INTRODUCTION:

Rural development occupies a significant place in the overall economic development

of the country. Ghandiji Said India lives in Villages. He stressed a rural character of
economy and the need for re-generation of rural life. Since independence, it has been
constant endower of our policy maker to give adequate trust to rural development as
the sector is directly related to agriculture. Rural banking in India started since the
establishment of banking sector in India. Rural Banks in those days mainly focused
upon the agro sector. Regional rural banks in India penetrated every corner of the
country and extended a helping hand in the growth process of the country. SBI has 30
Regional Rural Banks in India known as RRBs.

The rural bank of SBI is spread in 13 states extending from Kashmir to Karnataka
and Himachal Pradesh to North East. The total number of SBIs Regional Rural Banks
in India branches is 2349 (16%). Till date in rural banking in India, there are 14,475
rural banks in the country of which 2126 (91%) are located in remote rural areas.
Regional Rural Banks (RRB) was established under the provisions of an ordinance
promulgated on the 26th September 1975 and the RRB Act, 1976 with an objective to
ensure sufficient institutional credit for agriculture and other rural sectors.

The RRBs mobilize financial resources from rural / semi-urban areas and grant loans
and advances mostly to small and marginal farmers, agricultural laborers and rural
artisans. The area of operation of RRBs is limited to the area as notified by
Government of India (G.O.I) covering one or more districts in the State.

RRBs are jointly owned by GOI, the concerned State Government and Sponsor Banks
(27 scheduled commercial banks and one State Cooperative Bank); the issued capital
of a RRB is shared by the owners in the proportion of 50%, 15% and
35%respectively.

CURRENT STATE OF RURAL BANKING IN INDIA

The Indian Economy

India is the 12th largest economy in the world in terms of gross domestic product
(GDP), and fourth in terms of purchasing power parity (PPP) 1. The growth of the
economy is equally impressive with an average of over 8.0% during the last three
years2. However, in terms of GDP per capita, India ranks a lowly 160th among other
nations. Within the country, there is a stark divide in the incomes of urban and rural
areas with the average monthly per capita consumption expenditure (MPCE) in urban
India being almost double that of rural India.

In addition, there are significant disparities in urban and rural consumption

expenditure between different states. Jharkhand and Orissa, for example, have an
MPCE of approximately Rs. 900 in urban areas and Rs. 410 in rural areas4. In other
states like Punjab and Haryana, the urban rural disparity is significantly lower. A fifth
of the Indian population is below the poverty line (BPL) today with a MPCE below
Rs 340. In some states like Jharkhand and Orissa, the proportion of BPL is greater
than 40%. Diamond believes that the segments that are not considered BPL should all
be considered as potentially bankable with genuine financial needs that could be
met by formal financial and banking systems.

Current State of Indian Banking

An important metric to determine the level of financial outreach/inclusion is the ratio
of the number of deposit accounts to population. It gives a snapshot of the penetration
of deposit accounts and credit accounts in India in comparison with a few select
countries with similar socio-cultural and economic conditions. Even in comparison
with other developing economies, India has a significant opportunity for increasing
penetration of both deposit and credit accounts.

Not only is there a large disparity between India and other countries in banking
penetration but there is also a large variation in banking penetration within urban and
rural India. While urban India seems to be over-banked with more than 100%
penetration (many urban Indians have more than one bank account), rural India lags
far behind with a 19% penetration. The variance in rural and urban deposit and credit
account penetration is not restricted only to few states but is common across all states.

In addition, the average value of a deposit account and a credit account is also quite
low in rural areas as compared to urban areas. Diamond believes that the reasons for
lower penetration levels are partly economic, as explained by the low GDP per capita
in the rural areas of the country, and partly a result of controllable factors that are
inherent in formal banking systems in India today. The low deposit and credit account
penetration and low average values in deposit and credit accounts demonstrate that
banking outreach in rural India is sub-optimal. This low outreach can be explained by
two key parameters: access and usage.

Simply defined, access is the availability of financial services, and usage is the actual
use of those services. Access is influenced by issues such as the basic economic state
of rural India, lack of physical infrastructure facilities, regulatory constraints, and the
economics of rural banking.

Usage is constrained by social issues such as illiteracy, incomplete service offerings

by banks, and high transaction costs in the formal banking system. Access and usage
are not synonymous, as people may have access to financial services, but decide not
to use them, either for socio-cultural reasons or because opportunity costs are too
high.

List of Rural Banks in India

Rural banking in India started since the establishment of banking sector in India.
Rural Banks in those days mainly focused upon the agro sector. Regional rural banks
in India penetrated every corner of the country and extended a helping hand in the
growth process of the country.

