability to their concerns and, incidentally, also finan-
cial inclusion to their duties. Financial inclusion, along with financial
stability, has virtually become the joint responsibility of Central Banks
and governments.
Developing and emerging market economies have become leaders
in innovation in this regard, since their requirements are huge. The
objectives of financial inclusion have been expanded to derive politi-
cal support. It now encompasses ease of financial transactions and
economic development, well-beyond addressing issues relating to the
provision of credit to the under-privileged.
The coverage of financial inclusion has been expanded from house-
holds to include small enterprises, small businesses and some organ-
isational forms. At the same time, limits are set in terms of transaction
size to define what constitutes financial inclusion. Above all, techno-
logical developments are throwing up vast opportunities for financial
inclusion. For very valid reasons, financial inclusion recognises a vari-
ety of policies packaged as appropriate to different countries. They
may reflect differing emphasis on deposit taking, extending credit,
easing transactions and remittances, and popularising or innovating
financial instruments.
MSS: As a former Governor of a Central Bank, what in your view
are the issues being faced by Central Bankers now that they have to
deliver financial inclusion also.
YVR: I am not directly exposed to the issues being faced now by
Central Banks in dealing with financial inclusion. But, I gathered
some impressions from seminars and conferences I attended on the
subject, convened by BIS. Under the new dispensation that includes

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financial inclusion, there is a widening of mandate of Central Banks.

How much would this widening result in dilution of independence
of Central Banks? How much are the Central Banks going to the
other extreme from one-target–one instrument, to multi-target–multi-
instrument approach to Central banking?
How far would the acceptance of Financial Inclusion as a major
responsibility at this juncture threaten the effectiveness of Central
Banks core function, namely, monetary management? To what extent
would the Central Banks face reputational risks in the event of the
high expectations on financial inclusion not being met?
Do the Central Banks have the expertise to be closely involved in
a wider program of financial inclusion since the demand factors are
difficult to assess?
Three major roles have been identified for governments by the IMF
in the program: promoter, enabler and developer. Is there a global
understanding of what governments could do in this regard, as distinct
from what Central Banks are expected to?
Is there merit in focussing on financial services and products, other
than credit, inasmuch as credit involves issues of risks and leverage,
much more than other banking products do? A study by IMF indicates
that excess emphasis on credit could impact stability adversely.
A policy on financial inclusion essentially involves moving fron-
tiers of formal finance into informal finance, particularly in regard to
households. By its very nature, the informal sectors in different coun-
tries and in different communities are highly varied and significantly
routed in local conditions.
MSS: The mandates of Central Banks differ from country to coun-
try. So how do you generalise the role of Central Banks in financial
inclusion?
YVR: I agree. So, we have to differentiate the functions of a Central
Bank, namely the provider of infrastructure for financial sector, the mon-
etary authority and the regulator of financial intermediaries and markets.
All functions of the Central Bank are not relevant to financial
inclusion. As provider of infrastructure for the financial sector, Cen-
tral Banks have an important role to play. Efficient payment systems
and access to payment systems are often within the jurisdiction of the
Central Bank. Similarly, deposit insurance would be relevant. Credit
information bureaus would be helpful. Broadly, this can be described
as the plumbing aspect of the financial sector. The importance of the
functions generally common to all Central Banks, for a program of

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financial inclusion, is undisputed and non-controversial. More often

than not, the Central Bank is solely responsible.
The Central Bank is essentially a monetary authority; it is not very
clear how far a central bank plays a role in such a program. In other
words, monetary policy may not be much of an instrument for the
financial inclusion program, but financial inclusion could potentially
have an impact on monetary transmission and the effectiveness of
monetary policy. However, it is not very clear whether financial inclu-
sion would by itself enhance the extent and magnitude of financial
sector activity to make a difference to transmission.
If a Central Bank is also a regulator, say, of banks, as is usually the
case, then undisputedly it has greater relevance to financial inclusion.
In the context of financial inclusion, regulation of banks, regulation
of non-banks and regulation of their links with other forms of micro
finance institutions would be relevant. In countries like India, the larg-
est segment of the credit market is informal markets in the rural areas.
The question then is whether money lending activity can effectively be
brought under some sort of a regulation and whether a Central Bank
has a role.
MSS: Financial inclusion has several elements, such as credit and
payment services.
YVR: For convenience, it is useful to desegregate the elements of
finance into three categories: financial transactions, credit and other
products. The financial transactions require a focus on integrity, safety,
price and access.
A difficult part is credit. Credit can be for consumption smoothen-
ing in the short term and, I believe, that this will have maximum posi-
tive impact on the lives of the poor, particularly in the unorganised
sector. Working capital particularly for small businesses and the tiny
sector would be an area of credit which would have a large impact.
Credit for investment purposes may be riskier than for other purposes.
Credit for housing is generally considered desirable and appropriate.
However, the problem arises when the credit extended for housing is
well-above the income to value ratio. As regards other products, it
may be useful to distinguish between households and enterprises.
In any case, the issue of leverage, both in respect of the borrowers
and the lenders, is critical in the context of financial inclusion that
focuses on credit.
MSS: What are the emerging issues that we should add to the policy
and research agenda for the future?

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YVR: Perhaps the question should be, what next? If we assume that
we will succeed in full financial inclusion, then what happens to the
institutional channels that are created exclusively for financial inclu-
sion? If I may be blunt, are we trying to have two financial systems:
those meant for the poor and those meant for the non-poor? When
and how do we have a financial system that is fair to all?

Notes
* Dr Y. V. Reddy was Governor of the Reserve Bank of India between 6
September 2003 and 5 September 2008.
1 The Narasimham Committee I recommended that the PSL be done away
with, but as a transitional measure that it be restricted to 10% of the
portfolio as against the current practice of 40% of the portfolio. This was
the first significant committee that recommended several parameters to be
on par with international standards and market-based. A summary of the
report is given in Annexure 1.
2 CRB Capital Markets was a deposit-taking NBFC which defaulted on
public deposits in 1996 (India Forensic 2004). Until then, the NBFC sector
was lightly regulated, and NBFCs were permitted to access public deposits
of a certain tenor with minimal paperwork. There was also no need for
NBFCs to register themselves as such. Following the large-scale default
of CRB Capital Markets and its group companies, the RBI tightened the
norms for NBFC, making it mandatory for them to register with the RBI
in order to continue operations, put in place a capital adequacy frame-
work, link deposit taking ability with rating and bar prospective NBFCs
from deposit-taking. Even today there are multiple forms of NBFCs –
some undertaking specialised functions called the monoline NBFCs, like
the housing finance companies, and multiline NBFCs catering to multiple
needs. All these have been recognised by the RBI, and detailed guidelines
for their operations are in place. These guidelines are being updated from
time to time.
3 It is important to remember here that the first report on the Financial Sec-
tor Reform (Narasimham I) suggested that all rural operations of commer-
cial banks should be hived off to a rural subsidiary. It suggested capping
the PSL to 10% as a transitionary measure and to reckon the combined
achievement of the parent and the subsidiary for measuring achievement
under the target.
4 The policy followed by the Reserve Bank was to allow a bank to open one
branch in large metropolitan centres only when they had opened branches
in four unbanked locations. This is popularly known as the 1:4 policy.
5 The Task Force on Revival of Co-operative Credit Institutions (Vaidya-
nathan 2004) set up by the GoI – popularly known as the Vaidyanathan
Committee – submitted a report with far reaching reform in the co-
operative credit structure. It suggested a one time clean-up package for the
co-operatives, providing complete autonomy to co-operatives at all lev-
els and converting all co-operatives into depositor-based, member-owned

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institutions, operating on the principles of mutuality. Dr Reddy volun-

teered to chair the committee that would oversee implementation of the
recommendations of the committee.

References
Bandyopadhyay, Tamal. 2014. Sahara: The Untold Story. Mumbai: Jaico.
Burgess, Robin, and Rohini Pande. 2005. “Do Banks Matter? Evidence for
Indian Social Banking Experiment.” The American Economic Review
95 (3): 780–795.
Ramachandran, G. 2002. Report of the Review Group on the Working
of the Local Area Bank Scheme. Committee Report. Mumbai: Reserve
Bank of India. Accessed April 22, 2017. https://rbidocs.rbi.org.in/rdocs/
PublicationReport/Pdfs/32294.pdf.
Reddy, YV. 2015. “Financial Inclusion and Central Banking: Reflections and
Issues.” Keynote Speech by Dr Y V Reddy, at the 14th SEACEN Executive
Committee Meeting and High-Level Seminar, Port Moresby, 1–4 October
2015. Accessed May 6, 2017. www.bis.org/review/r151029a.pdf.
Thorat, Usha. 2006. Report of the Committee on Financial Sector Plan for the
North Eastern Region. Committee Report. Mumbai: Reserve Bank of India.
Vaidyanathan, A. 2004. Task Force on the Revival of Co-operative Credit
Insitutions. New Delhi: Government of India, Ministry of Finance.

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 4
CONVERSATIONS WITH
DR DUVVURI SUBBARAO*

Role of the RBI in financial inclusion

MSS: You and Dr Reddy both have had the fortune of being on both
sides – with the government and the RBI. Is there any sort difference
or dichotomy in the way we approach financial inclusion? Which of
these agencies could be more proactive and effective when it comes to
the agenda of financial inclusion?
DS: I don’t think you should think in terms of a dichotomy or a
difference in approach. We need both the government and the RBI to
make financial inclusion a success. The government is the sovereign,
owns 70% of the banking system and has a variety of options and
opportunities to push financial inclusion. The RBI is the regulator, not
just of banks, but also of non-banks and a dominant segment of the
microfinance sector. In that sense, both the government and the RBI
bring different comparative advantages to the task, and we need to
build synergies on that to make financial inclusion as success. During
my time at the RBI, it was the RBI taking the lead, with the govern-
ment playing a largely supplementary role; but now with the PMJDY,
the government has come into the driver’s seat, and that is just as it
should be.
In fact, I will go a step further and say that you need the active
involvement of the state governments too in this gigantic task. After
all, it is the state governments which are in the forefront, have a wider
interface with the public and are the delivery arm for all development
schemes including cash payouts.
MSS: If you look the recent phase in the last 10 to 15 years, the
definition of financial inclusion has broadened from pushing credit
to inclusive banking and account opening. The role of the RBI in
setting that agenda and re-articulating the problem back to the

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government, to look at inclusion in an integrative manner, is pos-

sibly important.
DS: I do not fully agree with that characterisation – of RBI shaping
the agenda. After all, the government has been driving the agenda of
pushing credit to the priority sector, to the Micro, Medium and Small
Enterprises (MSME) sector, to the weaker sections and to backward
areas for over 50 years. The relationship between the government and
the RBI was one of principal-agent, with the RBI using its regulatory
authority to pursue the government’s development priorities. What
the RBI should get credit for is for expanding the financial inclusion
agenda beyond just credit. As Dr K.C. Chakrabarty, former Deputy
Governor, used to say, financial inclusion must mean not just credit
but also include avenues for saving, remittance and micro-insurance.
The entry point may be different for different households and may
vary across segments of population and across different parts of the
country. For example, some households may come into the formal
financial sector through credit, others through a remittance facility,
etc. I don’t believe there is a unique or an optimal model for getting
the financially excluded into the formal financial system. Indeed, we
should be agnostic and be open to a variety of models and options.
MSS: I am happy that you mentioned Dr Chakrabarty. It was dur-
ing your and Dr Chakrabarty’s tenure that there was a greater focus
on bank-led financial inclusion. Of course Dr Chakrabarty was very
articulate, arguing that inclusion should be bank led, and other players
in the financial system were necessary but only incidental. He argued
that the push for inclusion should come from banks. Is there a justifi-
cation for it being predominantly with the banks?
DS: The justification is quite straightforward. It is only banks that
can give all the four components of financial inclusion that we just
spoke about – credit, micro insurance, savings and remittance. In fact,
telecom companies used to complain that the RBI was biased against
them. There was no such thing. The RBI was quite open to allow-
ing telecom companies to ride on their comparative advantage and
contribute to financial inclusion. But we have to recognise that by
themselves, telecoms cannot deliver the full gamut of financial inclu-
sion. Only banks can do that.
MSS: In fact, you famously held out that telecom companies are a
threat to the banking companies in your College of Agricultural Bank-
ing (CAB) speech, if I remember right.
DS: It’s possible I said that, but that must be seen in the context in
which I said it. The point is that the banks are trusted, be they public

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sector banks or private banks. A telecom company, on the other hand,

is typically a private enterprise. In order to get people outside the
system to come in, we need that trust. Only banks can inspire that
trust.
Now with PBs coming in, telecom companies have an opportunity
to get into the banking space. They can leverage on their technology
and penetration while the RBI will have comfort as the telecom com-
pany sponsored banks will come within its regulatory purview.
MSS: Of the governors that we are talking to, you were the one who
articulated the need to demystify the RBI, took upon that agenda and
started the outreach program, until the RBI was seen as one of the
Mumbai-based regulators. And how did the outreach program help,
and why do you think that was important?
DS: In answer to your question, I must tell you about the genesis
of the outreach programme. During 2009–2010, we were celebrating
the Platinum Jubilee of the RBI. There were a lot of events planned
through the year and across the country, with the grand finale in
Mumbai with the Prime Minister as the chief guest. Even as we were
planning all that, I felt that we must do something during the jubilee
year that would have an enduring value – something that would con-
tinue beyond the jubilee year. The outreach evolved out of that aspira-
tion. It was not as if we fleshed out the programme in minute detail
before starting off; in fact, it evolved as we moved forward based on
experience.
At its heart, the outreach required that all the top executives of the
RBI, Governor included, visit at least a couple of villages every year.
They spend an entire day in the village, talking, listening and under-
standing. The idea was twofold – that we learn about village life, and
in turn, we can tell the villagers about the RBI, what we do and how
it makes a difference to their everyday lives. In that sense, it was more
than just financial inclusion.
Let me also tell you where “demystification” came from. Early in
my IAS career, I was posted as Sub-Collector of Parvathipuram in
north coastal AP. The subdivision comprised large Scheduled Tribe
(ST) tracts. That was in the mid-’70s when that region of AP was just
getting out of the Naxalite influence. It was quite evident that chronic
indebtedness was one of the main reasons tribals were alienated from
the system and fell victim to Naxalite influence. Our main task was
to improve tribal livelihood so that they do not become beholden
to moneylenders and end up as bonded labour. This required that
we ensure banks lend to tribals. But banks were wary of doing that

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because they were worried about repayment and thought tribals to

be not credit worthy. However, the common excuse banks would
proffer in denying credit to tribals was that the RBI regulations do
not permit them to lend. The net result was that the RBI became a
scapegoat for the plight of the tribals. Of course, I learned later in
my career that there are all sorts of misinformation that get spread
about the RBI. It was necessary to “demystify” the RBI so that the
common public understood that, far from being obstructionist, the
RBI, in fact, has the welfare and development of the poor in its mind
and its heart.
There was, of course, criticism against the outreach programme –
that we were wasting money, that it was a gimmick, that there was too
much pomp and gaiety and too little learning. That when a dignitary
like the Governor or Deputy Governor visits a village, the whole vil-
lage is decked up and they don’t get to see the village in its everyday
setting. I do not dismiss this criticism outright, but I do believe that
even with all the constraints, the programme had enormous learning
value for all of us.

Approach to financial inclusion

MSS: Historically, the RBI’s approach to spread banking has been to
do the easiest thing – open more branches in unbanked locations
through quotas. Initially it was one metropolitan/urban branch for
four branches in unbanked locations. The policy has evolved to have
region specific detail, but largely it has been about physical outlets and
touch points. Even during your tenure the RBI was trying to reach out
to the larger part of the population by identifying all the villages with
a population above 2,000 and allocating them to banks to provide
banking touch points. The current government is following a different
approach. They are pushing people to the bank. Was the physical pres-
ence a necessary sequential step? Because unless you are at the physi-
cal outlet, people wouldn’t have gone. Or was there any other
approach?
DS: I don’t think there was any pre-thought through sequencing. It
is certainly true that, historically, the main thrust of the RBI’s financial
inclusion was through bank branch penetration into the hinterland of
the country. This shouldn’t be surprising because we are talking about
a time before the technology breakthroughs of the last decade, which
have revolutionised barefoot banking. In other words, a bank branch
was seen as an essential requirement for pushing financial inclusion,

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and our approach, like in all other government programmes, was

supply-led.
The technology breakthroughs of the last decade have made it pos-
sible to turn the financial inclusion programme from supply-led to
demand-led. Today the government is pushing DBT which makes poor
people actively want to open a bank account. I believe the DBT initia-
tive has given a great fillip to the financial inclusion programme. Poor
households enter the banking system for the purpose of accessing the
DBT, and hopefully they will soon demand and get all other products
and services that a bank can offer.
The present government deserves the credit for pushing DBT and
PMJDY aggressively. But we must also recognise that they are build-
ing on the foundations laid by the previous government. Recall that
it was the previous government which started two pilots for DBT in
Chandigarh and Coimbatore. Today’s DBT is building on those les-
sons of experience.
MSS: So, we are supply driven, and in being that have we lost out
on the urban poor and bringing them into the banking system? The
drive is about opening branches in certain locations and making credit
available to certain sectors like agriculture, so in a way the rural poor
got attention. But were the urban poor who were generally invisible
get left out?
DS: It is quite possible to argue that the focus was on the rural
poor. But that need not necessarily mean that the urban poor would
have remained left out forever. They certainly would have come
within the ambit of financial inclusion at some point of time. Rec-
ognise the demographic characteristics of the urban poor. They
are largely immigrants, moving from rural areas across the coun-
try to urban areas in search of livelihoods. Today, we see waves of
immigration of wage labour from the North and North-East of the
country to the South and West – from UP and Bihar to Mumbai
and from Tripura and Manipur to Kerala, for example. These mil-
lions of wage labour remit money home. If they can establish their
KYC (Know Your Customer), they can use the banking system for
these remittances, and if they cannot, they will have to depend on
informal sources for remittances which are more expensive and less
trustworthy.
MSS: So, you are basically saying that there is no either/or approach;
we need to try multiple approaches, as the problem is large enough.
DS: Absolutely. India is large and diverse. There cannot be a uni-
form model for the whole county. What works in UP may not work

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in Kerala, and what works in Nagaland may not work in Odisha.

So, we should allow, if not actively encourage, experimentation and
innovation. And if there are successful practices anywhere, we should
publicise them for adaptation elsewhere.

Regional disparities
MSS: It brings me to the question of regional disparity. Both Dr Rajan
and Dr Reddy had reservations about the RBI mandating the banks to
open branches in locations where the real economy is not taking off.
They say that you can take a bank there as a catalyst for demand side
to pick up, but if that does not happen, we will end up with unviable
branches. The RBI policy of one urban branch for four branches in
unbanked locations has naturally led to concentration of rural
branches in Southern and Western regions. The Central, East and
North-Eastern regions remain under-banked. Is there any way in
which we can address this? Or, if the demand side is not picking up,
should it be the RBI’s responsibility at all?
DS: I am not as definitive on that as Dr Reddy or Dr Rajan. I think
the RBI can be a bit proactive in this regard. Yes, in a laissez-faire
sense banks will not go to places where business is low. But in the
nature of supply creating its own demand, the mere existence of a
bank branch can generate business. I think there is a lot to be said for
a carrot and stick policy.
However, I believe that we should not be too prescriptive in our
approach. It is not clear what will act as a catalyst for financial inclu-
sion in which area. We should focus on planning bottom-up rather
than working on a super model.

Agricultural co-operatives
MSS: One initiative, not from the RBI, but following the report of the
All India Rural Credit Survey Committee Report, we had state part-
nership with co-operatives. This effort was a decentralised effort and
led by states. The data of the ’60s and ’70s show that there is reason
to celebrate the achievement of co-operatives, where they gained share
at the cost of the informal sector as we have discussed in the introduc-
tion. But co-operatives later fell into sickness, followed by the first all
India debt waiver. This is corroborated by the All India Debt and
Investment Survey data for the later decades. Do you think co-
operatives continue to have relevance in the current day?

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DS: The story of co-operatives has been a very sad and dishearten-
ing one. In the early years of our development, we set a lot of store
by the co-operatives; they were seen as an inclusive and cost effective
way of reaching credit to the needy. Except in select parts of the coun-
try, co-operatives have failed to live up to those expectations. When
I was working in the field in the 1980s, malpractices in co-operatives
were quite common. There used to be complaints of capture by vested
interests, of corruption and of casteism. We have failed to keep co-
operatives apolitical and honest.

Regional Rural Banks

MSS: The RRBs, which also had a bounded geography, were set up in
mid-’70s and grew in numbers for a while. Several of them continued
to be sick and looked unviable and had doses of capital infusion.
But RRBs were evenly spread in terms of physical outreach. They
were decentralised. But the problem with RRBs was that they went
into sickness in the regions that were difficult. If you look at the sick-
ness of the RRBs, they are not working well in the Eastern and North-
Eastern parts of the country. Therefore, there is a regional penetration
versus viability conundrum.
The solution to this seems to be a consolidation of RRBs so that the
unviable parts are cross-subsidised by viable businesses in the same
but consolidated entity. Was it a good idea to consolidate RRBs?
DS: I do not have an informed response to your comment. I have
not studied RRBs closely. India is a vast country with so much diver-
sity that I think we should try everything. Different experiments in
different places. I don’t think we should say that one model is suitable
and another is not. Isn’t this what randomised trials are all about?
MSS: The RRBs, ever since they were consolidated into 57 banks,
stopped making losses. Not a single RRB made losses in the past three
years.1
DS: But, are they fulfilling their objectives?
MSS: The last year’s data shows that they are moving towards big-
ger amounts.
DS: Sure, so they are moving away from their original concept.
MSS: We are not sure in terms of physical presence whether they
have rationalisation of branches and so on. It is a difficult conundrum.
You have to balance inclusion and viability.
DS: Perhaps an element of cross-subsidisation is an inevitable part
of drawing that balance between inclusion and viability.

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Local Area Banks

MSS: The private sector effort, similar to RRBs, was the LAB, but
somehow it did not take off at all.
DS: Yes, but the problem with LABs was different from that of
RRBs. By definition, LABs have a geographic concentration and that
itself was an issue from a risk management perspective. Besides, there
was also an inherent contradiction in the LAB model. It was believed
that their Unique Selling Proposition (USP) would be that they were
small, local and they knew the local people and culture, and by vir-
tue of all this they would serve the clientele efficiently. But once they
became successful, LABs wanted to expand beyond the local area and
become large banks, forfeiting the unique comparative advantage that
made them successful in the first place. In other words, we wanted
LABs to remain local and serve a local clientele whereas the promoters
saw LABs as an entry point into the large and universal banking space.
MSS: But of the four (this is an aside), I spent some time with the
Capital LAB in Punjab, and they have got this combination being local,
professional and penetrating deeper fairly well. They were growing
within the bounds, but eventually their aspiration was also to become
a larger bank. They wanted to operate in more districts. The question
is whether their current systems and procedures, which were based on
personal contacts and moral suasion, will work with a regular bank.
That is a dilemma.
DS: You are exactly right. The question is when an LAB expands
beyond the local area, is it giving up the comparative advantages that
made it successful in the first place.

Small Finance Banks

MSS: Now one of the two new institutions that the RBI has proposed
is SFBs. Do you have any opinions on how it is panned out in its
design? Obviously none of them are out there on the field.
DS: I think it’s a good initiative.
MSS: The initial RBI guidelines indicated that SFBs would have
restricted areas, but the final guidelines and licences did not have any
geographical restrictions. So, from a geographic focus it has moved
towards a functional focus.
DS: I think that’s a neat classification. LABs are constrained by
a geographical restriction and SFBs are constrained by a functional
restriction. Sure, the business model of a SFB is constrained, but I

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believe it’s an experiment worth trying. Yes, their lending rates will
be higher if only because they will have to offer higher rates on their
depositors to win customers. But as I have always maintained, for
poor people what matters is not so much the cost of credit but access
to credit. My belief is that the poor will be willing to pay a higher rate
for a loan because the alternative – borrowing from informal markets –
will be significantly costlier. It is wrong to compare the rates charged
on these small borrowers with the rates that the top corporates com-
mand. The comparison has to be with their realistic alternatives which
are borrowing in informal markets. My only concern is that, like in
the case of LABs, promoters of SFBs treat this just as an entry point
into banking and do not show enough commitment to the goals of the
SFB model.
MSS: The RBI has announced that five years later then they can
apply for a universal bank licence.
DS: Yes, I am aware of that. Sure, an SFB should not be ineligible
for a universal bank licence merely because it started as an SFB. On
the other hand, the regulator should avoid giving the impression that
the operation as a SFB is a sure shot entry point for a universal licence
or indeed that every SFB will get a universal bank licence in course of
time.
The important thing to recognise is that SFBs add value because
they are small. There is a parallel here with small industries. Every
small-scale industry need not become a medium-scale industry. A
small-scale industry adds value because it is small, employment inten-
sive and capital augmenting. Similarly, the USP of an SFB is its size and
functional restriction.
MSS: So, if you look at the SFB guidelines, they say half your port-
folio should be in the sub Rs.2.5 million ticket size, and 75% of your
portfolio should be in the priority sector. The sub-targets of priority
sector are as applicable to other banks. The in-principle licenses have
been handed out to eight MFIs, one LAB and a NBFC.
The RBI notification for NBFC-MFIs limits the MFI loan size to
below Rs.100,000. With MFIs becoming SFBs, my guess is that they
will move upwards and go towards Rs.2.5 million limit and reach the
microenterprise sector.
MSS: Is this your reading of the MFIs which are not banks?
DS: Yes. MFIs which have got licences to be SFBs. They are currently
operating on a ticket size of Rs.100,000. As an SFB they are permitted
a ticket size of Rs 2.5 million. They will naturally move upwards and
veer towards the maximum limit in possibly in the five to six years’

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time. Not immediately, because this is the business they know as of

now. If they move upwards it will take them towards microenterprise
segment which is also a very interesting and underserved segment. But
this design doesn’t serve the last mile inclusion problem as much as it
serves the microenterprise problem. You think that is a good reading?
DS: I don’t think so. The scenario you are presenting is not inevi-
table. I don’t see why MFIs which are becoming SFBs should vacate
the low end ticket space. They can serve the Rs.2.5 million customers
without necessarily abandoning the Rs.100,000 customers.
MSS: And then there is MUDRA in between.
DS: Sure. But do let me continue with the point I was making. Con-
trary to your view that MFIs which become SFBs will veer towards the
upper bound of the allowed loan ticket size of Rs.2.5 million, I believe
they will continue to serve the Rs.100,000 customers at the lower end
of the spectrum. In serving the low end customers, they will have a
cost advantage as, by virtue of being banks, they will have access to
low cost deposits. So they can continue to serve their existing custom-
ers and also can move up the spectrum.
My concern actually is contrarian to what you are suggesting which
is that MFIs which are not SFBs will now be competed out of business
because of their higher cost of funds. It is important that these MFIs
stay in business as they do serve a valuable purpose. After all, our
commitment is to the low-income households and not the MFIs.
MSS: I must say that, as of now, your view is prevailing as far as
Bandhan is concerned.
DS: Which is?
MSS: Which is that Bandhan’s total portfolio on the non-MFI seg-
ment, after a year of operation, is Rs.1.7 billion. The microfinance
portfolio is strong at Rs.122 billion as of March 2016. So they are
continuing to serve the microfinance clients.
DS: If that’s their business model, it’s wise. What is the point of
competing with SBI or ICICI to lend to Reliance or Tatas in which
they have no competitive advantage? They are focusing on the niche
market they know well.
MSS: Yes, this is where they are starting, but I was thinking that for
a long horizon this will be a natural movement away from the tradi-
tional microfinance portfolio.
DS: Actually, MFIs which are becoming SFBs might initially focus
on their natural habitat like Janalakshmi in Karnataka and Capital
LAB in Punjab. Then, they will spread out after some preparatory
work to other geographies. Where they will decide to go is difficult to

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say. Will they venture into virgin but untested areas like Chhattisgarh
or crowded but potentially lucrative areas like Kerala?
MSS: Three of the ten players who have been handed in-principle
licences already have significant presence in more than ten states.
Interestingly, and as an aside, these MFIs – Bandhan and eight others
who have got in-principle licences– have a presence in the North and
the East, which were traditionally underserved.
DS: There still are underserved areas. Gujarat, for example, doesn’t
have many MFIs.
MSS: There isn’t much. Gujarat and Maharashtra are states which
have a disproportionately high number of UCBs, and the rural co-
operatives are relatively better. I think 80% of the country’s UCBs are
in Gujarat and Maharashtra.

Payments Banks
MSS: Let us talk about PBs. Remittances seem to be gravy in the rev-
enue model of the PB, apart from collecting deposits. What is your
view on PB?
DS: All through my tenure, the RBI was criticised for being a tech
luddite – that we were too cautious – and in the process, were forego-
ing the advantages that technology can offer in financial inclusion.
That criticism was misplaced. Yes, we were cautious but I believe cau-
tion was warranted since we were dealing with low-income house-
holds and consumer protection is paramount. Take the case of telecom
companies. They were active in the remittance space but they were not
regulated by the RBI. There were, therefore, limits to how far the RBI
could let them into this business.
With the increase in migration of wage labour across the country,
payment systems have become an increasingly important component
of financial inclusion. As I said earlier, today millions of workers are
travelling from the North-East of the country to the South-West for
manual labour. These people are able to send money home because
they are able to establish KYC as a result of having Aadhar. This is
in sharp contrast to the situation even less than ten years ago. I know
there was huge migration of labour from AP (now Telangana) to
Delhi for the construction of facilities for the Commonwealth Games
in 2010. We used to hear of stories of how these workers used to
sleep on the streets of Delhi with their earnings in bundles under their
heads. They were forced into this because they had no access to the
remittance facilities of the formal banking system.

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As labour becomes mobile, the importance of payments in financial

inclusion increases. The PB model is a response to this need. It gives
us an option to use technology while also giving the RBI authority to
regulate the operations of these banks.
Telecom companies have an advantage in the payment space because
of their technology and customer base. A number of telecom compa-
nies have obtained licences for PBs. But we have to make sure that
licences for PBs are not restricted to telecom companies, if only to
avoid the impression that starting a telecom company is an automatic
entry into the banking space.
MSS: Though one of the companies that withdrew from the PB
space after getting an in-principle licence was a telephone company.
DS: Tech Mahindra?
MSS: No, Uninor in association with Dilip Shanghvi. But they were
not a telephone company with a significant penetration.
DS: So, if you see the way we have moved – we moved from niche
banking to universal banking, and we are possibly moving back to
niche banking.
MSS: Though, you know, if you were to look only at telephone
companies they were progressing on this route. But there are also pre-
paid wallets, and I think there is a route for licenced prepaid instru-
ment players as well. Basically, they could be tech companies with
mobile wallets.
DS: Yes, but they are not regulated like banks; they are only regu-
lated like a payment system under the Payments Act. In the payment
systems they are not regulated as a bank
MSS: Right. But they could naturally progress as a payments bank.
DS: Sure, but that should not be inevitable.
MSS: What is intriguing in PBs is the deposit side of the business.
They can raise up to Rs.100,000 per customer, but this is to be com-
pletely kept with the government system. What value does that add to
the business?
DS: That need not be as constraining as you suggest. PBs have their
own niche clientele who will do their entire banking with them, even if
it means lower deposit rates and higher borrowing rates. Take the case
of the migrant labour in Ernakulam that we talked about just now. A
worker who uses a payments bank to remit money home to Megha-
laya, say, is likely to make a deposit in the same payments bank even
if the interest rate offered is lower than what a universal bank might
offer. The transaction cost of going to another universal bank is going
to be just too high for him.

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MSS: Right. But they don’t seem to have a huge revenue model out
of it because they will have to put back into the government system,
and so there is no margin there.
DS: I don’t believe it’s as bleak as you suggest. The point I am mak-
ing is that there still will be a decent margin, as they will have a dedi-
cated clientele already captured under the payment business. Take the
case of this guy in Ernakulam. This worker will leave his money in the
payments bank even if the Federal Bank or SBI offers 8% and the pay-
ments bank offers only 6.5%. He will do so because he is already used
to the bank and going to another bank will involve a transaction cost
which will likely neutralise the interest rate differential.
MSS: So, basically you are saying that they need to look at functional
specialisation and the segment of the population that has a niche need.
DS: I am saying that there is sizeable clientele which would deposit
money in the payments bank even if the interest rate is lower than
that offered by a commercial bank merely because a commercial
bank is not a realistic alternative for them. Consumer protection is
a priority objective of the RBI’s regulation. Mandating that the pay-
ments bank restrict risk taking by investing all its funds in govern-
ment securities is a way of ensuring the protection of these small
depositors’ monies.
MSS: The residuary NBFCs were somewhat similar. Except that for
a long time they kept 80% of their deposits with the government. It
was later increased to 100% during Dr Reddy’s time.
DS: Deposit-taking NBFCs are a vanishing category. It’s the RBI’s
policy that deposit taking should eventually be restricted only to banks
which are regulated by the RBI. PBs and SFBs provide a viable savings
avenue to low-income households.

