Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment

The question of whether state-led expansion of credit and savings facilities can reduce poverty has long been of interest to economists and policymakers. A large theoretical body of literature identifies different mechanisms through which access to such facilities can enable individuals to alter their production and employment choices, and thereby exit poverty (Philippe Aghion and Patrick Bolton, 1997; Abhijit Banerjee and Andrew Newman, 1993; Banerjee, 2004). The belief that governments can use public policy to alleviate financing constraints, and thereby engender development and reduce poverty, led to the widespread implementation of state-led rural credit and savings schemes in low-income countries in the postcolonial period. In most cases this was accomplished through government oversight of the banking sector, often aided by government ownership of banks. Today, these schemes remain important in many developing countries (Timothy Besley, 1995). Many believe, however, that formal subsidized credit was ineffective in reaching the poor, and may even have undermined rural development and increased rural poverty. Some claim that the elite capture concentrated formal subsidized credit in the hands of the powerful few and worsened terms in the informal markets on which the poor depend (Dale W. Adams et al., 1984; Avishay Braverman and J. Luis Guasch, 1986). Others argue that state control led to political considerations determining credit allocation and made the banking sector susceptible to elite capture (Rafael La Porta et al., 2002; Paola Sapienza, 2004). Credible evidence on whether state-led expansion of the banking sector can reduce poverty, however, remains limited. The central reason for this is the nonrandom nature of these programs. Specifically, banks favor opening branches in richer areas, while state-led bank branch expansion programs tend to target poorer areas. This makes identification of the causal impact of branch expansion on poverty outcomes problematic. In this paper, we evaluate how a large state-led bank branch expansion program in India affected rural poverty. The policy rules underlying the program provide a credible source of exogenous variation in rural branch expansion. This program is the largest branch expansion program undertaken by any single country. After bank nationalization in 1969, the Indian government launched an ambitious social banking program which sought to improve the access of the rural poor to formal credit and saving opportunities. The program ended in 1990. Between 1969 and 1990, bank branches were opened in roughly 30,000 rural locations with no prior formal credit and savings institutions (unbanked locations). An integral element of this program was branch expansion into rural unbanked locations. * Burgess: Economics Department, London School of Economics, Houghton Street, London WC2A 2AE (e-mail: r.burgess@lse.ac.uk); Pande: Economics Department, Economic Growth Center, Yale University, P.O. Box 208269, New Haven, CT 06520 (e-mail: rohini.pande@yale.edu). We thank Esther Duflo for very helpful and detailed comments. We have benefited from comments and suggestions from Abhijit Banerjee, Tim Besley, Richard Blundell, Bronwen Burgess, Anne Case, Ken Chay, Jonathan Murdoch, Atif Mian, Andrew Newman, Dominic Leggett, Debraj Ray, Mark Rosenzweig, Ken Sokoloff, Duncan Thomas, Robert Townsend, a co-editor, two anonymous referees, and numerous seminar participants. Juan de Laiglesia, Mattia Romani, Gaurav Shah, Heideeflower Stoller, Pataporn Sukontamarn, and Grace Wong provided exceptional research assistance. 1 Bank expansion and economic growth are positively correlated in cross-country data (e.g., Robert King and Ross Levine, 1993). The fact that countries with greater growth potential may attract more banks, however, makes causal inference difficult. 2 Throughout the paper, locations refer to villages, towns, and cities as defined by the Indian Census. The Census defines a location with fewer than 10,000 persons as rural. The same holds for rural and urban poverty definitions.