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insight Building a More Inclusive

Financial System in India

The opportunity to provide rural unbanked communities
with access to essential banking services.
By Vinod Nair, Andrew Sofield, and Vijay Mulbagal

Despite recent economic progress and explicit socialist goals, India has
amongst the world’s lowest GDP per capita ($763 USD) and lowest penetrated
retail banking systems, with less than 20% of rural India having access to
formal financial services. The reasons for this are complex, as is identifying
potential solutions. A multi-pronged approach is required to make the Indian
retail banking system more inclusive. This will require a concerted effort by
several stakeholders, including the Government of India, the Reserve Bank
of India, and the commercial banks. To bring about this transformation,
public and private sector banks will need to play a key role in defining
and implementing innovative business models and delivery channels using
appropriate technology solutions.
The Current State The Indian Economy expenditure between different states
India is the 12th largest economy in the (Figure 1). Jharkhand and Orissa, for
of Rural Banking example, have an MPCE of approximately
world in terms of gross domestic product
in India (GDP), and fourth in terms of purchasing Rs. 900 in urban areas and Rs. 410 in
power parity (PPP)1. The growth of the rural areas4. In other states like Punjab
economy is equally impressive with an and Haryana, the urban rural disparity
average of over 8.0% during the last three is significantly lower.
years2. However, in terms of GDP per
A fifth of the Indian population is below
capita, India ranks a lowly 160th among
the poverty line (BPL) today with a MPCE
other nations3.
below Rs 340 (Figure 2, see Page 3).
Within the country, there is a stark divide In some states like Jharkhand and Orissa,
in the incomes of urban and rural areas the proportion of BPL is greater than
with the average monthly per capita 40%. Diamond believes that the segments
consumption expenditure (MPCE) in urban that are not considered BPL should all be
India being almost double that of rural considered as “potentially bankable” with
India. In addition, there are significant genuine financial needs that could be met
disparities in urban and rural consumption by formal financial and banking systems.

Current State of the Indian Economy and the Urban/Rural Divide

Comparison with Other Countries Economic Status — Rural vs Urban India

GDP/capita ($) — 2004–05 Average MPCE 1 (Rs.)

Urban India 1,060

Rural India 565


Urban and Rural MPCE (Rs.)

763 688 405
High disparity

Mexico Brazil China India Pakistan Bangladesh 1,259


GDP growth — 2004–05

table of contents Orissa
Current State of Rural Banking in India . 2
Key Drivers of Financial Exclusion 7.5% Manipur
in India Today . . . . . . . . . . . . . 5 6.4% 6.3%
Low disparity

4.9% 1,050
The Way Forward . . . . . . . . . . 10 4.4% 879

Conclusion . . . . . . . . . . . . . 16 1,059
About the Firm . . . . . . . . . . . . 18
China India Pakistan Bangladesh Brazil Mexico
About the Author . . . . . . . . . . . 18 1. Monthly Per Capita
Consumption Expenditure.

For more information contact: Source: World Bank; National Sample Survey Organisation (NSSO)—Household expenditure report 2004.

Vinod Nair Figure 1

Managing Partner—India
Current State of Indian Banking Segmentation of the Rural Market
An important metric to determine
the level of financial outreach/inclusion Segmentation of the Rural Market 1 Average MPCE of States (Rural)

is the ratio of the number of deposit 1%


accounts to population. Figure 3 gives

20% 11%
a snapshot of the penetration of 39%

deposit accounts and credit accounts 30%

Potentially Bankable
in India in comparison with a few select

Banked &
29% 25%
countries with similar socio-cultural 34%
and economic conditions. Even in 51% 51%

