Y V Reddy: Financial inclusion and central banking - reflections and
issues
Keynote speech by Dr Y V Reddy, Governor of the Reserve Bank of India from 2003 to 2008,
at the 14th SEACEN Executive Committee Meeting and High-Level Seminar, Port Moresby,
1-4 October 2015.
* * *
I am thankful to Rakesh Mohan, Usha Thorat, Deepak Mohanty and Saibal Ghosh, all from the Reserve Bank of
India, for their valuable input.
Governor Loi Bakani, Chairman, SEACEN Board of Governors, Deputy Governors, Hans
Genberg of SEACEN, Madhusudan Mohanty of BIS, distinguished central bankers and
friends.
I am thankful to the BIS and SEACEN for giving me the opportunity of being with central
bankers again and delivering a keynote speech on a subject close to my heart. It is a
pleasure and privilege to be with you again. It is said that "once a central banker, always a
central banker", and so I remain one, although I joined the fraternity towards the end of my
career. I continue to have a close association with SEACEN, where I meet old friends and
make new ones.
I am grateful to Governor Bakani and his team for hosting this event; and for the excellent
arrangements. Governor, you and your team have been courteous, pleasant, cheerful and
helpful, and we greatly enjoyed the hospitality over dinner yesterday evening. We also had
discussions, as all central bankers do when they meet, about worrying about what we should
be worrying about.
In this presentation, I will share my personal reflections with you on the origins of financial
inclusion as a concept and a policy in India; and how it became a joint responsibility of the
government and the Reserve Bank.
I will follow it with what I may term the globalisation of financial inclusion as a policy and what
is new about it after the Global Financial Crisis. I will then summarise the issues of concern
to central banks that have been flagged so far.
I will conclude with what, I believe, are right questions, in addition to issues that central
banks should be asking when they deal with financial inclusion.
I took over as Governor of the Reserve Bank of India (RBI) in September 2003. I continued
with the reform process and like my predecessors recognised expectations that the RBI will
continue to be involved in credit availability for development and stability. Also, I was not a
blue-blooded central banker, having been in local, state and union governments. So, I
wanted to project the Reserve Bank as an institution concerned with the common people and
not just financial markets and financial institutions.
Keeping in view the need for continuity with change as appropriate to evolving
circumstances, we in the RBI pursued five broad policy directions. First, reforms in monetary
management consistent with global developments; second, alignment of bank regulation with
global standards; third, improving legal and institutional infrastructure to enable a modern
financial system, in particular in the payments system; fourth, harmonising as far as possible,
developmental objectives with those of stability in consultation with government, and; fifth,
exploring ways in which the financial sector could better serve ordinary people. I emphasised
the fifth aspect, that finance should serve ordinary people, as opposed to making the
assumption that the development of the financial sector by itself will contribute to economic
development and welfare. Some initiatives, particularly those relating to financial inclusion in
India since 2003, reflect this orientation towards the common people. Financial inclusion,
thus, was not designed as a programme in isolation, but as a part of the overall strategy in
regard to the role of the central bank, as warranted by the Indian context of inadequate
access to essential financial services.
I was acutely aware, having been a Deputy Governor for six years, that the needs of the
common person were not served well enough by the financial sector, despite all the
investment, innovation and strengthening of existing institutions in the financial system,
particularly banks. So, while pursuing the reform agenda already set, and in parallel, I put the
focus on serving the needs of ordinary people in their interactions with the banking system.
In doing this, I realised that our efforts were addressed to meeting the needs of those who
already had links to banks. What about the rest, who actually were far more in number than
those with links to banks? So, the reform agenda provided for improvements in the way that
the financial sector served ordinary people better and ensuring that it would reach out to all.
My assessment of the common person's requirements at that time was as follows:
What do ordinary people in India, at this juncture want most from us, the central bank? First
and foremost, a safe place to keep their cash especially for poor women who have to keep
their earnings out of the reach of their drunken husbands. Second, mechanisms for
consumption-smoothing since 90% of the population is employed in the unorganised sector
with seasonal or uncertain income flows. Third, remittances to families by migrant workers;
migration of labour within the country in search of seasonal employment was large. Workers
had to migrate to urban areas in order to continue supporting their families in rural areas.
This required attention to remittance facilities, also out in the countryside. Fourth, increased
stringency in regard to know-your-customer and anti-money laundering requirements after
9/11 were hindering access for people in the unorganised sector to banking facilities. This
understanding led me to a design for what we, at some stage, described as financial
inclusion.
