Raghuram Rajan: Inclusive growth and the role technology can play in it
Text of the Tenth D R Gadgil Memorial Lecture, delivered by Dr Raghuram Rajan, Governor
of the Reserve Bank of India, Mumbai, 13 February 2014.
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Thank you for inviting me to speak here today. Shri D.R. Gadgil is well known not only as an
economist but also as a great educationist and a statesman, having served as a member of
Rajya Sabha. We all know of the great contribution he made towards the distribution of plan
transfers amongst the Indian states through the famous "Gadgil Formula". The Gadgil
formula attempted to ensure that there was objectivity in distribution of funds amongst the
states in India. He wrote extensively on Indian agriculture and farm sector and the planning
process in India. The basic principles advocated by Shri Gadgil on food self-sufficiency and
employment orientation of planning, are significant even today for achieving "inclusive
growth". I thus, feel that the topic that I am going to speak on today has great relevance to
what he thought of viz. Inclusive Growth and the role technology can play in it.
The Dr. Nachiket Mor Committee Report has given the RBI much food for thought on the
issues of financial inclusion. I want to reflect on the recommendations, even while putting
some additional issues on the table.
But before that, let me offer a quick recap of the macroeconomic situation. Growth is
stabilizing on the back of a good harvest, strengthening exports, and some early signs of
resumption of large stalled projects. However, growth is still very weak. We have to work to
ensure macroeconomic stability, which means strengthening growth, especially through
investment, maintaining a moderate current account deficit, achieving a fiscal deficit
consistent with the government's fiscal roadmap, and reducing inflation. The government has
to be commended for its efforts to revive growth, narrow the current account deficit, and meet
fiscal targets. I have no doubt that the fiscal deficit for the year 2013-14 will be close to, or
below, the finance minister's red line.
Going forward, however, we need to continue on the path of fiscal consolidation constantly
improving the sustainability and quality of fiscal adjustment. It is very important that we spend
money on needed public investment, even while reducing misdirected subsidies and
entitlements.
Good fiscal control will help us in our fight against inflation. So will moderation in agricultural
support price inflation, which will ensure that these prices only provide a baseline level of
support when the farmer is in difficulty, without displacing market prices. Accurate market
prices, together with good dissemination of data on sowing patterns, can do a far better job
than support prices in directing agricultural production to where it is most valuable and
needed.
Somewhat paradoxically, raising energy prices to market levels will also lead to lower
inflation over the medium term, the horizon over which the RBI is trying to contain inflation.
The reason is that higher prices will reduce excessive consumption, reduce subsidies and
fiscal deficits, and incentivize investment and competition, even while allowing prices to be
determined by an increasingly stable and plentifully supplied global market for energy. The
consequences of inappropriate or inadequate price adjustments will be that the Reserve
Bank will have to bear more of the burden in combating inflation.
Let me turn now to financial inclusion. Financial inclusion is about (a) the broadening of
financial services to those people who do not have access to financial services sector; (b) the
deepening of financial services for people who have minimal financial services; and
(c) greater financial literacy and consumer protection so that those who are offered the
products can make appropriate choices. The imperative for financial inclusion is both a moral
one as well as one based on economic efficiency. Should we not give everyone, that is
capable, the tools and resources to better themselves, and in doing so, better the country?
Last week, I met with some members of Ela Bhatt's Self-Employed Women's Association. In
a room full of poor but confident women entrepreneurs, I asked how many borrowed from
moneylenders before they came to SEWA. About half the women raised their hands. When
asked how many thought of approaching a regular bank before they came to SEWA's
cooperative bank, not one raised her hand. Interestingly, many of them said that the loan
from SEWA freed them from the moneylender's high interest rate, which gave them enough
to service SEWA's loan fully even while focusing on other productive activities. I have heard
this from other micro-entrepreneurs - the highest return initial investment is often to free
oneself of the clutches of the moneylender. Despite this high return from the delivery of credit
to the poor, and despite much of our financial inclusion efforts being focused on credit, we
still reach too few of the target population. So there is much more to be achieved.
We have tried to effect inclusion in the past through mandates - whether it be through
direction on branch opening or on lending to priority sectors. That we are still far short of our
goals has led some critics to suggest we should abandon mandates because the market will
take care of needs; If the poor have demand for financial services, the critics say, providers
will emerge to supply it. Markets do respond to need, and competition is a very healthy force
for improvement, but market functioning can be impeded by poor infrastructure, uneven
regulation, natural or regulatory monopolies, and even cartelization.
While enlisting competitive forces wherever possible to compete for the bottom of the
pyramid's business, as a development central bank we also need to offer a supportive hand.
By putting in place the right infrastructure and enabling regulation, we have to encourage the
development of the products, institutions, and networks that will foster inclusion.