25% 25%
comparison with other developing
economies, India has a significant 3% 5%
All India Punjab Kerala Jharkand Orissa
opportunity for increasing penetration Affluent states Low income states
of both deposit and credit accounts.
Monthly Per Capita Average
Consumption MPCE (Rs.)
Not only is there a large disparity Expenditure N.A.
between India and other countries in >Rs. 775
Rs. 471–775
banking penetration but there is also Rs. 340–470 601–750
<Rs. 340 >750
a large variation in banking penetration
within urban and rural India. While 1. Based on Monthly Per Capita Consumption Expenditure (MPCE), segments are MPCE ranges of < Rs.340, Rs.341-470,
Rs.471-775, >Rs.775. Below Poverty Line (BPL): Individuals with MPCE less than Rs. 340

urban India seems to be over-banked Source: Diamond analysis; National Sample Survey Organisation (NSSO): Household Consumer Expenditure in India (2004).

with more than 100% penetration Figure 2

(many urban Indians have more than
one bank account), rural India lags far Current Status of Banking in India
behind with a 19% penetration. The
variance in rural and urban deposit and Comparison with Other
Developing Countries Penetration of Banking Services
credit account penetration is not restricted
only to few states but is common across Deposit Accounts1 (%) Deposit Accounts1 (%)

all states (Figure 4, see Page 4). In 125 Urban India 114 2
addition, the average value of a deposit
account and a credit account is also Rural India 19

quite low in rural areas as compared National

63 Average
to urban areas (Figure 4). Diamond
believes that the reasons for lower
penetration levels are partly economic, 19 23

as explained by the low GDP per capita

in the rural areas of the country, and Pakistan Bangladesh India Brazil Malaysia

partly a result of “controllable” factors Credit Accounts (%) Credit Accounts (%)
that are inherent in formal banking Urban India 17
systems in India today.
Rural India 4
The low deposit and credit account
penetration and low average values in Average

deposit and credit accounts (Figure 4) 1. Deposit accounts include both savings
demonstrate that banking outreach in rural 5 6 and current accounts,
2. 114% because some individuals or firms
India is sub-optimal. This low outreach 2 have more than one account.

can be explained by two key parameters: Pakistan Brazil Bangladesh India Malaysia
access and usage. Simply defined, Source: Census India 2001; BSR 2005—Reserve Bank of India; World Bank—Sept 2005.

access is the availability of financial Figure 3

Banking in India — Rural vs Urban Divide

Deposit Accounts in India Credit Accounts in India

Penetration (% of Population) Average Value (Rs. 000s) Penetration (% of Population) Average Value (Rs. 000s)

288 1 28 47 91
9 17 3 33
Affluent States

169 36 12 245
38 25 4 120

117 46 28 138
25 13 6 42

87 39 16 130
19 13 5 30
Low Income States

83 41 7 149
18 18 3 26

Madhya 80 31 10 128
Pradesh 12 15 2 48

1. Percentages above 100 are because some individuals or firms have more than one account.

Source: Census India 2001; BSR 2005—Reserve Bank of India; World Bank— Sept 2005, Diamond analysis.

Figure 4

services, and usage is the actual use of economics of rural banking. Usage are not synonymous, as people may have
those services. Access is influenced by is constrained by social issues such as access to financial services, but decide
issues such as the basic economic state of illiteracy, incomplete service offerings by not to use them, either for socio-cultural
rural India, lack of physical infrastructure banks, and high transaction costs in the reasons or because opportunity costs
facilities, regulatory constraints, and the formal banking system. Access and usage are too high.

Key Drivers of According to Diamond estimates, access to financial services, with 23%
approximately 245 million adults in rural of villages going without electricity, 67%
Financial Exclusion India do not have a bank account today. without a Post Office, and an average
in India Today As depicted in Figure 5, this reflects rural literacy rate of 59% and secondary
24% of the total population. While school penetration of 12%. This lack
60 million out of 245 million may not need of physical and social infrastructure in
banking services because they are below rural India is a key issue impacting access
the poverty line, Diamond believes to formal financial services.
that approximately 185 million “potentially
The average distance to a branch in
bankable” people do not use formal
India is approximately 3.8 Kms (Figure 7,
banking services because of reasons like
see Page 6). While this compares
poor access or usage.
favourably to the average distance to a
branch in a developed market like the
Access Issues for Rural Customers U.S. (which is 6 Kms6), there are significant
Access is explained in terms of additional challenges in India in the
infrastructure, physical distance, limited form of unpaved roads and limited access
delivery capabilities, regulatory constraints to modern transportation. Most rural
and the economics of rural banking. customers are likely to sacrifice an entire
day’s wage to travel to a bank branch
The banking infrastructure in rural India
which is open between 10:00am and
is not encouraging, with just 7% of villages
5:00pm. While some banking transactions
housing a bank branch5. What’s more,
could be done over phone, this is rarely
the poor physical and social infrastructure
an option in a country with such low rural
(Figure 6, see Page 6) also impacts the