MUDRA
MSS: Let us talk about MUDRA. One: the current government said
that it will be like National Housing Bank, that a separate bill called
the MUDRA Bill will be passed. This entity will do refinance as well
as the regulation of the MFI sector. The RBI seems to have indicated
that MUDRA should not have a regulatory function. This should
solely rest with the RBI as it has mechanism to deal with the regula-
tion. Whereas, in the case of NHB, it has a little bit of a regulatory role
and a refinance role. So do you think it is good to have the MUDRA
as a sectorally specialised organisation and take the role of regulating
the MFIs?

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DS: There are two issues here and they are separate. The first issue
is whether a refinance institution can also be a regulatory institution.
Whether it is NHB, SIDBI or MUDRA, the question is whether an
apex institution which refinances other institutors can, at the same
time, also regulate them. Isn’t there a conflict of interest? Of course,
there are practical issues of setting up another regulatory institution.
There are costs. Maybe we have to live with the second best.
The second issue is regarding who should regulate the MFI sector. You
say that the RBI was opposed to ceding regulation of MFIs to MUDRA
and wanted to retain the authority with itself. I am not sure of the RBI’s
position but I don’t believe it is as you put it – that the RBI wants to
regulate the entire financial inclusion sector. Under the current arrange-
ment, RBI does not regulate the entire MFI sector; it only regulates
large MFIs which are incorporated. Smaller unincorporated MFIs are
not regulated by the RBI. I think the RBI would have argued for retain-
ing the status quo. The RBI wants to continue to regulate large MFIs
because they are systemically important; any excess there will have sys-
temic implications and can threaten banks and the entire financial sys-
tem. At the same time, the RBI is not structured to regulate thousands
of small MFIs spread across the country. It will be efficient if some other
body with reach and penetration regulates them. In that sense, MUDRA
should be structured in such a way that it can regulate smaller MFIs and
leave the larger incorporated MFIs with the systemic importance to be
regulated by the RBI. That will be an efficient arrangement.
MSS: But was MUDRA necessary at all?
DS: I think so. I think an institution like MUDRA is needed both for
refinance and regulation of a sector that has both been neglected and
unregulated. The micro finance services have made headway in parts
of the country by lending to households, especially to women. At the
same time, the microenterprises have remained abandoned. Neither
the commercial banks nor NBFCs have paid attention to the microen-
terprise sector. The hope is that the avenue for refinance will give fillip
to lending to this sector which provides livelihood and employment
to millions of households across the country. And if lending increases,
you also need regulation so that consumers (microenterprise borrow-
ers) are protected.
MSS: At the same time as the RBI is changing the PSL norms to
break up the small and microenterprise obligation to have a hard and
specific target on microenterprises.
DS: Given the enormous unmet demand in this space, some tweak-
ing of the PSL norms is par for the course.

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MSS: But when we say refinance there is an underlying assumption

that that the resources are scarce and therefore we need a refinanc-
ing agency. But is this a constraint when banks are having adequate
liquidity?
DS: Excess liquidity is today’s situation; it cannot be assumed to be
permanent.
MSS: Yes, but we possibly do not even need MUDRA if the banks
have enough resources to fund these activities.
DS: The hope is that the very existence of a refinancing agency will
encourage banks to lend to the microenterprise sector even if they do
not draw refinance from MUDRA.

India Post
MSS: The Postal Department aspires to set up a bank. The sense that
I have got from the RBI is that they are too big to be given a universal
bank license. They don’t have an experience to be given a universal
bank licence and that is sealed. They applied for a universal bank
licence, but they did not get a licence; they recently got an in-principle
licence for a PB. But what would be the role of the postal network in
the larger financial inclusion space, given that banking is out?
DS: The case for a Postal Bank rests on two big advantages: the
penetration of India Post across the hinterland of the country – it’s
all over the place – and second, it is a government institution that is
both trusted and is seen as local. The big disadvantage is that it has
no prior experience. Yes, it is in the money order business, but that
is not the same as the full scale of payment options. Given this mix,
I believe going the PB route is an appropriate strategy for the Postal
Bank.
MSS: Their original proposal apparently (though they did not share
the proposals with me, but from what I could gather from conversa-
tions) was about having a banking outlet in every district over a five-
year horizon. They were not very aggressive about it and were not
converting the Post Office into a bank branch. They also wanted to
ring-fence banking. The contention was that they have some advan-
tage with the physical penetration and the knowledge about the area/
customer. Possibly they wanted to take a few steps.
DS: That’s a disappointment. I thought they would start out more
aggressively and integrate banking into their “bread and butter”
business. If this is the business model, the RBI could as well have
given a banking licence to LIC. In any case, I hope India Post will be

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innovative, set up “a new age” public sector bank and become a trail-
blazer in financial inclusion.
MSS: Can the banking system look at leveraging the postal net-
work? The Postal Department uses Gramin Dak Sevaks who are not
full-time employees but are equivalent to a BC.
DS: If it were possible it would have happened. If there were an
opportunity for, say, SBI to work with India Post, if there was a win-
win option there, they would have tried it out. That it has not hap-
pened is perhaps proof enough that there are no efficiency gains there.

Urban Co-operative Banks

MSS: I would like to know your views on Urban Co-operative Banks
(UCBs). It was during your time that the Malegam Committee was set
up for UCBs. Recently, the RBI got a report from the Gandhi Commit-
tee. Both committees suggested encouraging new UCBs. Malegam
Committee even suggested a lower capital requirement for UCBs being
set up in the North-East. But a co-operative bank is an oxymoron. A
bank by definition has public deposits, which are non- member trans-
actions. There is conflict of interest as the borrowers largely run the
bank. Do you think it’s a good idea to have more and more UCBs?
DS: I am not so sure, not because of the oxymoron you point out,
but because urban banks have not been uniformly successful or uni-
formly efficient across the country. They have served certain urban
areas well and elsewhere they have been a failure. What exactly are
you asking? Are you suggesting that we need more UCBs to further
financial inclusion?
MSS: In fact, the Gandhi Committee seems to suggest a road map.
The road map is to start with urban co-operative societies; when they
reach a certain size, hand over a UCB licence; when they become a
bigger, convert them to a SFB; get them into mainstream banking as
they achieve certain milestones. If they do not achieve the milestones
they remain where they are. There is also an ideological problem of a
co-operative becoming a commercial institution, that I will leave for
the moment. But thinking this of a road map, is it a . . .
DS: No. The Gandhi Committee Road Map looks reasonable;
indeed, well-thought out. At the beginning of this interview we talked
about how urban areas get neglected in financial inclusion. Maybe this
road map is the way to go to achieve urban financial inclusion. So if an
institution starts off as a thrift society and succeeds, maybe it should
be allowed to grow into a bank.

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MSS: But what about the ideological issues of co-operatives being

converted to for-profit entities?
DS: I am not so concerned about the “ideological shift” you are talk-
ing about as about the track record of co-operatives, about whether
they have been a force for the good. Sadly, I remain disheartened.
In some sense, the co-operatives symbolise everything that has been
wrong with our rural milieu. As I told you earlier, during my field
career as an IAS officer in the 1980s, I saw co-operatives being highly
politicised, being casteist, driven by factions, being captured by vested
interest and even exploiting the weaker sections. I thought maybe I
was making too harsh a judgement, that I shouldn’t judge the entire
co-operative movement by my own admittedly limited experience and
offered to go for a one-week training on co-operatives in Pune. My
impression did not change even after this training. Gandhiji articulated
the co-operative movement as a means of decentralised self-help that
would buttress the foundations of our economy. Sadly, co-operatives
have not evolved as Gandhiji visualised.
MSS: It certainly did not work everywhere. We do not have a Rabo-
bank or a Desjardins type of a story to narrate. Those institutions
integrated into the mainstream banking system but were able to retain
the co-operative character.
DS: Neither did we succeed in replicating the successful model of
credit unions of the West.

Microfinance institutions2
MSS: You mentioned that the AP episode was around the three big
issues. Is there any other way in which it could have been tackled? I
mean, in hindsight we can always be very wise.
DS: Can you please be more specific about it?
MSS: There was possibly an early signal in 2006. There was
enough market buzz that there was over-lending to the poor. Interest
rates were something Sa-Dhan3 had discussed with the Society for
Elimination of Rural Poverty and the state government in 2006, but
MFIs had not lived up to their commitments of moderating interest
rates and stopping multiple lending to people. Self-regulation did not
work. That indication was also there. And what we used to call as
social collateral and social pressure can now be termed as coercive
recovery. But from the indications available, including the suicide
cases, there was much more than just social pressure being applied
on the customers.

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DS: I get your question. I am thinking on my feet and cannot recall

sufficient detail to corroborate or contest your comments. The only
point I want to make is that the RBI’s regulation is guided by two
main objectives – financial stability and consumer protection. Banks
are tightly regulated because they are important for both dimensions.
NBFCs are typically less tightly regulated than banks in order not to
over constrain their business model. MFIs are a category of NBFCs.
It’s possible that the RBI was guided more by financial stability con-
cerns with the result that consumer protection in the MFI sector got
relegated as a secondary objective.
But there is also a special AP dimension to the blowout in the MFI
sector in the state. I know because I am from the AP cadre of the IAS.
The state government is very proactive; it had its own very success-
ful “Velugu”4 programme, and there may have been some rivalry or
overlap which caused friction. Admittedly, I cannot rule out the fact
that the RBI may have been blindsided to the developments in the MFI
sector, but in evaluating the blowout in the sector, you cannot ignore
the unique AP dimension.
MSS: There was also a larger political picture at that time, which
cannot be easily brought into equation.
DS: You are right. Political differences are omnipresent in our sys-
tem, and by definition, they are intangible. As I said, several factors,
including the RBI’s preoccupation with financial stability to the rela-
tive neglect of consumer protection, have together triggered the AP
MFI crisis.
Going beyond the genesis of the problem, resolving it also became a
big challenge for me. In the wake of the AP MFI agitation, we appointed
a committee headed by Mr. Malegam, a veteran and respected direc-
tor on the board of the RBI. The committee made a comprehensive
set of recommendations (see Annexure 4). By far the most significant
was to cap the interest rate that MFIs can charge. On the face of it,
it looks like a straightforward remedy given that the usurious interest
rate charged by MFIs was the main grievance in the entire agitation.
But implementing this recommendation posed an intellectual chal-
lenge to me.
Let me explain. There was a time when the RBI used to regulate
the entire structure of interest rates in the system, both on the deposit
and lending sides. As part of the reform process, that entire structure
of administered interest rates has been dismantled. This happened
over the tenure of several Governors. It was finally during my term
that we finally brought the curtain down on the administered interest

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rate structure by deregulating the interest rate on the savings deposit

account. It was widely hailed as it had the potential to benefit millions
of middle-class households in the country whose only savings avenue is
a savings deposit account. Some even said that this would be my lasting
legacy as Governor! And here I was, in the wake of the MFI agitation,
called upon to reverse regulation of interest rates, reversing it as if it
were a historic process. I was quite torn in reaching a decision on this.
MSS: In fact, that’s interesting. If you look at the entire discourse of
the RBI pre-Malegam not only during your time, but during Dr Red-
dy’s time as well, it had a very encouraging attitude towards the MFI
sector; the notification asked the banks to report progress on lend-
ing to MFIs on quarterly basis, and also proactively treated the joint
liability loans as secured loans, for provisioning and prudential norms.
DS: Yes, we possibly went a little overboard, but we learned from
the AP episode. So, there is always a silver lining!
MSS: Moving on, what would be the role of not-for-profits, trusts
and societies in this agenda? Should they be in the financial space at
all? If you look at the evolution of MFIs, it started as not-for-profits
and eventually got into a for-profit mode. So, they were the innova-
tors, they were trying to do something new. But at the same time, you
could take a strict view that they were innovative, but they were pos-
sibly violating some of the rules. So, should these institutions, NGOs
and not-for-profits be in the field?
DS: I don’t understand the question. What is the argument against?
Why would you say that not-for-profits should not be there?
MSS: Well, they were not registered under the RBI as a financial
institution. They continued to function like the NBFCs. So, function-
ally they were NBFCs.
DS: Small scale perhaps, and therefore beyond the RBI’s regulatory
purview . . .
MSS: Yes, very small scale.
DS: Why would you deny them the opportunity of business or ser-
vice, depending on how you look at it? If they are Christian mission-
aries, a temple trust or a non-denominational value based institution,
wanting to serve people, why would you want to prevent that?
MSS: Yes, but the nature of activity that they were doing was not
necessarily “charitable” in nature. They were commercial microfi-
nance organisations
DS: True, but as long as there is demand for microfinance loans,
we should be quite agnostic about who is delivering the service. Some
competition will, in fact, be a positive force.

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Let me tell you a story of my own in this regard. Early in my career,

possibly before you were born, I used to be project director of Small
Famers’ Development Agency (SFDA) in Srikakulam District of AP. My
main job was to give loans to small farmers so as to improve their agri-
culture; for example, for drilling wells in their fields. While on the job,
I discovered a lone Belgian woman located in Bobbili who was also in
the business of giving loans to small farmers for improving their farm-
ing. She probably came in as a missionary, but by the time I met her,
she had no missionary affiliation and was on her own. I was enchanted
by her zeal and sincerity. She was a foreigner, didn’t know the language
or culture and was working all by herself with no support staff. In the
SFDA, in contrast, I had a sizeable staff to inspect the works carried
out with the loan, evaluate it and meet all fiduciary requirements for
giving out the loans. This Belgian woman used to go on her cycle from
village to village to inspect works for which she gave loans. Although
she was not there for profit, she was not prepared to lose money either.
She knew that she could add value only by recovering the money lent
out and recycling it to others. I thought she added enormous value and
in some sense gave us “competition”. That story is my response to your
misgivings about not-for-profits in the MFI space.
MSS: So would you say that beyond a certain size they should come
under a regulation?
DS: Yes, I think so. If an institution exceeds a minimum size, it needs
to be regulated to protect consumers, possibly by MUDRA. As I said
earlier, the RBI is not suitably structured to regulate small MFIs in the
hinterland of the country. It can only take care of the larger NBFC
MFIs, which by the way account for nearly 80% of the total MFI
activity in the county.

Business Correspondents
MSS: The aspect that I wanted to discuss was the BC model. It has not
met with a success that it should have. Do you have any views on what
happened – particularly since we have the benefit of hindsight?
DS: Not just in hindsight, even in real time we were concerned about
the viability of the BC model. We advised banks that they could ask
BCs to charge for the transactions. Even so, volumes did not pick up
and most BCs don’t earn anything like a full-time income. One solu-
tion to the problem is to entrust the task of a BC to someone in the
village who already has some other occupation like a kirana shop, for
example. Then, even if the work of a BC provided only supplemental

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income, it would have been all right. In the event, banks outsourced
the task to large specialised corporates who in turn appointed full-time
BCs. Hopefully, as financial inclusion deepens, volumes will increase
and make the BC model viable.
MSS: Do you think with the DBTs being pushed through this chan-
nel will become viable?
DS: It will certainly be a positive, but whether it will be substantial
enough to make the BCs viable, I do not know.

Integration with the financial markets

MSS: How much should these MFIs, which are not as well-regulated
as the banks, be exposed to the secondary markets with products like
securitisation and collateralised debt obligations? Do we deepen the
markets by encouraging the small institutions to convert their loan
assets into financial instruments? Is that a good idea?
DS: You mean for MFIs which are not banks?
MSS: Right.
DS: Well, this is not a considered response since I haven’t thought
through all of this in a systematic way. My gut response is why not if
it helps their business. Of course, there should be some regulation but
there should not be an absolute bar.
MSS: See the only downside is that in the process they will be overle-
veraging themselves. The portfolio goes out of their books, but they are
still responsible for their portfolios because they are the ones who are in
touch with the clients, so there will be a collection agreement, etc. So, they
will not have adequate capital for the assets side that they are managing.
DS: Even so, I don’t think we should be overly cautious. We should,
of course, safeguard consumer safety, but let the institutions be largely
self-regulating. Let us say that a small MFI goes under. What happens?
What is the big deal? Systemic stability will not be threatened. Sure,
the owners of the MFI will lose. So be it. Creative destruction is part
of free enterprise.
MSS: Would it lead to an AP-like situation?
DS: The AP situation was triggered by three things: usurious lend-
ing rates, overburdening customers with debts and coercive recovery
practices. That may not be the problem here.
MSS: No, there is free flow of resources, which means MFIs are not
putting their own skin in the game but are leveraging. Because MFIs
are able to sell and clear their balance sheets, they could be much more
aggressive in the market, leading to overburdening the customers.

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DS: Yes, but we are assuming that the regulator will take care of
consumer safety. In other words, if the opportunity to take assets off
the balance sheet spurs over-lending, the regulator will curb that. I
think we should focus on consumer safety without over-constraining
the business models.
MSS: So, basically it comes back to the client protection framework.
DS: Yes. Regulation should ensure that client safety is not compro-
mised without being overly prescriptive on the business models of the
MFIs. As far as the MFIs are concerned, we should worry to the extent
their operation have systemic implications. Beyond that, laissez-faire
should prevail.

Risk and capital adequacy

MSS: There is one more small thing on which your view will be useful.
When we look at the institutions that are perceived to be “risky” small
banks, Local Area Banks, etc., the RBI insists on a higher risk adjusted
capital adequacy than regular banks. It is 15% for these banks when
it is less than 12% for the bigger banks. I understand that this is com-
ing from a depositor protection perspective. But it is a response to the
riskiness of your assets. So should the response not be on the asset side
itself? Can we look at how the asset side could be safer, rather than
saying that your skin should be greater in this game? The riskiness
does not reduce just because your capital has increased, as against
depositors’ money.
DS: I think that will be a misguided approach. The regulator has an
obligation to the depositors and asking for higher capital is a way of
ensuring depositor protection. But, you do not want to micromanage
the business of the bank. You’d expect that they will charge a higher
lending rate because of the higher cost of deposits, but that does not
necessarily imply the borrowers will be high risk. Ultimately, it is the
bank that should take care of its risk management, right?
MSS: Right!

Agriculture
MSS: Agricultural lending has been a sticky issue. There is a lot of
policy as well as political interference in this important portfolio. We
know the operational size of land holdings is going down, and possi-
bly plateaued out as there is no scope for further fragmentation.
DS: We have hit the lower end of the limit?

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MSS: Possibly families are getting fragmented – if one brother does

agriculture, the other brother drives a taxi in a city and sends money
home. But the agriculture account sizes in the banking sector are going
up. In fact, Dr Chakrabarty famously used to say that metropolitan
branches have a significant portfolio of agricultural loans; and it was
difficult to understand the statistics. Is there anything that as a regula-
tor the RBI can do about this? It is inherently an unattractive portfolio
for a bank to do. This you know is because banks are not allowed to
charge interest rates that clear the risk cost. And, there is an occasional
interference in terms of the waiver. Waiver is a third-party intervention
in a commercial contract between the lender and the borrower. Is there
a way out at all?
DS: The only way out is to gradually phase out the subsidised inter-
est rates. But we are far away from that . . .
MSS: Is there a way of creating a deliberate arbitrage: let NBFCs
and specialised financial institutions like MFIs lend to agriculture at
a price where the market takes and allow the sale of portfolio to a
bank for its priority sector obligations? That is a non-optimal way of
doing it.
DS: But then you are removing the interest subvention that the gov-
ernment thinks farmers should get.
MSS: Yes, you are removing that interest subvention and creating a
regulatory arbitrage. From a highly regulated bank to allowing some-
one who is lightly regulated as an NBFC. You sell a portfolio to a bank
and then treat it as the bank’s achievement.
DS: I don’t see that as the main problem. The main problem,
according to me, is the subsidised interest rate. Once the interest rate
is subsidised, a minefield of problems crops up – benami loans, non-
agriculture loans classified as agricultural loans, people taking agricul-
tural loans at subsidised rates and redepositing that in a fixed deposits
playing the interest rate arbitrage, gold loans being classified as agri-
culture and so on. If the government wants to subsidise agriculture,
there must be better ways of doing that than subsidised interest rates.
Now, about NBFCs acting as agents for banks. Once you remove
the interest subvention, I don’t see any problem in this principal-agent
relationship between banks and NBFCs. In fact, farmers will benefit
from an efficient mode of credit delivery.
MSS: This is exactly what happened in MFIs. MFIs were lending
market cleared, risk adjusted rates, and when they gave the portfolios
to the banks or when it was refinanced by the banks, it was treated as

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priority sector as long as the end use was for the priority sector. So the
interest rate was never a question there. But it was okay because those
interest rates, in any case, were not regulated or capped. The sticky
issue is agricultural end use interest rates are capped.
DS: I couldn’t agree with you more. The interest rate subvention is
the origin of all malpractices. Obviously, we need to find some other
way, apart from subsidised interest rate, to support farmers. How
about the KCC?5 Doesn’t that get around this problem?
MSS: No, it doesn’t because interest rates and KCC are also consid-
ered as agricultural loans. There is only 25% of the estimated income
of farmers as a consumption component, but they assume that it will
be an agricultural loan.
DS: True, but to the extent the KCC can be used only for buying
inputs, the scope for arbitrage – for example, taking cash and putting
that in a fixed deposit – is limited, isn’t it?
MSS: That issue can possibly be sorted out with technology. There
is an interesting pilot in Krishna district where the district collector is
trying to map Aadhar numbers with land records, with the soil health
cards and so on.
DS: Maybe you should go and document this. It will be very
instructive.
MSS: And it is possible that lot of these transactions could be cash-
less as well. You can load up your KCC account. The other thing to
examine is whether the KCC and the PMJDY accounts are mapped.
Can we convert the PMJDY account as a KCC account with an
overdraft – with a limit for agriculture? That is something we need to
do, but it might be worthwhile to look at what the collector is doing.

Priority sector lending

MSS: Under the new PSL norms, the banks, including the new and
foreign banks, will have to achieve the new PSL targets.
DS: But even foreign banks have always had priority obligations.
Except they have had some concessions in terms of substituting credit
for agriculture with credit for exports.
MSS: The foreign banks did not have agriculture obligations.
DS: Sure. Instead, they had obligations to small industries and
exports.
MSS: Yes. Now it is uniform across all banks, including foreign
banks. To be fair, not all foreign banks, but the ones with more than

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20 branches. So they will find it hard, and that’s the market which will
possibly open up.
DS: Yes, that was done during my time.
MSS: The Nair Committee Report (Nair 2012) came during your
time, but then what happened was that the master circular that fol-
lowed sort of acknowledged the Nair Committee Report but said
nothing about implementing it. And then there was another internal
working group set up by the RBI about a year ago which (sort of)
reaffirmed the Nair Committee recommendations, and now it’s been
implemented. That’s what happened.
DS: So, are you saying that as per revised regulation, foreign banks
have the same priority sector norms as all other banks, but with the
facility of PSLC?
MSS: PSLCs are in place. That is also interesting, as the physical
portfolio will not move, only the obligation will move. PSL notes
were discussed during your time as well. Why did you not accept the
V. K. Sharma Committee report? We do not know what the Sharma
Committee report was as it was never in the public domain.
DS: I was fully in favour of PSL notes. After all, it is a market-based
mechanism and adds to efficiency. If, for example, Standard Chartered
Bank’s comparative advantage is not making agricultural loans but
lending to software, and if some Indian bank, say Karnataka Bank,
has an advantage in lending for agriculture, Standard Chartered can
buy the portfolio from Karnataka Bank. Both banks will be better off
without any loss to the overall PSL.
In implementing PSL note, however, we hit against political head-
winds. You see, after the financial crisis, there was a backlash against
foreign banks in all emerging markets, including in India. They were
seen as retrenching operations at a time when their host authorities
wanted them to pump more credit. To that extent, they were seen as
fair weather friends. When the issue of PSL notes came up for informal
discussion, the government was reluctant to accept the proposal out
of an apprehension that it would be seen as a sop to foreign banks.
In reality, there was no sop, but the government was concerned about
the perceptions.

Looking at the future

MSS: After you demitted office, Aadhar penetration went up, multiple
players operate in the technology space and much is changing. Do you
have a picture to paint on as to what will happen in the next three to

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five years in the banking sector? How do you get this to the poor and
what would be its implication?
DS: Over the last few years, we have seen many innovations in the
financial sector made possible by technology – fintech companies,
peer-to-peer lending, crowd funding, cashless economy, virtual curren-
cies, etc. This is not an exhaustive list nor is this the end of innovation.
We are going to see many rapid changes in the financial sector driven
by technology and the “sharing economy”. All these innovations are
going to be both an opportunity and a challenge for financial inclu-
sion. All I can say is that in the business of financial inclusion, we have
to be open to ideas, be on the forefront of technology developments
and let a thousand flowers bloom.

Notes
* Dr Duvvuri Subbarao was Governor of Reserve Bank of India between 5
September 2008 and 4 September 2013.
1 This was true at the time of the interview, but in later years there have been
a handful of RRBs that have started reporting losses. These come from
under-banked and difficult regions.
2 The crisis in AP microfinance was triggered by incidents of borrower sui-
cides attributed to multiple borrowing and coercive recovery practices.
The AP government passed a law severely restricting the operations of
MFIs. For a detailed discussion on this, see Sriram (2012).
3 Sa-Dhan is an association of MFIs and is currently recognised as a self-
regulatory organisation. In 2006, it was the sole representative of all agen-
cies undertaking microfinance activities and was speaking on behalf of all
the regulated and unregulated microfinance organisations.
4 Velugu was the name given for the anti-poverty programme being rolled
out by the AP government. Currently the programme is called Indira Kran-
thi Patham, see Sriram (2005). The programme is being rolled out from a
specialised agency called the Society for Elimination of Rural Poverty and
operates the National Rural Livelihoods Mission – the flagship programme
of the Ministry of Rural Development, GoI. The main operating strategy
is to organise poor women into SHGs and lend through the groups. This
is a community-based model of microfinance as against the other micro-
finance models promoted by independent voluntary agencies and NBFCs.
Popularly, the government backed microfinance programmes are routed
through SHGs-Bank Linkage Programme; the non-governmental initia-
tives in microfinance go by the nomenclature of MFIs.
5 Kisan Credit Cards are not really in the nature of a regular credit card that
could be swiped in merchant establishments. Instead, they are basically a
loan limit approved to an agriculturist for a season to be drawn at the will
of the farmer from the bank. While KCC gives flexibility in terms of tim-
ing of withdrawal of cash in the form of loan, it does not give flexibility in
how the amounts could be withdrawn.

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References
Nair, MV. 2012. Report of the Committee to Re-examine the Existing Clas-
sification and Suggest Revised Guidelines With Regard to Priority Sector
Lending Classifications and Related Issues. Mumbai: Reserve Bank of India.
Sriram, MS. 23 April 2005. “Microfinance and the State: Examining Areas
and Sturctures of Collaboration.” Economic and Political Weekly 40 (7):
1699–1703.
Sriram, MS. 2012. “The AP Microfinance Crisis 2010: Discipline or Death?”
Vikalpa 37 (4): 113–127.

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 5
CONVERSATIONS WITH
DR RAGHURAM G. RAJAN *†

Approach to financial inclusion: PMJDY

MSS: The first issue that we would like to discuss is the approach to
financial inclusion. We have both the RBI and the GoI being interested
in this agenda in a big way, and the objectives of both the RBI and the
government are converging. However, while the objectives may be
converging, are the paths really converging? If they are not, then how
do we manage this? I ask this in the backdrop of the ambitious
announcement that the government made about the PMJDY and the
caution that the RBI has tried to exercise on the scheme.
RR: Historically, if we outline the paths of the government and the
RBI, we implicitly believe that a push is needed, and given a sufficient
push it can become self-sustaining. Now, over time we have discovered
that it hasn’t become self-sustaining. So, either the push hasn’t been
enough or the notion that sufficient push will create self-sustainability
itself is wrong. There is something else that needs to be done, and we
unfortunately have not found what it is thus far.
With PMJDY the government is giving yet another push and saying
let’s cover everybody to the extent possible. There is some virtue in this
approach. This is because some programs like DBTs are intended to be
linked to these accounts. These programs can work well if everybody
is covered. If something like Aadhar is also universal and linked to
these accounts, it also helps in measuring the extent of indebtedness.
If the coverage is partial it does not quite work. So, the thrust on uni-
versal accounts, Aadhaar and DBT is good.
At the same time, I think we need to reconsider and examine if the
gaps are in the institutional framework and the nature of institutions
that are participating in this endeavour. So, we are basically saying,
“We need local institutions that have lower costs and employ local

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labour that will not go the RRB’s way and then demand the terms and
pay scale that is national”. For that we need to empower local institu-
tions like SFB. We should see whether we could get structure where
they will be regulated like the SFBs. We have set up a committee to see
the possibilities for co-operative banks.1
The other issue is whether we can tap into the last mile. So, the
SFBs would be for small credit, whether it’s retail credit or rural
credit or rural industry or urban industry, but as far as bank accounts
and financial services go, they could be created in a Payments bank.
For example, just yesterday in a remote village in Sikkim, where
there is no bank, I saw an outlet selling mobile airtime. That point
can be used as a cash point operated by any mobile company. So
that’s where Payments Bank comes in. Can we include everybody
by including cash in-cash out points, which can be a BC of a variety
of banks? I am very hopeful that this way we can cover much more
ground.

Approach to inclusion: institutional innovation

MSS: On the institutional front, I have seen a shift in the approach
taken by the RBI. In case of LABs and even when the draft guidelines
for the SFBs were put up, it appeared that the RBI had a geographic
focus. But the final guidelines opened up the space for SFBs to have a
nationwide foot-print . . .
RR: Possibly, but not necessarily.
MSS: But that possibility is real. With LABs or SFBs with a restricted
geography we would have been able to achieve a regional penetration
much better. When it is open to a nationwide footprint, then it encour-
ages functional penetration. Instead of targeting some regions, we tar-
get certain types of customers.
RR: Yes, you are absolutely right. My hope is that we will also get
some local players. When we put up the draft guidelines the MFIs rep-
resented to us and said, “Look, we are already national. We are able to
make these small loans because we have a certain structure that decen-
tralises decisions locally. So why do you want to penalise us?” There
is also a stability issue with these small local entities. I mean, one firm
focused in, say, AP may be subject to both the political environment as
well as a hurricane and so on.
MSS: Yes, there is the geographical concentration risk, but the
growth of banking post-nationalisation when we had the 1:4 rule for
rural branches, and later the rule of 25% branches being in rural and

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semi-urban areas have not taken away the geographical mismatch.