SBI has 30 Regional Rural Banks in India known as RRBs. The rural bank of SBI is
spread in 13 states extending from Kashmir to Karnataka and Himachal Pradesh to
North East. The total number of SBIs Regional Rural Banks in India branches is 2349
(16%). Till date in rural banking in India, there are 14,475 rural banks in the country
of which 2126 (91%) are located in remote rural areas.

Apart from SBI, there are many other banks which function for the development of
the rural areas in India. These banks are listed below:
Andhra Pradesh

Bihar

Andhra Pradesh Grameena Vikas

Madhya Bihar Gramin Bank

Bank
Andhra Pragathi Grameena Bank
Deccan Grameena Bank
Chaitanya Godavari Grameena Bank

Bihar Kshetriya Gramin Bank

Uttar Bihar Kshetriya Gramin Bank
Kosi Kshetriya Gramin Bank
Samastipur Kshetriya Gramin Bank

Saptagiri Grameena Bank

Gujarat
Chhattisgarh
Chhattisgarh Gramin Bank
Surguja Kshetriya Gramin Bank

Dena Gujarat Gramin Bank

Baroda Gujarat Gramin Bank
Saurashtra Gramin Bank

Durg-Rajnandgaon Gramin Bank

Haryana

Himachal Pradesh

Harayana Gramin Bank

Himachal Gramin Bank

Gurgaon Gramin Bank

Parvatiya Gramin Bank

Jammu & Kashmir

Punjab

Jammu Rural Bank

Punjab Gramin Bank

Ellaquai Dehati Bank

Faridkot-Bhatinda Kshetriya Gramin Bank

Kamraz Rural Bank

Malwa Gramin Bank

Assam

Kerala

Assam Gramin Vikash Bank

Narmada Malwa Gramin Bank

Langpi Dehangi Rural Bank

North Malabar Gramin Bank

Jharkhand

Tamil Nadu

Jharkhand Gramin Bank

Pandyan Grama Bank

Vananchal Gramin Bank

Pallavan Grama Bank

Madhya Pradesh

Maharashtra

Narmada Malwa Gramin Bank

Marathwada Gramin Bank

Satpura Kshetriya Gramin Bank

Aurangabad -Jalna Gramin Bank

Madhya Bharath Gramin Bank

Wainganga Kshetriya Gramin Bank

Chambal-Gwalior Kshetriya Gramin

Vidharbha Kshetriya Gramin Bank

Bank
Rewa-Sidhi Gramin Bank
Sharda Gramin Bank

Solapur Gramin Bank

Thane Gramin Bank
Ratnagiri-Sindhudurg Gramin Bank

Ratlam- Mandsaur Kshetriya Gramin

Bank

Vidisha Bhopal Kshetriya Gramin

Bank
Mahakaushal

Kshetriya

Gramin

Bank
Jhabua Dhar Kshetriya Gramin Bank
Karnataka

Rajasthan

Karnataka Vikas Grameena Bank

Baroda Rajasthan Gramin Bank

Pragathi Gramin Bank

Marwar Ganganagar Bikaner Gramin Bank

Cauvery Kalpatharu Grameena Bank

Rajasthan Gramin Bank

Krishna Grameena Bank

Jaipur Thar Gramin Bank

Chikmagalur-Kodagu

Grameena

Bank

Hodoti Kshetriya Gramin Bank

Mewar Anchalik Gramin Bank

Visveshvaraya Gramin Bank

Orissa

West Bengal

Kalinga Gramya Bank

Bangiya Gramin Vikash Bank

Utkal Gramya Bank

Paschim Banga Gramin Bank

Baitarani Gramya Bank

Uttar Banga Kshetriya Gramin Bank

Neelachal Gramya Bank

Rushikulya Gramya Bank
Meghalaya

Arunachal Pradesh

Ka Bank Nogkyndong Ri Khasi-

Arunachal Pradesh Rural Bank

Jaintia

Manipur

Nagaland

Nagaland Rural Bank

Manipur Rural Bank

Tripura

Mizoram

Tripura Gramin Bank

Mizoram Rural Bank

Uttar Pradesh

Uttaranchal

Purvanchal Gramin Bank

Uttaranchal Gramin Bank

Kashi Gomti Samyut Gramin Bank

Nainital Almora Kshetriya Gramin Bank

Uttar Pradesh Gramin Bank

Shreyas Gramin Bank
Lucknow Kshetriya Gramin Bank
Ballia Kshetriya Gramin Bank
Triveni Kshetriya Gramin Bank

KEY DRIVERS OF FINANCIAL EXCLUSION OF RURAL

BANKING
According to Diamond estimates, approximately 245 million adults in rural India do
not have a bank account today. As depicted in Following Table, this reflects 24% of
the total population. While 60 million out of 245 million may not need banking
services because they are below the poverty line, Diamond believes that
approximately 185 million potentially bankable people do not use formal banking
services because of reasons like poor access or usage.