Size of Potentially Bankable Market in Rural India

100% 185 million people are potentially

bankable but unbanked because
of access and usage constraints

Demand limitation:
47% People below poverty line1
53% 16%

37% 13%

24% 6%

Total Non-adult Adult Urban Adult Rural Adult Banked Unbanked Financially Potentially
Population Population2 Population Population Population Population Population Constrained Bankable

1. Poverty Line: The cost of average basket of consumption of 2400 calories per capita per day (Rs 328/month as of 2001).
2. Population up to 18 years of age.

Source: Census India 2001;BSR 2005—Reserve Bank of India; World Bank & NCAER (2004).

Figure 5

Current Status of Rural Infrastructure Limited delivery capability is a
significant challenge. Much of rural India
Physical and is serviced through branches because
Banking Infrastructure Social Infrastructure
ATM penetration is low and other channels
Population Percentage of Villages such as Phone and Internet Banking
Number of Branches per Branch Having Listed Facilities
are non-existent. Intermediaries like
Urban India 38,000 7,500 Post Offices 23% Non-Governmental Organizations (NGOs),
Irrigation 76% Self-Help Groups, and Micro Finance
Rural India 31,970 23,200
Institutions (MFIs) are being used by banks
Electricity 77%
4,840 27,200 to improve access to credit and savings.
Community TV Centre 7%
However, these channels, in their current
Bihar 2,490 20,900
Primary School 72% form, offer limited services (Figure 8 and 9,
Karnataka 2,160 16,100
Secondary School 12%
see Page 7).
Rural Regions Only

Madhya 24,000
Self Help Groups 64% There are some regulatory constraints
Orissa 1,590 19,700 imposed by the Reserve Bank of India
(RBI) which may inadvertently contribute
Punjab 1,130 14,200
Percentage of further to the lack of formal banking
Population Covered
Jharkhand 970 21,600 services in rural areas. For example, the
Tele-density 2%
RBI does not allow banks to post any
Kerala 340 67,900
Literacy 59% person other than a security guard
at ATMs.Hence, banks cannot deploy
Source: Census India 2001; BSR 2005—Reserve Bank of India; National Sample Survey Organisation (NSSO) report on village facilities—2003.
many ATMs in rural areas as many rural
Figure 6
customers require in-person support. A
second regulatory inhibitor is that new
Current Status of Access to Rural Banking banks planning to establish a branch in
a rural area have to receive approval from
Average Distance to a Bank Branch Distance to a Bank Branch — Rural India the Lead Bank and District Collector of
that district. Hence, banks choose not to
34% open new branches in certain areas even
when it is profitable to do so because there
24% 23%
is no certainty of getting approvals.

Adult Population: 541,031,553 Many banks view the rural market as a

Area: 3,287,590 Sq. Kms. 12% regulatory requirement rather than an
Branches: 69,969 7% economic opportunity. Banks have from
time to time borne the social cost of
Within <2 kms 2–5 kms 5–10 kms >10 kms lending to the rural economy at rates
below their costs. They have also faced
81% of villages don’t
capital erosion because of the write-
have a bank branch
within a 2 km radius
off of loans, particularly agriculture loans.
Population per branch: 7,732
Banks are required via regulatory
Area Covered/Branch: 46 Sq. kms requirements to open branches in rural
Average distance to a branch: 3.8 kms
areas to provide loans to agriculture and
Source: Census India 2001; BSR 2005—Reserve Bank of India; Diamond analysis, National Sample Survey Organisation (NSSO) report
on village facilities‚2003.
other priority sectors. These branches are
often unprofitable because of low ticket
Figure 7
size, high cost to serve, higher risk of
credit, information asymmetry, and high
proportion of non-performing loans (NPLs):