North-East, East and Centre continue to be under-banked despite
these efforts. So, what do we do?
RR: That leads us to the real question: what comes first, industry
or finance? And I think that in these areas, typically the missing factor
is not primarily finance, it’s only partly finance. Primarily it is indus-
try. Unless the real sector flourishes, which means fixing all the issues
that are associated with the real sector, banking itself cannot be the
prime mover. So, people say CDR is low; it could be because there is
no demand for credit. Of course, you can always find somebody who
says, “I wanted a loan; I didn’t get it.” That does not negate the basic
point.
MSS: RRBs did equalise this balance a little bit, possibly at the cost
of the viability of some of the RRBs themselves. But if you look at
the ’60s data when it was predominately South and West, North has
caught up over these decades, and largely when I was looking at the
data, the deeper penetration of rural branches has been much more of
RRBs than commercial banks.
RR: This is why we are trying to foster these new institutions.
Locally managed institutions have a great incentive to give local loans.
We have to ensure that they are viable and are not unstable because
of their local dependency. That’s why we are willing to see a variety of
them, and also maybe look at strengthening the urban co-operatives as
well as the RRBs, including changes in their mode of governance. But
the other thing is that we also have to look at the financial infrastruc-
ture that supports these. Today we have credit information bureaus;
can they penetrate more fully in the rural area? Can Aadhaar be used
every time a loan is made so that everybody knows the extent of
indebtedness? Today, somebody who wants a loan needs to get a no-
objection certificate from everybody else.
MSS: But MFIs are also part of the Credit Information Bureaus.
RR: Exactly! It’s not linked with Aadhaar as yet, but it’s linked to
some address that seems to be working reasonably well. But can we
do this in a more systematic way? The second is collateral registries
for bigger players. Can we register collaterals with some entity and say
you have borrowed once against this you cannot go re-hypothecate it
somewhere else? If these kinds of structures are put down (credit infor-
mation bureaus, collateral registries), as well as more rapid action by
the small courts, I think credit will flow more easily.
MSS: This has always intrigued me, both on the LABs and the SFBs;
you’ve always had a higher Capital to Risk-weighted Assets Ratio

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(CRAR) at 15%. But you know the issue is on the assets side because
of either geographical concentration or functional concentration. With
a high CRAR that risk doesn’t go away. So how does a higher CRAR
help, apart from the fact that it keeps the depositors a little safer? It
does not attract capital because the Return on Equity (ROE) will not
be great unless you have leveraged enough.
RR: Presumably if you are taking on more risk, you’ll have to
charge a premium. This notion that somehow you’re going to charge
the riskier guys lower rates doesn’t hold.
MSS: Is there any other way in which the assets side itself can be
diversified by allowing them to do a lot more treasury and things like
that?
RR: You can do securitisation of loans. The only problem is you
need to have adequate skill in the game to collect because you cannot
securitise loans and then not be around to collect.
MSS: With Basel III kicking in do you think all the banks, including
RRBs, SFBs and co-operative banks, will be covered under the norms?
How does that pan out?
RR: Eventually some version of Basel will be there. I think apart
from capital ratios, we have to have some notion of liquidity for all
these entities, including counter-cyclical capital buffers. We’ll have to
see how to apply them across the board. But let us see.
MSS: Do you think RRBs should further consolidate?
RR: I think there is a process by which this is taking place. There is
some talk of one RRB per state rather than two.
MSS: That’s right. That is what the ministry was pushing a couple
of years ago.
RR: Yes, I would say we need to maintain the local character of
these institutions, rather than make them so big that policies are made
in Delhi or in Bombay, and not locally. I think when we get to that
point we have created too big an RRB.
MSS: Let us look at the public sector banking architecture. Would
it be a good idea to break them up functionally and say that you spe-
cialise and have a set of institutions, which penetrate into functional
specialisation, given that we are talking of tradable PSL notes?
RR: I think that could emerge, could be a regional specialisa-
tion as well as functional. But I don’t think we should force it from
Delhi or Bombay. It should be something that’s driven by the banks
primarily.
MSS: But you need to provide a framework which allows that to
happen.

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RR: We need to decentralise decision-making to the banks them-

selves. Which means we need to create strong boards as the govern-
ment has suggested. And let them be free; let them decide what the
policy is. And as you free up independent boards, they will say we
cannot all be doing the same thing.
MSS: Actually, if you go to a public sector bank and do a blind test
you will not know which bank it is.
RR: Exactly! So, let them differentiate themselves, but it can’t be
driven by the Ministry or the RBI. It has to be done by the bank itself.
MSS: In the inclusion space we also have a lot of unregulated enti-
ties, registered but unregulated, like trust, societies and possibly Sec-
tion 8 companies. What is the RBI’s outlook on such entities?
RR: As far the unincorporated entities go, including your local
money lender – I mean we do have a huge number of those but we
cannot do much about it unless it gets to a size that it starts creating
a systemic concern – our current view is that we will help coordinate
the regulation of these entities through State Level Coordination Com-
mittees (SLCCs). Many of them are more a law and order issue rather
than a systemic stability issue.
MSS: Therefore, are you saying that the RBI should not be too
concerned?
RR: No, no, we should be concerned about them. When some-
body loses money they are going to say that I was taken for a ride
by this financial institution; where were the regulators? We have had
enough adverse mentions by various judicial and investigative agen-
cies. Clearly, even if it’s not our baby, the public will hold us respon-
sible. So, what we are doing is activating these SLCCs in every state
which has the Chief Secretary, the Criminal Investigation Department,
the Director General of Police, etc. They come together to exchange
information about who these operators are or where there is a pos-
sibility of public harm.
MSS: . . . and also are of a size that could cause concern.
RR: Yes, the size will cause concern. For the tiny guys we are try-
ing to say that if you take deposits, or what are deemed deposits,
without having the regulatory permission, and then it will essentially
be a cognisable offense. So before you default on a deposit, even the
act of taking it without license should be seen as a cognisable offense.
Otherwise you have these guys who are running Ponzi schemes and
until they disappear; they are fine, they are legal. So I think we need
to make unlicensed deposit taking an offense. So those are two areas
where we are pushing harder.

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Microfinance institutions
MSS: The next thing I want to talk to you about is MFIs. Prior to 2010
they were growing at a very fast pace. Then the AP episode happened
and then the RBI set up the Malegam Committee. I think the RBI
announcement came on the same day as the AP ordinance. So, possi-
bly the RBI was anticipating a crisis because if you look at the dates,
it was the exact same date as the Chandigarh board meeting. Based on
the report of the committee, there are stringent norms laid out on
MFIs. Some of these are still possibly necessary, but some of these are
difficult to implement, like income, asset size, number of loans. Num-
ber of loans is, of course, possible to monitor.
RR: I have said that there has been some substantial improvement
in monitoring the over-indebtedness of the individual.
MSS: That is true, but there are a couple of things – 85% of the
qualifying assets (portfolio) have to be in a defined category of house-
holds with Rs.60,000 income in rural areas and Rs.120,000 income
in urban areas.2 Such norms lead to a large amount of misreporting.
It also becomes worthless data for their own data mining purposes.
RR: What we need to do is liberalise. We are trying to develop
a norm for NBFCs as a whole. See, the problem comes when some
NBFCs get regulatory preferences. So, for example, lending to NBFC-
MFI counts as priority sector. So, if we instead say that lending to any
NBFC against MFI-type loans, MFI portfolio, should count as prior-
ity sector, then the entire privilege for NBFC-MFI vanishes. So that is
probably something that we could examine. And that will alleviate
this problem of having to micro-manage the structure of the MFIs.
MSS: Yes because 85% is also a difficult ratio to maintain, given
that some of these clients actually graduate, and there is a fair mid-
level market developed.
RR: Yes, I know. We are trying to move away from creating these
silos for NBFCs, to make it continuous. If you are 95% in equipment
financing, you are treated as thus and such. But if you are 70% into
MFI financing . . . so you should get privileges based on what you do,
rather than because of the institution you are categorised as. That’s all.
We shouldn’t have 0/1 categories.

MUDRA
MSS: On MUDRA, what is your view? Do you want to talk about it
at all?

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RR: I am happy to talk about it. Firstly, it is not going to regulate

incorporated MFIs. That will stay with us. That has been established
with the government.
We need to bridge the gap in credit, but it will take hard work,
new frameworks and better systems. The MUDRA Bank will have to
work on all these dimensions. We just had a bunch of people come to
the RBI and represent that small guys are not getting credit. Yes, tell
me what is new? Small guys have not been getting credit across the
world since time immemorial. The real issue is you don’t solve this
problem by pushing more credit in their direction. You try and fig-
ure out what are the ways in which you can bridge the gap between
the financier and the small guy. Often the gap is informational and
enforcement.
Informational because if you are sitting in a nationalised bank you
may not know much about villages and what’s going on and who is
what, etc. And for a variety of reasons it may be too costly to enforce
anything. So, you depend on the borrower being willing to pay back.
If he isn’t willing to pay you back, you have no willingness or ability
to go and enforce.
MSS: MFIs overcome this with their various social collaterals. And
because they are closer they know what’s going on. So, unless you cre-
ate the institutions that get closer to the borrower, you’re not going to
bridge that gap. It’s not a question of cost of finance.
RR: No, you can always offer subsidised finance to somebody.
But, unless it is sustainable, it will never scale. Now a new institu-
tion, lending to the informal sector, is not a complete answer because
what are you going to do, how are you going to monitor them? You
take the local money lender – there is a belief that if you lend to him,
he’ll offer cheap loans to the people. Perhaps he will. Or perhaps he
won’t.
I think this is one of those things we’ll have to think outside the box
and experiment a little bit. Do it on a small scale so we don’t do too
much damage and see what happens. So refinancing, we’ve tried that.
I don’t think that’s the complete answer. Securitisation, maybe. If you
can, you know, see some way of creating the necessary infrastructure,
fine. If you can do some hand-holding, fine. Maybe the MUDRA Bank
will do a little bit of all these. The diagnosis of the problem seems to
be that nobody is lending to these informal MFIs, so therefore let us
create an institution to lend to them. But we have to be careful that
we put in place adequate frameworks and systems, else we could incur
substantial losses.

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Agriculture
MSS: Would you like to talk about the PSL norms and the changes
(Reserve Bank of India 2015a) that are on the anvil?
RR: Yes. We are increasing the small and marginal farmer support
and the micro support. Our approach was, let us figure out who really
needs access, because we have mixed up access, priority and national
importance together. In some cases, we don’t know where it ends up.
So, these are the customers who desperately need access. Let us push
here. For the rest, these are broadly national priorities; we’ll put it
broadly and you can choose between one and the other. The agricul-
ture target is still 18% but 7% (going up to 8%) to small and mar-
ginal farmers is the harder target. Those are people who truly need
credit. Once we achieve the marginal farmer and the microenterprise
category, the rest are probably going to be relatively easy to achieve.
And therefore, it won’t become that binding, but these two essentially
become binding.
MSS: That brings me to the agriculture portfolio. It’s a wicked prob-
lem in a typical public policy sense. When you are talking of trading
PSL notes, the report recommends trading obligations without mov-
ing the portfolio and restricts this to banks. So there is no regulatory
arbitrage. Does it make sense for us to think of actually encourag-
ing a regulatory arbitrage? Say NBFCs lend at a higher interest rate
for agriculture and the banks achieve their targets by purchasing this
portfolio. If that is possible then there will possibly be a specialised
institution marked which actually caters to the needs, but banks also
achieve their targets, in a lazy way.
RR: The problem with that is it makes it too easy, and the banks
themselves will back off lending to the priority sector. The NBFCs that
have been doing this lending will come into the market and sell. You
will not get incremental lending to the priority sector, and maybe even
a decline. Basically, NBFCs will crowd out the banks and sell priority
sector loans to them. So, unless we impose targets on the NBFCs also,
it will not serve the purpose.
MSS: With the recommendations of the internal working group on
tradability of PSL obligations, do you think it may morph into a larger
trading platform across structures in future, or you want to keep it
limited to the banking system?
RR: As of now banks. But let’s see how it goes.
MSS: Is there no other way, with which we can do anything about
this subvention and make lending to agriculture inherently attractive?

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RR: No. Subvention doesn’t necessarily imply that you have to lend
at 9%. That’s not so much the subvention than the fixed price. The
subvention actually tries to make lending a little more attractive. We
have said to the government that they should eliminate fixed price.
Otherwise what happens is that you get an excessive focus on gold
loans. We have this policy of saying do “A” but you cannot either
charge the appropriate interest rate or take collateral. In that case
banks are basically saying, “Why should I do ‘A’?”
MSS: That’s right. Then they’ll do the minimalist thing required.
RR: Or find somebody who looks like “A” but is not really “A”. I
have pledged my gold; I get a gold loan. And that counts as agriculture.
MSS: But the banks still don’t get the return, and that’s the problem.
Even if they look at the total adjusted cost of funds, agriculture has to
become a loss-making portfolio because of the interest rate cap.
RR: It does not have to be that way. But we do worry about cases where
the same guy who borrows from the bank goes back and re-deposits,
because he is charged effectively 4% and earns 8% on fixed deposits.

Post Bank
MSS: Can we talk about the Post Bank? I am not sure what happened,
but they had applied for a license as a mainstream bank, the Finance
Minister announced in the budget that they will be a Payments bank.
Any reason why they were not considered for a universal bank?
RR: At that time we did not proceed with the universal bank appli-
cation because it had not been sent with government approval. With
the Payments bank application announced in the budget, we are exam-
ining the proposal for a Payments bank.
MSS: Do you think it would have been a good idea to grant a uni-
versal bank licence?
RR: I would say it would be appropriate for them to first start as a
Payments bank.
MSS: But they are already a Payments bank in one sense.
RR: Yes, well they say that. But it would be nice to segregate all that
properly into a structure, have a clear accounting, have a sense of who
is in the structure and who is not. There is a need for transparency
about the banking operations. What kind of a relationship do they
have with the Postal Department? That needs to be clarified substan-
tially. Once that is clear, the separation is clear.
MSS: The Postal Department had a consultant’s report which had a
road map basically saying that every Post Office will not have a bank

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branch but in six to seven years every district head quarter will have
a banking outlet.
RR: See, our worry about credit to any untested organisation, espe-
cially if the organisation can in a span of a year or two generate two
lakh crores in deposits, is how will that be deployed? What kinds of
loans will be made? Where is the credit evaluation capacity? We need
to have a greater comfort with that.
MSS: One of the arguments made was that they don’t have credit
experience. That is an oxymoronic argument. But you are saying size
is the argument . . .
RR: Exactly, but let us first get the bank management, cash man-
agement and the structure together. Once we have confidence that
all those things are working well and there are no operational risks,
then we can start slowly seeing how we can move the Post Payments
Bank towards more. In a number of countries, the Postal Bank is just
cash in-cash out, no lending. It doesn’t make loans. Some advocates
are basically saying the postman knows the local area and can make
loans. But the postman has no financial experience. He can only do
KYC at best. He can’t make the loans objectively, because his friends
are there. So, in what sense is he going to make loans and collect
them?

Urban Co-operative Banks

MSS: You are moving towards converting co-operatives into main-
stream banks. But the form of the organisation doesn’t permit you to
do that in one sense, because there is no residual claim on liquidation
income as far as co-operatives are concerned. There is only residual
claim on current income. With all these large banks, what route would
you take?
RR: There are two options for co-operatives that we regulate. They
could morph into the kind of structure that the Malegam Committee
(Malegam 2011) has proposed, which gives us a little more regulatory
confidence. The other is to transform into the joint stock bank. In the
United States when it went through this, they basically gave the equity
rights to the existing depositors. We’ll have to worry about how the
membership of the co-operative will get rights to the equity.
MSS: Particularly since these banks are largely controlled by bor-
rowers rather than depositors.
RR: Exactly!
MSS: So that is a tougher problem and a much more gradual issue.

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RR: We’ll have to figure out how to do it. So, we’ll have to make
sure that members are involved in the proportion of the cost of sub-
scription. Maybe the appropriate proportion would be one member,
one equity share. And so that way we don’t get an excess concentra-
tion of the surplus value in a few hands.
MSS: What do you do with the accumulated reserves and the
surpluses?
RR: So, it would be divided up equally across the membership. That
would also accord with the co-operative nature. However, all this
needs to be thought through in discussions with stakeholders.

Last mile delivery

MSS: On the last mile delivery of financial services, the last big idea
that we tried was BC, and that has had mixed response and mixed
results. Are there any other big ideas you have on this?
RR: I think BC has to go together with connectivity and with mobile
transfers. BC has to be perhaps cash in-cash out. But having agents who
do other functions acting as a BC may also allow for recovery of cost.
MSS: That’s the SBI model, where they have put this Customer Ser-
vice Points (CSP) very near the branch in most of the places so they
divert small ticket traffic to the CSP. It’s safe in the sense that the expo-
sure of the CSP is backed up by a fixed deposit. As the point is near
the branch, anytime CSP runs out of limits they can go top it up. They
have given limited access to CBS. It’s a very interesting model but not
many banks have picked it up.
RR: Well some have, but I was thinking more in terms of, he’s doing
another business, and the BC is on the side. So, the other business
which is not a banking business, like he’s running a shop and he does
BC also on the side.
MSS: Yes, these guys also do photocopying, sell insurance products
and other small services.
RR: In some states, they are doing government business.
MSS: Yes, the Sahaj is doing that, wherein you share the sunk costs
across.
RR: Exactly! The fixed costs are shared, so that, I think, would
work. We are trying to figure out what we can do with white label
BCs. So, allow them to do business for multiple banks. Now there, the
problem right now is which bank controls them. Let them have one
bank which they do primary business with, but let the bank not make
it disadvantageous to work with other banks.

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Concluding comments
MSS: One last personal question: you’ve been outside the system, you’ve
been extensively writing, including your Hundred Small Steps and so
on. Has your outlook, having occupied the office, changed a little bit
with the internal constraints kicking in? In a way you have cautiously
advocated the markets approach and deepening of the markets.
RR: I have broadly moved in the direction of that report in a number
of dimensions. I just saw the currency markets; trading has increased
substantially over the past few months, interest rate futures markets
have increased, so this notion that somehow we are against markets is
wrong. Where I have become a little more cautious is that, post finan-
cial crisis, the notion that market participants are fully responsible is
hard to hold. A variety of problems plague them.
Take, for example, External Commercial Borrowings. Should we,
as the Sahoo Committee suggests, allow unbridled external commer-
cial borrowings, regardless of who you are, so long as you hedge? I
am uncomfortable because I don’t think the only problem is lack of
hedging. I think there are number of players who basically are willing
to take on dollar loans and remain unhedged because they pay 1.5%.
They basically say that if the dollar appreciates substantially against
the rupee, I am in deep trouble. But then I go to the bank and say,
“Take a hit”, so I am not really in trouble, my banker is in trouble.
And if the dollar stays where it is, I make a ton of money.
MSS: So, there is an upside but there is no downside. Downside goes
back to the public.
RR: Exactly! That is the game the unhedged promoter could be
playing. In that game, if we don’t have proper bankruptcy, the moral
hazard involved is tremendous. So this notion, that we liberalise and
just require hedging, may be optimistic . . . first, they don’t hedge; sec-
ond, I cannot monitor what they hedge. Banks tell us they cannot
monitor, obviously because he hedges the first day and he undoes it
the second day. How do you know if he undid it? You have no idea. I
think there is a value here to being reasonably conservative. Of course,
you don’t want to be so conservative that you hold back necessary
change. So I am open to change, but I, precisely your point, want it
explained, and I want to understand whether it’s an ivory tower view
of participants or a reasonable view.
The banks have a constraint because some bank managers also have
a short horizon and are desperate to find every which way to off-load
the problem to the future, so the next manager can take care of it. So

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in that kind of an environment, the kinds of outcomes can be quite

different from what you get in a well-functioning capital market. Even
in a well-functioning capital market we have the experience of 2008.
So basically, I am cautious. I’d like to see markets work better; I’d like
to bring more of them into the picture, but let’s be a little more careful
about how much we rely on them.

Notes
* Dr Raghuram G. Rajan was Governor of the Reserve Bank of India between
5 September 2013 and 4 September 2016.
† Originally published in Inclusive Finance India Report 2015, Copyright

2016 © ACCESS Development Services. All rights reserved. Reproduced

with the permission of the copyright holder and the publishers, Sage Publi-
cations India Pvt. Ltd., New Delhi.
1 The Gandhi Committee has submitted its report since, and this aspect is
discussed elsewhere in the book. Please see Gandhi (2015) for a detailed
report.
2 These two amounts have since been revised upwards to a household income
of Rs.100,000 in rural areas and Rs.160,000 in urban areas, vide circular
No.DNBR.013/CGM(CDS)-2015 dated April 8, 2015. (Reserve Bank of
India 2015b).

References
Gandhi, R. 2015. Report of the High Powered Committee on Urban Co-
operative Banks. Mumbai: Reserve Bank of India.
Malegam, YH. 2011. Report of the Expert Committee on Licencing New
Urban Co-operative Banks. Mumbai: Reserve Bank of India. Accessed
April 1, 2016. https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/
MFR120911RF.pdf.
Reserve Bank of India. 1 July 2015a. “Master Circular – ‘Non-Banking Finan-
cial Company-Micro Finance Institutions’ (NBFC-MFIs) – Directions.”
RBI Master Circulars. Mumbai. Accessed May 5, 2017. www.rbi.org.in/
SCRIPTS/BS_ViewMasCirculardetails.aspx?id=9827#F2.
Reserve Bank of India. 2015b. Report of the Internal Working Group to
Revisit Existing Priority Sector Lending Guidelines. Mumbai: Reserve Bank
of India.

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 6
CONVERSATIONS WITH
DR URJIT R. PATEL *

General
MSS: You have taken over as Governor of the RBI at a stage where
there have been two significant initiatives – the mission mode opening
of accounts under the PMJDY and the opening up of banking for dif-
ferentiated banks. How do you see the agenda of financial inclusion
being carried forward in the next few years?
UP: My view about financial inclusion is probably different from
that of my predecessors. Going forward I see that the market will take
over this agenda, through technology and innovation. The role of the
RBI will take a backseat. What was not done in decades was done by
PMJDY. The supply side solution was to ensure that everybody had
access, not only in physical terms, but also in operational terms. With
PMJDY, the transaction cost for opening a bank account is already
taken care of and the accounts have been opened. This is thanks to
the initiative of the government; a very large portion of the excluded
households has access to a formal banking system.
Now we need to wait and watch on how the market and institu-
tions will take this forward. At this juncture, there is not much that
the RBI needs to do in terms of a policy push or regulatory initiative.
We assume that with economic growth the country would prosper
in the future and that, in itself, will lead to more and more forms of
intermediation.
One other aspect we have to remember is that with the onslaught of
innovation by the players in the markets and with technology evolving
there will be disrupting innovations. It won’t be too long before suit-
able financial products are designed and delivered for the poor using
this platform. I envision the role of the Central Bank to be limited but

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significant in ensuring that consumers are protected and that there is

no scope for systemic risk. If there are other initiatives required, they
will be addressed as and when required.
MSS: If we look at the history of inclusion, we have had four
phases – active promotion of co-operatives in the first phase; followed
by bank nationalization and regulatory diktats; followed by institu-
tional innovation and experimentation (RRBs); and now by providing
regulatory architecture for players to come in. Do you foresee a new/
alternate approach as we celebrate our achievement and look at the
residual exclusion?
UP: As of now we are not looking at alternative approaches. We
have to follow through and complete what we started. Historically,
after nationalization, the public sector banks have not done enough
in terms of innovation for achieving inclusion. However, with new
banking structures just starting operations we expect this prob-
lem to be addressed in a commercially viable manner. For now, the
role of the RBI is more or less over as far as this specific aspect is
concerned.

Institutional structures
MSS: The RBI issued a draft paper on regulating peer-to-peer lending
platforms. And Dr Rajan also indicated that draft guidelines would be
put up soon. Would the RBI continue to look at these possibilities, or
do we wait for some consolidation of the current efforts?
UP: I believe that peer-to-peer lending is not exactly a “financial
inclusion” instrument. It is just another form of intermediation. So,
we have to appreciate that every new development in the banking sec-
tor is not just about inclusion.
MSS: Going forward, do you think Small Finance Banks could
change the banking architecture particularly with reference to inclu-
sion? If these succeed, do you see the RBI open to the concept of a
large number of SFBs like in the US?
UP: Well, each country has a different context. What worked in the
US need not work in India. We need to look at what is appropriate;
Indian Banking has long been under the License-Permit Raj and state
control. It is only now that we are opening up the banking sector deci-
sively. Therefore, we have not yet seen the market dynamics play out
completely and are yet to figure out what is the optimal number for
India and what should be the mix of different structures.

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It can be Small Finance Banks, Rural Co-operative Banks or the

Urban Co-operative Banks – we do not know it yet. For instance, the
on-tap licensing for universal banks was announced in August 2016,
and there has not been much response until now. So, whether the mar-
kets will see merit in having a large number of small banks, whether
banks will consolidate or whether there would be enthusiasm to set up
new banks, all these will play out in the future.
MSS: Would it make sense to put SFBs and RRBs on a similar regu-
latory platform (giving RRBs to go out of their area of operation and
have a national footprint – subject to adequate capital and safeguards)
and put all other operational conditions (priority sector, branch open-
ing, ATM, technology, scheduling) similar?
UP: In general, a large part of regulation is common for all banks
except for incorporation, size, minimum amount of capitalization. I
think there is fair amount of convergence and I don’t see a reason for
explicitly seeking a further convergence.
MSS: Given our concerns about geographical penetration, how did
you see the role of RRBs? Should they consolidate further?
UP: There has been no concrete proposal from any RRBs or anyone
else, and in case a specific proposal comes up, we could examine this
on its merits. But such a proposal, if needed, should come from RRBs
and their management, rather than from the RBI.
MSS: Do you see some transformation in RRBs once the SFBs start
operating? The RRBs also have portfolio concentration and geo-
graphic concentration risk. Is there a way in which we can mitigate
them and bring them on par with SFBs?
UP: The solution for this is within the respective governance struc-
tures. They have to take a call on how to carry the institution forward
with the imperatives of growth and profitability.

Agricultural Co-operatives
MSS: The Kerala Government has set up a committee to look at con-
solidation of the State co-operative bank and the district co-op banks.
Similar consolidation is happening in the credit movement in the
Netherlands, Germany and Canada. Do you think it is a good idea,
and should this be mooted as an idea beyond Kerala also?
UP: The Co-operative Structures in India in general has had a poor
reputation due to governance issues. And wherever they are good, it has
been spotty. In the case of co-operatives, there is also an interest of the

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state government that makes any intervention complicated; state govern-

ments also regulate co-op banks. Size itself is not an issue but fundamen-
tally it is about governance. Whenever there is an attempt to consolidate,
we need to be cautious of the systemic risk that it will create.

Agriculture
MSS: What is your outlook on this sticky issue of agricultural lending?
Statistics indicate that the number of holdings is going up, the average
farm size is going down, while the banking statistics indicate that the
average account size is going up. Is there something that an institution
like the RBI could do?
UP: If farm sizes are small then it is not a banking issue. You should
also realise that agriculture contributes only 16% to the GDP and the
credit to that sector should grow accordingly.
The problem is mainly because of lack of adequate incentives for
the banks to lend to agriculture. If there is a problem in the viability of
the price at which the agricultural credit is being deployed, the govern-
ment is subsidizing these loans and the banks should be lending within
these parameters.
We also hear of blanket statements on farmers’ suicide which are
solely attributed to credit side issues in the agriculture sector. On the
other hand, some commentators say it is a more nuanced issue, and
we need to have an informed view on what is leading to suicides. Is it
necessarily because of agricultural credit, or whether there are other
economic or social reasons?
The issue of having very small and fragmented holdings is also not
solely a credit side issue. There is only so much that a bank can do.
From the RBI’s side, we have taken care of this problem by putting
stringent priority sector lending norms in place.
Let me add, in this context we need to have an overall and critical
look at NABARD and its role in agriculture and refinancing. And I
hope that somebody does an objective study. NABARD is also the
agency that deals with the co-operatives that we talked about.
MSS: In terms of geographical spread, banking has physically spread
to the South, West, and, to some extent, Northern regions. The Cen-
tral, Eastern and North-Eastern regions are under-banked . . .
UP: The banks will go where the business is and it is not the job of
the RBI to force banks into certain regions. However, with the spread

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of technology and innovation, physical presence may no longer be

an issue. The upcoming Payments Banks and telecom networks have
wide reach and network, and we need to rethink banking. As long as
there are incentives and intermediary structures, banks will go all the
way. This issue does not require a regional policy focus of the central
bank.

MUDRA
MSS: MUDRA, as of now, is doing refinance and managing the
PMMY, but the original role envisaged was much larger, including
registering and regulating microfinance. Do you see MUDRA morph-
ing into a larger role than it is playing now?
UP: MUDRA is currently a Non-Banking Financial Company
undertaking the functions of a refinance agency. There has been no
occasion where the RBI could examine a larger role for MUDRA, and
we have not revisited it yet.
MSS: With the SFB portfolio being pegged at Rs.2.5 million rather
than Rs.100,000 which was for MFIs, I see that the SFBs will eventu-
ally occupy the space for which MUDRA was created (offering loans
up to Rs.1 million) Do you see merit in expecting the SFBs eventually
taking forward the agenda of MUDRA?
UP: What you surmise seems to make sense.
MSS: In the initial formulation, MUDRA as a regulator was also
supposed to regulate MFIs falling outside the purview of the RBI. Do
these MFIs registered in the not-for-profit format (trusts, societies and
Section 8 companies) and not registered with the RBI worry you? Is
there a need for a regulatory architecture for them as well? I ask this
because, even if it is not the mandate of the RBI, any financial scam
will result in the RBI being questioned.
UP: There will be much more innovations as we open up. And as
long as they are in the mainstream, the RBI will regulate them. We will
also keep an adequate customer protection framework for mainstream
regulated institutions. We, as the RBI, will also be tolerant towards
failure of institutions if they have no reason to survive. As average
incomes increase, other forms of finance will come in, and as aware-
ness increases, there will be more formal institutions. Other irrelevant
intermediaries will die a natural death. On the unregulated institu-
tions, we need to work with the state government, and we have a
framework for that.

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Specialised institutions/products
MSS: Would it make greater sense to break up the existing banking
structure into functional specialization and consolidation on those
lines? Like banks focusing on agriculture/housing/education and doing
retail business – for instance, the Rabobank focusses largely on the
food and agribusiness sector? Or for that matter, the NBFC-MFI
which was doing specialised microlending?
UP: The RBI has not prevented any bank from specializing. They
are free to do that as long as they do not contribute to potential sys-
temic risk. There is a framework to look at all the concentration risks.
In addition, where there are obligatory portfolios like agriculture, we
have provided a platform for trading the portfolio through Priority
Sector Lending Certificates.

Digital financial inclusion

MSS: In the recent past there has been much concern about data
privacy – particularly about the data of the poor that may be used for
predatory lending practices, like the payday lenders. Is there some-
thing proactive that the RBI would do to protect the algorithm-based
lending to the vulnerable sections of the society?
UP: Every objective of inclusion or accessibility should be number
three. The first two objectives of the RBI in this area are safety and
security of the customers. These things cannot be rushed. If there is
a loss of data, it is not only a business risk, but also a reputational
risk.
When you are looking at safety, security and data integrity, the
first thing you should look at is how your data will be attacked.
One needs to be prepared to prevent an attack, but to pretend
that the data will never be attacked or hacked is being somewhat
naïve. Data will be stolen; vulnerabilities cannot be taken care of
completely. Therefore, firewalling and preventing the attack is one
part of it, but an equally important strategy should be about how
quickly you can bounce back and recover. One needs to be mature
and resilient.
MSS: With the push to digital, we are moving from cash as a public
good to cash management through the private fee-based providers.
How do you think it will impact the agenda of inclusion and the
poor?

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UP: The government may consider compensating banks for the

transaction costs at an appropriate level. On the other hand, if elec-
tronic transactions already had a transaction fee, and people were
already paying the fee, the market was being created; then offering ser-
vices completely free is not a good idea. Anything that is free is usually
not valued (as, I believe, Gandhiji had implied), and the provider of
that service will not have an incentive to invest, expand and innovate.

Note
* Dr Urjit R. Patel is Governor of the Reserve Bank of India since 4 September
2016.