100
47

53

Series1

37
16

13

24
6

18

To
ta
lP
op
ul
N
at
on
io
A
n
du
lt
P
op
ul
at
io
Ad
n
ul
tP
op
U
rb
ul
at
an
io
Ad
n
ul
tP
op
R
ul
ur
at
al
io
A
n
du
lt
Po
pu
la
Ba
tio
nk
n
ed
P
op
U
ul
nb
at
io
an
n
ke
d
P
op
Fi
na
ul
at
nc
io
ia
n
ll y
C
on
st
Po
ra
nt
in
ts
en
tia
lly
Ba
nk
ab
le

120
100
80
60
40
20
0

Source: Census India; BSR 2008Reserve Bank of India; World Bank & NCAER
(2008).
Access Issues for Rural Customers
Access is explained in terms of infrastructure, physical distance, limited delivery
capabilities, regulatory constraints and the economics of rural banking.

The banking infrastructure in rural India is not encouraging, with just 7% of villages
housing a bank branch. Whats more, the poor physical and social infrastructure also
impacts the access to financial services, with 23% of villages going without
electricity, 67% without a Post Office, and an average rural literacy rate of 59% and
secondary school penetration of 12%. This lack of physical and social infrastructure
in rural India is a key issue impacting access to formal financial services.

The average distance to a branch in India is approximately 3.8 Km. While this
compares favorably to the average distance to a branch in a developed market like the
U.S. (which is 6 Kms6), there are significant additional challenges in India in the
form of unpaved roads and limited access to modern transportation. Most rural
customers are likely to sacrifice an entire days wage to travel to a bank branch which
is open between 10:00am and 5:00pm. While some banking transactions could be
done over phone, this is rarely an option in a country with such low rural tele-density.

Limited delivery capability is a significant challenge. Much of rural India is serviced

through branches because ATM penetration is low and other channels such as Phone
and Internet Banking are non-existent. Intermediaries like Non-Governmental
Organizations (NGOs), Self-Help Groups, and Micro Finance Institutions (MFIs) are
being used by banks to improve access to credit and savings. However, these
channels, in their current form, offer limited services.

There are some regulatory constraints imposed by the Reserve Bank of India (RBI)
which may inadvertently contribute further to the lack of formal banking services in
rural areas. For example, the RBI does not allow banks to post any person other than a
security guard at ATMs. Hence, banks cannot deploy many ATMs in rural areas as
many rural customers require in-person support. A second regulatory inhibitor is that
new banks planning to establish a branch in a rural area have to receive approval from
the Lead Bank and District Collector of that district. Hence, banks choose not to open
new branches in certain areas even when it is profitable to do so because there is no
certainty of getting approvals.

Many banks view the rural market as a regulatory requirement rather than an
economic opportunity. Banks have from time to time borne the social cost of lending
to the rural economy at rates below their costs. They have also faced capital erosion
because of the write-off of loans, particularly agriculture loans. Banks are required via
regulatory requirements to open branches in rural areas to provide loans to agriculture
and other priority sectors.
9

CURRENT RURAL BANKING CHANNELS

Description

- Fully fledged Branches and

Branch

Intermediaries

ATM

Extension Counters of
Scheduled Commercial Banks
including Regional Rural Banks
Cooperative Banks

RURAL FINANCE

- Deposit Accounts
- Credit Accounts
- Remittances
- Cards
- Third-Party Products

Remarks

- 96% of total deposit and95%

of total loans are with schedule
commercial banks with
cooperative banks holding
the difference
- Has a high cost-to-serve

- NGOs, SHGs, MFIs and

Cooperatives that act as
Intermediaries to take financial
Services to the rural areas

- MFIs directly lend to the poor

and also act as agents for
he banks
- SHGs borrow from banks and
are beneficiaries of loans
themselves

- This channel delivers limited

services in its current form

- Onsite
ATM installed at a branch
- Offsite
ATM installed at a remote
Location

- Cash Withdrawal
- Cash Deposit
- Money Transfer
- Cheque Book Request
- Bill Payments

- Negligible presence of this

channel in rural areas

- Cash Withdrawal
- Cash Deposit
- Money Transfer
- Cheque Book Request
- Bill Payments

- Almost non-existent in rural

- India because of low:
Tele-density
Internet-penetration
Credit appetite of banks

-Phone Banking
Others

Service Provided

Manual
Interactive Voice Response
- Internet Banking
- Kisan Credit Card
SERVICE
ProvidePROVIDERS
short-term credit

India has a range of rural financial service providers, including formal sector financial
institutions at one end of the spectrum, informal providers (mostly moneylenders) at
the other end, and between these two extremes a number of semi-formal/microfinance
providers.