Prior to the formal articulation of this concept, with the support of Indian Bank, especially Dr
Chakraborty and Mr Samba Murthy, we attempted a survey of people's access to banking
facilities and their utilisation in one region. Efforts were also made to experiment with "no frills
accounts" and "zero balance accounts". We made assessments that revealed a distinction
between access and utilisation, and the underlying factors. A major issue was the all-in cost
of a financial service. For instance, when the costs of travel to a bank, foregone wages for
that day, the need for documentation, and uncertainty about the timely availability of credit
are included, the cost of formal credit to the borrower may exceed that of credit from an
informal source.
In parallel, the Institute for Development & Research in Banking Technology (IDRBT) in
Hyderabad, in collaboration with the Government of Andhra Pradesh, was experimenting on
the scope for transfer of funds from the government to individual beneficiaries of government
cash disbursement programmes via the use of technology. This required the opening of
accounts for individual beneficiaries who were widely dispersed and large in number. This
laid the foundation for what has been described as a new system of government-to-person
payments.
A committee under the chairmanship of Mr H R Khan gave several recommendations, of
which the Business Correspondent Model was an important one. We tried to expand the
reach of each bank branch through a correspondent; and the bank was expected to ensure
compliance of the correspondent with all the RBI's regulatory requirements. People had
comfort that they were linked to a bank branch and the Reserve Bank could have some
regulatory comfort. Microfinance institutions, which were for the most part not-for-profit
institutions at that time, were also supported as instruments of financial inclusion. They,
however, tended to concentrate on areas that were already banked or covered by self-help
groups sponsored by banks, such as those in Andhra Pradesh. A measure that had great
impact on financial inclusion was making all ATM transactions across all branches,
irrespective of where accounts are held, free of charge. This initiative actually became a
means of transferring money to migrants and students at no cost. It reduced the need to hold
cash in advance of needs. Unlike a branch, it was a place where everyone, rich or poor, was
in the same queue.
As we were undertaking all these different measures, I wanted to communicate this policy
commitment to meeting the needs of ordinary people for essential financial services in the
Monetary Policy Statement of 2005. Mrs Usha Thorat, the Deputy Governor, and I worked
together on a draft. It required several painstaking interactions. A literature review indicated
that most policy measures in this regard related to the development of financial markets,
financial sector deepening, regulation of financial institutions and payment, clearing and
settlement systems and, to some extent, the provision of microcredit. There were some
examples of policy actions that addressed the issue of exclusion from facilities available
through banking system. Examples were found mainly in the United States. In France we
found that access to a bank account was a right. I initially considered the title of "Financial
exclusion" and a description of measures to overcome it. As I was finalising the draft of the
Annual Policy Statement for the year 2006-07, issued on 18 April 2006, it struck me that
what had been attempted particularly in the past year was actually reaching out, and hence
the title should be "Financial inclusion". This articulation by the Reserve Bank is the origin of
the concept of financial inclusion. It also paves the way for the central bank's involvement, in
India at least.
The concept of financial inclusion as articulated by the RBI caught the imagination of many
people, particularly in state governments. It also attracted the attention of the central
government, and a Committee on Financial Inclusion under the Chairmanship of Dr C
Rangarajan was appointed. Financial inclusion was formally defined by the Committee, as
"the process of ensuring access to financial services and timely and adequate credit where
needed to vulnerable groups such as weaker sections and low income groups at affordable
cost". Mrs Usha Thorat was also a member. The Committee's report (January 2008)
presented what I may call the "government's view" of financial inclusion, and continued to
give a central place to provision of credit to vulnerable sections, especially for productive
purposes, as an important ingredient of the financial inclusion concept. The main
responsibility for the programme was assigned to the National Bank for Agriculture and
Development, an apex development institution in India.
These are the origins of the concept of financial inclusion, which has now become an agenda
item in public policy with responsibility shared between the government and the RBI.
However, it first caught the attention of the global community immediately after the Global
Financial Crisis in 2008.
Globalisation of financial inclusion
I believe that financial inclusion gave a positive twist to the policy responses to the Global
Financial Crisis (GFC). The GFC warranted a massive coordinated policy intervention, by
both governments and central bankers, to save the world economy from depression. The
financial sector was viewed as a villain by many, and governments and central banks were
often accused of bailing banks out at great expense to the exchequer. In the context of the
GFC and Occupy Wall Street etc, policymakers must have felt a need to demonstrate that
they were concerned as much with people as with finance. Further, they had to create a
direct stake for larger segments of the population in the financial sector that they were
intending to build for the future.
Many developing countries were concerned for quite some time with issues of connecting
people with finance, but for the global community this became an issue only as a
consequence of the GFC. Before the GFC, for advanced economies, the focus was on
extending credit to those without assets.