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 Annexure 1
REPORT OF THE
COMMITTEE ON THE
FINANCIAL SYSTEM, 1991*
Chairman: M Narasimham (Narasimham I)

Summary
1 The Committee’s approach to the issue of financial sector reform is
to ensure that the financial services industry operates on the basis
of operational flexibility and functional autonomy with a view
to enhancing efficiency, productivity and profitability. A vibrant
and competitive financial system is also necessary to sustain the
ongoing reform in the structural aspects of the real economy. We
believe that ensuring the integrity and autonomy of operations of
banks and DFIs is by far the move relevant issue at present than
the question of their ownership.
2 The Indian banking and financial system has made commendable
progress in extending its geographical spread and functional reach.
The spread of the banking system has been a major factor in pro-
moting financial intermediation in the economy and in the growth
of financial savings. The credit reach also has been extensive, and
the banking system now caters to several million borrowers, espe-
cially in agriculture and small industry. The DFIs have established
themselves as a major institutional support for investment in the
private sector. The last decade has witnessed considerable diversi-
fication of the money and capital markets. New financial services
and instruments have appeared on the scene.
3 Despite this commendable progress, serious problems have
emerged, reflected in a decline in productivity and efficiency and
erosion of the profitability of the banking sector. The major fac-
tors responsible for these are: (a) directed investments and
(b) directed credit programmes. In both these cases, rates of interest
that were available to banks were less than the market related
rates or what they could have secured from alternate deployment

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of funds. There has been deterioration in the quality of the loan

portfolio, which in turn has come in the way of banks’ income
generation and enhancement of their capital funds. Inadequacy of
capital has been accompanied by inadequacy of loan loss provi-
sions. The accounting and disclosure practices also do not always
reflect the true state of affairs of banks and financial institutions.
The erosion of profitability of banks has also emanated from the
side of expenditure as a result of fast and massive expansion of
branches – many of which are unremunerated, especially in the
rural areas; a considerable degree of over-manning, especially in
the urban and metropolitan centres; and inadequate progress in
updating work technology. Both management weakness and trade
union pressures have contributed to this. There have been weak-
nesses in the internal organisational structure of the banks, lack of
sufficient delegation of authority and inadequate internal controls
and deterioration in what is termed “housekeeping”, such as bal-
ancing of books and reconciliation of inter-branch and inter-bank
entries. The DFIs also suffer from a degree of portfolio contami-
nation. This is more pronounced in the case of the State Finance
Corporations (SFC). Being smaller institutions, the internal organ-
isational problems of the DFIs have been less acute than those of
the banks. However, both banks and the DFIs have suffered from
excessive administrative and political interface in individual credit
decision-making and internal management. The deterioration in
the financial health of the system has reached a point where unless
remedial measures are taken soon, it could further erode the real
value of and return on the savings entrusted to them and even
have an adverse impact on depositor and investor confidence. This
diagnosis of the problem indicates the line of solution which the
Committee proposes with a view as much to improving the health
of the system as for making it an integral part of the ongoing pro-
cess of economic reforms.
4 The Committee is of the view that the SLR instrument should be
deployed in conformity with the original intention of regarding it
as a prudential requirement and not be viewed as a major instru-
ment of financing the public sector. In line with the government’s
decision to reduce the fiscal deficit to a level consistent with mac-
roeconomic stability, the Committee recommends that the SLR
be brought down in the phased manner to 25% over a period of
about five years, starting with some reduction in the current year
itself.

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5 As regards the Cash Reserve Ratio (CRR), the RBI should have the
flexibility to operate this instrument to serve its monetary policy
objectives. The committee believes that given the government’s
resolve to reduce the fiscal deficit, the occasion for the use of CRR
to control the secondary expansion of credit should also be less.
The Committee accordingly proposes that the RBI consider pro-
gressively reducing the cash reserve ratio from its present high
level. With the deregulation of interest rates there would be more
scope for the use of open market operations by the RBI Bank with
correspondingly less emphasis on variations in the cash reserve
ratio.
6 The Committee proposes that the interest rates paid to banks
on their SLR investments and on CRR in respect of impounded
deposits above the basic minimum should be increased. As dis-
cussed later, the rates on SLR investments should be progressively
market related while that on the cash reserve requirement above
the basic minimum should be broadly related to banks’ average
cost of deposits. However, during the present regime of adminis-
trated interest rates, this rate may be fixed at the level of banks’
one-year deposit rate.
7 With respect to directed credit programmes, the Committee is of
the view that they have played a useful purpose in extending the
reach of the banking system to cover sectors which were neglected
hitherto. Despite considerable unproductive lending, there is evi-
dence that the contribution of bank credit to growth of agricul-
ture and small industry has made an impact. This calls for some
re-examination of the present relevance of directed credit pro-
grammes, at least in respect of those who are able to stand on
their own feet and to whom the directed credit programmes with
the element of interest concessionality that has accompanied it
has become a source of economic rent. The Committee recognises
that, in the last two decades, banking and credit policies have been
deployed with a redistributive objective. However, the Committee
believes that the pursuit of such objectives should use the instru-
mentality of the fiscal rather than the credit system. Accordingly,
the Committee proposes that the directed credit programmes
should be phased out. This process of phasing out would also rec-
ognise the need that for some time it would be necessary for a mea-
sure of special credit support through direction. The Committee,
therefore, proposes that the priority sector be redefined to com-
prise the small and marginal farmer, the tiny sector of industry,

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small business and transport operators, village and cottage indus-

tries, rural artisan and other weaker sections. The credit target for
this redefined priority sector should henceforth be fixed at 10%
of aggregate credit, which would be broadly in line with the credit
flows to these sectors at present. The Committee also proposes
that a review may be undertaken at the end of three years to see
if directed credit programmes need to be continued. As regards
medium and large farmers, and the larger among small industries
including transport operators, etc., who would not now constitute
part of the redefined priority sector, the Committee proposes that,
to further encourage banks to provide credit to these erstwhile
constituents of the priority sector, the RBI and other refinancing
agencies institute a preferential refinance scheme in terms of which
incremental credit to these sectors would be eligible for preferen-
tial refinance subject to normal eligibility criteria.
8 The Committee is of the view that the present structure of adminis-
tered interest rates is highly complex and rigid. This is so in spite of
the recent moves towards deregulation. The Committee proposes
that interest rates be further deregulated so as to reflect emerg-
ing market conditions. At the same time, the Committee believes
that a reasonable degree of macroeconomic balance through a
reduction in the fiscal deficit is necessary for successful deregula-
tion of interest deregulation of interest rates. Premature moves to
market crest rates and determined interest rates could, as experi-
ence abroad has shown, pose the danger of excessive bank lending
at high nominal rates to borrowers of dubious creditworthiness,
eventually creating acute problems for both the banks as well as
the borrowers. Accordingly, the Committee recommends that for
the present, interest rates on bank deposits may continue to be reg-
ulated, the ceilings on such rates being raised as the SLR is reduced
progressively as suggested by us earlier. Similarly, the interest rate
on government borrowing may also be gradually brought in line
with market-determined rates which would be facilitated by the
reduction in SLR. Meanwhile, the Committee would recommend
that concessional interest rates should be phased out. The struc-
ture of interest rates should bear a broad relationship to the bank
rate which should be used as an anchor to signal the RBI’s mon-
etary policy stance. It would be desirable to provide for what may
be called a prime rate, which would be the floor of the lending
rates of banks and DFIs. The spreads between the bank rate, the
bank deposit rates, the government borrowing rates and the prime

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rate may be determined by the RBI broadly in accordance with the

criteria suggested by the Chakravarty Committee so as to ensure
that the real rates of interest remain positive.
9 The inadequacy of capital in the banking system is a cause for
concern. While progress towards BIS norms is desirable, the
Committee recognises that this will have to be phased over time.
The Committee suggests that the banks and financial institutions
should achieve a minimum 4% capital adequacy ratio in relation
to risk weighted assets by March 1993, of which Tier 1 capital
should be not less than 2%. The BIS standards of 8% should be
achieved over the period of the following three years, that is, by
March 1996. For those banks with an international transport
presence it would be necessary to reach these figures even earlier.
10 The Committee believes that in respect of those banks whose oper-
ations have been profitable and which enjoy a good reputation in
the markets they could straightaway approach the capital market
for enhancement of their capital. The Committee, therefore, rec-
ommends that in respect of such banks, issue of fresh capital to the
public through the capital market should be permitted. Subscrib-
ers to such issues could include mutual funds, profitable structure
undertakings and employees of the institutions besides the general
public. In respect of other banks, the government could meet the
shortfall in their capital requirements by direct subscription to
capital or by providing a loan which could be treated as subordi-
nate debt.
11 Before arriving at the capital adequacy ratio for each bank, it is
necessary that the assets of the banks be evaluated on the basis
of their realisable values. The Committee proposes that the bank
and financial institutions adopt uniform accounting practices par-
ticularly in regard to income recognition and provisioning against
doubtful debts. There is need also for adopting sound practices in
regard to valuation of investments on the lines suggested by the
Ghosh Committee on Final Accounts.
12 In regard to income recognition the Committee recommends
that, in respect of banks and financial institutions which are fol-
lowing the accrual system of accounting, no income should be
recognised in the accounts in respect of non-performing assets.
An asset would be considered non-performing if interest on such
assets remains past due for a period exceeding 180 days at the bal-
ance sheet date. The Committee further recommends that banks
and financial institutions be given a period of three years to move

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towards the above norms in a phased manner beginning with the

current year.
13 For the purpose of provisioning, the Committee recommends that,
using the health code classification, which is already in vogue in
banks and financial institutions, the assets should be classified into
four categories; namely, Standard, Sub-standard, Doubtful and
Loss Assets. In regard to Sub-standard Assets, a general provision
should be created equal to 10% of the total outstandings under
this category. In respect of doubtful debts, provision should be
created to the extent of 100% of the security shortfall. In respect
of the secured portion of some doubtful debts, further provision
should be created, ranging from 20% to 50%, depending on the
period for which such assets remain in the doubtful category. Loss
assets should either be fully written off or provision be created to
the extent of 100%. The Committee is of the view that a period of
four years should be given to the banks and financial institutions
to conform to these provisioning requirements. The movement
towards these norms should be done in a phased manner begin-
ning with the current year. However, it is necessary for banks and
financial institutions to ensure that, in respect of doubtful debts,
100% of the security shortfall is fully provided for in the shortest
possible time.
14 The Committee believes that the balance sheets of banks and
financial institutions should be made transparent and full disclo-
sures made in the balance sheets as recommended by the Inter-
national Accounting Standards Committee. This should be done
in a phased manner commencing with the current year. The RBI,
however, may defer implementation of such parts of the standards
as it considers appropriate during the transitional period until the
norms regarding income recognition and provisioning are fully
implemented.
15 The Committee suggests that the criteria recommended for non-
performing assets and provisioning requirements be given due rec-
ognition by the tax authorities. For this purpose, the Committee
recommends that the guidelines to be issued by the RBI under Sec-
tion 43-D of the Income-tax Act should be in line with our recom-
mendations for the determination of non-performing assets. Also,
the specific provisions made by the banks and institutions in line
with our recommendations should be made permissible deduc-
tions under the Income-tax Act. The Committee further suggests
that in regard to general provisions, instead of deductions under

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Section 36(1) (viia) being restricted to 5% of the total income and

2% of the aggregate average advances by rural branches, it should
be restricted to 0.5% of the aggregate average non-agricultural
advances and 2% of the aggregate average advances by rural
branches. This exemption should also be available to banks hav-
ing operations outside India in respect of their Indian assets, in
addition to the deductions available under Section 36(1) (viii).
16 Banks, at present, experience considerable difficulties in recoveries
of loans and enforcement of security charged to them. The delays
that characterise our legal system have resulted in the blocking of a
significant portion of the funds of banks and DFIs in unproductive
assets, the value of which deteriorate with the passage of time. The
Committee, therefore, considers that there is urgent need to work
out a suitable mechanism through which the dues to the credit
institutions could be realised without delay and strongly recom-
mends that Special Tribunals on the pattern recommended by the
Tiwari Committee on the subject be set up to speed up the process
of recovery. The introduction of legislation for this purpose is long
overdue and should be proceeded with immediately.
17 While the reform of accounting practices and the creation of
Special Tribunals are essential, the Committee believes that an
arrangement has to be worked out under which part of the bad and
doubtful debts of the banks and financial institutions are taken off
the balance sheet so that the banks could recycle the funds realised
through this process into more productive assets. For this purpose,
the Committee proposes the establishment, if necessary by special
legislation, of an Assets Reconstruction Fund (ARF) which could
take over from the banks and financial institutions a portion of the
bad and doubtful debts at a discount, the level of discount being
determined by independent auditors on the basis of clearly stipu-
lated guidelines. The ARF should be provided with special powers
for recovery somewhat broader than those contained in Sections
29–32 of the State Financial Corporation’s Act, 1951. The capital
of the ARF should be subscribed by the public-sector banks and
financial institutions.
18 It is necessary to ensure that the bad and doubtful debts of banks
and financial institutions are transferred to the ARF in a phased
manner to ensure smooth and effective functioning of the ARF. To
begin with, all consortium accounts where more than one bank or
institution is involved should be transferred to the ARF. The num-
ber of such accounts will not be large, but the amounts involved

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are substantial to make a difference to the balance sheets of banks.

Gradually, depending on the progress achieved by the ARF, other
bad and doubtful debts could be transferred over time. Mean-
while, banks and institutions should pursue recovery through the
Special Tribunals. Based on the valuation given in respect of each
asset by a panel of at least two independent auditors, the ARF
would issue bonds to the concerned institution carrying an inter-
est rate equal to the government bond rate and repayable over a
period of five years. These bonds will need to be guaranteed by
the GoI and should be treated as qualifying for SLR purposes. The
advantage to banks of this arrangement would be that their bad
and doubtful debts would be off their books, though at a price,
but they would have in substitution of these advances bonds up
to the discounted value with a certainty of interest income which
would be an obviously important aspect from the point of view of
income recognition, and further by making these bond holdings
eligible for SLR purposes; banks’ fresh resources could become
available for normal lending purposes. We wish to emphasise that
this proposal should be regarded as an emergency measure and not
as a continuing source of relief to the banks and DFIs. It should be
made clear to the banks and financial institutions that once their
books are cleaned up through this process, they should take nor-
mal care and pay due commercial attention in loan appraisals and
supervision and make adequate provisions for assets of doubtful
realisable value.
19 Selling these assets to the Fund at a discount would obviously
mean an obligation on the banks/DFIs to write off these losses,
which many of them are in no position to do now given their
weak capital position. We propose that to enable the banks to
finance the write-off represented by the extent of the discount,
the GoI would, where necessary, provide, as mentioned earlier, a
subordinated loan counting for capital. As far as the GoI itself is
concerned, we believe that the Rupee counterpart of any exter-
nal assistance that would be available for financial sector reform
could be used to provide this type of capital to the banks and DFIs.
20 The ARF would be expected to deal with those assets which are
in the process of recovery. In respect of sick units which are under
nursing or rehabilitation programmes, it is necessary to work out a
similar arrangement to ensure smooth decision-making and imple-
mentation in respect of such nursing programmes. The Committee
recommends that in respect of all such consortium accounts which

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are under a nursing programme or in respect of which rehabili-

tation programmes are in the process of being worked out, the
concerned lead financial institution and/or lead commercial bank
should take over the term loan and working capital dues respec-
tively from other participating institutions and banks. Such acqui-
sitions should be at a discount based on the realisable value of the
assets assessed by a panel of at least two independent auditors, as
in the case of transfer of assets to ARF.
21 In regard to the structure of the banking system, the Committee is
of the view that the system should evolve towards a broad pattern
consisting of:

a Three or four large banks (including the SBI) which could

become international in character;
b Eight to ten national banks with a network of branches through-
out the country engaged in ‘universal’ banking;
c Local banks whose operations would be generally confined to
a specific region; and
d Rural banks (including RRBs) whose operations would be con-
fined to the rural areas and whose business would be predomi-
nantly engaged in financing of agriculture and allied activities.

The Committee is of the view that the move towards this revised
system should be market-driven and based on profitability con-
siderations and brought about through a process of mergers and
acquisitions.

22 The Committee is of the view that the structure of rural credit

will have to combine the local character of the RRBs and the
resources, skills and organisational/managerial abilities of the
commercial banks. With this end in view, the Committee recom-
mends that each public-sector bank should set up one or more
rural banking subsidiaries, depending on the size and administra-
tive convenience of each sponsor bank, to take over all its rural
branches and, where appropriate, swap its rural branches with
those of other banks. Such rural banking subsidiaries should be
treated on par with RRBs in regard to CRR/SLR requirements
and refinance facilities from NABARD and sponsor banks. The
10% target for directed credit, which we have recommended
as a transitional measure, should be calculated on the basis of
the combined totals of the parent banks and their subsidiaries.

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The Committee proposes that while RRBs should be allowed to

engage in all types of banking business, their focus should con-
tinue to be to lend to the target groups to maintain at a minimum
the present level of their lending to these groups. With a view to
improving the viability of their operations, the Committee pro-
poses that the interest rate structure of the RRBs should be in
line with those of the commercial banks. The Committee would
leave the option open to the RRBs and their sponsor banks as to
whether the RRBs should retain their identity. So that their focus
on lending to the target groups is not diffused or where both
the RRBs and the sponsor banks wish to do so, they could be
merged with the sponsor banks, and the sponsor banks in such
cases should take them over as 100% subsidiaries by buying out
the shares from other agencies at a token price, and eventually
merge them with the rural banking subsidiaries which we have
proposed. For those RRBs that retain their identity and whose
viability would need to be improved, we propose that instead of
investing in government bonds as part of their SLR requirements,
they could place the amounts stipulated under SLR as depos-
its with NABARD or some special federal type of agency that
might be set up for this purpose. This would also be consistent
with the statutory requirements in this regard, and NABARD or
this agency could pay interest on such balances by investing or
deploying these funds to the best advantage on their behalf and
thus help to augment the income of the RRBs.
23 The Committee proposes that government should indicate that
there would be no further nationalisation of banks. Such an assur-
ance will remove the existing disincentive for the more dynamic
among the private banks to grow. The Committee also recommends
that there should not be any difference in treatment between the
public sector and the private sector banks. The Committee would
propose that there be no bar to new banks in the private sector
being set up, provided they conform to the start-up capital and
other requirements as may be prescribed by the RBI and the main-
tenance of prudential norms with regard to accounting, provision-
ing and other aspects of operations. This in conjunction with the
relevant statutory requirements governing their operations would
provide adequate safeguards against misuse of banks’ resources to
the detriment of the depositors’ interests.
24 The Committee recommends that branch licensing be abolished,
and the matter of opening branches or closing of branches (other

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than rural branches for the present) be left to the commercial judg-
ment of the individual banks.
25 The Committee also believes that, consistent with other aspects
of government policy dealing with foreign investment, the policy
with regard to allowing foreign banks to open offices in India
either as branches or, where the RBI considers it appropriate, as
subsidiaries, should be more liberal, subject to the maintenance of
minimum assigned capital as may be prescribed by the RBI and the
statutory requirement of reciprocity. Joint ventures between for-
eign banks and Indian banks could also be permitted, particularly
in regard to merchant and investment banking, leasing and other
newer forms of financial services.
26 Foreign banks, when permitted to operate in India, should be
subjected to the same requirements as are applicable to domestic
banks. If, in view of certain constraints such as absence of branch
network, the foreign banks are unable to fulfil certain require-
ments such as directed credit (of 10% of aggregate credit), the
RBI should work out alternative methods with a view to ensuring
a level playing field.
27 The Committee is of the view that the foreign operations of
Indian banks need to be rationalised. In line with the structure
of the banking system visualised above, there would seem to be
scope for one or more of the large banks, in addition to the SBI,
to have operations abroad in major international financial cen-
tres and in regions with strong Indian ethnic presence. Pending
the evolution of new Indian banks with an international char-
acter, the Committee recommends as an interim measure that
those Indian banks with the largest presence abroad and strong
financial position could jointly set up one or more subsidiaries
to take over their existing branches abroad. The SBI operations
abroad can continue and indeed be strengthened in the course
of time. The government may also consider the larger banks
increasing their presence abroad by taking over existing small
banks incorporated abroad as a means of expanding their inter-
national operations.
28 The Committee believes that the internal organisation of banks is
best left to the judgment of the managements of individual banks,
depending upon the size of the bank, its branch spread and range
of functions. However, for the medium and large national banks,
the Committee proposes a three-tier structure in terms of head
office, a zonal office and branches. In the case of very large banks,

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a four-tier organisation, as is the case with the State Bank, with

head office, zonal office, regional office and branch may be appro-
priate. Local banks may not need an intermediate tier between the
branch and the central office.
29 The Committee endorses the view of the Rangarajan Committee
on Computerisation that there is urgent need for a far greater
use of computerised systems than at present. Computerisation
has to be recognised as an indispensable tool for improvement
in customer service, the institution and operation of better con-
trol systems, greater efficiency in information technology, and the
betterment of the work environment for employees. These are
essential requirements for banks to function effectively and prof-
itably in the increasingly complex and competitive environment
which is fast developing in the financial services segment of the
economy.
30 Consistent with the Committee’s view that the integrity and inter-
nal autonomy of banks and DFIs is far more important than the
question of ownership, the Committee makes the following rec-
ommendations regarding recruitment of officers and staff and
appointments of chief executives and constitution of the board of
the institutions.
31 The Committee recommends that instead of having a common
recruitment system for officers, individual banks should be free
to make their own recruitment. Thus, there is no need for setting
up a Banking Service Commission for centralised recruitment of
officers or for their recruitment, as at present, through Banking
Service Recruitment Boards (BSRBs). This will provide scope for
the bank to scout for talent and impart new skills to their person-
nel. The Committee, however, predicates this recommendation on
the assumption that the banks will set up objective, fair and impar-
tial recruitment procedures and, wherever appropriate, they could
voluntarily come together to have a joint recruitment system. As
regards clerical grades, the present system of recruitment through
BSRBs may continue, but we would urge that the appointment of
the Chairman of these Boards should be totally left to the coordi-
nating banks.
32 The Committee believes that there has to be a recognition on the
part of managements and trade unions that the system cannot
hope to be competitive internally and be in step with the wide-
ranging innovations taking place abroad without a radical change
in work technology and culture and greater flexibility in personnel

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policies. We have been reassured to know that organised labour

is as much convinced of the importance of enhancing the viability
and profitability of the banking industry and providing efficient
customer service. It is equally incumbent on management of banks
to adapt forward-looking personnel policies which would help to
create a satisfying work environment.
33 The Committee recommends that the various guidelines and direc-
tives issued by the government or the RBI in regard to internal
administration of the banks should be reviewed to examine their
continuing relevance in the context of the need to ensure the inde-
pendence and autonomy of banks. Such guidelines which relate to
matters of internal administration, such as creation and categori-
sation of posts, promotion procedures and similar matters, should
be rescinded.
34 The Committee believes that the Indian banking system, at pres-
ent, is over-regulated and over-administered. Supervision should
be based on evolving prudential norms and regulations which
should be adhered to rather than excessive control over admin-
istrative and other aspects of banks organisation and function-
ing. The Committee would also like to place greater emphasis
on internal audit and internal inspection systems of banks. The
inspection by the supervisory authorities should be based essen-
tially on the internal audit and inspection machinery (which will
cover the credit appraisal system and its observance) that should
be adequate and conform to well-laid down norms.
35 The Committee is firmly of the opinion that the duality of control
over the banking system between the RBI and the Banking Divi-
sion of the Ministry of Finance should end and that the RBI should
be the primary agency for the regulation of the banking system.
The supervisory function over the banks and other financial insti-
tutions, the Committee believes, should be hived off to a separate
authority to operate as a quasi-autonomous body under the aegis
of the RBI but which would be separate from other central bank-
ing functions of the RBI. The Committee recognises that as long
as the government has proprietary interest in banks and financial
institutions, it would be appropriate for the Ministry of Finance
to deal with other government departments and Parliament and
discharge its other statutory obligations but not to engage in direct
regulatory functions.
36 Central to the issue of flexibility of operations and autonomy
of internal functioning is the question of depoliticising the

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appointment of the Chairman and Managing Director (CMD) of

the banks and the boards of the banks and ensuring security of
tenure for the CMD. The Committee believes that professionalism
and integrity should be the prime considerations in determining
such appointments, and while the formal appointments have to
be made by government, they should be based on a convention
of accepting the recommendations of a group of eminent persons
who could be invited by the Governor of the RBI to make recom-
mendations for such appointments. As regards the boards of pub-
lic sector banks and institutions, as long as the government owns
the banks, it would be necessary to have a government director to
take care of “proprietorial” concerns, but we believe that there is
no need for the RBI to have a representative on the boards.
37 As regards DFIs, the main issue with regard to their operations
is to ensure operational flexibility, a measure of competition and
adequate internal autonomy in matters of loan sanctioning and
internal administration. The Committee proposes that the system
recommended for commercial banks in the matter of appoint-
ment of chief executives and boards should also apply to DFIs.
The present system of consortium lending has been perceived
as operating like a cartel. The Committee believes that consor-
tium lending should be dispensed with and, in its place, a system
of syndication or participation in lending, at the instance not
only, as now, of the lenders but also of the borrowers, should be
introduced. The Committee also believes that commercial banks
should be encouraged to provide term finance to industry, while
at the same time, the DFIs should increasingly engage in provid-
ing core working capital. This will help to enhance healthy com-
petition between banks and DFIs. The Committee proposes that
the present system of cross holding of equity and cross represen-
tation on the boards of the DFIs should be done away with. The
Committee welcomes the removal of the tax concession enjoyed
by IDBI as an important step in ensuring equality of treatment
between various DFIs. As a further measure of enhancing compe-
tition and ensuring a level playing field, the Committee proposes
that the IDBI should retain only its apex and refinancing role and
that its direct lending function be transferred to a separate insti-
tution which could be incorporated as a company. The infected
portion of the DFI’s portfolio should be handed over to the ARF
on the same terms and conditions as would apply to commercial
banks.

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38 In the case of state level institutions, it is necessary to distance

them with the state governments and ensure that they function on
business principles based on prudential norms and have a man-
agement set-up suited for this purpose. We propose that an action
plan on these lines be worked out and implemented over the next
three years.
39 As regards the role of DFIs in corporate takeovers, the Committee
believes that DFIs should lend support to existing managements
who have a record of conducting the affairs of the company in
a manner beneficial to all concerned, including the shareholders,
unless in their opinion the prospective new management is likely
to promote the interests of the company better. In doing so we
would expect the institutions to exercise their individual profes-
sional judgment.
40 The DFIs should seek to obtain their resources from the market
on competitive terms and their privileged access to concessional
finance through the SLR and other arrangements should gradually
be phased out over a period of three years.
41 The last decade has witnessed a considerable growth in capital
market operations with the emergence of new instruments and
new institutions. The capital market, however, is tightly controlled
by the government whose prior approval is invariably required
for new issue in the market, the terms of the issue and its pric-
ing. The process of setting up Securities and Exchange Board of
India (SEBI) for overseeing the operations of the market is still not
complete with the legislation for this purpose yet to be enacted.
We believe the present restrictive environment is neither in tune
with the new economic reforms nor conducive to the growth of
the capital market itself.
42 The Committee strongly favours substantial and speedy liberalisa-
tion of the capital market. Prior approval of any agency – either
government or SEBI – for any issue in the market should be dis-
pensed with. The issuer should be free to decide on the nature of
the instrument, its terms and its pricing. We would recommend, in
this context, that the SEBI formulate a set of prudential guidelines
designed to protect the interests of investor, to replace the extant
restrictive guidelines issued by the Controller of Capital Issues
(CCI). In view of the above, the office of the CCI will cease to have
relevance. In the Committee’s view, SEBI should not become a con-
trolling authority substituting the CCI, but should function more
as a market regulator to see that the market is operated on the basis

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of well-laid down principles and conventions. The capital market

should be gradually opened up to foreign portfolio investment and
simultaneously efforts should be initiated to improve the depth of
the market by facilitating the issue of new types of equities and
innovative debt instruments. Towards facilitating securitisation of
debt, which could increase the flow of instruments, appropriate
amendments will need to be carried out in the Stamp Acts.
43 In the last decade, several new institutions have appeared on the
financial scene. Merchant banks, mutual funds, leasing compa-
nies, venture capital companies and factoring companies have
now joined hire purchase companies in expanding the range of
financial services available. However, the regulatory framework
for these new sets of institutions has still to be developed.
44 The Committee recommends that the supervision of these institu-
tions which form an integral part of the financial system should
come within the purview of the new agency to be set up for this
purpose under the aegis of the RBI. The control of these institu-
tions should be principally confined to off-site supervision with
the on-site supervision being resorted to cases which call for active
intervention. The Securities and Exchange Board of India (SEBI),
which is charged with the responsibility of ensuring orderly func-
tioning of the market, should have jurisdiction over these institu-
tions to the extent their activities impinge on market operations. In
regard to mutual funds, there is a good case for enacting new leg-
islation on the lines of the legislation existing in several countries
with a view to providing an appropriate legal framework for their
constitution and functioning. The present guidelines with regard
to venture capital companies are unduly restrictive and affecting
the growth of this business, and they need to be reviewed and
amended.
45 As in the case of banks and financial institutions, there is need to
lay down prudential norms and guidelines governing the function-
ing of these institutions. These prudential guidelines should relate,
among other things, to capital adequacy, debt-equity ratio, income
recognition provisioning against doubtful debts, adherence to
sound accounting and financial policies, disclosure requirements
and valuations of assets. The eligibility criteria for entry, growth
and exit should also be clearly stipulated so that the growth of
these institutions takes place on proper lines.
46 The Committee would like to emphasise that a proper sequenc-
ing of reforms is essential. Deregulation of interest rates can only

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follow success in controlling fiscal deficits. Asset reconstruction,

institution of capital adequacy and establishment of prudential
norms with a good supervisory machinery have to be proceeded
with in a phased manner over the next three to five years, but, we
believe, it is important that the process must begin in the current
year itself.
47 The above set of proposals would necessitate certain amend-
ments to existing laws which the government should undertake
expeditiously.
48 The Committee’s approach thus seeks to consolidate the gains
made in the Indian financial sector while improving the quality
of the portfolio, providing greater operational flexibility, and,
most importantly, greater autonomy in the internal operations of
the banks and financial institutions so as to nurture a healthy,
competitive and vibrant financial sector. This will, above all else,
require de-politicisation of appointments, implying at the same
time a self-denial by government and the perception that it has
distanced itself from the internal decision-making of the banks
and the financial institutions. The proposed deregulation of the
financial sector and the measures aimed at improving its health
and competitive vitality would, in the Committee’s view, be con-
sistent with the steps being taken to open up the Indian economy,
enable the Indian financial sector to forge closer links with global
financial markets and enhance India’s ability to take competitive
advantage of the increasing international opportunities for Indian
trade, industry and finance.

Note
* Source: Narasimham, M. 1991. Report of the Committee on Financial
Sector Reform. Delhi: Government of India.

149
 Annexure 2
REPORT OF THE
COMMITTEE ON BANKING
SECTOR REFORMS, 1998*
Chairman: M Narasimham (Narasimham II)

Summary
1 Reform of the Indian banking sector is now under way follow-
ing the recommendations of the Committee on Financial System
(CFS) which reported in 1991. Meanwhile, major changes have
taken place in the domestic economic and institutional scene, coin-
ciding with the movement towards global integration of financial
services. These developments have reinforced the importance of
building a strong and efficient financial system.
2 The second generation of reform could be conveniently looked at
in terms of three broad inter-related issues: (1) Actions that need
to be taken to strengthen the foundations of the banking system;
(2) related to this, streamlining procedures, upgrading technol-
ogy and human resource development; and (3) structural changes
in the system. These would cover aspects of banking policy and
institutional, supervisory and legislative dimensions.

Measures to strengthen the banking system

Capital adequacy
3 The Committee suggests that, pending the emergence of markets
in India where market risks can be covered, it would be desirable
that capital adequacy requirements take into account market risks
in addition to credit risks.
4 The Committee recommends that in the next three years the
entire portfolio of government securities should be marked to
market, and this schedule of adjustment should be announced at
the earliest. At present, government and other approved securi-
ties are subject to a zero risk weight. It would be appropriate that

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there should be a 5% weight for market risk for Government and

approved securities.
5 The risk weight for a government-guaranteed advance should
be the same as for other advances. To ensure that banks do not
suddenly face difficulties in meeting the capital adequacy require-
ment, the new prescription on risk weight for government guaran-
teed advances should be made prospective from the time the new
prescription is put in place.
6 There is an additional capital requirement of 5% of the foreign
exchange open position limit. Such risks should be integrated into
the calculation of risk weighted assets. The Committee recom-
mends that the foreign exchange open position limits should carry
a 100% risk weight.
7 The Committee believes that it would be appropriate to go beyond
the earlier norms and set new and higher norms for capital ade-
quacy. The Committee accordingly recommends that the minimum
capital to risk assets ratio be increased to 10% from its present
level of 8%. It would be appropriate to phase the increase as was
done on the previous occasion. Accordingly, the Committee rec-
ommends that an intermediate minimum target of 9% be achieved
by the year 2000 and the ratio of 10% by 2002. The RBI should
also have the authority to raise this further in respect of individual
banks if in its judgment the situation with respect to their risk
profile warrants such an increase. The issue of individual banks’
shortfalls in the CRAR needs to be addressed in much the same
way that the discipline of reserve requirements is now applied,
viz., of uniformity across weak and strong banks.
8 In respect of PSBs, the additional capital requirements will have to
come from either the government or the market. With the many
demands on the budget and the continuing imperative need for
fiscal consolidation, subscription to bank capital funds cannot be
regarded as a priority claim on budgetary resources. Those banks
which are in a position to access the capital market at home or
abroad should, therefore, be encouraged to do so.