Current Rural Banking Channels High Non-performing Loans (NPL):
Banks have higher non-performing
Description Services Provided Remarks loans in rural areas because rural
• Full fledged Branches and • Deposit Accounts • 96% of total deposit and 95% of households have irregular income and
Extension Counters of • Credit Accounts total loans are with scheduled
Branch — Scheduled Commercial Banks • Remittances commercial banks with expenditure patterns. The issue
cooperative banks holding
including Regional Rural Banks
— Cooperative Banks

Third-Party Products the difference is compounded by the dependence of
• Has a high cost-to-serve
the rural economy on monsoons,
• NGOs, SHGs, MFIs and • MFIs directly lend to the poor • This channel delivers limited
Cooperatives who act as and also act as agents for services in its current form and loan waivers driven by political
Intermediaries intermediaries to take financial the banks
services to the rural areas • SHGs borrow from banks and agendas. NPLs from the agriculture sector
are beneficiaries of loans
themselves are 7.7%, compared to 3.5% across
• Onsite • Cash Withdrawal • Negligible presence of this
— ATM installed at a branch • Cash Deposit channel in rural areas
non-agriculture sectors8.
ATM • Offsite • Money Transfer
— ATM installed at a remote

Cheque Book Request
Bill Payments
In order for banks to view rural India
as a growth opportunity, rather than
• Phone Banking • Cash Withdrawal • Almost non-existent in rural
— Manual • Cash Deposit India because of low: a regulatory requirement, a combination
Others — Interactive Voice Response (IVR) • Money Transfer — Tele-density
• Internet Banking • Cheque Book Request — Internet-penetration of these issues must be addressed.
• Kisan Credit Card • Bill Payments — Credit appetite of banks
— Provide short-term credit
Increasing financial access to rural areas
Source: Reserve Bank of India; Diamond analysis.
is contingent upon basic conditions
Figure 8
such as proper infrastructure and an
enabling regulatory framework, as
Low Ticket Size: The average ticket for rural households. The poor rural well as innovative thinking on the part
size of both a deposit transaction and households (landless and marginal of commercial banks. Access issues,
a credit transaction in rural areas is farmers) are particularly dependent however, explain only one part of the
small (Figure 4). This means that banks on irregular wage employment. Rural problem. Usage is an equally important
need more customers per branch or households also have irregular expenditure issue for rural customers.
channel to break even. Considering the patterns. The typical expenditure
small catchment area of a branch in profile of rural households is small, with
Cost Per Transaction in Indian Banks
rural areas, generating a customer base daily or irregular expenses incurred
with critical mass is challenging. through the month. Furthermore, a
Cost Per Transaction (Rs)1
majority of households incur at least one
High cost to serve: Branches are the unscheduled expenditure per year, 48

most used channel in rural areas. This with the most frequent reasons being
is because many rural people are medical or social emergency 7. In short,
not literate and are not comfortable using the rural customer is generally considered 25
technology-driven channels such as to be a risky one. 18
ATMs, phone banking or internet banking.
On the other hand, a branch is an Information Asymmetry: Since many 8
expensive channel for banks (Figure 9). rural people do not have bank accounts, 4

In addition, rural people, whenever they there is a lack of information on customer