The G20 statement and subsequent follow-up actions by various multilateral institutions have
to be viewed in this context. Financial inclusion was put on the G20 agenda in November
2008 and, in 2010, it became one of the pillars of the global development agenda. So, we
now have the G20's Financial Inclusion Action Plan and the Global Partnership for Financial
Inclusion, apart from follow-up work by the IMF, World Bank and BIS, among others. As a
result of the GFC, the policy of leaving it to the markets had to be replaced with a promise of
a little more financial sector regulation. To secure a wider acceptance of globally coordinated
actions, a commitment to bailouts had to be accompanied by a policy of reaching out to the
underprivileged.
The net result has been that central banks, who pre-GFC were required to focus on
monetary policy with a single objective or at least one primary objective, namely, price
stability, are now encouraged to add financial stability to their concerns and also financial
inclusion.
What is new?
As the Indian case has illustrated, central banks and governments all over the world have
been taking measures, as part of their normal policies, to ensure the availability of and
access to financial services for all segments of population. In particular, developing countries
have been promoting microfinance, which has been recognised as a form of financial
inclusion. So, what is new about financial inclusion? I will attempt a few generalisations.
First, as already mentioned, financial inclusion, along with financial stability, has become the
joint responsibility of central banks and governments. However, developing and emerging
market economies have become leaders in innovation in this regard, since their requirements
are huge.
Second, the objectives of financial inclusion have been expanded to encompass ease of
financial transactions and economic development, well beyond addressing issues relating to
the provision of credit to the underprivileged. Financial inclusion is expected to deliver on
several fronts. It is expected to provide a more stable retail deposit base and reduce reliance
on borrowed funds. Combined with IT solutions, it is a powerful catalyst for payments system
and remittances. It could enhance financial stability by improving the health of household
sector. It is also expected to help in the monitoring of suspicious transactions by expanding
the scope for the formal sector. Financial inclusion is also expected to lead to innovative
solutions, as it extends the provision of financial services to a larger and more diverse
population. There are claims that financial inclusion could also help reduce income inequality
and narrow the gender gap. Policies for financial inclusion, which were hitherto restricted to
credit and, to some extent, deposit-taking, cover several financial products, especially
insurance products. There have been some voices, such as the IMF's, which take a
balanced view of the benefits, costs and risks of various components of financial inclusion.
Third, new types of bank, with a special focus on local areas and specific tasks, are being
considered, as in India. No doubt, many countries have community banks and other
institutions, but financial inclusion has led to a search for new institutions with a different
focus. Non-bank financial institutions are also involved in financial inclusion. Policies for
financial inclusion recognise and, indeed, emphasise the role of for-profit enterprises to
ensure scalability and sustainability. This is in contrast to microcredit, where in the past
notfor-profit institutions and the integration of credit with income generation were preferred.
Notfor-profit entities such as the Bill Gates Foundation have extended full support to the global
initiatives in this regard.
Fourth, the coverage of financial inclusion has been expanded from households to include
small enterprises, small businesses and some organisational forms. At the same time, limits
are set in terms of transaction size to define what constitutes financial inclusion.
Fifth, some of the regulatory and procedural prescriptions that had inhibited financial
inclusion, such as know-your-customer, are being revisited.
Sixth, above all, technological developments are throwing up vast opportunities for financial
inclusion.
Finally, for very valid reasons, financial inclusion recognises a variety of policies packaged as
appropriate for different countries. They may reflect differing degrees of emphasis on
deposit-taking, extending credit, easing transactions and remittances, or popularising or
innovating financial instruments. Data have been collated and are being analysed on many
aspects of financial inclusion for purposes of cross-country comparisons, and difficulties in
interpreting the data are recognised.
The Indian case
Financial inclusion as currently understood in India is, in some ways, different from what I
had envisaged when it was adopted in India. The RBI's policy objective for financial inclusion
at that time was related to activities within its jurisdiction, namely, the payments system,
banking system, and to a limited extent, non-banks that were under its jurisdiction. RBI put a
high priority on the spread of financial literacy and financial counselling. To the extent that
financial inclusion has a broader import, government then took the initiative, as
recommended by Dr Rangarajan's Committee, and the major instrument was the National
Bank for Agriculture and Rural Development (NABARD). Currently, India's financial inclusion
policy encompasses several objectives, several institutions and several financial products,
and the central bank is the major instrument of national policy. The intellectual origins of the
current policy may be traced to the Nachiket Mor Committee, while a massive policy thrust
was given by the Prime Minister in 2014. The national government has galvanised the RBI,
the regulator, the public sector banking system, and disbursements by governments. So the
RBI now appears to be the lead agency in the implementation of financial inclusion policy.