Asset quality, Non-Performing Assets (NPA)

and directed credit
9 The Committee recommends that an asset be classified as doubt-
ful if it is in the substandard category for 18 months in the first
instance and eventually for 12 months and loss if it has been

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so identified but not written off; these norms, which should be

regarded as the minimum, may be brought into force in a phased
manner.
10 The Committee has noted that NPA figures do not include
advances covered by government guarantees which have turned
sticky and which in the absence of such guarantees would have
been classified as NPAs. The Committee is of the view that for the
purposes of evaluating the quality of asset portfolio such advances
should be treated as NPAs. If, however, for reasons of the sov-
ereign guarantee argument such advances are excluded from the
computation, the Committee would recommend that government
guaranteed advances which otherwise would have been classified
as NPAs should be separately shown as an aspect of fuller disclo-
sure and greater transparency of operations.
11 Banks and financial institutions should avoid the practice of “ever-
greening” by making fresh advances to their troubled constituents
only with a view to settling interest dues and avoiding classifica-
tion of the loans in question as NPAs. The Committee notes that
the regulatory and supervisory authorities are paying particular
attention to such breaches in the adherence to the spirit of the NPA
definitions and are taking appropriate corrective action. At the
same time, it is necessary to resist the suggestions made from time
to time for a relaxation of the definition of NPAs and the norms
in this regard.
12 So far, a sum of Rs.20,000 crores has been expended for recapi-
talisation, and to the extent to which recapitalisation has enabled
banks to write off losses, this is the cost which the Exchequer has
had to bear for the bad debts of the banks. Recapitalisation is a
costly and, in the long run, not a sustainable option. Recapitalisa-
tion involves budgetary commitments and could lead to a large
measure of monetisation. The Committee urges that no further
recapitalisation of banks be undertaken from the Government
Budget. As the authorities have already proceeded on the recapi-
talisation route, it is perhaps not necessary to consider de novo
the institution of an ARF of the type envisaged by the earlier CFS
Report. The situation would perhaps have been different if the
recapitalisation exercise had not been undertaken in the manner
in which it has been.
13 The Committee believes that the objective should be to reduce the
average level of net NPAs for all banks to below 5% by the year
2000 and to 3% by 2002. For those banks with an international

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presence, the minimum objective should be to reduce gross NPAs

to 5% and 3% by the year 2000 and 2002, respectively, and
net NPAs to 3% and 0% by these dates. These targets cannot
be achieved in the absence of measures to tackle the problem of
backlog of NPAs on a one time basis and the implementation of
strict prudential norms and management efficiency to prevent the
recurrence of this problem.
14 The Committee is of the firm view that in any effort at financial
restructuring in the form of hiving off the NPA portfolio from the
books of the banks or measures to mitigate the impact of a high
level of NPAs must go hand in hand with operational restructur-
ing. Cleaning up the balance sheets of banks would thus make
sense only if simultaneous steps were taken to prevent or limit
the re-emergence of new NPAs which could only come about
through a strict application of prudential norms and managerial
improvement.
15 For banks with a high NPA portfolio, the Committee suggests
consideration of two alternative approaches to the problem as an
alternative to the ARF proposal made by the earlier CFS. In the
first approach, all loan assets in the doubtful and loss categories –
which in any case represent bulk of the hard-core NPAs in most
banks – should be identified and their realisable value determined.
These assets could be transferred to an Asset Reconstruction Com-
pany (ARC) which would issue to the banks NPA Swap Bonds
representing the realisable value of the assets transferred, provided
the stamp duties are not excessive. The ARC could be set up by
one bank, a set of banks or even in the private sector. In case the
banks themselves decide to set up an ARC, it would need to be
ensured that the staff required by the ARC is made available to it
by the banks concerned either on transfer or on deputation basis,
so that staff with institutional memory on NPAs is available to
ARC and there is also some rationalisation of staff in the banks
whose assets are sought to be transferred to the ARC. Funding of
such an ARC could be facilitated by treating it on par with venture
capital for the purpose of tax incentives. Some other banks may
be willing to fund such assets in effect by securitising them. This
approach would be worthwhile and workable if stamp duty rates
are minimal and tax incentives are provided to the banks.
16 An alternative approach could be to enable the banks in difficulty
to issue bonds which could form part of Tier II capital. This will
help the banks to bolster capital adequacy which has been eroded

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because of the provisioning requirements for NPAs. As the banks

in difficulty may find it difficult to attract subscribers to bonds,
government will need to guarantee these instruments which
would then make them eligible for SLR investment by banks and
approved instruments by LIC, GIC and Provident Funds.
17 Directed credit has a proportionately higher share in the NPA
portfolio of banks and has been one of the factors in erosion in
the quality of bank assets. There is continuing need for banks to
extend credit to agriculture and the small scale sector which are
important segments of the national economy, on commercial con-
siderations and on the basis of creditworthiness. In this process,
there is scope for correcting the distortions arising out of directed
credit and its impact on banks’ assets quality.
18 The Committee has noted the reasons why the government could
not accept the recommendation for reducing the scope of directed
credit under priority sector from 40% to 10%. The Committee
recognises that the small and marginal farmers, the tiny sector
of industry and small businesses have problems with regard to
obtaining credit, and some earmarking may be necessary for this
sector. Under the present dispensation, within the priority sector,
10% of net bank credit is earmarked for lending to weaker sec-
tions. A major portion of this lending is on account of government-
sponsored poverty alleviation and employment generation schemes.
The Committee recommends that given the special needs of this
sector, the current practice may continue. The Branch Managers
of banks should, however, be fully responsible for the identifica-
tion of beneficiaries under the government-sponsored credit linked
schemes. The Committee proposes that given the importance and
needs of employment-oriented sectors like food processing and
related service activities in agriculture, fisheries, poultry and dairy-
ing, these sectors should also be covered under the scope of PSL.
The Committee recommends that the interest subsidy element in
credit for the priority sector should be totally eliminated and even
interest rates on loans under Rs.2 lakhs should be deregulated
for scheduled commercial banks as has been done in the case of
Regional Rural Banks and co-operative credit institutions. The
Committee believes that it is the timely and adequate availability
of credit rather than its cost which is material for the intended
beneficiaries. The reduction of the pre-empted portion of banks’
resources through the SLR and CRR would, in any case, enlarge
the ability of banks to dispense credit to these sectors.

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Prudential norms and disclosure requirements

19 With regard to income recognition, in India, income stops accru-
ing when interest or instalment of principal is not paid within
180 days. The Committee believes that we should move towards
international practices in this regard and recommends the intro-
duction of the norm of 90 days in a phased manner by the year
2002.
20 At present, there is no requirement in India for a general provision
on standard assets. In the Committee’s view, a general provision,
say, of 1% would be appropriate and the RBI should consider its
introduction in a phased manner.
21 The Committee believes that in the case of all future loans, the
income recognition, asset classification and provisioning norms
should apply even to government-guaranteed advances in the
same manner as for any other advance. For existing government-
guaranteed advances, RBI, government and banks may work out
a mechanism for a phased rectification of the irregularities in these
accounts.
22 There is a need for disclosure, in a phased manner, of the maturity
pattern of assets and liabilities, foreign currency assets and liabili-
ties, movements in provision account, and non-performing assets.
The RBI should direct banks to publish, in addition to financial
statements of independent entities, a consolidated balance sheet
to reveal the strength of the group. Full disclosure would also be
required of connected lending and lending to sensitive sectors.
Furthermore, it should also ask banks to disclose loans given to
related companies in the banks’ balance sheets. Full disclosure
of information should not be only a regulatory requirement. It
would be necessary to enable a bank’s creditors, investors and rat-
ing agencies to get a true picture of its functioning – an important
requirement in a market driven financial sector.
23 As an incentive to banks to make specific provisions, the Com-
mittee recommends that consideration be given to making such
provisions tax deductible.
24 Banks should also pay greater attention to asset liability manage-
ment to avoid mismatches and to cover, among others, liquidity
and interest rate risks.
25 Banks should be encouraged to adopt statistical risk management
techniques like Value-at-Risk in respect of balance sheet items
which are susceptible to market price fluctuations, forex rate

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volatility and interest rate changes. While the Reserve Bank may,
initially, prescribe certain normative models for market risk man-
agement, the ultimate objective should be that of banks building
up their own models and the RBI backtesting them for their valid-
ity on a periodical basis.

Systems and methods in banks

26 Banks should bring out revised Operational Manuals and update
them regularly, keeping in view the emerging needs and ensure
adherence to the instructions so that these operations are conducted
in the best interest of a bank and with a view to promoting good
customer service. These should form the basic objective of internal
control systems, the major components of which are: (1) Internal
Inspector and Audit, including concurrent audit, (2) Submission
of Control Returns by branches/controlling offices to higher level
offices, (3) Visits LI, enrolling officials to the field level offices, (4)
Risk management systems, (5) Simplification of documentation,
procedure and of inter-office communication channels.
27 An area requiring close scrutiny in the coming years would be
computer audit, in view of large scale usage and reliance on infor-
mation technology.
28 There is enough international experience to show the dangers to
an institution arising out of inadequate reporting to and checking
by the back offices of trading transactions and positions taken.
Banks should pay special attention to this aspect.
29 There is need to institute an independent loan review mechanism
especially for large borrowal accounts and systems to identify
potential NPAs. It would be desirable that banks evolve a filter-
ing mechanism by stipulating in-house prudential limits beyond
which exposures on single/group borrowers are taken, keeping in
view their risk profile as revealed through credit rating and other
relevant factors. Further, in-house limits could be thought of to
limit the concentration of large exposures and industry/sector/geo-
graphical exposures within the Board approved exposure limits
and proper overseeing of these by the senior management/boards.
It would be appropriate if the management committees are recon-
stituted to have only whole time functionaries in them, somewhat
on the pattern Central Office Credit Committee constituted in the
SBI. All decisions taken by these Committees could be put up to
the Board of Directors for information.

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30 It would be appropriate to induct an additional whole-time direc-

tor on the Board of the banks with an enabling provision for more
whole-time directors for bigger banks.
31 The Committee feels that the present practice of the RBI selecting
the statutory auditors for banks with the Board of Directors hav-
ing no role in the appointment process is not conducive to sound
corporate governance. The RBl may review the existing practice in
this regard.
32 The Committee notes that public sector banks and financial insti-
tutions have yet to introduce a system of recruiting skilled man-
power from the open market. The Committee believes that this
delay has had an impact on the competency levels of public sec-
tor banks in some areas, and they have consequently lost some
ground to foreign banks and the newly set up private sector banks.
The Committee urges that this aspect be given urgent consider-
ation, and in case there are any extant policy-driven impediments
to introducing this system, appropriate steps should be taken by
the authorities towards the needed deregulation. Banks have to
top up their skills base by resorting, on an ongoing basis, to lat-
eral induction of experienced and skilled personnel, particularly
for quick entry into new activity/areas. The Committee notes that
there has been considerable decline in the scale of merit-based
recruitment, even at the entry level in many banks. The concept
of direct recruitment itself has been considerably diluted by many
PSBs, including the SBI, by counting internal promotions to the
trainee officers’ cadre as direct recruitment. The Committee would
strongly urge the managements of public sector banks to take steps
to reverse this trend. The CFS had recommended that there was no
need for continuing with the Banking Service Recruitment Boards
insofar as recruitment of officers was concerned. This Committee,
upon examination of the issue, reaffirms that recommendation. As
for recruitment in the clerical cadre, the Committee recommends
that a beginning be made in this regard by permitting three or four
large well-performing banks, including SBI, to set up their own
recruitment machinery for recruiting clerical staff. If the experi-
ence under this new arrangement proves satisfactory, it could then
pave the way for eventually doing away completely with the Bank-
ing Service Recruitment Boards.
33 It seems apparent that there are varying levels of overmanning in
public sector banks. The managements of individual banks must
initiate steps to measure what adjustments in the size of their

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work force is necessary for the banks to remain efficient, competi-

tive and viable. Surplus staff, where identified, would need to be
redeployed on new business and activities, where necessary after
suitable retraining, It is possible that even after this some of the
excess staff may not be suitable for redeployment on grounds of
aptitude and mobility. It will, therefore, be necessary to introduce
an appropriate Voluntary Retirement Scheme with incentives. The
managements of banks would need to initiate dialogue in this area
with representatives of labour.
34 The Committee feels that the issue of remuneration structure at
managerial levels prevailing in public sector banks and finan-
cial institutions needs to be addressed. There is an urgent need
to ensure that public sector banks are given flexibility to deter-
mine managerial remuneration levels taking into account market
trends. The Committee recommends that the necessary authority
in this regard be given to the Boards of the banks initially in the
case of profit making public sector banks which have gone pub-
lic, for they would, in any ease, be required to operate with an
accountability to the market. The forthcoming wage negotiations
provide an opportunity to review the existing pattern of industry-
wise negotiations and move over to bank-wise negotiations.
35 This Committee is of the view that in today’s increasingly chal-
lenging business environment, a large institution can only be led
effectively by a Chief Executive who has a reasonable length of
tenure, which the Committee believes should not be less than five
years. Since, however, moving over to this tenure may be difficult,
we suggest that in the first instance, the minimum tenure should
be three years. The Committee feels that there is now a need to
delink the pay scales of the Chief Executives of public sector banks
and financial institutions from the Civil Service pay scales and
that this should be left to be decided by the individual banks, not
excluding the possibility of performance-based remuneration. The
Committee would like to add that these observations and recom-
mendations also apply to the whole-time Directors on the Boards
of banks and financial institutions appointed by the government.
36 The Committee would urge the managements of Indian banks
to review the changing training needs in individual banks, keep-
ing in mind their own business environment, and to address
these urgently. The Committee would suggest that they explore,
wherever appropriate, the feasibility of entering into collabora-
tive arrangements with universities and other institutions in India

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and abroad, offering specialised training to the financial services

industry, so that there can be an arrangement in place for ongoing
inflow of emerging training packages and methodologies.
37 There may be need to redefine the scope of external vigilance and
investigative agencies with regard to banking business. External
agencies should have the requisite skill and expertise to take into
account the commercial environment in which decisions are taken.
The vigilance manual now being used has been designed mainly for
use by government Departments and public sector undertakings. It
may be necessary that a separate vigilance manual which captures
the special features of banking should be prepared for exercising
vigilance supervision over banks. The Committee feels that this is
an extremely critical area and arrangements similar to the Advisory
Board for Bank Frauds be made for various levels of staff of banks.
A suggestion has been received by the Committee that the banks
should put in place a system where a record of all credit decisions
made by an individual officer together with his successful perfor-
mance is maintained. Public sector banks should consider the sug-
gestion and try to devise a system suited to their needs.
38 Globally, banking and financial systems have undergone funda-
mental changes because of the ongoing revolution in information
and communications technology. Information technology and
electronic funds transfer systems have emerged as the twin pil-
lars of summary modern banking development. This phenomenon
has largely bypassed the Indian banking system, although most
technologies that could be considered suitable for India have been
introduced in some diluted form. The Committee feels that req-
uisite success in this area has not been achieved because of the
following reasons:

a Inadequate bank automation,

b Not so strong commercially oriented inter-bank platform,
c Lack of a planned, standardised, electronic payment systems
backbone,
d Inadequate telecom infrastructure,
e Inadequate marketing effort,
f Lack of clarity and certainty on legal issues, and
g Lack of data warehousing network.

The Committee has tried to list out series of implementation steps

for achieving rapid induction of information technology in the

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banking system. Further information and control systems need to

be developed in several areas like:

a Better tracking of spreads, cost; and NPAs for higher profit-

ability;
b Accurate and timely information for strategic decisions to iden-
tify and promote profitable products and customers;
c Risk and Asset-Liability management; and
d Efficient Treasury Management.

Structural issues
39 The Committee has taken note of the twin phenomena of consoli-
dation and convergence which the financial system is now experi-
encing globally. In India also, banks and DFIs are moving closer to
each other in the scope of their activities. The Committee is of the
view that with such convergence of activities between banks and
DFIs, the DFIs should, over a period of time, convert themselves
to banks. There would then be only two forms of intermediaries,
viz., banking companies and NBFCs. If a DFI does not acquire a
banking licence within a stipulated time, it would be categorised
as a NBFC. A DFI which converts to a bank can be given some
time to phase in reserve requirements in respect of its liabilities
to bring it on par with the requirements relating to commercial
banks. Similarly, as long as a system of directed credit is in vogue,
a formula should be worked out to extend this to DFIs which have
become banks.
40 Mergers between banks and DFIs and NBFCs need to be based
on synergies and locational and business specific complimentari-
ties of the concerned institutions and must obviously make sound
commercial sense. Mergers of public sector banks should ema-
nate from the managements of banks with the government as the
common shareholder playing a supportive role. Such mergers,
however, can be worthwhile if they lead to rationalisation of the
workforce and the branch network; otherwise the mergers of pub-
lic sector banks would lie down the management with operational
issues and distract attention from the real issue. It would be neces-
sary to evolve policies aimed at “rightsizing” and redeployment of
the surplus staff either by way of retraining them and giving them
appropriate alternate employment or by introducing a voluntary
retirement scheme (VRS) with appropriate incentives, This would

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necessitate the co-operation and understanding of the employees,

and towards this direction managements should initiate discus-
sions with the representatives of staff and would need to convince
their employees about the intrinsic soundness of the idea, the com-
petitive benefits that would accrue and the scope and potential
for employees’ own professional advancement in a larger institu-
tion. Mergers should not be seen as a means of bailing out weak
banks. Mergers between strong banks/Fls would make for greater
economic and commercial sense, would be a case where the whole
is greater than the sum of its parts and have a “force multiplier
effect”.
41 A “weak bank” should be one whose accumulated losses and net
NPAs exceed its net worth or one whose operating profits less its
income on recapitalisation bonds is negative for three consecutive
years. A case-by-case examination of the weak banks should be
undertaken to identify those which are potentially revivable with a
programme of financial and operational restructuring. Such banks
could be nurtured into healthy units by slowing down on expan-
sion, eschewing high cost funds/borrowings, judicious manpower
deployment, recovery initiatives, containment of expenditure, etc.
The future set-up of such banks should also be given due consid-
eration. Merger could be a solution to the problem of weak banks
but only after cleaning up their balance sheets. If there is no vol-
untary response to a takeover of these banks, it may be desirable
to think in terms of a Restructuring Commission for such public
sector banks for considering other options, including restructur-
ing, merger and amalgamation, or, failing these, closure. Such
a Commission could have terms of reference which, inter alia,
should include the suggestion of measures to safeguard the inter-
est of depositors and employees and to deal with possible negative
externalities. Weak banks which on a careful examination are not
capable of revival over a period of three years, should be referred
to the Commission.
42 The policy of licensing new private banks (other than Local Area
Banks) may continue. The start-up capital requirements of Rs.100
crores were set in 1993, and these may be reviewed. The Commit-
tee would recommend that there should be well-defined criteria
and a transparent mechanism for deciding the ability of promot-
ers to professionally manage the banks, and no category should
be excluded on a priori grounds. The question of a minimum
threshold capital for old private banks also deserves attention,

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and mergers could be one of the options available for reaching the
required capital thresholds. The Committee would also, in this
connection, suggest that as long as it is laid down (as now) that
any particular promoter group cannot hold more than 40% of the
equity of a bank, any further restriction or voting rights by limit-
ing it to 10% may be done away with.
43 The Committee is of the view that foreign banks may be allowed
to set up subsidiaries or joint ventures in India. Such subsidiaries
or joint ventures should be treated on par with other private banks
and subject to the same conditions with regard to branches and
directed credit as these banks.
44 The Committee attaches the greatest importance to the issue of
functional autonomy with accountability within the framework
of purposive, rule bound, non-discretionary prudential regulation
and supervision. Autonomy is a prerequisite for operational flex-
ibility and for critical decision-making whether in terms of strat-
egy or day-to-day operations. There is also the question whether
full autonomy with accountability is consistent and compatible
with public ownership. Given the dynamic context in which the
banks are operating and considering the situational experience
further capital enhancement would be necessary for the larger
Indian banks, and against the background of the need for fiscal
consolidation and given the many demands on the budget for
investment funds in areas like infrastructure and social services,
it cannot be argued that subscription to the equity of public sector
banks to meet their enhanced needs for capital should command
priority. Public sector banks should be encouraged, therefore, to
go to the market to raise capital to enhance their capital. At pres-
ent, the laws stipulate that not less than 51% of the share capital
of public sector banks should be vested with the government
and, similarly, not less than 55% of the share capital of the SBI
should be held by the RBI. The current requirement of minimum
GoI/RBI shareholding is likely to become a constraint for raising
additional capital from the market by some of the better placed
banks unless government also decides to provide necessary bud-
getary resources to proportionately subscribe to the additional
equity, including the necessary premium on the share price, so as
to retain its minimum stipulated shareholding. The Committee
believes that these minimum stipulations should be reviewed. It
suggests that the minimum shareholding by Government/Reserve
Bank in the equity of the nationalised banks and the State Bank

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should be brought down to 33%. The Reserve Bank as a regula-

tor of the monetary system should not also be the owner of a
bank in view of the potential for possible conflict of interest. It
would not be necessary for the government/RBI to divest their
stake in these nationalised banks and in the SBI. A reduction in
their shares would come about through additional subscription
by the market to their enhanced capital. A proportion of up to
5 or 10% of the equity of the bank concerned may be reserved
for employees of the bank with a provision at some later date
for the introduction of stock options. The appointment by the
Government of Boards and top executives of banks derives from
its majority holding, and if, as suggested above, the majority
holding itself were to be given up, the appointment of Chairmen
and Managing Directors should be left to the Boards of the banks
and the Boards themselves left to be elected by shareholders.
Needless to say, with a significant stock holding of not less than
33%, government would have a say in the election of Boards
and indirectly of the chief executives without their being seen
as administrative appointments. The reduction in the minimum
holding of government below 51% would in itself be a major and
clear signal about the restoration to banks and financial institu-
tions of autonomy in their functioning. The Committee makes
this recommendation in the firm belief that this is essential for
enhancing the effectiveness and efficiency of the system and not
on any other consideration.
45 To provide the much needed flexibility in its operations, IDBI
should be corporatised and converted into a Joint Stock Company
under the Companies Act on the lines of ICICI, IFCI and IIBI. For
providing focused attention to the work of State Financial Corpo-
rations, OBI shareholding in them should be transferred to SIDBI,
which is currently providing refinance assistance to State Financial
Corporations. To give it greater operation and autonomy, SIDBI
should also be delinked from IDBI.
46 All NBFCs are statutorily required to have a minimum net worth
of Rs.25 lakhs if they are to be registered. The Committee is of the
view that this minimum figure should be progressively enhanced
to Rs.2 crores, which is permissible now under the statute and that
in the first instance it should be raised to Rs.50 lakhs.
47 Deposit insurance for NBFCs could blur the distinction between
banks, which are much more closely regulated, and the non-banks
as far as safety of deposit is concerned and consequently lead to a

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serious moral hazard problem and adverse portfolio selection. The

Committee would advise against any insurance of deposits with
NBFCS.
48 Urban Co-operative Banks are an important link in the credit deliv-
ery system, and ensuring their sound health is important. The cur-
rent entry norms, especially the capital requirements, are much too
liberal. The RBI should urgently undertake a review of these norms
and prescribe revised prudent minimum capital norms for these
banks. Further, with a view to achieving an integrated system of
supervision over the financial system, the Committee recommends
that urban co-operative banks (UCBs) should also be brought
within the ambit of the Board of Financial Supervision. One of the
problem areas in supervision of the UCBs is the duality in control
by the state government and the RBI. Though co-operation is a
state subject, since UCBs are primarily credit institutions meant to
be run on commercial lines, the Committee recommends that this
duality in control should be dispensed with. It should be primarily
the task of the Board of Financial Supervision to set up regulatory
standards for UCBs and ensure compliance with these standards
through the instrumentality of supervision.
49 The Committee is of the view that there is need for a reform of
the deposit insurance scheme. In India, deposits are insured up to
Rs.1 lakh. There is no need to increase the amount further. There
is, however, need to shift away from the “flat” rate premiums to
“risk based” or “variable rate” premiums. Under a risk based
premium system all banks would not be charged a uniform pre-
mium. While there can be a minimum flat rate which will have to
be paid by all banks on all their customer deposits, institutions
which have riskier portfolios or which have lower ratings should
pay a higher premium. There would thus be a graded premium.
As the Reserve Bank is now awarding CAMELS ratings to banks,
these ratings could form the basis for charging a deposit insurance
premium.
50 The Committee is of the view that the inter-bank call and notice
money market and inter-bank term money market should be
strictly restricted to banks. The only exception should be the pri-
mary dealers who, in a sense, perform a key function of equilibrat-
ing the call money market and are formally treated as banks for
the purpose of their inter-bank transactions. All the other present
non-bank participants in the inter-bank call money market should
not be provided access to the inter-bank call money market. These

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institutions could be provided access to the money market through

different segments.
51 There must be clearly defined prudent limits beyond which banks
should not be allowed to rely on the call money market. This
would reduce the problem of vulnerability of chronic borrowers.
Access to the call market should be essentially for meeting unfore-
seen swings and not as a regular means of financing banks’ lending
operations.
52 The interest rates movements in the inter-bank call money market
should be orderly, and this can only be if the RBI has a presence in
the market through short term Repos for as short a period as one
day. The RBI support to the market should be through a Liquid-
ity Adjustment Facility under which the RBI would periodically,
if necessary daily, reset its Repo and Reserve Repo rates which
would, in a sense, provide a reasonable corridor for market play.
While there is much merit in an inter-bank reference rate like a
LIBOR, such a reference rate would emerge as banks implement
sound liquidity management facilities and other suggestions made
above are implemented. Such a rate cannot be anointed, as it has
to earn its position in the market by being a fairly stable rate which
signals small discrete interest rate changes to the rest of the system.
53 Non-bank parties can be provided free access to bill rediscounts,
commercial paper (CP), Certificates of Deposits (CD), Treasury
Bills (TB) and Money Market Mutual Funds (MMMFs). The issue
arises of the minimum period for the issue of these instruments.
At present, the minimum period for bills rediscounting by sched-
uled commercial banks is 15 days. The minimum lock-in period
for CDs, CP and MMMFs is 30 days. In the restructuring of the
market proposed by the Committee, the minimum period of fixed
deposit could, in the first instance, be reduced to 15 days and all
money market instruments should likewise have a similar reduced
minimum duration. There is reason for keeping a minimum
duration for fixed deposits as in the absence of such a minimum
all current accounts would become fixed deposits and thereby
greatly add to the cost of funds of banks. The question needs to
be addressed of the non-bank institutions, which have funds for
a duration less than the minimum period stipulated for money
market instruments. At the present time, the investors in money
market instruments invariably hold the instruments to maturity,
and as such there is no secondary market in these instruments. In
the kind of structure envisaged by the Committee, there will be an

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active secondary market in money market instruments. The Com-

mittee is of the view that these structural changes would result in
the development of a strong and stable money market with liquid-
ity and depth.
54 The Committee recommends that the RBI should totally with-
draw from the primary market in 91 days Treasury Bills; the RBI
could, of course, have a presence in the secondary market for
91 days Treasury Bills. If the 91 days Treasury Bills rate reflects
money market conditions, the money and securities market would
develop an integral link. The Committee also recommends that
foreign institutional investors should be given access to the Trea-
sury Bill market. Broadening the market by increasing the partici-
pants would provide depth to the market.
55 With the progressive expansion of the forward exchange market,
there should be an endeavour to integrate the forward exchange
market with the spot forex market by allowing all participants
in the spot forex market to participate in the forward market up
to their exposures. Furthermore, the forex market, the money
market and the securities market should be allowed to integrate,
and the forward premia should reflect the interest rate differ-
ential. As instruments move in tandem in these markets, the
desiderative of a seamless and vibrant financial market would
hopefully emerge.

Rural and small industrial credit

56 The Committee is of the view that the banking system should be
in a position to equip itself to identify the eligible clients based
on prescribed norms in the government-sponsored programmes
so that the full responsibility for all aspects of the credit decision
remains with it. This should also help improve the client-bank
relationship instead of the present system of virtually imposed cli-
entele and build a credit culture and discipline.
57 The Committee also recommends that a distinction be made
between NPAs arising out of client-specific and institution-specific
reasons and general (agro climatic and environmental issues) fac-
tors. While there should be no concession in treatment of NPAs
arising from client specific reasons, any decision to declare a par-
ticular crop or product or a particular region to be distress hit
should be taken purely on techno-economic consideration by a
technical body like NABARD.

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58 The Committee strongly urges that there should be no recourse to

any scheme of debt waiver in view of its serious and deleterious
impact on the culture of credit.
59 As a measure of improving the efficiency and imparting a measure
of flexibility, the Committee recommends consideration of the
debt-securitisation concept within the priority sector. This could
enable banks which are not able to reach the priority sector tar-
get to purchase the debt from institutions which are able to lend
beyond their mandated percentage.
60 Evolution of a risk management system would provide the needed
comfort to the banking system to finance agriculture. At present,
under the Income Tax Act, provision for bad and doubtful debts
not exceeding 5% of income and 10% of the aggregate aver-
age advances made by rural branches of a scheduled or a non-
scheduled bank is allowed as deduction in computing the income
chargeable to tax. Consideration could be given to increasing this
to 5% of income and 20% of average aggregate advances of rural
branches to provide incentive to banks for lending to rural sectors.
61 The Committee recommends that the RRBs and co-operative
banks should reach a minimum of 8% capital to risk weighted
assets over a period of five years. A review of the capital structure
of RRBs should be undertaken with a view to enlarging public
subscription and give the sponsor banks greater ownership and
responsibility in the operation of RRBs. While considering the
issue of salaries of employees of RRBs, the Committee strongly
urges that there should be no further dilution of the basic fea-
ture of RRBs as low cost credit delivery institutions. Co-operative
credit institutions also need to enhance their capital through sub-
scription by their members and not by government. There should
be a delayering of the co-operative credit institutions with a view
to reducing the intermediation cost and thus providing the benefit
of cheaper NABARD credit to the ultimate borrowers.
62 The supervisory function over rural financial institutions has been
entrusted to NABARD. While this arrangement may continue for
the present, over the longer term, the Committee would suggest
that all regulatory and supervisory functions over rural credit
institutions should vest with the Board for Financial Regulation
and Supervision.
63 The present duality of control over the co-operative credit institu-
tions by State government and RBI/NABARD should be elimi-
nated, and all the co-operative banking institutions should come

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under the discipline of Banking Regulation Act, under the aegis of

RBl NABARD/Board of Financial Supervision (BFS). This would
require amendments to the Banking Regulation Act. The control
of the Registrar of Co-operative Sector over co-operatives would
then be somewhat on the lines of control that Registrar of Compa-
nies has over the Banking Institutions, registered under the Com-
panies Act.
64 Banking policy should facilitate the evolution and growth of
microcredit institutions, including LABs which focus on agri-
culture, tiny and small scale industries, including such specialist
institutions as may be promoted by NGOs for meeting the bank-
ing needs of the poor. Third-tier banks should be promoted and
strengthened to be autonomous, vibrant, effective and competi-
tive in their operations.
65 Banks should devise appropriate criteria suited to the small indus-
trial sector and be responsive to its genuine credit needs, but this
should not be by sacrificing canons of sound banking. Borrowers
also need to accept credit discipline. There is also need to review
the present institutional set up of state level financial/industrial
development institutions.