10

Formal Providers:
In terms of their sheer size and spread of operations, formal-sector financial
institutions dominate the rural finance landscape: Commercial banks, mostly public
sector banks (but also some private- sector banks) and regional rural banks (RRBs)
together have more than 32,000 rural branches India also has a vast network of rural
cooperative banks, with a three tiered structure at the state, district, and village levels.

There are some 14,000 branches of rural cooperative banks and more that 98,000
grassroots retail outlets of Primary Agricultural Credit Societies (PACS), which are
used by the cooperative system as channels for fund flows.

The post office system adds to the physical service point network of the country with
more than 154,000 post office branches handling more than 110 million money orders
and administering 114 million savings accounts Formal financial institutions are
regulated by the Reserve Bank of India (RBI), although it has delegated the task of
supervising rural cooperative banks and RRBs to the National Bank for Agriculture
and Rural Development (NABARD). 14Development banks such as NABARD and
the Small Industries Development Bank of India (SIDBI) provides support to both
formal and semi-formal segments through funding refinancing arrangements.
NABARD provides refinancing to banks lending in rural areas and SIDBI funds and
supports MFIs.

The semi-formal/microfinance sector

While India is home to many microfinance innovations, in terms of people reached
and the scale of financing, microfinance in India is still a drop in the ocean. It reaches
between 5 and 6 percent of the countrys poor rural households, or about 30 percent of
the rural poor, either directly or indirectly. Dominant among the microfinance models
is Self-Help Group (SHG) Bank linkage, whereby womens SHGs are linked to the
rural branches of commercial banks, RRBs, or cooperative banks, which often benefit
from refinancing by NABARD.
11

SHG-Bank linkage has reached out to around 12 million familys interns of savings
accounts. Credit outstanding remains low; disbursements in FY 200203 accounted
for only 2 percent of the formal-sector credit outstanding in rural areas. The other
model is Specialized Microfinance institutions (MFIs), which reach around 1 million
clients. The total branches of MFIs are estimated to be in the range of a few thousand,
compared to the vast numbers of bank branches.

Recent developments have led to other inter linkages between the formal both publicand private sector banks and semi-formal sector initiatives, particularly in the context
of SHGBank linkage, as well as through lending by SIDBI and commercial banks to
MFIs. Moreover, a few private-sector commercial banks, such as ICICI Bank, have
tried innovative ways of incorporating lessons from microfinance into their
operations, and have made inroads in using micro finance methodologies to deliver
rural financial services.

Informal providers, Informal financiers include a range of actors-landlords, local

shopkeepers, traders, professional moneylenders, etc. While there are no definite
estimates of the number of informal-sector providers, these are spread very widely
across the country. Survey data indicate that poor rural households rely heavily on
informal finance to meet a range of financing needs: from consumption and
emergency financing to investment loans.

12

REASONS FOR UNPROFITABLE OF RURAL BANKING IN

INDIA

High Non-performing Loans (NPL):

Banks have higher non-performing loans in rural areas because rural households have
irregular income and expenditure patterns. The issue is compounded by the
dependence of the rural economy on monsoons, and loan waivers driven by political
agendas. NPLs from the agriculture sector are 7.7%, compared to 3.5% across nonagriculture sectors8. In order for banks to view rural India as a growth opportunity,
rather than a regulatory requirement, a combination of these issues must be addressed.
Increasing financial access to rural areas is contingent upon basic conditions such as
proper infrastructure and an enabling regulatory framework, as well as innovative
thinking on the part of commercial banks. Access issues, however, explain only one
part of the problem. Usage is an equally important issue for rural customers.

Low Ticket Size:

The average ticket size of both a deposit transaction and a credit transaction in rural
areas is small. This means that banks need more customers per branch or channel to
break even. Considering the small catchments area of a branch in rural areas,
generating a customer base with critical mass is challenging.

High cost to serve:

Branches are the most used channel in rural areas. This is because many rural people
are not literate and are not comfortable using technology-driven channels such as
ATMs, phone banking or internet banking. On the other hand, a branch is an
expensive channel for banks (Following Table). In addition, rural people, whenever
they have access to banks, have frequent low ticket and cash-based transactions,
which increase the overall transaction cost for their bank.

13

Cost Per Transaction in Indian Banks

60
50

48

40
30

25

Series1
18

20

10

0
Branch

Phone (Call
Centre)

ATM

Phone (IVR)

Internet

Source: Reserve Bank of India; CGAP, World Bank.

Higher risk of credit:
Rural households may have highly irregular and volatile income streams. Irregular
wage labor and the sale of agricultural products are the two main sources of income
for rural households. The poor rural households (landless and marginal farmers) are
particularly dependent on irregular wage employment. Rural households also have
irregular expenditure patterns. The typical expenditure profile of rural households is
small, with daily or irregular expenses incurred through the month. Furthermore, a
majority of households incur at least one unscheduled expenditure per year, with the
most frequent reasons being medical or social emergency7. In short, the rural
customer is generally considered to be a risky one.