The game changers in Indian policy in the recent past have taken advantage of the
opportunities provided by technology for implementing financial inclusion. This needed
significant changes in institutional and regulatory systems. Avenues other than public sector
banks, on whom the main burden of Financial Inclusion policy fell, are being explored. The
initiative still remains bank-led but with different types of bank. RBI has taken the lead in this
regard.
A new policy framework has been designed by the RBI following the report of the Nachiket
Mor Committee. The Committee recommended four design principles and advocated multiple
models and partnerships. They also recommended differentiated banks. The Prime Minister's
Jan Dhan Yojana, the National Mission for Financial Inclusion, gave a boost to the
implementation of the recommendations.
In July 2015, the RBI constituted a Committee to formulate a Medium-Term Path on
Financial Inclusion at the Prime Minister's suggestion to take the lead in encouraging
financial institutions and to set a medium- to long-term target for sustainable inclusion. The
Committee has representation from academia, bankers, the Bill Gates Foundation and other
parties. The components of financial inclusion are specified, and include payments, deposit,
credit, social security transfers, pensions and insurance.
Simultaneously, small finance banks in the private sector have been licensed, primarily to
undertake basic banking activities such as deposit-taking and lending to unserved and
underserved sectors including small businesses, small and marginal farmers, micro and
small industries, and unorganised sector entities. These are, in some ways, similar to local
area banks, an experiment that was abandoned, but with a significant difference, namely,
that there is no restriction in their area of operations.
A more innovative initiative is licenses to payment banks, of which the Department of Posts
with its deep penetration is one. The banks offer only deposits, which are described as an
enhanced version of a prepaid wallet. Banks have to consider a model that will allow people
to deposit and withdraw cash. The benefits expected include seamless payments, swift
remittances, a higher rate on deposits, and the replacement of unregulated entities. Banks
may potentially become sourcing agents for third-party products, such as insurance and
mutual funds. This is uncharted territory. We had a category known as non-bank finance
companies, and two such entities out of six accounted for over 70% of total deposit-taking
activities in the non-bank finance category. They were permitted to take retail deposits
across the country and expected to invest the money almost wholly in government securities.
RBI viewed them with disfavour and encouraged them to quit and change their business
model. But the payment banks are expected to be vastly different in some respects.
Thus, in India, financial inclusion has become a national policy with the Prime Minister and,
hence, the government taking the lead and the RBI being the most important institution
involved in the policy.
Issues
Recent developments in regard to the emphasis on financial inclusion and the responsibilities
assigned to or assumed by central banks raise several issues and these have been well
documented. I will flag them here to facilitate deliberations in the meeting.
First, how far are the central banks going to the other extreme, from a "one target-one
instrument" to a "multi target-multi instrument" approach to central banking? How much
would this result in a dilution of the focus of central banks? What should be the relative
emphasis between the various objectives?
Second, under the new dispensation, there is a widening of central bank mandates. How
much would this widening result in a dilution of the independence of central banks?
Third, in view of recent developments relating to the responsibility for and response to global
financial crisis, the independence of central banks and, more importantly, the credibility of
central banks is under stress. At the same time, the central banks, by and large, are already
in uncharted waters in handling the exit from the Global Financial Crisis. 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 policy.
Fourth, there is evidence that very high expectations have been created for a positive
outcome for the programme of financial inclusion. It is being described as a win-win game.
National targets that appear to be quite ambitious have been adopted. To what extent would
the central banks face reputational risks in the event of the expectations not being met?
Fifth, there is increasing recognition that there are limits to what monetary policy can
achieve, and there is acute awareness of complexities of regulation of financial sector. In
such an environment, how far could a central bank deliver some of the laudable objectives of
financial inclusion, such as poverty alleviation, reduction of inequality and environmental
improvements?
Sixth, do central banks have the expertise to be closely involved in a wider programme of
financial inclusion since the demand factors are difficult to assess, even assuming that the
central bank can ensure the supply of financial services?
Seventh, what are the lessons that could be learnt from experience in regard to programmes
for financial inclusion, including those from the US housing bubble, credit facilities to
government employees in South Africa, and microfinance in India?
Eighth, a programme of financial inclusion, as generally understood in the current global
initiatives, warrants inter-agency regulatory coordination. The policy encompasses regulatory
institutions, financial institutions, financial instruments, financial markets and governmental
programmes. Three major roles have been identified for the governments by the IMF in the
programme, ie promoter, enabler, and developer. Is there a global understanding of what
governments could do in this regard, corresponding to what central banks are expected to
do?