Regulation and supervision

66 The Committee recommends that to improve the soundness and
stability of the Indian banking system, the regulatory authori-
ties should make it obligatory for banks to take into account risk
weights for market risks. The movement towards greater market
discipline in a sense would transform the relationship between
banks and the regulator. By requiring greater internal controls,
transparency and market discipline, the supervisory burden itself
would be relatively lighter.
67 The Committee notes that there is insufficient awareness of the
Core Principles in India and perhaps even a complacent feeling
that these are being implemented. This is not the case. There is,
in fact, a need for all market participants to take note of the new
guidelines. It is essential to formally announce full accession to
these principles, their prescription to the financial institutions and
their full and effective implementation.
68 Proprietorial concerns in the case of public sector banks impact on
the regulatory function leading to a situation of “regulatory cap-
ture” where the regulators tend to identify regulatory activity with

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banking interests, and as a consequence of which the quasi fiscal

impact of appropriate regulation affects the quality of regulation.
69 The Committee recommends that the regulatory and supervisory
authorities should take note of the developments taking place else-
where in the area of devising effective regulatory norms and to
apply them in India, taking into account the special characteristics
but not in any way diluting the rigour of the norms so that the
prescriptions match the best practices abroad. It is equally impor-
tant to recognise that pleas for regulatory forbearance, such as
waiving adherence to the regulations to enable some (weak) banks
more time to overcome their deficiencies, could only compound
their problems for the future and further emasculate their balance
sheets.
70 An important aspect of regulatory concern should be ensuring
transparency and credibility, particularly as we move into a more
market-driven system where the market should be enabled to form
its judgment about the soundness of an institution. There should
be punitive penalties both for the inaccurate reporting to the
supervisor or inaccurate disclosures to the public and transgres-
sions in spirit of the regulations.
71 The Committee is of the view that banks should be required to
publish half-yearly disclosure requirements in two parts. The first
should be a general disclosure, providing a summary of perfor-
mance over a period of time, say three years, including the over-
all performance, capital adequacy, information on the bank’s
risk management systems, the credit rating and any action by the
regulator/supervisor. The disclosure statement should be subject
to full external audit and any falsification should invite criminal
procedures. The second disclosure, which would be a brief sum-
mary aimed at the ordinary depositor/investor should provide
brief information on matters such as capital adequacy ratio, non-
performing assets and profitability, vis-a-vis, the adherence to the
stipulated norms and a comparison with the industry average.
This summary should be in a language intelligible to the depositor
and be approved by the supervisors before being made fully public
when soliciting deposits. Such disclosure, the Committee believes,
will help the strong banks to grow faster than the weaker banks
and thus lead to systemic improvement.
72 The Committee recommends that an integrated system of regu-
lation and supervision be put in place to regulate and supervise
the activities of banks, financial institutions and NBFCs. The

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functions of regulation and supervision are organically linked, and

we propose that this agency be renamed as the Board for Financial
Regulation and Supervision (BFRS) to make this combination of
functions explicit. An independent regulatory supervisory system
which provides for a closely coordinated monetary policy and
banking supervision would be the ideal to work towards.
73 The Board for Financial Regulation and Supervision (BFRS) should
be given statutory powers and be reconstituted in such a way as to
be composed of professionals. At present, the professional inputs
are largely available in an advisory board which acts as a distinct
entity supporting the BFS. Statutory amendment which would give
the necessary powers to the BFRS should develop its own autono-
mous professional character. The Committee, taking note of the
formation of BFS, recommends that the process of separating it
from the Reserve Bank should begin, and the Board should be
invested with requisite autonomy and armed with necessary pow-
ers so as to allow it to develop experience and professional exper-
tise and to function effectively. However, with a view to retain an
organic linkage with the RBI, the Governor, RBI should be head
of the BFRS. The Committee has also set out specific measures
to ensure an effective regulatory/supervisory system which are
detailed in para 7.27.

Legal and legislative framework

74 A legal framework that clearly defines the rights and liabilities
of parties to contracts and provides for speedy resolution of dis-
putes is essential for financial intermediation. The evolution of the
legal framework has not kept pace with the changing commercial
practices and with the financial sector reforms. The Transfer of
Property Act enacted in 1882 is a case in point.
75 Given the unsatisfactory state of the law of mortgage, the response
has been to vest through special statute the power of sale in cer-
tain institutions like Land Development Banks and State Finance
Corporations. This approach could be extended to other financial
institutions and, if possible, to banks. The other approach is to set
up special tribunals for recovery of dues to banks and financial
institutions. These Tribunals need to have powers of attachment
before judgment, for appointment of receivers and for ordering
preservation of property. For this purpose, an amendment to the
concerned legislation may be necessary. The Committee would

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like to emphasise the importance of having in place a dedicated

and effective machinery for debt recovery for banks and financial
institutions.
76 Securitisation of mortgages is also critically dependent on the ease
of enforcement and the costs associated with transfer of mort-
gages. The power of sale without judicial intervention is not avail-
able to any class of mortgages except where the mortgagee is the
government or the mortgage agreement so provides and the mort-
gaged property is situated in Mumbai, Chennai and Calcutta and
other towns so notified. Even if the power of sale without judicial
intervention were available there would need to be measures to
put the buyer in possession.
77 The question of stamp duties and registration fees also requires
review. There is a case for reducing stamp duties and registration
fees substantially.
78 In view of the recent amendments to Section 28 of the Indian Con-
tract Act, banks have expressed a fear that they can no longer
limit under bank guarantees to a specified period and that they
would have to carry such guarantee commitments for long peri-
ods as outstanding obligations. Government departments do not
generally return the original guarantee papers even after the pur-
pose is served. The whole issue needs to be re-examined and bank
guarantees exempted from the purview of the recent amendment
to Section 28 of the Indian Contract Act. The issue of enforcing
securities in the form of book debts also calls for review. The Com-
mittee also agrees with the proposal to amend the Sick Industrial
Companies Act, seeking to trigger off the remedial mechanism on
the sight of incipient sickness.
79 With the advent of computerisation there is need for clarity in law
regarding evidentiary value of computer generated documents.
The Shere Committee had made some recommendations in this
regard and the Committee notes that the government is having
with public sector banks in this matter. With electronic funds
transfer several issues regarding authentication of payment instru-
ments, etc., require to be clarified. The Committee recommends
that a group be constituted by the Reserve Bank to work out the
detailed proposals in this regard and implement them in a time
bound manner.
80 Certain legislative requirements would also be needed to implement
some of the Committee’s recommendations regarding the struc-
ture of the banking system and matters pertaining to regulation

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and supervision. The Banking Regulation Act is structured on the

premise that bank supervision is essentially a government function
and that the RBI’s position is somewhat on the lines of an agent.
The Act also provides appellate powers to government over the
decisions of the RBI in this regard. It also provides original pow-
ers in certain instances. The Committee feels that these provisions
should be reviewed.
81 With respect to recommendations regarding constitution of a
Board Financial Regulation and Supervision, it would be neces-
sary for amendments in the Banking Regulation Act and RBI Act.
Amendments would also be needed in the Bank Nationalisation
Acts to enable the grant of greater managerial autonomy to pub-
lic sector banks, for lowering the minimum requirements of 51%
Government Ownership and as regards the constitution of Boards
of Directors and of the Management Committees. The provisions
relating to prior approval of government for regulations framed
under the Act would also need to be reviewed. In line with the
above, amendments would also be needed in the SBI Act with
regard to shareholding of the RBI and constitution of its Central
Board.
82 These suggestions are not exhaustive and we would recommend
that the legal implications with reference to each of these recom-
mendations be examined and detailed legislative steps identified
by the Ministry of Finance, Banking Division in consultation with
the Ministry of Law. In view of the wide-ranging changes needed
in the legal framework, the Committee recommends setting up of
an expert committee comprising, among others, representatives
from the Ministry of Law, Banking Division, Ministry of Finance,
RBI and some outside experts to formulate specific legislative pro-
posals to give effect to the suggestions made above.

Note
* Source: Narasimham, M. 1991. Report of the Committee on Financial
Sector Reform. Delhi: Government of India.

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 Annexure 3
REPORT OF THE
COMMITTEE ON FINANCIAL
INCLUSION, 2008*
Chair: C. Rangarajan

Executive summary and recommendations

Financial inclusion – defined

The recent developments in banking technology have transformed
banking from the traditional brick-and-mortar infrastructure like
staffed branches to a system supplemented by other channels like
automated teller machines (ATM), credit/debit cards, internet bank-
ing, online money transfers, etc. The moot point, however, is that
access to such technology is restricted only to certain segments of
the society. Indeed, some trends, such as increasingly sophisticated
customer segmentation technology – allowing, for example, more
accurate targeting of sections of the market – have led to restricted
access to financial services for some groups. There is a growing
divide, with an increased range of personal finance options for a
segment of the high and upper-middle income population and a sig-
nificantly large section of the population who lack access to even
the most basic banking services. This is termed “financial exclu-
sion”. These people, particularly those living on low incomes, can-
not access mainstream financial products such as bank accounts,
credit, remittances and payment services, financial advisory services,
insurance facilities, etc.
Deliberations on the subject of Financial Inclusion contributed to
a consensus that merely having a bank account may not be a good
indicator of financial inclusion. Further, indebtedness as quantified
in the NSSO 59th round (2003) also may not be a reflective indica-
tor. The ideal definition should look at people who want to access
financial services but are denied the same. If genuine claimants for

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credit and financial services are denied the same, then that is a case of
exclusion. As this aspect would raise the issue of credit worthiness or
bankability, it is also necessary to dwell upon what could be done to
make the claimants of institutional credit bankable or creditworthy.
This would require re-engineering of existing financial products or
delivery systems and making them more in tune with the expectations
and absorptive capacity of the intended clientele. Based on the above
consideration, a broad working definition of financial inclusion could
be as under:

Financial inclusion may be defined as the process of ensur-

ing access to financial services and timely and adequate credit
where needed by vulnerable groups such as weaker sections
and low income groups at an affordable cost.

The essence of financial inclusion is in trying to ensure that a range of

appropriate financial services is available to every individual and
enables them to understand and access those services. Apart from the
regular form of financial intermediation, it may include a basic no
frills banking account for making and receiving payments, a savings
product suited to the pattern of cash flows of a poor household, money
transfer facilities, small loans and overdrafts for productive, personal
and other purposes, insurance (life and non-life), etc. While financial
inclusion, in the narrow sense, may be achieved to some extent by
offering any one of these services, the objective of “Comprehensive
Financial Inclusion” would be to provide a holistic set of services
encompassing all of the above.
With a view to understanding the extent of exclusion, the Commit-
tee perused data put out by various sources. The summary of conclu-
sions is indicated below.

Extent of exclusion – NSSO survey 59th round

(a) General:
• 51.4% of farmer households are financially excluded from
both formal/informal sources.
• Of the total farmer households, only 27% access formal sources
of credit; one third of this group also borrow from non-formal
sources.
• Overall, 73% of farmer households have no access to formal
sources of credit.

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(b) Region-wise:
• Exclusion is most acute in Central, Eastern and North-Eastern
regions – having a concentration of 64% of all financially
excluded farmer households in the country.
• Overall indebtedness to formal sources of finance alone is only
19.66% in these three regions.
(c) Occupational Groups:
• Marginal farmer households constitute 66% of total farm
households. Only 45% of these households are indebted to
either formal or non-formal sources of finance.
• About 20% of indebted marginal farmer households have
access to formal sources of credit.
• Among non-cultivator households, nearly 80% do not access
credit from any source.
(d) Social Groups:
• Only 36% of Scheduled Tribe (ST) farmer households are
indebted (Scheduled Castes (SC) and Other Backward Classes
(OBC) – 51% mostly to informal sources.

Analysis of the data provided by the RBI through its Basic Statistical
Returns reveal that critical exclusion (in terms of credit) is manifest in
256 districts, spread across 17 States and 1 Union Territory, with a credit
gap of 95% and above. This is in respect of commercial banks and RRBs.
As per CMIE (March 2006), there are 11.56 crore land holdings.
5.91 crore KCCs have been issued as at the end of March 2006, which
translated into a credit coverage of more than 51% of land holdings
by formal sources. Further data with NABARD on the doubling of
agricultural credit indicates that agricultural loan disbursements dur-
ing 2006–2007 covered 3.97 crore accounts.
Thus, there are different estimates of the extent of inclusion through
formal sources, as the reference period of the data is not uniform.
Consequently, this has had an impact on quantifying the extent of
levels of exclusion.

Strategy for building an inclusive financial sector

1 Overall strategy for building an inclusive financial sector may be
based on:
• Effecting improvements within the existing formal credit deliv-
ery mechanism;

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• Suggesting measures for improving credit absorption capac-

ity, especially amongst marginal and sub-marginal farmers and
poor non-cultivator households;
• Evolving new models for effective outreach; and
• Leveraging on technology-based solutions. (Para 3.01)

National Rural Financial Inclusion Plan (NRFIP)

2 Looking at the enormity of the task involved, financial inclusion
must be taken up in a mission mode as a Financial Inclusion Plan
at the national level. (3.03)
3 The target for NRFIP could be to provide access to comprehensive
financial services to at least 50% (55.77 million) of the excluded
rural cultivator and non-cultivator households across different
States by 2012 through rural/semi-urban branches of CBs and
RRBs. The remaining households, with such shifts as may occur
in the rural/urban population, have to be covered by 2015. (3.03)
4 Semi-urban and rural branches of commercial banks and RRBs
may set for themselves a minimum target of covering 250 new
cultivator and non-cultivator households per branch per annum,
aggregating 11.15 million households per annum, with clear
emphasis on financing marginal farmers, tenant cultivators and
poor non-cultivator households. (3.04)
5 The national targets would have to be disaggregated State-wise
with adequate focus on districts having a large percentage of pop-
ulation not accessing bank credit. (3.05)
6 Since per branch annual coverage under the Plan would be quite
high in some of the North-Eastern, Eastern and Central States,
needed support, including financial assistance, may be provided
to banks operating in the above regions. (3.06)
7 To operationalise the NRFIP, DLCCs at the district level shall
draw up block-wise/village-wise maps of rural households not
having access to formal credit sources.

This information should be disseminated widely. District adminis-

tration and Lead Banks will extend appropriate help to DLCC for
completing the exercise in a time bound manner. This should to be
dovetailed with the work being done by the monitoring mechanism set
up at the district level for implementation of the recommendations of
the CD Ratio Committee.

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Thereafter, a State Level Rural Financial Inclusion Plan (SLRFIP)

shall be prepared jointly by the State Level Bankers’ Committee
(SLBC) and NABARD for arriving at a conclusive Financial Inclusion
Plan for the State. With a minimum target coverage of 50% currently
excluded by the year 2012, States will be free to set for themselves
higher targets. (3.07)

8 The Plan so prepared will thereafter be allocated institution-wise,

among commercial banks and RRBs. Other institutions like co-
operative banks, NBFCs and MFIs may also be asked to join in
the task of financial inclusion with self-set targets. The progress in
implementation shall be reported to and monitored at the DLCC.
(3.08)
9 With a view to firming up the implementation of the recommen-
dations of the Committee, it is proposed that GoI may consider
constituting a National Mission on Financial Inclusion (NaMFI)
comprising representatives of all stakeholders. The purpose of the
Mission shall be to aim at achieving universal financial inclusion
within a specific time frame. The Mission should be responsible
for suggesting the overall policy changes required for achiev-
ing the desired level of financial inclusion, and for supporting a
range of stakeholders – in the domain of public, private and NGO
sectors – in undertaking promotional initiatives. The government
may decide on appropriate representation from all stakeholders in
the Mission. (3.09)

Commercial banks
Specific recommendations for achieving the targets under NRFIP by
leveraging the existing commercial bank branch network in rural areas
would include the following:

Targets for rural/semi-urban branches

10 Given the existing staff strength, it should be possible for com-
mercial banks (including RRBs) to provide access to credit to at
least 250 hitherto excluded rural households at each of their exist-
ing rural and semi-urban branches. For this, banks will have to
strengthen their staff and use a variety of delivery mechanisms.
(4.18)

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Targeted branch expansion in identified districts

11 In districts where population per rural and semi-urban branch
office is much higher than the national average, the DLCCs may
identify centres for opening branches by commercial banks and
RRBs in the next three years. (4.19)
12 For the North-Eastern Region, the Committee on Financial Sec-
tor Plan has already identified such centres and branch expansion
plans as indicated therein may be implemented. (4.20)

Product innovation
13 The excluded segments of the population require products which
are customized, taking into consideration their varied needs. The
products and services offered at present do not effectively meet
these needs.
(a) Savings: Savings products to meet the specific requirements of
the poor need to be evolved. SHGs may be utilized for tapping
the small savings by providing incentives to SHGs with suitable
back-end technology support. Banks can develop medium- and
long-term savings instruments by issue of pre-printed deposit
receipts to SHGs, which in turn can be sold to SHG members.
Banks could be given the freedom to develop their own prod-
ucts, suited to local requirements and felt needs of the poor.
(b) Credit: A savings-linked financing model can be adopted for
these segments. The approach should be kept simple which
should guarantee the beneficiaries a credit limit, subject to
adherence to simple terms and conditions. Credit within a
specified limit can be made available in two to three tranches,
with the second and subsequent tranches disbursed based on
repayment behaviour of the first tranche. This is to ensure that
the vulnerable groups do not get into a debt trap; it would also
ensure good credit dispensation.
(c) Insurance: Banks can play a vital role in this regard by distrib-
uting suitable micro-insurance products. (4.21)

Incentivising human resource – measurable

performance indicators
14 Lending to low income groups and providing inclusive financial
services need motivated bank staff. Such motivation is a function
of attitudes and beliefs, also a system of incentives/disincentives

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put in place by the bank’s management for special efforts/failures

to achieve desired levels of financial inclusion. (4.22)
15 The existing staff posted to rural branches can be incentivised
within a framework of performance parameters including cover-
ing new households through deposit and loan accounts, increase
business in existing and new small loan/deposit accounts, increase
in number of SHGs/Joint Liability Groups (JLGs) formed and
credit linked, efforts put in for promotion of asset management
skills and developing linkages to promote credit absorption. (4.23)

Funding
16 There is a cost involved in providing credit plus services and adopt-
ing technology applications. Commercial banks are expected to
meet a part of the costs. In the initial stages some funding support
may be extended through specially constituted Funds. (4.24)

Financial inclusion funds

17 Two funds may be constituted – a Financial Inclusion Promotion &
Development Fund, with NABARD, for meeting the cost of
developmental and promotional interventions, and a Financial
Inclusion Technology Fund, with NABARD to meet the costs of
technology adoption. Each Fund will have an initial corpus of
Rs.500 crore, with a startup funding of Rs.250 crore each, to be
contributed equally by GoI/RBI/NABARD and annual accretions
thereto. Banks will be eligible for support from the Funds on a
matching contribution of 50% from the Fund in regard to districts
other than tribal districts and 75% in case of branches located in
tribal districts identified under the Tribal Sub Plan. (4.25)

Financial Inclusion Promotion and

Development Fund
The Financial Inclusion Promotion and Development Fund will focus
on financing the following interventions:

Farmers’ Service Centres (FSC)

18 The Centres will network on the technology front with Agri-
cultural Universities/KVKs, farmers clubs, the formal extension

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machinery of the state governments, technical staff of banks,

portals of national level Commodity Exchanges, etc. Such FSCs
can be financed by the banks on the pattern of agri clinics. In the
initial stages, some support by way of viability gap funding may
be provided. (4.26)

Promoting rural entrepreneurship

19 Commercial banks may consider setting up institutions like
farmer training centres and Rural Development and Self Employ-
ment Training Institutes (RUDSETI) for developing skills among
farmers/rural entrepreneurs for effectively managing the assets
financed. (4.27)

Self Help Groups

20 The SHG movement is yet to catch up on a big scale in regions
manifesting high levels of exclusion (Central, Eastern and North-
Eastern Regions). Funding support for promotion, nurturing and
credit-linking of SHGs can be extended. (4.28)

Developing HR – addressing attitudinal issues

through training
21 Lending to the poor raises, inter-alia, issues of attitudes towards
the poor as viable and profitable customers. The Committee has
observed that: (4.29)
There is a positive correlation between training received by the
branch managers and their overall attitudes. (4.30)
The training module developed and tested for commercial
banks and RRBs in the College of Agricultural Banking, Pune may
be used/adopted by banks for bringing about the right mindset
among branch staff. (4.31)

Resource Centres
22 Resource Centres, apart from facilitating members of mature SHGs
to graduate to micro enterprises, also helps in ensuring long-term
sustainability of SHGs. The cost of setting up such centres can be
met out of this Fund and/or the MFDEF. This is discussed in detail
later in the Report. (4.32)

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Federations
23 As indicated later in the Report, funding support may also be
extended from this Fund and/or MFDEF for voluntary establish-
ment of federations. (4.33)

Capacity building of BFs/BCs

24 Funding support, on priority basis, to be extended to specialised
institutions which provide capacity building inputs to BFs/BCs, as
discussed later in the Report. (4.34)

Financial Inclusion Technology Fund

Technology Applications for Greater Financial Inclusion:

25 Extending outreach on a scale envisaged under NRFIP would

require the application of low-cost technology solutions, which
call for certain levels of funding support for rolling out such IT-
based and inclusive financial sector plans. (4.35)
26 Funds Guidelines
• NABARD, in consultation with RBI, may prepare detailed
guidelines for operationalising the Funds. (4.36)

Procedural changes
Simplifying mortgage requirements
27 Enabling legislation has been passed in some States for acceptance
of a simple declaratory charge as equitable mortgage. This may be
done by all the state governments. (4.37)

Exemption from Stamp Duty for Loans to Small and Marginal Farmers:

28 Stamp duty may be waived in respect of loans for small/marginal

farmers, tenant cultivators and oral lessees. (4.38)

Saral documentation for agricultural loans

29 NABARD, in cooperation with a core group of bankers, has pre-
pared a one page document for agricultural loans up to Rs.1 lakh.
This may be adopted by all banks. (4.39)

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Nodal branches (ADB model)

30 One branch of the lead bank at the block/taluka level may be
identified as the nodal branch to address the issue of exclusion.
Lead banks may strengthen these nodal branches with technical
staff to provide agricultural/business development services in farm
and non-farm sectors respectively, comprising technical inputs and
extension services. The services of the nodal branch technical staff
may be made available to all other branches in the block, under an
appropriate cost sharing arrangement. (4.40)
31 In some districts, where RRBs have dominant presence, sponsor
banks may assist the RRBs in putting in place arrangements for
technical staff for providing credit plus services. NABARD may
defray the cost of such technical staff, particularly in the North-
Eastern Region. (4.41)

Business Facilitators/Business Correspondents (BFs/BCs)

32 RBI has permitted banks to use the services of NGOs/SHGs, MFIs
and other civil society organisations as intermediaries in provid-
ing financial and banking services through the use of BF and BC
Models. (4.42)
33 The response of the banking system has been low key and the
model is yet to be fully grounded. (4.48)

The following recommendations in respect of the BF/BC Model are

made:

Business Facilitators (BFs)

34 Originally, only individuals who were insurance agents could act
as BFs while no individuals could be placed as a BC. This was later
on widened to include retired officials, viz., government servants
like postmasters, school teachers and headmasters, who were con-
sidered by the RBI as eligible to act as BF. Banks may make use of
this relaxation and use individuals as indicated above as BF. (4.51)
35 Banks may appoint ex-servicemen/retired bank staff as their
BFs. (4.52)
36 Banks should ensure that the banking awareness created by BFs
get converted to business potential by providing suitable banking
services like mobile outlets. (4.53)

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37 Banks may facilitate easy roll-out of this mobile banking model

through simplification and rationalisation of back-end processes
and front-end procedures so that banking operations are made
more customer-friendly. (4.54)

Business Correspondents (BCs)

38 In addition to the institutions presently allowed by the RBI to
function as BCs, individuals like locally settled retired government
servants (postmasters, school teachers, ex-servicemen and ex-bank
staff) whose relationship with the banking system through a pen-
sion account has already been established may be permitted to act
as BCs. (4.56)
39 Further, MF-NBFCs may be allowed to act as limited BCs of banks
for only providing savings and remittance services. (4.57)
40 Technology has to be an integral part in sustaining outreach
efforts through the BC model. Ultimately, banks should endeav-
our to have a BC touch point in each of the six lakh villages in the
country. (4.58)
41 In order to sustain and encourage the arrangements, banks may
formulate suitable incentive mechanisms for BCs linked to the
number of accounts opened/transactions put through by them.
Further, banks may consider placing BCs even in areas having
their own branches. (4.59)
42 To begin with, the BC model envisaged by the RBI could be imple-
mented widely. In due course, when the BCs reach a higher level
of turnover, they should bear commensurate financial responsibili-
ties. (4.60)
43 Banks may appoint any individual/institution of their choice as
BCs, after exercising due diligence. This will facilitate greater
acceptance of the BC Model by banks. (4.61)
44 Funds may be provided to specialised institutions which provide
capacity building inputs to BCs. Such funding support could be
extended on a priority basis to most excluded areas/sectors of the
society. (4.62)
45 SLBC convener banks may initiate discussion with their respec-
tive state governments regarding routing government payments
through BCs using the smart card or other relevant technology on
a pilot basis. (4.63)
46 SLBCs may undertake a study to identify organisations having the
capacity to serve as customer service points and BC. In States like

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AP and Kerala, the VOs and Kudumbashree structures already

exist, and these can be used as customer service points. (4.64)
47 Training modules for BFs/BCs may be prepared in vernacular and
in culture sensitive pictorial forms. (4.65)

Role in microfinance
48 Deepening the outreach of the microfinance programme is an
effective way in reaching out to the excluded segments. Commer-
cial Banks have played a very important role in the SHG-Bank
Linkage Programme having linked 15.95 lakh SHGs, forming
more than 54% of the total SHGs credit-linked in the country.
This programme should be strengthened and carried further, play-
ing a key role in financial inclusion. (4.66)

Financing poor farmers

49 Joint Liability Groups (JLGs) of the poor such as landless, share
croppers and tenant farmers is another innovative mechanism
towards ensuring greater financial inclusion. Commercial Banks
can actively promote such groups for effectively purveying credit
and other facilities to such clients. The RBI may encourage banks
to adopt the JLG model for lending to SF/MF, tenant cultivators,
sharecroppers and oral lessees. (4.67)

Making marginal farm holdings viable and enabling

their financial inclusion
50 The following recommendations are made:
• Government programmes aimed at enhancing agricultural
productivity should be effectively linked with bank credit (e.g.
Banking Plan in post-watershed projects).
• A massive programme for financing minor irrigation structures
(wherever ground water levels are safe or where surface irri-
gation potential is available) may be undertaken specifically
targeting marginal farm households.
• Supplementary activities like dairy, small poultry, sheep-rearing,
etc. have to be specifically targeted for marginal farmers, ten-
ants and non-cultivator households.

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• A National Dairy Plan (NDP) has been prepared to target produc-

tion enhancement in 323 potential districts. Similar initiatives may
be considered for other sectors also like poultry, horticulture, etc.
• Farm aggregation models, including contract farming fully protect-
ing the interests of farmers, could be an option. Credit-marketing
linkage can also be effected. (4.68)

Regional Rural Banks

Post-merger, RRBs, with 14,494 branches, represent a powerful instru-
ment for financial inclusion. Their role and relevance in financial
inclusion is crucial as:

• In rural areas, they account for 37% of total offices of all

Scheduled Commercial Banks.
• 91% of the total workforce in RRBs is posted in rural and semi-
urban areas as compared to 38% for other Scheduled Commer-
cial Banks.
• In rural areas, RRBs account for 31% of deposit accounts and
19% of deposit amount of all Scheduled Commercial Banks.
Lower average deposit amount per account in RRBs as com-
pared with commercial banks implies their better reach to small
depositors.
• Share of RRBs in loan accounts is an impressive 37% in rural areas.
• Of all the scheduled commercial banks, RRBs account for 34%
of branches in the North-East, 30% in the Eastern and 32% in
the Central regions. Incidentally, these regions manifest finan-
cial exclusion of a high order.
• Of the total 29.25 lakh SHGs credit linked by the banking sys-
tem (as on 31 March 2007), 31% linkage is done by RRBs.
More significantly, the more backward a region, greater is the
share of RRBs. In the North-Eastern Region, it is 56%, Central
region, 48%, and Eastern region, 40%.
• RRBs have also played a significant role as Self Help Promoting
Institutions (SHPIs). As many as 104 RRBs (31 March 2006)
are functioning as SHPIs with grant assistance from NABARD.

Keeping the above in view, the following recommendations are made

for RRBs.

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Recommendations
51 RRBs should extend their services to unbanked areas and increase
their credit-to-deposit (CD) ratio. The post-merger scenario of
RRBs poses a series of challenges for them, and these are to be
addressed. The following areas would require attention from the
point of view of financial inclusion:
• Setting exclusive targets for microfinance and financial inclusion,
• Providing funding support and
• Providing technology support. (5.26)

No further merger of RRBs

52 Further merger of all RRBs at the State-level across sponsor banks
is not required. It may not also be desirable if there has to be a firm
reinforcement of their rural orientation with a specific mandate on
financial inclusion. Therefore, the process of merger should not
proceed beyond the level of sponsor bank in each State. (5.27)

Recapitalisation of RRBs with negative net worth

53 Recapitalisation of RRBs with negative net worth has to be given
a serious consideration as it would facilitate their growth, pro-
vide lenders a level of comfort and enable their achieving standard
capital adequacy ratio. (5.28)

Widening network and expanding coverage

54 As on 1 April 2007, RRBs are covering 535 districts. They may be
directed to cover all unbanked areas in these districts, taking the
village as a unit, either by opening a branch (wherever feasible) or
through the BF/BC model in a time bound manner. Eighty-seven
districts in the country were not covered by RRBs as of 1 April
2007, and their area of operation may be extended to cover these
districts. (5.29)

Strategic microfinance plan with NABARD support

55 RRBs have the potential and capability to emerge as niche opera-
tors in microfinance. They are playing a major role in the SHG-
Bank Linkage Programme, especially also as SHPIs. Their dual role

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has special meaning in areas which face severe financial exclusion

and which do not have a sufficient presence of well-performing
NGOs. However, to upscale the programme to a level where it can
really make a visible impact, RRBs need handholding, particularly
in the areas of training, promotion and development. NABARD
may provide required assistance. (5.30)
56 NABARD should prepare a strategic action plan RRB-wise, for
promotion and credit linkage of SHGs. RRBs may be asked to form,
nurture and credit link at least 3,000 SHGs in districts covered by
them in the North-Eastern, Eastern and Central Regions. A Memo-
randum of Understanding (MoU) may be signed by RRBs with
NABARD for a period of five years – with NABARD providing
the promotional and development assistance out of the “Financial
Inclusion Promotion and Development Fund” and RRBs forming,
nurturing and providing financial services to SHGs. RRBs may
accomplish the task with the support of individual rural volunteers,
BFs, their staff members, etc. NABARD may closely monitor the
programme, with a focus on qualitative aspects. (5.31)

NRFIP for RRBs

57 The strategy recommended for NRFIP for commercial banks
would be equally applicable for RRBs. They would require pro-
motional, funding and technology support in different areas as
outlined below. RRBs may endeavour to cover a large part of their
incremental lending through the group mode (SHGs/JLGs), as it
will enhance their outreach to the financially excluded. Lending
through group mode would also keep NPAs at a low level. (5.32)

Pilot testing of BF/BC model by RRBs

58 RRBs should adopt the BF and BC models as a major strategy
of financial inclusion. NABARD should extend the required sup-
port, including running pilots in selected banks. The proposal for
a technology-based intervention under the BC model would be
equally relevant for RRBs. However, RRBs would require some
handholding in implementing the proposal. NABARD may iden-
tify ten RRBs across the country, giving greater weightage to
regions manifesting higher levels of financial exclusion and work
in strategic alliance with these RRBs and their sponsor banks in

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implementing the proposal. The RRBs identified by NABARD for

the project will be required to develop a core banking software for
proper integration of the technology model proposed. NABARD
should enter into a MoU with identified sponsor banks and RRBs
and provide initial funding and technology support. (5.33)

Separate credit plan for excluded regions

59 The RRBs operating in predominantly tribal areas and having
high levels of exclusion may prepare annual credit plans having a
separate component for excluded groups, which would integrate
credit provision with promotional assistance. Refinance and pro-
motional support may be provided by NABARD to RRBs on a
large scale for implementation of these credit plans. (5.34)

Computerisation
60 With a view to facilitating the seamless integration of RRBs with
the main payments system, there is a need to provide computerisa-
tion support to them. Banks will be eligible for support from the
Financial Inclusion Funds on a matching contribution of 50% in
regard to districts other than tribal districts and 75% in case of
branches located in tribal districts under the Tribal Sub Plan. (5.35)

Strengthening Boards of Management

61 Post-merger, it is necessary that Boards of Management of RRBs
are strengthened and powers delegated to them on policy and
business operations, viz. introduction of new liability and credit
products, investment decisions, improving market orientation in
raising and deployment of resources, non-fund based business,
career progression, transfer policy, etc. (5.36)

Tax incentives
62 From 2006–2007, RRBs are liable to pay income tax. To fur-
ther strengthen the RRBs, profits transferred to reserves could be
exempted from tax until they achieve standard capital adequacy
ratios. Alternately, RRBs may be allowed tax concessions to the
extent of 40% of their profits, as per provisions under Section 36
(1)(viii) of the Income Tax Act. (5.37)

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NABARD to support HR development in RRBs

63 NABARD may continue to give special priority to RRBs to train
their staff through its training institutions. NABARD may design
suitable training programmes to enable RRBs to meet the chal-
lenges in the post-merger environment. This training may also
cover members of the Board of RRBs. (5.38)

Implementation of RBI initiatives for

financial inclusion
64 All the recent circulars relating to financial inclusion, viz., no
frills accounts, GCC, One Time Settlement (OTS) for loans up to
Rs.25,000, use of intermediaries, etc., should be implemented by
RRBs. (5.39)

Local Area Banks (LABs)

65 The RBI may allow new LABs to come into operation, especially
in districts/regions manifesting high levels of exclusion, without
compromising on regulatory prescriptions. LABs can integrate
well with local financial markets and offer a host of financial
services including savings, credit, remittances, insurance, etc.
(5.40)

Co-operative credit institutions

Rural credit co-operatives, in India, have a very long history. Demo-
cratic in features, the co-operative movement was envisaged as a
mechanism for pooling the resources of people with small means and
providing them with access to different financial services. In the back-
drop of the reform process underway for co-operative banks, they
have a very significant role to play in facilitating greater inclusion.