Branch Phone ATM Phone Internet
have access to banks, have frequent behaviour in rural India. Absence of (Call Centre) (IVR)

low ticket and cash-based transactions, a Credit Information Bureau also 1. Cost per transaction refers to the operating cost
that a bank incurs per customer transaction on a
particular channel.
which increase the overall transaction complicates the problem as banks have
Source: Reserve Bank of India; CGAP, World Bank.
cost for their bank. to rely on informal sources to learn the
Figure 9
credit history of rural customers. A lack
Higher risk of credit: Rural households of reliable information can result in either
may have highly irregular and volatile missed opportunities in not approving
income streams. Irregular wage labor otherwise eligible loan candidates, or non-
and the sale of agricultural products performing loans.
are the two main sources of income

Usage Issues for Rural Customers Financial Needs and Service Requirements
Even if access to formal banking is
provided to rural customers, there is no Current
guarantee that these services will be Via Formal
used. According to a study conducted by Critical Needs Description Banking Rationale

the World Bank, many households, even in Frequent and daily Banks do not offer daily
Micro-savings surplus savings small savings deposit
developed countries, choose not to have Savings schemes

a bank account as they do not engage in Frequent withdrawals

To meet contingencies,
social functions and
Branch channel is cost-
ineffective for rural
many financial transactions—they collect working capital customers

wages in cash, spend in cash and do not For consumption, Rural banks generally do not
Micro-credit education and give loans for consumption
wish to be burdened by a bank account9. To Credit emergency purposes & emergency purposes

compound the situation many customers in Micro-enterprise Loans

Working capital or small Banks provide seasonal and
capital investments long-term agriculture loans
rural India, who have access to and would requirements but there are delays and
excess documentation
otherwise choose to use formal financial Banks have not targeted
Asset Protection, Health,
services, do not do so because the product Insurance &
Micro-insurance Life and Savings the rural poor for insurance
and service mix do not meet their needs. To Access funds Rural branches are not
Remittance & Transfers remitted by relatives computerized and usually
remittances take more
The financial service needs of rural than 2 weeks to reach the
customers are not confined to just savings
and credit, as is usually assumed. Their High Medium Low Negligible

financial needs are linked to their life cycle Source: Diamond analysis.

needs, ranging from savings to credit Figure 10

to insurance to remittances (Figure 10).
In fact, even the savings and credit
Purpose of Borrowings
products currently offered to rural
customers do not entirely meet their needs.
Rural Household Borrowing Bank Lending to Rural Households

Access to savings and investment facilities

is critical for the poor. The two critical Business
needs for the rural poor are micro-savings Expenditure

and frequent withdrawals. These needs

Household Other
facilitate a customer in building capital Expenditure
48% Loans
over the long term, as well as coping with Agriculture

income shocks in the near term.10. However, 38%

banks do not offer adequate services to

address these needs. The lack of services,
therefore, leaves the rural poor with little A significant percentage of borrowing is toward consumption and other household
option than to transact with the informal expenditure, whereas formal financial institutions in rural India provide loans primarily
for productive purposes.
banking market. A study conducted by
MicroSave also concludes that the poor Source: AIDIS—2003, National Sample Survey Organisation (NSSO); Diamond analysis.

transact with the informal sector because it Figure 11

will accept small amounts, provide doorstep
service, and ensure ease of enrolment11.
emergencies. Though banks offer purpose- from the informal system are almost
Rural customers need loans not only free loans (personal loans and credit cards) always repaid or renewed12). In addition,
for productive purposes but also for in urban areas quite liberally, in rural areas larger households need occasional
consumption needs (Figure 11). As shown sanction of such loans is significantly high value micro-enterprise loans for
in Figure 10, apart from agricultural restricted. Therefore, the poor raise these small capital investment. Though
support, rural customers need micro- loans through the informal financial system banks offer these loans, they require
credit for consumption, education and (it is worth noting that these loans taken excessive documentation and time-
consuming processes which discourage Aspects of Credit and Deposit in Rural India
customer applications.