Finally, relative to advanced economies, emerging and developing economies possess
valuable experience and have a greater stake in the debates on financial inclusion. Perhaps,
they could contribute more than before to global knowledge and wisdom on this subject.
Asking the right questions
There are issues for central bankers in pursuing the goal of financial inclusion, but central
banks cannot afford to ignore their legitimate role in financial inclusion. In fact, the adoption
of such policies has a humanising influence on central banks. However, each central bank
has to carve out its role and responsibilities in this regard carefully, with a view to enhancing
its effectiveness and mitigating downside risks. With this objective, let me suggest a list of
questions that the participants in the seminar could address during the deliberations, in
addition to the issues that I have listed.
First, what are the externalities that require or demand that global standards are set for the
policies that affect financial institutions? What is the likelihood and risk of a country's financial
inclusion policy influencing other countries? In other words, is there enough justification for
considering or recommending global standards in regard to financial inclusion?
Second, financial inclusion is predominantly a problem for emerging market economies and
other developing countries. The weight of their financial sector in global finance is very
limited. It is unlikely that a programme for financial inclusion would warrant global attention,
however significant it may be for its home country, except as a part of an issue affecting the
wider global economy such as poverty, environment and public health. To what extent should
the definition of financial inclusion be extended beyond households to include provision of
credit to enterprises, thus diluting the focus of financial inclusion?
Third, is it possible that a programme for financial inclusion will be treated as a substitute for
a commitment to provide the poor with public services such as education and health, or, in
other words, is such a programme likely to undermine the global commitment to welfare
programmes?
Fourth, a policy on financial inclusion essentially involves moving frontiers of formal finance
into informal finance, particularly in regard to households. By its very nature, the informal
sectors in different countries and in different communities are highly varied and deeply rooted
in local conditions. So, should the focus be on learning from other countries' experiences, as
considered useful by individual countries?
Fifth, is there merit in focusing on financial services and products, other than credit,
inasmuch as credit involves issues of risks and leverage, much more than other banking
products do? In other words, what should be the relative emphasis on different components
of financial inclusion such as remittances, deposit-taking, consumption-smoothing, vis-à-vis
financial products such as insurance? The relative emphasis may, of course, be
countryspecific.
Sixth, a study by the IMF indicates that too much emphasis on credit could adversely affect
stability. Easier credit delivery as part of a policy of financial inclusion may lead to the excess
indebtedness of poor households, as experience has shown. If the emphasis is on credit,
which institution will bear the risks involved? Should the central bank assess the risks, if any,
in the respective country's financial inclusion programme and, in particular, who would bear
the risks? Would it be the banking system or the central bank or government?
Seventh, experience in India shows that institutions such as local area banks that address
exclusively one area or one segment of the population or one type of activity may not be
viable unless the regulatory environment is softer than that of their competitors. At the same
time, soft regulation provides an opportunity for arbitrage. Smaller institutions with limited
expertise may find it difficult to deliver financial inclusion. At the same time, there are very
few mechanisms available to ensure that larger conglomerates will find it profitable to adopt
this programme. In other words, what are the limitations on instruments available to the
central bank to implement financial inclusion programmes?
Eighth, what would be the role of regional or local government in the financial inclusion? How
does a central bank co-opt such local governments? My experience suggests that local
governments, especially in large economies, are better able than national governments to
reach poorer sections of the population.
Ninth, do we recognise that the major issue is not one of inclusion or exclusion, but huge
inequalities in terms of inclusion? A low-income person has to pay disproportionately higher
fees for any financial service than a high-income person does. This is common to both
advanced and emerging economies. Can and should central banks address the issue of
terms on which financial inclusion takes place? Should we propose equitable terms of
financial inclusion for the global agenda?
Finally, the limits to the spread of financial inclusion may be set by the economic or social
disadvantages of segments of the population. Financial inclusion programmes may do many
things to facilitate financial transactions and financial sector coverage, as well as the
penetration and the efficiency of financial sector, but the temptation to treat them as a
panacea must be resisted. They can at best facilitate but cannot deliver employment,
development, equity or environmental benefits. The most important lessons of the Global
Financial Crisis must not be forgotten. Financialisation in excess doses can be injurious to
health. Finance can facilitate, but cannot lead, and central banks should focus on money and
finance, while never ignoring economic, social and political factors.
Let me conclude by saying that financial inclusion is an important policy that gives a human
face to the tasks of central banking. But its role in policy depends on how broad or how
narrow the scope of financial inclusion is in any given country. It would be useful to
demarcate what government should do, what central banks could do, and how they should
relate to each other in pursuit of a national policy for financial inclusion.
Thank you.
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