Let us start with products. We have been trying for decades to expand credit. We have
focused much less on easing payments and remittances or on expanding remunerative
saving vehicles or on providing easy-to-understand insurance against emergencies. Perhaps
we should try to expand financial inclusion by encouraging these other products, and allow
credit to follow them rather than lead. Indeed, many successful organizations working with
the poorest of the poor try to get them to put aside some money as savings, no matter how
little, before giving them loans. Some of our self-help groups (SHGs) work on this principle.
Not only does the savings habit, once inculcated, allow the customer to handle the burden of
repayment better, it may also lead to better credit allocation. With the power of information
technology, perhaps the analysis of the savings and payment patterns of a client can indicate
which one of them is ready to use credit well.
One roadblock to access, even to something as simple as a universal basic savings account,
is Know Your Customer (KYC) requirements. Experts have emphasized the need to make it
far simpler to open basic accounts, and have suggested minimizing the required
documentation. In an effort to do so, the Dr. Nachiket Mor Committee recommends requiring
proof of only a permanent address. This is nevertheless more onerous than current RBI
norms, which allow an applicant to self-certify her address and other details for accounts
below Rs.50,000. But despite RBI's exhortations, few banks have reduced their demand for
documentation - they fear that they will be held responsible if something goes wrong, no
matter what the regulatory norms. The acceptance of third party KYC certification is
particularly difficult.
Today, stringent KYC norms keep too many out of the banking system, and lead to
unnecessary harassment for others. Banks may adopt these norms more because of
regulatory or legal liability than to safeguard against true criminal or terrorist activity. Can't we
do better? Some bankers suggest that by monitoring activity patterns in accounts carefully,
even while putting some limits on basic accounts (such as holding a large value cheque for a
few days before it is cashed), much of the suspicious activity can be detected and stopped.
Could we allow a commercial bank some regulatory dispensation in case there is minor
mischief in some low value accounts, provided the bank has a reliable system in place to
detect greater mischief? Could the gains in easing widespread access to safe accounts
outweigh the costs of minor fraud? How can we get entities within the system to rely on each
other's KYC, without the process having to be continuously repeated? How can technology
assist in effectively addressing the above issues? These are questions we have to examine
and address.
The broader issue is whether through sophisticated state-of-the-art technology, we can offer
customers products that are simple, low-cost, and easy to use. We have done this with
mobile phones, can we do it with banking? Payments may be another obvious product. I
should note that our payments infrastructure in India is very advanced. We have three large
RBI technology centers devoted to supporting payments and robust payment and settlement
networks for both large value and small transactions. We have introduced an additional
factor of authentication for all e-commerce transactions - which makes these transactions
more secure - and are swiftly moving to Chip and PIN technology for credit card
transactions. SMS alerts for bank and credit card transactions are an important advance
relative to even the United States, where thieves find it easy to bill thousands of dollars to
your credit card even before you know it is stolen. All this means that we have the
infrastructure to provide cheap and safe payments and remittances. What we need are
nongovernmental players to utilize this infrastructure to provide the products and access that
people want.
With over 900 million mobile phones, the potential for mobile banking as a delivery channel
for financial services is a big opportunity in India. We have consciously adopted the bank led
model for mobile banking, while the non-banks, including Mobile Network Operators, have
been permitted to issue mobile wallets, where cash withdrawal is not permitted as of now.
The key to cheap and universal payments and remittances will be if we can find a safe way
to allow funds to be freely transferred between bank accounts and mobile wallets, as well as
cashed out of mobile wallets, through a much larger and ubiquitous network of business
correspondents. The Nachiket Mor Committee suggests the creation of Payment Banks as a
step towards this goal. Other suggestions include interoperable business correspondents
who will get the scale economies to serve in remote locations, and the usage of NBFCs as
banking correspondents. We will examine all this.
In the meantime, interesting solutions are emerging. Cashing out is important for
remittances, because we have a large recipient population in the country, most of whom do
not have access to formal banking services. We have recently approved the in-principle
setting up of a payment system which will facilitate the funds transfer from bank account
holders to those without accounts through ATMs. Essentially, the sender can have the
money withdrawn from his account through an ATM transaction. The intermediary processes
the payment, and sends a code to the recipient on his mobile that allows him to withdraw the
money from any nearby bank's ATM. The system will take care of necessary safeguards of
customer identification, transaction validation, velocity checks etc. We need more such
innovative products, some of which mobile companies are providing.