Insurance reduces the vulnerability

Aspects of Banking Cost of Cost of
of poor households by replacing the Transactions Formal Financing Informal Financing
uncertain prospect of large losses with the 24%–120%
Interest rate (median) % p.a. 9.5%
certainty of payout against small, regular (Varies from state to state)
Loan amount received as % of
premium payments. It is integral to a amount applied
92% 100%
comprehensive risk management strategy Bribe as % of amount approved 10% 0%
for poor households. This includes life, Time taken to process a loan
33 Weeks –1 Week
health, accident and asset (dwelling, crop, application
Cost of opening & operating
and livestock) insurance. Banks and insurance a deposit account
10% 0–2%

firms do not offer these services in many Interest earned 3.5% 0–10%
rural areas, leading the poor to rely on the Medium to High
Associated risk Low
informal financial system. (In extreme cases,
deposit facility provider
may abscond)
There are many rural households which Source: State Bank of India; World Bank.
depend on weekly or monthly remittances Figure 12
from their family members who have moved
to urban areas. At present, they depend
on informal channels to remit the money receive the loan is negligible and there are being offered by any financial service
and consequently either risk the loss no indirect costs or commission. Banks provider, including:
of money or pay high transaction fees. also insist on collateral security which many
• Products—Are financial services
Banks do not offer seamless remittance rural poor cannot afford.
available and tailored to my needs?
facilities between urban and rural branches
As far as savings are concerned, though
as many of the rural branches are not • Cost—What is the total cost of the
the formal banking system provides
computerized and connected to the main service (including opportunity cost)?
financial security, the cost of opening
bank’s computer systems. This often results
and operating an account is high. The • Convenience—How easy is it to access
in the beneficiary receiving the amount
overall cost of transacting with the formal and use?
two weeks after it has being transferred.
financial system increases for a rural
This represents yet another key service
person because of additional costs such • Eligibility—Am I eligible for financial
which is not provided.
as expenses incurred to reach a branch services and can they be accessed
The transaction cost for a rural customer and the opportunity cost of lost wages. repeatedly?
to receive credit primarily constitutes four Since rural banks are generally not within
As explained earlier, the savings products
attributes: the interest rate, loan amount an accessible area and do not operate
offered in the current format do not qualify
received as a percentage of amount applied, at convenient times, the rural customer
as a flexible, convenient and cost-efficient
bribes paid, and the lead time to process must forgo a day’s wage to reach a branch.
service. Similarly, loan products do
the loan. Though the formal banking system Informal systems, on the other hand,
not meet product and eligibility criteria.
offers loans at interest rates lower than involve a lower transaction cost, but
In addition, insurance and remittance
informal banking systems, the time taken for they are risky and in some cases result in
services are not even available. The cost
a loan to be sanctioned (Figure 12) is high the loss of one’s entire capital. In short,
of services, despite lower interest rates, is
which increases uncertainty and opportunity this leaves the rural customer to choose
high because of other indirect costs which
cost. In addition, the customer needs to pay between two unfavourable options.
make the banking services cost-inefficient.
almost 10% of the loan amount in bribes and
In summary, the services being offered
eventually receives an amount that is less The access and usage issues need to be
by the formal banking system do not seem
than what was applied for. Therefore, while addressed to improve financial inclusion.
to meet the needs of the rural poor. A
the interest rates are usurious in the informal The next segment of the paper looks
World Bank study suggests that the poor
financing system, rural customers still resort at some changes that the government,
apply a set of criteria to judge the services
to this channel because the waiting time to RBI and banks need to make.
The Way Forward In building an inclusive financial system, has an additional responsibility to improve
each of the three key stakeholders—the social infrastructure by improving literacy
government, RBI and commercial banks— rates and education facilities. In addition,
has a role to play. The following chapter the government should educate rural
briefly examines the desired actions to be people about the negative effects of
taken by the government and RBI, and then debt-trap and the benefits of using formal
provides more in-depth recommendations banking channels. Finally, to regulate
for banks. We focus on the actions to be the informal credit market, the government
taken by banks because they are able can not only enact laws such as the
to more rapidly implement change than Moneylenders Act, but also needs to
the government or RBI, even within successfully implement them.
the current regulatory environment.
Reserve Bank of India: The Reserve
Bank of India, as the regulator of the
Stakeholders formal banking system, has a critical
The Government: As noted, weak role in improving rural access and usage.
infrastructure is an important factor limiting Changes in technology, banking systems,
access to rural branches even in areas where and market conditions may require
it would seem that customers are within that the RBI revisit some of its guidelines
a reasonable distance of a bank branch. governing the licensing of new branches,
The government has initiated the Bharat operations of ATMs, and use of technology.
Nirman plan13 to improve infrastructural The following are a few suggestions
conditions in rural India, but there is a need to address each of these three issues.
to ensure rapid implementation. The two
First, with improvements in banking
critical elements of rural infrastructure which
technology, it may not be essential to have
have a direct impact on the accessibility of
a bank branch to reach rural customers.
banking channels are road and transportation
The RBI need not require banks to open a
infrastructure and electricity and power
branch in rural areas as a requirement
to grant licenses for urban branches.
Similarly, high levels of illiteracy deter rural Instead, banks should be allowed to
customers from actively engaging in formal explore alternative, more economical
financial channels. Hence, the government channels to reach the rural customers.