Information Asymmetry:
Since many rural people do not have bank accounts, there is a lack of information on
customer behavior in rural India. Absence of a Credit Information Bureau also
complicates the problem as banks have to rely on informal sources to learn the credit
history of rural customers. A lack of reliable information can result in either missed
opportunities in not approving otherwise eligible loan candidates, or nonperforming
loans.

14

USAGE ISSUES FOR RURAL CUSTOMERS

Even if access to formal banking is provided to rural customers, there is no guarantee

that these services will be used. According to a study conducted by the World Bank,
many households, even in developed countries, choose not to have a bank account as
they do not engage in many financial transactionsthey collect wages in cash, spend
in cash and do not wish to be burdened by a bank account9. To compound the
situation many customers in rural India, who have access to and would otherwise
choose to use formal financial services, do not do so because the product and service
mixes do not meet their needs.

The financial service needs of rural customers are not confined to just savings and
credit, as is usually assumed. Their financial needs are linked to their life cycle needs,
ranging from savings to credit to insurance to remittances. In fact, even the savings
and credit products currently offered to rural customers do not entirely meet their
needs.

Access to savings and investment facilities is critical for the poor. The two critical
needs for the rural poor are micro-savings and frequent withdrawals. These needs
facilitate a customer in building capital over the long term, as well as coping with
income shocks in the near term. However, banks do not offer adequate services to
address these needs. The lack of services, therefore, leaves the rural poor with little
option than to transact with the informal banking market. A study conducted by Micro
Save also concludes that the poor transact with the informal sector because it will
accept small amounts, provide doorstep service, and ensure ease of enrolment.

Rural customers need loans not only for productive purposes but also for consumption
needs (Following Table). A part from agricultural support, rural customers need micro
credit for consumption, education and emergencies. Though banks offer purpose free
loans (personal loans and credit cards) in urban areas quite liberally, in rural areas
15

sanction of such loans is significantly restricted. Therefore, the poor raise these loans
through the informal financial system (it is worth noting that these loans taken from
the informal system are almost always repaid or renewed12). In addition, larger
households need occasional high value micro-enterprise loans for small capital
investment. Though banks offer these loans, they require excessive documentation
and time-consuming processes which discourage customer applications.

Purpose of Borrowing
Rural Household Borrowing

Other business
expenditure, 14%
Agriculture
expenditure, 38%

Other business
expenditure
Household
expenditure
Agriculture
expenditure

Household
expenditure, 48%

Bank Lending to Rural Households

Personel Loans, 12%

Personel Loans
Other Business Loan,
52%

Agriculture Loan
Agriculture Loan, 36%

Other Business Loan

Source: AIDIS2008, National Sample Survey Organization (NSSO); Diamond

analysis.

16

A significant percentage of borrowing is toward consumption and other household

expenditure, whereas formal financial institutions in rural India provide loans
primarily for productive purposes.

Insurance reduces the vulnerability of poor households by replacing the uncertain

prospect of large losses with the certainty of payout against small, regular premium
payments. It is integral to a comprehensive risk management strategy for poor
households. This includes life, health, accident and asset (dwelling, crop, and
livestock) insurance. Banks and insurance firms do not offer these services in many
rural areas, leading the poor to rely on the informal financial system.

There are many rural households which depend on weekly or monthly remittances
from their family members who have moved to urban areas. At present, they depend
on informal channels to remit the money and consequently either risk the loss of
money or pay high transaction fees. Banks do not offer seamless remittance facilities
between urban and rural branches as many of the rural branches are not computerized
and connected to the main banks computer systems. This often results in the
beneficiary receiving the amount two weeks after it has being transferred. This
represents yet another key service which is not provided.

The transaction cost for a rural customer to receive credit primarily constitutes four
attributes: the interest rate, loan amount received as a percentage of amount applied,
bribes paid, and the lead time to process the loan. Though the formal banking system
offers loans at interest rates lower than informal banking systems, the time taken for a
loan to be sanctioned is high which increases uncertainty and opportunity cost. In
addition, the customer needs to pay almost 10% of the loan amount in bribes and
eventually receives an amount that is less than what was applied for. Therefore, while
the interest rates are usurious in the informal financing system, rural customers still
resort to this channel because the waiting time to receive the loan is negligible and
there are no indirect costs or commission. Banks also insist on collateral security
which many rural poor cannot afford.
17

As far as savings are concerned, though the formal banking system provides financial
security, the cost of opening and operating an account is high. The overall cost of
transacting with the formal financial system increases for a rural person because of
additional costs such as expenses incurred to reach a branch and the opportunity cost
of lost wages. Since rural banks are generally not within an accessible area and do not
operate at convenient times, the rural customer must forgo a days wage to reach a
branch. Informal systems, on the other hand, involve a lower transaction cost, but they
are risky and in some cases result in the loss of ones entire capital. In short, this
leaves the rural customer to choose between two unfavorable options.