Recommendations
Early implementation of Vaidyanathan
Committee revival package
66 All necessary steps should be taken for the early implementation
of the STCCS revival package in all States. (6.31)

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Co-operatives in SHG-bank linkage – need

for enabling legislation
67 In certain States, legislation has been enacted admitting SHGs as
members of PACS. Similar legislation in other States would require
to be enacted to enable the emergence of co-operatives as effective
SHPIs. Federations of SHGs may be registered in all the States
under the Co-operative Societies Act or the parallel Self Reliant
Co-operatives Act, and availability of funds to these co-operatives
for advancing loans may be considered by NABARD, based on
objective rating criteria. NABARD may also set aside requisite
funds for sensitising the co-operative movement in this regard.
(6.32)

Use of PACS and other primary co-operatives

as business correspondents
68 There are a large number of PACS and primary co-operatives
under the parallel Acts located in rural areas where there are
no other financial services outlets. Many of these co-operatives
are in districts where the DCCBs are defunct or moribund. Such
PACS could provide valuable services to their members if they
get access to a commercial bank. The RBI has already listed
Co-operatives as eligible institutions under the BF/BC Model.
(6.33)
69 In the circumstances, Co-operatives may make use of this oppor-
tunity, at least in States which have accepted the Vaidyanathan
Committee recommendations. NABARD may be asked to suggest
appropriate guidelines for the purpose, subject to the approval of
the RBI. (6.34)

Co-operatives adopting group approach

for financing excluded groups
70 Micro-enterprises, in order to be successful, require larger funding
which NGOs cannot provide. It will, therefore, be necessary to
develop/test a new form of community based organisation other
than SHGs, which may be more appropriate to support members
who engage in micro-enterprises. Those members of SHG who
opt to graduate to micro-enterprises could be formed into JLGs or
some similar organisation. (6.35)

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71 The relations of mutual trust and support which is described as

affinity in a SHG tend to be weaker in a JLG. Therefore, new forms
of collateral or guarantee may have to be worked out. Guidelines
circulated by NABARD may be adopted by banks. (6.36)
72 Further, the use of the BF model could be thought of to organise
vulnerable segments of the population into JLGs. The pilot proj-
ect presently under implementation by NABARD should be suf-
ficiently broad-based to cover the role of facilitators in formation
and linkage of JLGs. (6.37)

Risk mitigation – setting up of Credit

Guarantee Fund
73 A Credit Guarantee Fund may be set up as a risk mitigation mech-
anism and also for providing comfort to the banks for lending to
such JLGs (akin to the Credit Guarantee Fund Scheme of SIDBI
for Small/Microenterprises Industries – CGFSI – available for
small-scale industries – SSI – at present). (6.38)

Self Help Group – bank linkage model

The SHG-Bank Linkage Programme is a major plank of the strategy
for delivering financial services to the poor in a sustainable manner. As
at the end of March 2007, as many as 29.25 lakh SHGs have been
credit-linked with banks, benefiting more than 400 lakh poor families.
There is a need for further deepening and upscaling of microfinance
interventions.

Encouraging SHGs in excluded

regions – funding support
74 If the SHG-Bank Linkage programme has to reach a critical scale,
the Department of Women and Child Development at state-level
should be actively involved in promoting and nurturing of SHGs.
The state governments and NABARD may, therefore, set aside
specific funds out of budgetary support and the Micro Finance
Development and Equity Fund (MFDEF) respectively for the pur-
pose of promoting SHGs in regions with high levels of exclusion.
(7.28)
75 The spread of SHGs in hilly regions, particularly in the North-
Eastern Region, is poor. One of the reasons for this is the low

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population density in hilly areas and weak banking network. There

is a need to evolve SHG models suited to the local context. (7.29)

Capacity building of government functionaries

76 Certain deficiencies like poor follow-up, ineffective monitoring
and inadequate training and capacity building efforts have been
observed in the past. Adequate safeguards may, therefore, be
devised and built in future programme implementation strategies.
NABARD can also facilitate this process by providing support for
capacity building of government functionaries from grass root
level upwards within the SHG framework. (7.30)

Legal status for SHGs

77 As of now, SHGs are operating as thrift and credit groups. They
may, in future, evolve to a higher level of commercial enterprise.
The question of providing a simplified legal status to the SHGs
may have to be examined in full, in this context. This would also
facilitate their becoming members of PACS. (7.31)

Maintenance of participatory
character of SHG movement
78 A movement of such a large scale involving people’s participa-
tion could lead to attempts towards politicisation. This must
be avoided. Sufficient care has to be taken to ensure that the
SHG movement retains its participatory and self-help character.
(7.32)

NABARD to open ‘project offices’

in identified priority states
79 NABARD is managing the MFDEF with a corpus of Rs.200 crore.
One major focus of the Fund should be promoting the SHG-Bank
Linkage Programme in States where it has been comparatively
slow moving. NABARD has already identified 13 States with a
large population of the poor, but exhibiting low performance in
implementation of the programme. The ongoing efforts of NAB-
ARD to upscale the programme in the identified States need to be
given a fresh impetus. (7.33)

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80 NABARD can open dedicated project offices in the 13 States

for upscaling the SHG-Bank Linkage Programme by strategising
interventions such as stronger involvement of state governments,
capacity building of NGOs, broadening the range of SHPI, etc.
(7.34)

Incentive package for NGOs

81 Many of the NGOs have played a commendable role in promoting
SHGs and linking them with banks. NGOs, being local initiators
with their low resources, are finding it difficult to expand in other
areas and regions. There is, therefore, a need to evolve an incen-
tive package which should motivate these NGOs to diversify into
other backward areas. Incentive package could be in the form of
expeditious and hassle-free grant support. (7.35)

RBI/NABARD to study the issue of “evergreening”

82 A certain element of “evergreening” of loans is reportedly taking
place among credit linked SHGs. This, if established, is a mat-
ter of concern. RBI/NABARD may expeditiously study this aspect
and come out with suggestions for reversing this unsettling trend.
(7.36)

Transparency in maintenance of records

83 In order to ensure sustainability of the SHGs, their activities and
linkages, there should be better transparency in the books of
accounts maintained at the group level. These books should reflect
the position of deposits in members’ accounts, interest paid on
savings, distribution of corpus or operating surplus among mem-
bers, evergreening of loan accounts, etc. Banks, with the help of
NABARD, should evolve a checklist for concurrent monitoring of
SHGs. (7.37)

SHGs to evolve norms for distribution of surplus

84 Many of the SHGs do not have the practice of distributing the sur-
plus generated from their business activities within the group and
the awareness on this issue among the SHG members is very low.
There is a need to evolve norms for distribution of surplus (akin to

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dividend), especially at the time when a member drops out of the

group. (7.38)

Need to restructure design and direction of SGSY subsidy

85 Subsidies provided under SGSY need to be restructured. Linking
credit with subsidy is not an effective approach for reaching out to
the poor. There is a need to formulate a single programme synergis-
ing the positive features of SGSY such as specific targeting of Below
Poverty Line (BPL) families, etc. and those of the SHG-Bank Link-
age Programme such as group cohesiveness, discipline, etc. (7.39)
86 While recognising that individual subsidies are distortionary, the
government may consider redirecting subsidies in the SGSY Pro-
gramme for the following purposes:
• Capacity building of NGOs and other field based agencies such
as Krishi Vigyan Kendras, to form and strengthen SHGs.
• Exposure visits to successful models by bankers, government
officials, SHG leaders, etc.
• For strengthening input supply and marketing arrangements.
(7.40)
87 Some of the state governments like West Bengal and AP have initi-
ated efforts in this direction. Further, it is understood that the pro-
posals are awaiting approval of the GoI. The approaches adopted
by these States for bringing synergy between SGSY groups and the
SHGs of the linkage programme can be studied so that the same
can be replicated in other States. The broad features of the pro-
posed convergence model are indicated in Annexure V of the main
report. (7.41)
88 The need for technology adoption for effective disbursal of Govt.
subsidy should be recognised. The existing dispensation of subsidy
under SGSY and payouts under NREGP could be routed through
bank accounts, with suitable technology support. (7.42)

Interest rate subsidy

89 Certain States are reportedly providing a subsidy on interest rates
being charged by banks to the SHGs. The margin available to
SHGs is sufficient to take care of operational costs, even after con-
sidering the small amounts of loan provided to members. Thus,
a subsidy on interest rates cuts at the very root of the self-help

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character of SHGs. The subsidy could be re-directed towards

capacity building efforts or in providing input supplies and mar-
keting support to the SHGs. (7.43)

Resource centres
90 For ensuring the long-term sustainability of SHGs and for helping
the members of mature SHGs to graduate from microfinance to
microenterprises, Resource Centres on the lines of the AP Mahila
Abhivruddhi Society (APMAS) can be set up in different parts of
the country. (7.44)
91 There are a large number of SHGs which are well-established in
their savings and credit operations. Their members want to expand
and diversify their activities with a view to attain economies of
scale. Many of the groups are organising themselves into federa-
tions and other higher level structures. To achieve this effectively,
resource centres can play a vital role. (7.45)
92 Resource centres can be set up by various stakeholders such as
NGOs, banks, government departments, NABARD at the State/
district level to play an important role in preparing training mod-
ules, developing a cadre of trainers, conduct of field studies and in
promoting interface between SHG members and service providers.
The specific role of Resource Centres would be:
• To work towards a comprehensive capacity building of SHGs,
• Share innovative ideas and models that can be replicated else-
where,
• Enhance functional literacy among SHG members,
• Support livelihood interventions among SHG members,
• Facilitate availability of all services to SHG members under one
roof. (7.46)
93 The cost for setting up Resource Centres can be met out of the
Financial Inclusion Fund and/or the MFDEF. (7.47)

SHGs to provide alternative savings products

94 Most of the SHGs encourage compulsory savings with equal small
amounts by members on a regular basis. SHGs need to offer a
wide range of savings products so as to capture the huge potential
of savings that remains untapped. Groups should be free to design
savings products suited to members’ requirements. A certain level
of experimentation could be attempted by the Resource Centres

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in designing new saving products and NABARD should encourage

and support such experiments. (7.48)

Adoption of JLG model to cover marginalised groups

95 A scheme for financing JLGs of tenant farmers and oral lessees has
been evolved by NABARD for implementation by all the commer-
cial banks, RRBs and Co-operatives. The adoption of the concept
of JLGs, if properly grounded, could be another effective method
for purveying credit to mid-segment clients such as small farmers,
marginal farmers, tenant farmers, etc. and thereby reduce their
dependence on informal sources of credit. (7.49)

From microcredit to microenterprise – challenges

96 The present challenge is to induce SHGs and their members to
graduate into matured levels of enterprise, factor in livelihood
diversification, increase their access to the supply chain, linkages
to the capital market and appropriate production and processing
technologies. (7.50)
97 A spin off of this challenge is how to address the investment capital
requirements of matured SHGs, which have initially met members’
consumption needs and are now on the threshold of taking off into
“enterprise”. There is evidence in MYRADA experience where
lending for productive purposes has already been given greater
emphasis by SHGs. The Community Managed Resource Centres
(CMRCs) organised by MYRADA provide a variety of linkage
services to SHGs and individual entrepreneurs among SHG mem-
bers. This model requires to be studied. The SHG – Bank Linkage
Programme needs to introspect whether it is sufficient for SHGs to
only meet the financial needs of their members, or whether there
is also a further obligation on their part to meet the non-financial
requirements necessary for setting up business and enterprises.
Ideally, it must meet both. (7.51)

Greater role for NABARD

98 While greater emphasis is needed for growth and spread of SHGs
across the country, the quality in terms of outreach of financial
services, capacity building, sustainability, etc., needs to be reem-
phasised. NABARD shall play a pro-active role and identify new

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initiatives that will contribute to effectively improving outreach to

the poor through SHGs, MFIs, etc. (7.52)

Federations
99 Federations, if they emerge voluntarily from amongst SHGs, can
be encouraged. However, the Committee feels that they cannot
be entrusted with the financial intermediation function.
In AP, federations are registered as societies under the MACS
Act. The SHG members (as individuals) are permitted to be
members in the federation. In Uttarakhand, SHGs are permitted
to become members of PACS directly. Other States may adopt
similar enabling legislation. (7.53 & 7.54)

100 Voluntary establishment of federations could be supported out

of the Financial Inclusion Fund and the MFDEF. While extend-
ing support, it should be ensured that:
• Federations emerge voluntarily, on the felt need of the
SHGs,
• Federations provide other value added services to member
SHGs. Based on a study of Federations operating across the
country, a broad list of such services and the modus operandi
of federations in providing such services can be prepared and
circulated by NABARD.
• Federations, in terms of distance, operate in close proximity
to members. (7.55)

Urban microfinance
101 There are no clear estimates of the number of people in urban
areas with no access to organised financial services. This may
be attributed, in part at least, to the migratory nature of the
urban poor, comprising mostly of migrants from the rural areas.
Even money lenders often shy away from lending to urban poor.
(7.56)
102 There have been a few instances of MFIs venturing into this
area of lending to urban poor who are undertaking micro enter-
prises and small business activities. Urban branches of banks,
even though having manpower and technology support, are not
attuned to SHG lending or microfinance. (7.57)

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103 Opening of specialised micro finance branches/cells in potential

urban centers exclusively catering for microfinance and SHG –
bank linkages could be thought of to address the requirements
of the urban poor. BFs/BCs could be the mechanism to reach
the target clientele in these areas. Banks can also consider asso-
ciating with MFIs undertaking urban microlending as a viable
option. (7.58)

Amendment to NABARD Act

104 At present, NABARD is permitted, as per its Act and Mandate,
to support microfinance activities in rural and semi-urban areas
only. An enabling provision could be made in the NABARD Act,
1981 permitting NABARD to provide microfinance services to
the urban poor. (7.59)

Microfinance Institutions
Introduction
105 Firm data regarding the number of MFIs operating under differ-
ent forms is not available. However, it is roughly estimated that
there are about 1,000 NGO-MFIs and more than 20 Company
MFIs. Further, in AP, nearly 30,000 co-operative organisations
are engaged in MF activities. However, the company MFIs are
major players accounting for over 80% of the microfinance loan
portfolio. (8.02)

Definition of MFI
106 The proposed Microfinance Services Regulation Bill defines
microfinance services as “providing financial assistance to an
individual or an eligible client, either directly or through a group
mechanism for an amount, not exceeding rupees fifty thousand
in aggregate (Rs.1,50,000 if for housing purposes)”. (8.03)
107 Greater legitimacy, accountability and transparency will not
only enable MFIs to source adequate debt and equity funds, but
could eventually enable MFIs to take and use savings as a low
cost source for on-lending. (8.05)

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Recognising MF-NBFCs
108 There is a need to recognise a separate category of Microfinance –
Non Banking Finance Companies (MF-NBFCs), without any
relaxation on start-up capital and subject to the regulatory
prescriptions applicable for NBFCs. Such MF-NBFCs could be
defined as companies that provide thrift, credit, micro-insurance,
remittances and other financial services up to a specified amount
to the poor in rural, semi-urban and urban areas. (8.07)
109 At least 80% of the assets of MF-NBFCs should be in the form
of microcredit of up to Rs.50,000 for agriculture, allied and non-
farm activities and in case of housing, loans up to Rs.1,50,000
per individual borrower, whether given through a group mecha-
nism or directly. (8.08)

MF-NBFCs as BCs
110 To enable the poor to have access to savings services, MF-NBFCs
may be recognised as BCs of banks only for providing savings
and remittance services. (8.09)

Relaxation in FIPB guidelines

111 Current guidelines used by FIPB (Foreign Investment Promotion
Board) require a minimum of US$500,000 equity investment
from a foreign entity. MF-NBFCs’ initial capital needs may not
be very large and the Committee is of the view that the minimum
amount of foreign equity for MF-NBFCs may be reduced to a
level of US$100,000. (8.10)
112 NABARD may extend equity support out of its MFDEF to such
MF-NBFCs based on objective rating/criteria. NABARD may
accord priority in providing equity support to those MF-NBFCs
operating in regions featuring high levels of exclusion. (8.11)
113 The SEBI Venture Capital Guidelines may permit Venture Capi-
tal Funds to invest in MF-NBFCs. (8.12)

Tax concessions
114 MF-NBFCs may be allowed tax concessions to the extent of 40%
of their profits, as a proportion to their business portfolio in
excluded districts as identified by NABARD without attracting

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tax. For this, MF-NBFCs may be included as eligible institutions

under Section 36(1) (viii) of the Income Tax Act. (8.13)

MF-NBFCs as microinsurance agents

115 The IRDA Microinsurance Guidelines, 2005 may permit MF-
NBFCs to offer microinsurance services as agents of regulated
life and non-life insurance companies. (8.14)

Code of conduct
116 A voluntary mutual code of conduct, already prepared, cover-
ing aspects including mission, governance, transparency, interest
rates, handling of customer grievances, staff conduct, recovery
practices, etc., may be made mandatory for MFIs. (8.15)

Accounting and disclosure norms

117 The Institute of Chartered Accountants of India (ICAI) may be
involved in formulating appropriate accounting and disclosure
norms for MFIs. (8.16)
118 Banks lending to MFIs may undertake studies on the cost of
funds of MFIs, risk premium, etc. and exercise a lender’s dis-
cipline in enforcing reasonable rates of interest and acceptable
modes of recovery. (8.17)

Unifying regulatory oversight

119 The RBI may consider bringing all regulatory aspects of
microfinance under a single mechanism. Further, supervision
of MF-NBFCs could be delegated to NABARD by the RBI.
(8.18)

Microfinance bill
120 While Section 25 Companies could be covered by the Micro
Financial Sector (Development and Regulation) Bill, 2007, co-
operatives can be taken out of the purview of the proposed Bill.
(8.19)

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Technology applications
Technology – the driving force for low-cost
inclusion initiatives
121 Technological developments in the recent past have provided the
perfect launch pad for extending banking outposts to remote
locations without having to open bank branches. This could be
achieved by leveraging technology to open up channels beyond
the branch network and create the required banking footprints
to reach the unbanked so as to extend banking services similar
to those dispensed from branches. (9.01)
122 The Committee, while concurring with the RBI’s advisory group
for IT enabled financial inclusion, is of the view that nearly all
pilot models converge on certain essential components and pro-
cesses to be followed in technology application.
The essence of a majority of the models under consideration
features the issue of a smart card to the farmer on which all his
transactions are recorded, a hand-held terminal with the BC at
the village level and a Central Processor Unit (CPU) linking the
smart cards and BC terminals with the banks. There are also
other models where smart cards are dispensed with and mobile
telephones, etc., are used. (9.02/9.03)

123 The fundamental outlines of the existing technology-based mod-

els may be examined for application in such manner and to such
extent as may be deemed fit. (9.04)
124 The operating costs of the various models are expected to be
minimal and can be easily absorbed by banks as the increase in
business volumes will justify the incremental operating costs.
Also, the costs are substantially lowered if the infrastructure is
shared. It is, therefore, recommended that shared infrastructure
among different banks enabling nationwide financial inclusion
would confer large scale benefits and also enable effortless
transfer of funds between the card holders of various banks.
(9.06)
125 Essentially, the startup costs are the initial investment costs com-
prising cost of the smart card, terminals with the BC and the
CPU. The Committee is of the view that the Financial Inclusion
Technology Fund can provide the necessary support for defray-
ing part of the costs. (9.07)

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Optimisation of existing infrastructure

126 The Committee is of the opinion that the existing banking infra-
structure and NGOs which have already made extensive inroads
in rural areas should be made of optimal use for enabling the
outreach of banking services. The BF/BC models backed by
technology applications should encourage a role for the small
players and integrate them with the national system. The Com-
mittee is of the opinion that the state governments should make
payments under National Rural Employment Guarantee Scheme
and Social Security Payments through such technology-based
solutions. (9.09)

Building database
127 The creation of a national database, sectoral, geographic and
demographic reports, and also a payment system benefiting the
card holders from the underprivileged/unbanked population will
not be possible without the extensive use of IT.
This alone can bring down the costs of the small ticket trans-
actions of the poor and make nationwide financial inclusion a
reality. (9.10)

128 The technology suppliers and banks should evolve common

minimum standards for ensuring inter-operability between their
systems. (9.11)

Remittance needs of poor

129 Ahmednagar DCCB has implemented a system of low cost
anywhere banking solution which has a facility of card-to-
card transfer. Savings/current account holders at all its 280
branches have a choice to keep their savings bank account or
a part thereof in a separate account at the bank’s head office.
Customers can have access to this account from all the bank
branches. It was learned that the customer is charged only Rs.4
per transaction. Such experiments may be studied for replica-
tion. (10.09)
130 A low value card linked to a bank account, which can be
encashed at PoS and which allow the transfer of small amounts
from one card to another, would alleviate remittance problems.

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This would substantially increase banking outreach as at pres-

ent there are about 3 lakh PoS as compared to around 70,000
scheduled commercial bank branches and 22,000 ATMs. How-
ever, a majority of PoS machines are now located in urban and
semi-urban areas. It is expected that as the system takes root,
more PoS will come in rural areas, facilitating such transfers.
(10.10)
131 The e-kiosks in villages could be yet another source of operating
a remittance system that is accessible to the poor. (10.11)

Other recommendations
132 The following suggestions would substantially address the remit-
tance needs of the poor in the country:
a The combined network of nearly 70,000 branches of sched-
uled commercial banks (including RRBs) and a network
of more than 1.50 lakh post offices can ideally provide the
institutional mechanism for extending remittance facilities
in remote areas. With adoption of appropriate technology, it
may be possible to bring down the transaction costs which
would encourage and enable the poor to make use of such
remittance facilities. A committee may be set up with repre-
sentatives from the RBI, Department of Posts, NABARD and
commercial banks for exploring the feasibility of integrating
the postal network with the banking system and developing a
nationwide remittance system.
b The remittance product could be an electronic product similar
to “Instacash” where a 16-digit code is given to the originator
of the transaction, and the beneficiary can take the amount
from select Post Offices by giving the code, and identity proof.
This product should be available across banks, Post Offices
and other institutions and be affordable. Another option
could be to credit the remitted amount to a central server at
the originating point and at every touch point should be able
to withdraw it.
c Banks should endeavour to have a BC touch point in each of
the six lakh villages in the country. There should be a micro-
bank in every village.
d Banks should introduce card-based remittance products which
can be encashed all over the country. This may be card-to-card
transfer, or simply a scratch card type remittance card. (10.14)

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Micro-insurance
133 Micro-insurance should provide greater economic and psycho-
logical security to the poor as it reduces exposure to multiple
risks and cushions the impact of a disaster. Micro-insurance in
conjunction with micro-savings and microcredit could go a long
way in keeping this segment away from the poverty trap and
would truly be an integral component of financial inclusion.
(11.02)
134 In 2003, GoI constituted a Consultative Group on Micro-
Insurance to examine existing insurance schemes for the rural
and urban poor. The report of the consultative group has brought
out the following key issues:
• Micro-insurance is not viable as a standalone insurance
product.
• Micro-insurance has not penetrated rural markets. Tradi-
tional insurers have not made much headway in bringing
micro-insurance products to the rural poor. (In addition, the
Committee feels that micro-insurance has not penetrated even
among the urban poor.)
• Partnership between an insurer and a social organisation like
a NGO would be desirable to promote micro-insurance by
drawing on their mutual strengths.
• Design of micro-insurance products must have the features
of simplicity, availability, affordability, accessibility and flexi-
bility. (11.04)
135 The Committee studied four different models for deliver-
ing micro-insurance services to the targeted clientele, viz., the
Partner-Agent Model, Full Service Model, Community Based
Model and Provider Model. (11.11)

Recommendations
Leveraging the existing network for micro-insurance
136 To economise on costs and to increase the outreach of micro-
insurance to the poor, the insurers need to utilize existing gov-
ernment organisations and NGOs, having greater acceptability
among the financially excluded. The partner-agent model for
delivery where the insurer underwrites the risk and the distri-
bution is handled by an existing intermediary seems apt in this
scenario. (11.12)

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Linking microcredit with

micro-insurance
137 The Committee concurs with the view that offering microcredit
without micro-insurance is financial behaviour fraught with risk.
There is, therefore, a need to emphasise the linking of micro-
credit with micro-insurance. (11.13)
Further, as it helps in bringing down the inherent risk cost of
lending, the Committee feels that NABARD should be regularly
involved in issues relating to rural and micro-insurance to lever-
age on its experience of being a catalyst in the field of micro-
credit. (11.14)

Implementation strategy for

micro-insurance
138 The Committee has identified major areas for formulation of
strategies for effective implementation of micro-insurance pro-
grammes as explained in the following paragraphs. (11.15)

Human resources requirement

and training
139 To tap the huge micro-insurance potential, IRDA may consider
putting in place an appropriate institutional structure for decid-
ing on service packages including premia and formulating strate-
gies for effective promotion of micro-insurance. There is also a
felt need for development, of both full-time and part-time staff,
through effective training in insurance marketing and servicing
concepts. (11.16)

Operations and systems

140 To address the requirements of the huge market potential avail-
able, appropriate systems should be evolved for tracking client
information, either manually or using technology. While a tech-
nology platform may take time for setting up, in the long-run
the same will be cost-effective and reliable. Similarly, the pro-
cedures for claims, premium payments/renewals and other ser-
vices should be formalised along with increased customisation of
products to stimulate demand. (11.17)

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Development of adequate feedback mechanism

141 Keeping in view the diverse nature of market requirements, suit-
able mechanisms to collect market intelligence, collating and
interpretation of the same in a formally structured manner, is
important for product development and process refinement.
(11.18)

Development of database
142 High costs of penetration and acquisition often leads to higher
pricing of products, thereby impacting client outreach and mar-
ket depth. Building up an historical database on risk profiles,
claims, settlement ratios, etc. will facilitate in better pricing of
products, based on actual rather than presumed risks. Besides
enabling cost reduction, warehousing of such data will make
the market more transparent for the entry of more operators.
(11.19)

Consumer education, marketing

and grievance handling
143 The micro-insurance sector is unique in the sense that there is
an ongoing challenge to explain the concept and benefits to the
insured. Creating awareness through use of pictorial posters,
local folk arts and street theatres might be useful to explain the
mechanisms of insurance. Local community-based organisations
could organise premium collections, as they have better access
to the local people. To make it more acceptable to the people,
micro-insurance products, apart from covering only risks, should
also provide an opportunity for long-term savings (endowment).
(11.20)

Product development/process re-engineering

144 Customised product development to suit the varying require-
ments of the local populace is a pre-requisite. The processes/
procedures are to be streamlined and simplified, to facilitate eas-
ier access for the rural poor. Information should be made avail-
able in vernacular for easy understanding of the terms on offer.
(11.28)

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Using existing infrastructure

145 Micro-insurance service providers can use the existing banking
infrastructure and also adopt the agency-mode (NGOs, SHGs,
NBFCs, etc.) for providing services, thereby leveraging on the
existing physical branch network and reducing costs. (11.30)

Use of technology
146 The technology platforms being envisioned to facilitate finan-
cial inclusion should enable micro-insurance transactions also.
Towards this end, there is a need to integrate the various mod-
ules – savings, credit, insurance, etc. – into the technology frame-
work so that holistic inclusive efforts are possible in the rural
areas. (11.31)

Review of existing schemes

147 There are a large number of group life and health insurance
schemes which are run by various central ministries and state
governments. The level of actual coverage in terms of claims
preferred and settled in such schemes is disturbingly low. These
schemes should be reviewed by an expert group set up by the
IRDA. (11.32)

Life insurance
148 A wide range of products are available, but penetration is really
limited in rural areas. The procedural requirements at the time of
entry and in case of claims settlement are cumbersome. The com-
mission structure for agents is also heavily weighed in favour of
getting new policies with very little incentive to service existing
policies. In this regard, Micro Insurance Guidelines (MIG) 2005,
issued by IRDA, has provided for equal commission throughout
the life of a policy, and this will now remove the disincentive in
servicing existing policy holders. (11.34)

Health insurance
149 In case of Health Insurance, penetration level is even much lower
than Life Insurance. The two categories viz., Critical Illness and

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Hospitalisation are the main product segments. Some state gov-

ernments have developed Health Insurance schemes which are
still in very early stages.
150 The Committee has observed that the mutual health insurance
models have advantages of its members performing a number
of roles such as awareness creation, marketing, enrolment, pre-
mium collection, claims processing, monitoring, etc. Under this
arrangement, the costs of offering small-ticket health insurance
gets significantly reduced. The high co-variant risks such as epi-
demics will have to be taken care of by a mutual entity taking
re-insurance for such risks.
151 IRDA has also suggested that the capital requirements for stand-
alone health insurance companies be reduced to Rs.50 crore
as against Rs.100 crore for Life Insurance Companies, and the
Committee endorses the same. (11.35)

Crop insurance
152 This is a very important risk mitigation arrangement for small
and marginal farmers. However, leaving the discretion to notify
crops/regions to state governments has contributed to adverse
selection. Further, claims settlement based on yield estimation
has been cumbersome, and the sampling area for crop cutting
experiments is very large. An alternative model based on weather
insurance has been attempted.
To make it more effective, there is a need for having a large
number of smaller weather stations. The Committee recom-
mends that policies be evolved to make crop insurance univer-
sal, viz., applicable to all crops/regions and pricing actuarial.
(11.36)

Livestock insurance
153 As in Life Insurance, the problem lies in the process of enrolment
and claims settlement. Several pilots indicate that the involve-
ment of local organisations like SHGs, dairy co-operatives,
NGOs and MFIs improves the quality of service, reduces false
claims and expedites claims settlement. The Committee recom-
mends that these experiences be studied and adopted by insur-
ance companies. (11.37)

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Asset insurance
154 This could cover a wide range including residential buildings,
farm and non-farm equipments and vehicles. The main con-
straint seems to be lack of distribution channels appropriate for
lower income groups. The Committee again recommends that
involving local NGOs, MFIs, SHGs, etc. as distribution channels
as well as facilitators of claims settlements would be quite useful.
(11.38)

Demand side Causes and solutions for

financial inclusion
155 The Committee’s Report has so far concentrated on supply side
issues of financial inclusion and what can be done to enhance
supply of financial services, through increased outreach by exist-
ing institutions, enhancing their incentives to serve the excluded
and adding new distribution channels. The Committee is of
the view that financial exclusion is also caused by demand side
issues. Unless some initiatives are taken on the demand side, or
in the “real sectors”, mere supply side solutions from the finan-
cial sector will not work. (12.01)

Recommendations
Human development
156 Regions, segments and sectors financially excluded require
substantial investments in human development. In particular,
primary health, nutrition, primary education and vocational
training need attention. The Twelfth Finance Commission had
already taken a lead in this direction by earmarking additional
funds for health and education in backward States. The Com-
mittee is of the view that this will lead to enhanced economic
efficiency and consequent demand for financial inclusion within
a few years. (12.15)

Access to land and titling

157 The Committee is supportive of various government programmes
under which surplus land is distributed to landless and marginal
farmers. The Committee has also noted that the government has

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enacted recently The Forest Dwellers and Tribal Land Rights

Act, 2006, which will ensure that those who had been cultivat-
ing a piece of land for decades in the middle of forests, will now
get security of tenure. This will open up the possibility of their
accessing credit from banks. (12.16)
158 The Committee has noted and endorses the recent move by
NABARD to provide refinance for credit extended by banks and
co-operatives to oral lessees and tenant farmers. This category
of farmers has long been financially excluded due to lack of land
titling or recorded tenures. Procedural changes in banks must be
brought about to extend credit outreach to all such productive
farmers. (12.17)
159 Banks hesitate to finance tenant farmers/oral lessees as they do
not have documentary proof of their right to till the land for
raising crops or for investment purposes. Recording of tenancy
and ownership rights on land is an important measure to enable
access to credit. (12.18)
160 Certificates by revenue officers or a system of land cultivation
certificate by the Village Panchayats or local bodies may be made
acceptable as documentary proof for cultivating the land. (12.19)
161 Computerisation of land records will lead to systematisation of
land records and overall availability of required information to
banks facilitating their loan appraisal process. It is observed that
12 States have already initiated the process, and GoI may advise
all States to give priority for completing this process within a
year. This will reduce cost to farmers in obtaining various docu-
ments and recording encumbrance. (12.20)

Access to work – NREGA

162 Given the fact that nearly 80% of farmer households in the
country are small and marginal farmers, who rarely have work
on their own farms for more than 100 days a year, the avail-
ability of wage employment in the vicinity of their villages is
critical. In this context the Committee noted the nation-wide
roll-out plans supported by the National Rural Employment
Guarantee Act (NREGA) which ensures that every household
in need can ask for paid wage work for up to 100 days per year.
(12.21)
163 The Committee endorses the creative use of the NREGP pay-
ments through bank accounts to enhance financial inclusion, as

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practiced in AP. In AP, the beneficiaries/depositors will be issued

smart cards to enable transactions at several locations besides
the bank branch. (12.22)

Infrastructure support
164 The Committee noted the significant progress made for rural
connectivity through the Pradhan Mantri Gram Sadak Yojana
and the attempt to extend electric power to unconnected villages
through the Rajiv Gandhi Gram Vidyutikaran Yojana.