Stakeholders Involved in Improving Access and Usage

Issues Stakeholder Involvement Role Description

Government RBI Banks • Government to play an important role

in building basic infrastructure
Access • RBI to bring necessary changes in
• Banks to innovate and use technology
to improve the banking outlets

• RBI to relax guidelines to permit banks

improve services & operations
Usage • Banks to introduce new products, improve
processes, establish new partnerships and
manage pricing to improve usage of banking

High Medium Low Negligible

Source: Diamond analysis.

Figure 13

Second, ATMs are an effective channel Rural India has a Large Untapped Credit and Deposit Market
to deliver many services at significantly
lower cost than a branch. However, ATMs Current Coverage of
Total Market Scheduled Commercial Banks
are not effective in rural areas if they
are unattended, as required by the current 1. Consumption or Working Capital
Rs. 6,000 per household for all Households
RBI guidelines. The RBI should consider Credit +
2. Capital Investment
the option of allowing banks to appoint Rs. 30,000 per household for 10% of 91%
customer service agents in rural ATM
kiosks subject to some stringent rules to
Total Credit Market
Untapped Market Size
prevent fraud. = ~ Rs. 1,330 Billion
= Rs. 1,204 Billion

Savings Per Household

Last, the RBI should examine the Rs. 7,800
potential impact of allowing bank business Deposit Financial Savings Non-Financial Savings
Per Household Per Household 46% 54%
correspondents to use point-of-sale Rs. 2,800 Rs. 5,000

technologies such as Palmtops to deliver

financial services in rural areas. Total Deposit Market
= ~ Rs. 400 Billion
Untapped Market Size
= Rs. 215 Billion
While there are additional regulatory Note: No. of Rural Households—148 Million

reforms which would enhance banking Source: BSR 2005—Reserve Bank of India, RBI; World Bank 2003.

access and usage for rural customers, Figure 14

Diamond believes that addressing these
three points would be a significant start. Contrary to the widely held notion, As we identified earlier, access and usage
Banks: Even within the sub-optimal however, the rural market is attractive are two broad concerns which explain
infrastructure and regulatory framework from both a credit and deposit perspective. why the potentially bankable are unbanked.
laid out by the government and RBI, The credit demand in rural areas is With regard to access, the challenge for
there is an opportunity for banks to approximately Rs 1,330 billion (based on banks is to identify profitable channels that
improve the rural customers’ access and an estimate by World Bank). There are meet the needs of rural customers. With
usage. Access can be enhanced through other studies by the Planning Commission regard to usage, banks need to understand
new and innovative channels which and ICICI Bank which put the figure even the requirements of the rural customer
the RBI already permits, and by leveraging higher at Rs 1,440 billion and Rs 1,500 and customize products and services
cost-effective technology in existing billion respectively. Similarly, on the accordingly (Figure 15).
channels. Usage can also be improved deposit side, a large segment of the rural
if banks revise their product and service population does not save with formal Proposed Approach to Tap
offerings to meet the needs of the banking channels because banks Potentially Bankable Population