In summary, the services being offered by the formal banking system do not seem to
meet the needs of the rural poor. A World Bank study suggests that the poor apply a
set of criteria to judge the services being offered by any financial service provider,
including:

Productsare financial services available and tailored to my needs?

Costwhat is the total cost of the service (including opportunity cost)?
Conveniencehow easy is it to access and use?
EligibilityAm I eligible for financial services and can they be accessed
repeatedly?

As explained earlier, the savings products offered in the current format do not qualify
as a flexible, convenient and cost-efficient service. Similarly, loan products do not
meet product and eligibility criteria. In addition, insurance and remittance services are
not even available. The cost of services, despite lower interest rates, is high because
of other indirect costs which make the banking services cost-inefficient.

18

MARKET OPPORTUNITY OF RURAL BANKING

At present, a rapidly growing urban India is the focus of the banking sector; however,
as the deposit penetration numbers suggest (Figure 3 & 4), the market is highly
competitive and over banked. Despite this, most banks are still not shifting their focus
to the rural opportunity, as they are apprehensive about the total market potential of
the rural market and the profitability of rural banking channels. Contrary to the widely
held notion, however, the rural market is attractive from both a credit and deposit
perspective.

The credit demand in rural areas is approximately Rs 1,330 billion (based on an

estimate by World Bank). There are other studies by the Planning Commission and
ICICI Bank which put the figure even higher at Rs 1,440 billion and Rs 1,500 billion
respectively. Similarly, on the deposit side, a large segment of the rural population
does not save with formal banking channels because banks are not accessible and do
not provide the appropriate products and service, leaving a significant opportunity to
grow the deposit base.

At present, the penetration of banking in rural areas is sub-optimal with a large market
remaining untapped in both the liability (~ Rs 215 billion) and asset (~ Rs 1,204
billion) sides of the business. These estimates clearly suggest that there is sufficient
demand in the rural market to encourage banks to think seriously about rural areas as
an alternative growth opportunity.

As we identified earlier, access and usage are two broad concerns which explain why
the potentially bankable are unbanked. With regard to access, the challenge for banks
is to identify profitable channels that meet the needs of rural customers. With regard
to usage, banks need to understand the requirements of the rural customer and
customize products and services

19

Accordingly (Following Table).

Proposed Approach to Tap Potentially Bankable Population

Improve
Access
For Rural
Customers

Address
Access Needs
Of Rural
Customers
Ensure
Channel
Profitability

Convert
Potentially
Bankable

Encourage
Usage of
Services

Address
Usage Needs
Of Rural
Customers

Bank
Initiatives
To Improve
Usage

Source: Diamond analysis

20

IMPROVING ACCESS FOR RURAL BANKING

Today, branches are the primary delivery channel in rural areas. Though there are
32,000 commercial bank branches in India, they cover less than 7% of total villages.
Opening more branches is not necessarily profitable as many pockets of rural areas do
not have business enough to justify an expensive branch channel. Therefore, to
improve access in rural areas, banks need to modify existing channels, introduce new
channels and identify innovative ways to integrate the two.

Modify Existing Channels

Fortunately there are a variety of options available for banks looking to modify their
existing channels. To reduce the costs imposed by branches, banks should consider
the option of sharing their branch infrastructure. This would not be too dissimilar to
the example of the telecom industry sharing network infrastructure or the fast food
industry sharing food courts in urban areas. Though infrastructure sharing may raise
concerns over client confidentiality and data leakage, in the long run banks will only
benefit from such collaboration.

ATMs are an effective channel which can deliver many of the services frequently
used by a branch customer. However, ATMs, in their current form, are not suitable for
rural areas as the literacy level and transaction ticket amount is too low. ATMs can,
however, be designed to meet the needs of rural customers. For example, ICICI Bank
is working with IIT Chennai to develop an ATM that has a biometric fingerprint
login, accepts soiled notes, and lower value denominations. In addition to modifying
the design of the machines, banks should also hold discussions with the RBI to allow
an attendant to be posted at ATMs. This will enhance the usability of ATMs.

Though phone banking and internet banking are cost-effective channels, given very
low tele-density and low internet penetration in rural areas, the ability to use these

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channels to reach the rural customer is low. However, phone and internet banking
should be considered once infrastructure and literacy levels improve in rural India. A
business correspondent could then run an e-kiosk to assist customers to transact over
these channels. For example, Centenary Bank in Uganda uses internet and phone
banking to provide bill payments, money transfers and loan repayments.