In several states the RIDF managed by NABARD has enabled the

creation of much needed roads, bridges, irrigation canals, water har-
vesting structures and other useful infrastructure. The Committee
endorses this and recommends a further impetus in the area. (12.23)

165 The National Development Council (NDC) has recommended

that the normative allocation of RIDF funds among States should
be decided by factoring in, inter alia, the CD ratio as a relevant
criterion. This should be attempted by NABARD to improve
equitable distribution of RIDF resources. (12.24)

Enhancing productivity and incomes

Productivity enhancement
166 In this connection, the Committee has already recommended the
establishment of Nodal Branches in each block to undertake inten-
sive efforts for agricultural and business development services to
farm and non-farm sector borrowers respectively. The Commit-
tee also recommends that banks explore tie-ups with government
extension agencies, Krishi Vigyan Kendras, reputed NGOs work-
ing in this field, agri-business clinics and corporates engaged in
agricultural activities, to provide inputs, extension services and
market linkages to the bank’s borrowers so as to offer credit plus
services and enhance the efficiency of credit. (12.26)

Value addition – primary processing

167 The Committee recommends that efforts should be made to
ensure that all agricultural produce is subjected to primary and
if possible secondary value addition locally. This means that

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post-harvest drying, sorting, grading and packing can be done at

the village level, preferably by women’s SHGs. Farmers groups
can come together to establish secondary value addition facili-
ties such as groundnut shelling, cotton ginning, dal milling, rice
hulling, fruit pulping, milk chilling, etc. (12.27)

Alternate market linkages

168 Roads, transport, power and water provide critical linkages
in support of production-based activities. Social services like
health, education, etc. contribute to improvements in the quality
of rural life. State governments should prioritise infrastructure
planning, use of funds of the National Rural Employment Guar-
antee Programme (NREGP) for building critical infrastructure
and encourage community participation in creation and mainte-
nance of assets. (12.28)

Reducing vulnerability
Risk mitigation through non-financial channels
169 A vast majority of poorer households in India are exposed to
high levels of risk and considered as not insurable at reasonable
levels of premium. Their risk levels need to be mitigated through
soil and water conservation measures, watershed development,
installing protective irrigation and by using appropriate agro-
nomic practices all the way from ploughing techniques to seed
selection and timely farm operations. In the case of livestock
rearers, risks can be reduced by proper herd management prac-
tices and mass vaccination; for example, against foot and mouth
disease. It is only after these type of investments have reduced
the risks in farming that the private expense in buying insurance
can be affordable. (12.29)

Calamity relief fund

170 Repeated natural calamities and consequent rescheduling of
bank loans take the debt burden beyond the repaying capacity
of farmers. There is a need for the creation of a National Calam-
ity Fund to address the problems of farmers in distress districts.

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Further, the subsidy on crop insurance may be directed more

effectively towards the disadvantaged sectors. (12.30)

Managing price risks through warehouse

receipts and commodity derivatives
171 Apart from the physical risks which impact crop yields, farm-
ers also suffer from price risks. In bumper years, their harvest
fetches low prices. In order to hedge against such price risks, the
right instrument is commodity derivatives, particularly futures
options in which a farmer can be assured of selling his produce
at a certain price in future. (12.31)
172 The Committee also noted that the Indian farmer is highly
attuned to dealing in spot markets, traditionally known as Man-
dis, where the commodity is exchanged for cash. The Commit-
tee, therefore, supports any initiatives towards improving the
transactional efficiency of spot markets. (12.32)
173 The Committee noted that several multi-commodity exchanges
have come up in the last few years and that they are registering a
large turn over. This enables farmers to discover the future price
and take decisions related to crop selection. The Committee is
supportive of such initiatives. (12.33)
174 However, the Committee noted the fact that a vast majority
of financially excluded farmers have only a small marketable
surplus and thus cannot benefit from the vibrant commodity
exchanges, where the minimum traded lot is much larger than
what the individual farmer has to offer. In order to extend the
benefits of derivative exchanges to excluded farmers, aggrega-
tion mechanisms such as co-operatives need to come up. (12.34)
175 In the interim, financial instruments such as warehouse receipts
and postharvest credit can be offered so that farmers can avoid
distress sales. The passage of the Warehousing (Development
and Regulation) Bill, 2005 by Parliament is likely to open up a
number of avenues for farmers to mitigate their price risks by
encashing stock pledged in a warehouse to meet their cash needs,
while waiting for the right price. The Committee is supportive
of efforts to establish a chain of authorised warehouses through-
out rural India, to provide such services, particularly when such
warehouses are linked to PACS. (12.35)

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Organising the unorganised producers

176 In order for financial inclusion efforts to be sustainable, banks
need to aggregate credit demand from the small borrowers. The
celebrated mechanism for this is the SHG of which there are now
more than 2.9 million in India linked with banks. (12.36)
177 Another well-known mechanism for collective action is com-
modity co-operatives. There is no better example than the dairy
producers co-operative societies established by the NDDB.
(12.37)
178 The Committee recommends the establishment of similar com-
modity co-operatives to cover a large number of small and mar-
ginal producers all over the country. The effort for bringing the
producers together can be undertaken by specialised agencies
like NDDB and suitable NGOs, while the cost for this should be
defrayed by either the government or by the banks, or a combi-
nation thereof. (12.38)
179 The Financial Inclusion Fund cannot be used for a better purpose
than supporting a competent and committed agency to organise
commodity producer co-operatives in areas such as large carda-
mom in Sikkim, lac in tribal areas of Eastern Madhya Pradesh,
Tasar in Northern Jharkand and seaweed in coastal AP. (12.39)
180 The Committee endorses government programmes such as the
Velugu programme in AP, which promotes organising the unor-
ganised producers, and recognises that this cannot happen with-
out the social intermediate of competent and committed NGOs.
The legitimate expenses of such intermediaries need to be met.
Initially, banks can lend to groups based on considerations of
viability; but this will eventually lead to individual lending as
individual producers grow. This is the slow and steady process
that the Committee recommends to build true financial inclu-
sion. (12.41)

Note
* Source: Rangarajan, C. 2008. Report of the Committee on Financial Inclu-
sion. Committee Report. New Delhi: Ministry of Finance, Government
of India. www.sidbi.in/files/Rangarajan-Commitee-report-on-Financial-
Inclusion.pdf, accessed on 22 April 2017.

214
 Annexure 4
REPORT OF THE
SUB- COMMITTEE OF
THE CENTRAL BOARD OF
DIRECTORS OF THE RESERVE
BANK OF INDIA TO STUDY
ISSUES AND CONCERNS IN
THE MFI SECTOR, 2011*
Chair: Y. H. Malegam

Summary of recommendations
Recommendations
1 The need for regulation
A separate category be created for NBFCs operating in the
Microfinance sector, such NBFCs being designated as
NBFC-MFI.
2 Definition
A NBFC-MFI may be defined as “A company (other than a com-
pany licensed under Section 25 of the Companies Act, 1956)
which provides financial services pre-dominantly to low-
income borrowers with loans of small amounts, for short-
terms, on unsecured basis, mainly for income-generating
activities, with repayment schedules which are more frequent
than those normally stipulated by commercial banks and
which further conforms to the regulations specified in that
behalf”. Provision should be made in the regulations to fur-
ther define each component of this definition.

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3 Regulations to be specified
A NBFC classified as a NBFC-MFI should satisfy the following
conditions:
a Not less than 90% of its total assets (other than cash and
bank balances and money market instruments) are in the
nature of “qualifying assets”.
b For the purpose of (a) above, a “qualifying asset” shall
mean a loan which satisfies the following criteria:
the loan is given to a borrower who is a member of a house-
hold whose annual income does not exceed 50,000;
the amount of the loan does not exceed 25,000, and the
total outstanding indebtedness of the borrower, includ-
ing this loan, also does not exceed 25,000;
the tenure of the loan is not less than 12 months where the
loan amount does not exceed 15,000 and 24 months in
other cases with a right to the borrower of prepayment
without penalty in all cases;
the loan is without collateral;
the aggregate amount of loans given for income generation pur-
poses is not less than 75% of the total loans given by the MFIs;
the loan is repayable by weekly, fortnightly or monthly
installments at the choice of the borrower.
c The income it derives from other services is in accordance
with the regulation specified in that behalf.
4 Regulations to be specified
A NBFC which does not qualify as a NBFC-MFI should not be
permitted to give loans to the microfinance sector, which in the
aggregate exceed 10% of its total assets.
5 Pricing of interest
There should be a “margin cap” of 10% in respect of MFIs which
have an outstanding loan portfolio at the beginning of the year
of 100 crores and a “margin cap” of 12% in respect of MFIs
which have an outstanding loan portfolio at the beginning of
the year of an amount not exceeding 100 crores. There should
also be a cap of 24% on individual loans.
6 Transparency in Interest Charges
a There should be only three components in the pricing of the
loan, namely (1) a processing fee, not exceeding 1% of the
gross loan amount, (2) the interest charge and (3) the insurance
premium.

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b Only the actual cost of insurance should be recovered and no

administrative charges should be levied.
c Every MFI should provide to the borrower a loan card which
(1) shows the effective rate of interest, (2) the other terms and
conditions attached to the loan, (3) information which ade-
quately identifies the borrower and (4) acknowledgements by
the MFI of payments of installments received and the final dis-
charge. The Card should show this information in the local
language understood by the borrower.
d The effective rate of interest charged by the MFI should be
prominently displayed in all its offices and in the literature
issued by it and on its website.
e There should be adequate regulations regarding the manner in
which insurance premium is computed and collected and policy
proceeds disposed of.
f There should not be any recovery of security deposit. Security
deposits already collected should be returned.
g There should be a standard form of loan agreement.
7 Multiple-lending, over-borrowing and ghost-borrowers
a MFIs should lend to an individual borrower only as a member
of a JLG and should have the responsibility of ensuring that the
borrower is not a member of another JLG.
b A borrower cannot be a member of more than one SHG/
JLG.
c Not more than two MFIs should lend to the same borrower.
d There must be a minimum period of moratorium between the
grant of the loan and the commencement of its repayment.
e Recovery of loan given in violation of the regulations should be
deferred till all prior existing loans are fully repaid.
8 Multiple-lending, over-borrowing and ghost-borrowers
All sanctioning and disbursement of loans should be done only
at a central location and more than one individual should be
involved in this function. In addition, there should be close
supervision of the disbursement function.
9 Credit Information Bureau
a One or more Credit Information Bureaus should be established
and be operational as soon as possible and all MFIs be required
to become members of such bureaus.
b In the meantime, the responsibility to obtain information from
potential borrowers regarding existing borrowings should be
on the MFI.

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10 Coercive Methods of Recovery

a The responsibility to ensure that coercive methods of recovery
are not used should rest with the MFIs, and they and their man-
agements should be subject to severe penalties if such methods
are used.
b The regulator should monitor whether MFIs have a proper
Code of Conduct and proper systems for recruitment, training
and supervision of field staff to ensure the prevention of coer-
cive methods of recovery.
c Field staff should not be allowed to make recovery at the place
of residence or work of the borrower, and all recoveries should
only be made at the Group level at a central place to be desig-
nated.
d MFIs should consider the experience of banks that faced simi-
lar problems in relation to retail loans in the past and profit by
that experience.
e Each MFI must establish a proper Grievance Redressal Proce-
dure.
f The institution of independent Ombudsmen should be exam-
ined, and based on such examination, an appropriate mecha-
nism may be recommended by the RBI to lead banks.
11 Customer Protection Code
The regulator should publish a Client Protection Code for MFIs
and mandate its acceptance and observance by MFIs. This Code
should incorporate the relevant provisions of the Fair Practices
Guidelines prescribed by the Reserve Bank for NBFCs. Similar
provision should also be made applicable to banks and finan-
cial institutions which provide credit to the microfinance sector.
12 Improvement of efficiencies
MFIs should review their back office operations and make the
necessary investments in Information Technology and systems
to achieve better control, simplify procedures and reduce costs.
13 Support to SHGs/JLGs
Under both the SBLP model and the MFI model, greater resources
should be devoted to professional inputs both in the formation
of SHGs and JLGs as also in the imparting of skill development
and training and generally in handholding after the group is
formed. This would be in addition to and complementary to
the efforts of the state governments in this regard. The archi-
tecture suggested by the Ministry of Rural Development should
also be explored.

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14 Corporate size
All NBFC-MFIs should have a minimum Net Worth of 15 crores.
15 Corporate governance
Every MFI should be required to have a system of Corporate Gover-
nance in accordance with rules to be specified by the Regulator.
16 Maintenance of solvency
Provisioning for loans should not be maintained for individual
loans, but an MFI should be required to maintain at all times
an aggregate provision for loan losses which shall be the higher
of: (1) 1% of the outstanding loan portfolio or (2) 50% of the
aggregate loan installments which are overdue for more than
90 days and less than 180 days and 100% of the aggregate loan
installments which are overdue for 180 days or more.
17 Maintenance of solvency
NBFC-MFIs should be required to maintain Capital Adequacy
Ratio of 15% and subject to recommendation 21 below, all of
the Net Owned Funds should be in the form of Tier I Capital.
18 Need for competition
Bank lending to the Microfinance sector both through the SHG-
Bank Linkage programme and directly should be significantly
increased, and this should result in a reduction in the lending
interest rates.
19 Priority sector status
Bank advances to MFIs shall continue to enjoy “PSL” status. How-
ever, advances to MFIs which do not comply with the regulation
should be denied “PSL” status. It may also be necessary for the
Reserve Bank to revisit its existing guidelines for lending to the pri-
ority sector in the context of the Committee’s recommendations.
20 Assignment and securitisation
a Disclosure is made in the financial statements of MFIs of the
outstanding loan portfolio which has been assigned or secu-
ritised and the MFI continues as an agent for collection. The
amounts assigned and securitised must be shown separately.
b Where the assignment or securitisation is with recourse, the
full value of the outstanding loan portfolio assigned or securi-
tised should be considered as risk-based assets for calculation
of Capital Adequacy.
c Where the assignment or securitisation is without recourse
but credit enhancement has been given, the value of the credit
enhancement should be deducted from the Net Owned Funds
for the purpose of calculation of Capital Adequacy.

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d Before acquiring assigned or securitised loans, banks should

ensure that the loans have been made in accordance with the
terms of the specified regulations.
21 Funding of MFIs
a The creation of one or more “Domestic Social Capital Funds”
may be examined in consultation with SEBI.
b MFIs should be encouraged to issue preference capital with a
ceiling on the coupon rate, and this can be treated as part of
Tier II capital subject to capital adequacy norms.
22 Monitoring of compliance
a The primary responsibility for ensuring compliance with the
regulations should rest with the MFI itself, and it and its man-
agement must be penalised in the event of non-compliance.
b Industry associations must ensure compliance through the
implementation of the Code of Conduct with penalties for non-
compliance.
c Banks also must play a part in compliance by surveillance of
MFIs through their branches.
d The Reserve Bank should have the responsibility for off-site and
on-site supervision of MFIs, but the on-site supervision may be
confined to the larger MFIs and be restricted to the function-
ing of the organisational arrangements and systems with some
supervision of branches. It should also include supervision of
the industry associations in so far as their compliance mecha-
nism is concerned. Reserve Bank should also explore the use of
outside agencies for inspection.
e The Reserve Bank should have the power to remove from office
the CEO and/or a director in the event of persistent violation of
the regulations quite apart from the power to deregister an MFI
and prevent it from operating in the microfinance sector.
f The Reserve Bank should considerably enhance its existing
supervisory organisation dealing with NBFC-MFIs.
23 Moneylenders Acts
NBFC-MFIs should be exempted from the provisions of the
Money-Lending Acts, especially as we are recommending inter-
est margin caps and increased regulation.
24 The Micro Finance (Development and Regulation) Bill 2010
Subject to Smt. Rajagopalan’s reservations as expressed in para.
24.6 above, we would, therefore, recommend the following:
a The proposed Act should provide for all entities covered by
the Act to be registered with the Regulator. However, enti-

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ties where aggregate loan portfolio (including the portfolio

of associated entities) does not exceed 10 crores may be
exempted from registration.
b If NABARD is designated as the regulator under the pro-
posed Act, there must be close co-ordination between NAB-
ARD and Reserve Bank in the formulation of the regulations
applicable to the regulated entities.
c The microfinance entities governed by the proposed Act
should not be allowed to do the business of providing thrift
services.
25 The Andhra Pradesh Micro Finance Institutions (Regulation of
Money Lending) Act
If the Committee’s recommendations are accepted, the need for a
separate Andhra Pradesh Micro Finance Institutions (Regula-
tion of Money Lending) Act will not survive.
26 Transitory Provisions
a 1 April 2011 may be considered as a cut- off date by which time
our recommendations, if accepted, must be implemented. In
particular, the recommendations as to the rate of interest must,
in any case, be made effective to all loans given by an MFI after
31 March 2011.
b As regards other arrangements, Reserve Bank may grant such
extension of time as it considers appropriate in the circum-
stances. In particular, this extension may become necessary for
entities which currently have activities other than microfinance
lending and which may need to form separate entities confined
to microfinance activities.

Note
* Source: Malegam, YH. 2011. Report of the Sub-Committee of the Central
Board of Directors of of Reserve Bank of India to Study Issues and Con-
cerns in the MFI Sector. Mumbai: Reserve Bank of India. https://rbidocs.
rbi.org.in/rdocs/PublicationReport/Pdfs/YHMR190111.pdf, accessed on
19 May 2017.

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 Annexure 5
REPORT OF THE INTERNAL
WORKING GROUP TO
REVISIT EXISTING
PRIORITY SECTOR LENDING
GUIDELINES, 2015 *

Executive summary
1 In the past, the objective of PSL has been to ensure that the vulner-
able sections of society get access to credit and there is adequate flow
of resources to those segments of the economy which have higher
employment potential and help in making an impact on poverty alle-
viation. Thus, the sectors that impact large sections of the population,
the weaker sections and the sectors which are employment-intensive
such as agriculture and micro and small enterprises were included in
the priority sector. India, in her quest for inclusive growth, has exper-
imented with a variety of policy mix since gaining independence in
1947. Policymaking, however, evolves based on experience gained in
success and failure of past measures, and reflects changing priorities
over time. The Indian economy has not only undergone a structural
transformation, but has also been increasingly integrated into the
global economy. The national priorities have changed over the last
four decades, as India has moved up to middle income level status.
The emphasis now, over and above lending to vulnerable sections,
is to increase employability, create basic infrastructure and improve
competitiveness of the economy, thus creating more jobs.
2 Hence, there is a need to ensure adequate allocation of credit to
emerging priority sectors. The issue regarding the need for con-
tinuance of priority sector prescriptions was discussed with a rep-
resentative section of bankers and some of the other stakeholders
to get a wider perspective. A general perception that emerged
was that if the prescriptions under PSL had not been there, the

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identified sectors would not have benefited to the extent they have,
and hence, there is a need to continue with priority sector pre-
scriptions. However, the composition of the priority sector needs
a re-look and review to re-align it with the national priorities and
financial inclusion goals of the country.
3 The Working Group, therefore, felt that while revisiting the extant
guidelines on the priority sector, the focus will be on giving a
thrust to areas of national priority as well as inclusive growth.
In this backdrop, the Working Group has looked at the follow-
ing sectors for priority sector status viz., agriculture, Micro, Small
and Medium Enterprises (MSMEs), exports, social infrastructure,
renewable energy, educational loans and housing.

Overall priority sector target

4 In view of the continued need for making credit available to vari-
ous priority sectors on grounds of growth and equity, the Working
Group recommends that the target for lending to the redefined
priority sector may be retained at 40% of ANBC or Credit Equiva-
lent of Off-Balance Sheet Exposure (CEOBE), whichever is higher,
for all scheduled commercial banks uniformly. All foreign banks
(irrespective of number of branches they have) may be brought
on par with domestic banks, and the same target/sub-targets may
be made applicable to them. Foreign banks with 20 and above
branches may be given time up to March 2018 in terms of extant
guidelines and submit their revised action plans. Other foreign
banks, i.e. with less than 20 branches, may be given time up to
March 2020 to comply with the revised targets as per action plans
submitted by them and approved by the Reserve Bank.
5 In view of the need for efficiency in PSL, the Working Group has
made certain recommendations which include introduction of
PSLCs. These instruments would provide a mechanism for banks
to specialise in certain segments of the priority sector and leverage
on their comparative advantage.

Agriculture
6 The Working Group has attempted to focus on “credit for agri-
culture” rather than “credit in agriculture”. While the Working
Group recommends retaining the agriculture target of 18%, the
approach and thrust has been re-defined to include (1) Farm Credit

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(which will include short-term crop loans and medium/long-term

investment credit to farmers), (2) Agriculture Infrastructure and
(3) Ancillary Activities and on-lending as defined in Chapter 4.
7 Considering the significant share of landholdings of small and
marginal farmers and their contribution to the agriculture sector,
the Working Group recommends a sub-target of 8% of ANBC
for lending to them, which is to be achieved in a phased man-
ner within a period of two years, i.e., achieve 7% by March
2016 and 8% by March 2017. The remaining 10% may be
given to other farmers, agri-infrastructure and ancillary activi-
ties. Perceiving the huge need to create rural infrastructure and
processing capabilities, the Working Group decided not to put
any caps on the loan limits for lending for agri-infrastructure and
agri-processing.
8 The Working Group has designed a framework for a periodic reset of
the agricultural targets. It has recommended that while the agricul-
ture lending target should be retained at 18% of ANBC, the designed
framework can be followed for resetting of this target every three
years, depending on the function of three variables viz., contribution
of agriculture to GDP, employment and number of credit accounts.

Micro, small and medium enterprises

9 Presently, credit extended to micro and small enterprises counts
for the priority sector. The Working Group recommends extending
PSL status to Medium Enterprises (MEs) in addition to the Micro
and Small Enterprises (MSEs). While all MEs (Manufacturing)
may be included under PSL, MEs (Service) with credit limit up to
Rs.10 crore may be eligible to qualify for PSL.
10 To ensure that the smallest segment within the MSME sector, i.e.
microenterprises, is not crowded out with the inclusion of the
medium enterprises, the Working Group recommends a target of
7.5% of ANBC for lending to microenterprises to be achieved in
stages, i.e. achieve 7% by March 2016 and 7.5% by March 2017.
11 Further, as the MSMED Act 2006 does not provide for any sub-
categorisation within the definition of microenterprise and a
separate sub-target for microenterprises has been suggested, the
Working Group recommends that the extant provisions of further
bifurcating microenterprises may be dispensed with.
12 To ensure that MSMEs do not remain small and medium units
merely to be eligible for priority sector status, the Working Group

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recommends that the PSL status may stay with them for up to
three years after they grow out of the category of MSMEs.
13 It was announced in the Union Budget 2014–15 that the definition
of MSME will be reviewed to provide for a higher capital ceiling.
In the light of the Budget announcement, the Working Group rec-
ommends that the matter may be pursued with the government.
Any change in definition will automatically apply to PSL norms
from the date it is notified.

Exports
14 Given the importance of exports in the economy and to give focused
attention to export finance within the PSL, the Working Group rec-
ommends carving out a separate category of export credit under
the priority sector. The Working Group recommends that incre-
mental export credit from a base date (i.e. the outstanding export
credit as on the date of reckoning minus outstanding export credit
as on the base date) to units having turnover of up to Rs.100 crore
having sanctioned credit limit of up to Rs.25 crore from the bank-
ing system may be included in priority sector. The export credit
under the priority sector may have a ceiling of 2% of ANBC in
order to ensure that other segments are not crowded out.

Education
15 The Working Group endorses the need for continuation of includ-
ing education loans and including loans for vocational courses
under the priority sector. The recent trends in education loans,
however, suggested a concentration of educational loans in the
size class of up to Rs.5 lakh, notwithstanding the extant ceilings
of Rs.10/20 lakh. Taking this into account, the Working Group
recommends that an amount of Rs.10 lakh for education loans
per borrower, irrespective of the sanctioned limit, be considered
eligible under the priority sector. As the extant guidelines provide
for loans up to Rs.20 lakh for study abroad, all such existing loans
may continue under the priority sector until the date of maturity.

Housing
16 With a view to ensure that the credit flows to needy persons for
affordable housing, it is recommended that the overall cost of the
dwelling unit in the metropolitan centre and at other centres should

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not exceed Rs.35 lakh and Rs. 25 lakh respectively. Further, with a
view to align it with guidelines on Loan to Value Ratio (presently
80% for loans above Rs.20 lakh) prescribed by the Reserve Bank, it
recommends that the priority sector limits be modified and fixed at
Rs.28 lakh in metropolitan centres and Rs.20 lakh in other centres.
17 The recent guidelines allow exemption from ANBC for long-term
bonds for lending to housing loans with a loan up to Rs.50 lakh.
As the inclusion of priority sector housing loans, which are backed
by the long term bonds, would result in “double counting” on
account of an exemption from ANBC, the Working Group rec-
ommends that banks should either include housing loans to indi-
viduals up to the prescribed ceiling under the priority sector or
take benefit from exemption from ANBC, but not both. All other
existing guidelines regarding housing loans may be continued.

Weaker sections
18 So that vulnerable sections of the society get a reasonable share of
bank credit, the Working Group recommends that existing catego-
ries and the target of 10% of ANBC for loans to weaker sections
may continue as per extant guidelines with some enhancement in
the existing loan limits.

Social infrastructure
19 Given the importance of social infrastructure for development and
its impact on ultimate credit absorption in rural and urban areas,
the Working Group recommends that financing for building infra-
structure for certain activities viz., schools and health care facili-
ties, drinking water facilities and sanitation facilities in Tier II to
Tier VI centres, with population less than 1 lakh, may be treated
as a separate category under priority sector, subject to a ceiling of
Rs.5 crore per borrower.

Renewable energy
20 The Working Group recommends that bank loans up to Rs.10
crore to borrowers other than households, for purposes like solar-
based power generators, biomass-based power generators, wind
mills and micro-hide plants and for purposes like non-conventional
energy-based public utilities viz., street lighting systems, remote

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village electrification, etc., be included under the priority sector.

For the household sector, the loan limit may be Rs.5 lakh.

Review of limits
21 The Working Group recommends that the various loan limits rec-
ommended should be reviewed once in three years. In addition,
based on the experience gained, the targets and sub-targets recom-
mended may also be revisited.

Monitoring and reporting

22 Presently, PSL compliance is monitored on the last day of March
each year. The Working Group recommends that more frequent
monitoring of PSL compliance by banks may be done. To start
with, it may be done on a “quarterly” basis. The Working Group
recommends that PSL shortfall should be worked out based on the
average shortfall for the four quarters during the financial year.
The base for determining the target achievement for each quarter
end, i.e. ANBC, should be as of the corresponding date of the
previous year so that banks get sufficient time for planning and
achieving the targets, and seasonalities are taken care of.
23 The reporting format for PSL may be modified to capture the
achievement of banks on the PSL targets/sub-targets recom-
mended by the Working Group. While monitoring the lending to
small and marginal farmers, it may have to be ensured that the
format captures lending to small and marginal farmers directly as
well as through SHGs/JLGs, farmer producer organisations, etc.
To ensure accurate reporting to the Reserve Bank, banks would
have to ensure that they build a robust database on PSL.

Priority Sector Lending Certificates (PSLCs)

24 The Working Group recommends introduction of PSLCs to enable
banks to meet their PSL requirements and allow leveraging of their
comparative advantage. The model on PSLCs envisages that banks
will issue PSLCs that can be purchased at a market determined
fee on an electronic platform. This purchase will give the buyer a
right to undershoot his PSL achievement for the stated amount of
PSLC. PSLCs would count specifically towards PSL achievement,

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and thus would be sector/sub-sector specific where particular tar-

gets have been mandated. It would not be necessary for an issuer
to have underlying assets on his books at the time of issue of PSLC
or for the buyer to have a shortfall in obligation of that amount.
The issuer could assess possible credit achievement during the year
and issue PSLCs of the estimated surplus. However, as the PSLCs
could be issued without an underlying, there is a risk that the issu-
ing bank may overestimate its achievement and fall short on the
reporting date, thereby subjecting itself to penalties. Therefore, no
bank can issue PSLCs of more than 50% of last year’s PSL achieve-
ment or excess over the last year’s PSL achievement, whichever is
higher. However, there would be no limit on the amount of PSLCs
that could be purchased for achievement of various targets.
25 The buyer could also estimate possible credit shortfall without
the need for waiting till the time of such shortfall or he could
also buy PSLCs with a view to trading them when premiums are
higher. This would add to efficiency in meeting targets and create
a deep and liquid forward market. PSLCs envisage the separa-
tion of transferring priority sector obligations from the credit risk
transfer and refinancing aspects. While the PSLCs will be sold, the
loans would continue to be on the books of the original lender.
If the loans default, for example, no loss would be borne by the
certificate buyer. As stated in the Report of the Committee on
Financial Sector Reforms, the merit of a scheme of this nature is
that it would allow the most efficient lender to provide access to
the poor, while finding a way for banks to fulfil their norms at a
lower cost. Essentially, the PSLCs will be a market-driven interest
subsidy to those who make priority sector loans.
26 In the future, the Reserve Bank may intervene in the market for
PSLCs to encourage further lending to a particular sector.

Non-achievement of targets
27 With the inclusion of new sectors and introduction of PSLCs,
banks would be better placed to achieve the targets and sub-
targets. However, in case of shortfall, the prevailing penal provi-
sions would continue. The need for more stringent measures such
as imposition of monetary penalties could be considered either
independently or in combination with the existing provisions after
a period of three years of operationalisation of the PSLC market
and based on the performance of banks in achievement of targets.

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Improving the credit culture

28 The Working Group observed that it would also be necessary to
look at the credit delivery mechanism to ensure that credit reaches
the intended beneficiaries and misuse in the form of availing of
credit from multiple institutions does not take place. The Working
Group, therefore, recommends that, to be eligible for PSL status,
any borrowal account, including that to individual members of
SHGs and JLGs, should be reported to one of the credit bureaus.
The information should also capture the borrower’s Aadhaar num-
ber, which will help in identification of the borrower. The deadline
for this may be linked to that of UIDAI deadline for completion of
Aadhaar enrolment. A system of information sharing may be put
in place between the credit bureaus.

Note
* Source: Reserve Bank of India. 2015. Report of the Internal Working
Group to Revisit Existing Priority Sector Lending Guidelines. Mumbai:
Reserve Bank of India. https://rbidocs.rbi.org.in/rdocs/PublicationReport/
Pdfs/PSGRE020315.pdf, accessed on 19 May 2017.

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