In India, despite the high mobile density, it is also a reality that most of the handsets are very
basic ones and many of the mobile connections are prepaid subscriptions. These are
important constraints. The RBI's Technical Committee on Mobile Banking has
recommended, among others, the need for a standardized and simplified procedure for
registration/authentication of customers for mobile banking services, a cohesive awareness
programme to be put in place, the adoption of a common application platform across all
banks to be delivered to the customers independent of the handset being used, along with
use of SMS and USSD technology for providing necessary level of security (through
encryption) for such transactions. The Telecom Regulatory Authority of India (TRAI) has
prescribed optimum service parameters, as also a ceiling on charges for provision of USSD
services by telecom operators to the banks and their agents. We have a great opportunity for
banks and telecom service providers to come together to deliver mobile banking services of
all kinds in a seamless and secure manner to their customers. In the next few months, we
will accelerate the dialog between key players.
Technology can also be used to facilitate credit, a product I started the talk with. MSMEs get
squeezed all the time by their large buyers, who pay after long delays. All would be better off
if the MSME could sell its claim on the large buyer in the market. The MSME would get its
money quickly, while the market would get a claim on the better rated large buyer instead of
holding a claim on the MSME. The large buyer could get a better price for his purchases. All
this requires setting up a Trade-receivables Exchange, which the RBI has been discussing
with market participants. Once again, the key is to reduce transaction costs by automating
almost every aspect of the transaction so that even the smallest MSMEs can benefit.
One of the difficulties the poor and small businesses have in accessing credit is the lack of
information about them, both up front as they are being evaluated for credit, and after lending
where the lender has to monitor them. If savings and payments products are sold widely, and
information, including payments to mobile companies, utility companies, as well as the
government, collected, then the excluded can build information records that will help them
access credit. If, in addition, negative information on defaults is shared in a fair and
responsible way through the financial network, every individual borrower will have something
at stake - their credit history - which can serve to encourage timely repayment. This, in turn,
can improve the willingness of banks to lend.
The Nachiket Mor Committee has also opined on how priority sector norms can be altered so
that we achieve the objective of credit to priority sectors, even while doing it more efficiently.
So, for example, banks that are good at rural lending should do more of it, while banks that
are good at lending to micro and small enterprises should be free to specialize there. The
Committee advocates attaching weights to performance on different norms and adding
performance up. So one bank may achieve its priority sector target by lending predominantly
to agriculture, while another may lend only to MSMEs in meeting its target. The weights will
be adjusted so that overall targets are met by the system. So if agricultural lending is
inadequate while we are getting over-performance on MSME loans, the weight on the former
will be increased while the weight on the latter will be reduced. These are interesting ideas,
and we will explore them in greater detail.
Finally, let me turn to consumer literacy and protection. As we reach more and more of the
population, we have to be sure that they understand the products they are being sold and
have the information to make sensible decisions. Caveat emptor or let the buyer beware is
typically the standard used in financial markets - that is, so long as the buyer is not actively
misled, she is responsible for researching her product choices and making purchase
decisions. While this puts a lot of burden on the buyer to do due diligence, it also gives her a
lot of freedom to make choices, including of course the freedom to make bad choices.
But with poorly informed and unsophisticated investors, we should consider the Dr. Nachiket
Mor Committee's recommendation of setting some guidelines on what products are suitable
for different categories of investors. Broadly speaking, the more complicated the product the
more sophisticated should be the target customer. Should we move to a norm where a suite
of simple products is pre-approved for dissemination to all, but as products get more
complicated, financial sector providers bear more and more responsibility to show that the
buyer was sophisticated and/or appropriately counseled before she purchased the product?
Of course, the longer run answer is for customers to become more savvy. Can the
technology sector help educate people in financial matters? After all, finance is not
something most people learn in schools, but it is something they encounter every day in the
world. Low cost but high quality distance finance education is something the country very
much needs and we look to entrepreneurs here to think of innovative ways to provide it.
Before I conclude, one caveat. Technology can magnify the reach of finance for bad
purposes as well as good. Many of you must receive frequent emails, purportedly from me,
informing you of a large sum of money that awaits you at the RBI, and urging you to send me
your account details so that I can transfer the money to you. Let me assure you that the RBI
does not give out money, I do not send these emails, and if you do fall for such emails, you
will lose a lot of money to crooks and be reminded of the adage - if anything looks too good
to be true, it probably is not true.
Of course, technology can also offer answers to check fraud. Can we enlist social media in
enabling the public to identify fraud and help regulation? How can we do this in a responsible
way? Again, these are questions at this point, but I am sure we will find the answers.
Let me conclude. Technology, with its capacity to reduce transaction costs, is key to enabling
the large volume low ticket transaction that is at the center of financial inclusion. By collecting
and processing large volumes of data easily, technology can also improve the quality of
financial decision making. When products have network effects, technology can ensure not
just interoperability, key to obtaining the benefits of networking, but also security, key to
maintaining the confidence of people and preventing them from withdrawing from the formal
financial system once again. I sincerely hope the successful ICT industry will partner with the
finance industry to revolutionize financial inclusion in this country.