Business correspondents can be provided with point-of-sale (POS) functionality to

allow customers to deposit and withdraw cash from their accounts. Combining POS
with a smart card is one way to improve access. Brazil has successfully used banking
correspondents who use POS and card readers to provide current accounts, loans, and
insurance, accept bill payments, and perform other transactions.

Introduce New Channels

The RBI allows banks to appoint business correspondents and facilitators to be used
as intermediaries in providing banking services. NGOs, MFIs, Societies, Section 25
companies, registered NBFCs not accepting public deposits, and Post Offices can be
appointed as Business Correspondents. Business Correspondents can provide several
services which are not currently offered by SHGs and MFIs, including:
1. Identification of borrowers and fitment of activities;
2. Collection and preliminary processing of loan applications including
verification of primary information/data;
3. Creating awareness about savings and other products and education and advice
on managing money and debt counseling;
4. Processing and submission of applications to banks;
5. Promotion and nurturing Self Help Groups/Joint Liability Groups;
6. Post-sanction monitoring;

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7. Monitoring

and

handholding

of

Self

Help

Groups/Joint

Liability

Groups/Credit Groups/others;
8. Follow-up for recovery;
9. Disbursal of small value credit,
10. Recovery of principal/collection of interest
11. Collection of small value deposits
12. Sale of micro-insurance/ mutual fund products/ pension products/ other thirdparty products
13. Receipt and delivery of small value remittances/ other payment instruments.

The introduction of Business Correspondents may face some challenges from labor
unions. However, Diamond believes that there may be some options to address the
concerns of the current workforce while using Business Correspondents to capture
more value from rural customers.

Caxias Economical, a state-owned bank in Brazil, manages the countrys lottery

network and distributes government benefits. To increase the access of its services,
Caixa extensively utilizes the Banking Correspondent channel, with 14,000 banking
correspondents covering all of Brazils 5,500 municipalities. In less than 2 years,
Caixa opened about 2.8 million new accounts and estimates that 40% of its banking
transactions are handled through the banking correspondent channel.

Satellite offices are a cost-effective alternative to branches. These offices can be

established at fixed premises in villages and are controlled and operated from a base
branch located at a block headquarters. All types of banking transactions may be
conducted at these offices. Banks have, however, not used this channel actively,
despite the argument that this channel is relatively less expensive, as it can draw
personnel from the main branch and can remain open for just two days a week. This

23

channel, therefore, is appropriate in blocks and districts which are densely populated.
In the urban areas, most Indian banks opt for an extension counter where the business
does not justify a full-fl edged branch. Similarly, satellite branches can cater to rural
areas which do not justify a large branch.

Where banks do not find it economical to open full-fl edged branches of satellite
offices, mobile offices may be more appropriate. Mobile offices extend banking
facilities through a well-protected truck or van. The mobile unit visits villages on
specified days/ hours. The mobile office would be affiliated with a branch of the bank,
and serve areas which have a large concentration of villages. This will not be
dissimilar to the mobile ATMs implemented by some of the Indian banks in the urban
areas.

Determine the Combination of Channels

There is no one right channel or solution to improve access in rural areas. Banks have
to evaluate the trade-offs between those channels that are most convenient to
customers and those that are the most profitable. Banks are not comfortable opening
new rural branches because many of those that already exist are unprofitable.
Therefore, determining the right combination of channels is critical to improving
access in profitable ways. An innovative approach to improving access will consider a
combination of these channels. For example:

Branches and Satellite Branches

In addition to providing regular banking operations, providing backend support to
manage and audit the operations of business correspondents.
A low-cost, custom-made ATM
Managed by a business correspondent to bring down the operating cost and scales the
channel.

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 An e-kiosk
Managed by a business correspondent with internet banking, ATM and POS terminal
in relatively large rural areas.
A business correspondent
Using manual ledgers or POS/Palmtop to act as deposit collector and remitting agent
in smaller rural areas.

While this list is not exhaustive, it highlights the need for creative solutions that apply
the right channel to the right market and transaction. In South Africa, Capital has
combined convenient branches along transportation routes (for example, train and bus
stations, and taxi stops). In addition, it has rolled-out debit cards and automatic teller
machines across 200 of these branches to stimulate savings among low-income
earners. Between February and August 2007, the number of customers jumped from
around 30,000 to more than 90,000

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SUGGESTIONS
ENHANCING the growth rate in agriculture to 4.1 per cent, as envisaged in the
Approach Paper to the Eleventh Five Year Plan, and improving its robustness would
require substantial investment in irrigation and water management technologies,
diversification and boosting productivity of different crops through improved seeds
and plant-care practices. The move towards inclusive growth is a big challenge for the
financial system of the country, including commercial banks. Banks would need to
adopt an innovative, customer-friendly approach to increase their effective reach so
that the share of organised finance increases. A participatory and partnership-based
model for financial inclusion, coupled with community-linked financial initiatives is
the need of the hour. In the near future customer-friendly products, delivery channels,
relationship banking, dependency on IT systems and competitive pricing would be the
driving forces. Banks will to move to high-tech banking. The Internet would be the
engine of the banking revolution in the decades to come and e-commerce would be its
fuel. Therefore, the key to survival of banks in future will be the retention of customer
loyalty by providing value-added services tailored to their needs.

First, traditionally banks have viewed rural areas as a segment purely in need of up
liftment. This was based on the underlying philosophy of a social obligation.
However, the future lays with those who see the poor as their customers, namely,
financial inclusion. By financial inclusion is meant the provision by the financial
system, of financial products and services at an affordable price, to those who have
been financially excluded. As banking services are in the nature of a public utility
service, it is essential that banking and payment services are provided to the entire
population without discrimination. The harsh reality is that the spread of banking
facilities in India is uneven, with a substantial portion of the households, especially in
the rural areas, still outside the coverage of the formal banking system. Almost 40 per
cent of the adult population of the country is unable to access mainstream financial
products.3 The Reserve Bank of India has recently adopted a decentralised approach
in this regard with close involvement of State Governments and banks and has used
multiple channels to expand the outreach of banks. It is important to mention that the
Union Bank has launched a new initiative called Village Knowledge Centres. Here,

26

technology is used to help the farmer improve his productivity. The Banks staff at
these village knowledge centres act as relationship managers, liaising between local
authorities and farmers, facilitating the opening of accounts and ensuring that credit is
provided to the needy. Such examples need to be followed by other banks.

Secondly, commercial banks should change their marketing concept. Under the new
concept of marketing, the task of management should not so much be skill in making
the customer do what suits the rest of the business, as to be skilful in conceiving and
making business do what suits the interest of the customers.

Thirdly, stress should be laid on deposit mobilisation from the agricultural sector
itself to finance its own credit requirements. Such a move will entail two steps
curtailment of unproductive expenditure and deposit of savings by the agriculturists in
banks. It is common knowledge that villagers spend huge sums on unproductive
social ceremonies, drinking, litigation, etc. Their outlook needs to be changed with the
help of banking staff and utilising the services of the mass media. Villagers must be
convinced that money spent on such social obligations is a waste and they themselves
would gain in the long run if they would save and invest. The services of officers and
staff of the community development projects may also be utilised for this purpose.

Fourthly, the more important aspect of the whole drive is the deposit of savings by the
agriculturist in the banks. Vast sums of money are lying idle even today in rural areas.
We think that, in spite of different agencies engaged in providing agricultural finance,
the village moneylender continues to be a necessary evil. These moneylenders have
great influence on the villagers. To mobilise the savings of the villagers, the services
of these moneylendersboth professional and agriculturalcan be utilised. The
nationalised banks may appoint them as their agents. The banks should then ask them
to encourage the villagers to deposit their money in the banks and approach the banks
for loans through them. The banks may give them a sort of del credere commission,
depending upon the quantum of business done by them, as is done in the case of
agents of the Life Insurance Corporation, General Insurance Corporation, National
27

Savings Organisation, etc. Such a step would help in mobilising savings. The
appointment of moneylenders as agents has an added advantage. These moneylenders
have been living in villages for a long time and are, therefore, accustomed to the rural
way of life. They know the local language and can, therefore, mix well with the
villagers.4 This is not the case with the qualified, educated and sophisticated bank
staff. Many a time, superiority complex on the part of the bank employees drives
away the villagers. As a corollary to this, it is also suggested that, as far as possible,
the staff to be deputed in the rural branches, should be drawn from the villages or
semi-urban areas themselves and better living conditions be assured for the bank
employees.
.
Finally, it needs to be remembered that stray attempts would not solve the problem of
agricultural credit. The credit system as a wholegovernment, commercial and
cooperativemust be so knit together that it does not suffer either from a gap or an
overlap. It is only then that the real fruits of credit facilities will be enjoyed by the
country at large in the form of agricultural development which stills the key to Indias
prosperity in future.

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CONCLUSION

There are 185 million bankable adults in rural India who are unbanked because of
access and usage issues. This presents a significant opportunity for commercial banks.

However, to reach this market and subsequently build an inclusive financial system,
there must be a coordinated and concerted effort by the three key stakeholders: the
Government of India, the Reserve Bank of India and the commercial banks.

In addition, a partnership between banks and business correspondents, and

collaboration amongst banks is critical.

Furthermore, banks should tailor their product and service mix to meet rural

Needs, and adapt their delivery models to ensure commercial viability of their rural
banking operations.

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BIBLIOGRAPHY
www.cia.gov
Census
Access to and Usage of Financial Services, World Bank
www.rbi.org.in

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