rural customer. are not accessible and do not provide

the appropriate products and service, Address
Access Needs
leaving a significant opportunity to grow of Rural
Market Opportunity the deposit base. Access

for Rural
At present, a rapidly growing urban Customers
India is the focus of the banking sector; At present, the penetration of banking Channel
however, as the deposit penetration in rural areas is sub-optimal with a large Convert

numbers suggest (Figure 3 & 4), the market remaining untapped in both Potentially
market is highly competitive and over- the liability (~ Rs 215 billion) and asset Usage Needs

banked. Despite this, most banks (~ Rs 1,204 billion) sides of the business of Rural

are still not shifting their focus to the rural (Figure 14). These estimates clearly Usage of
Services Bank
opportunity, as they are apprehensive suggest that there is sufficient demand Initiatives
to Improve
about the total market potential of in the rural market to encourage banks Usage

the rural market and the profitability to think seriously about rural areas
Source: Diamond analysis

of rural banking channels. as an alternative growth opportunity.

Figure 15

Improving Access Though phone banking and internet Groups; (vi) post-sanction monitoring;
Today, branches are the primary delivery banking are cost-effective channels, given (vii) monitoring and handholding of Self
channel in rural areas. Though there are very low tele-density and low internet Help Groups/Joint Liability Groups/Credit
32,000 commercial bank branches in India, penetration in rural areas, the ability to use Groups/others; and (viii) follow-up for
they cover less than 7% of total villages14. these channels to reach the rural customer recovery; (ix) disbursal of small value
Opening more branches is not necessarily is low. However, phone and internet banking credit, (x) recovery of principal/collection
profitable as many pockets of rural areas should be considered once infrastructure of interest (xi) collection of small value
do not have business enough to justify and literacy levels improve in rural India. deposits (xii) sale of micro-insurance/
an expensive branch channel. Therefore, A business correspondent could then run mutual fund products/ pension products/
to improve access in rural areas, banks an e-kiosk to assist customers to transact other third-party products and (xiii) receipt
need to modify existing channels, over these channels. For example, and delivery of small value remittances/
introduce new channels and identify Centenary Bank in Uganda uses internet other payment instruments.
innovative ways to integrate the two. and phone banking to provide bill payments,
The introduction of Business Correspondents
money transfers and loan repayments.
may face some challenges from labour
Modify Existing Channels Business correspondents can be provided unions. However, Diamond believes that
Fortunately there are a variety of options with point-of-sale (POS) functionality there may be some options to address
available for banks looking to modify to allow customers to deposit and withdraw the concerns of the current workforce while
their existing channels. cash from their accounts. Combining POS using Business Correspondents to capture
with a smart card is one way to improve more value from rural customers.
To reduce the costs imposed by branches, access. Brazil has successfully used
banks should consider the option of Caixa Economica, a state-owned bank
banking correspondents who use POS and
sharing their branch infrastructure. in Brazil, manages the country’s lottery
card readers to provide current accounts,
This would not be too dissimilar to network and distributes government
loans, and insurance, accept bill payments,
the example of the telecom industry benefits. To increase the access of its
and perform other transactions.
sharing network infrastructure or services, Caixa extensively utilizes the
the fast food industry sharing food courts Banking Correspondent channel, with
in urban areas. Though infrastructure Introduce New Channels 14,000 banking correspondents covering all
sharing may raise concerns over client The RBI allows banks to appoint business of Brazil’s 5,500 municipalities. In less
confidentiality and data leakage, in the correspondents and facilitators to than 2 years, Caixa opened about 2.8 million
long run banks will only benefit from be used as intermediaries in providing new accounts and estimates that 40% of
such collaboration. banking services. NGOs, MFIs, Societies, its banking transactions are handled
Section 25 companies, registered NBFCs through the banking correspondent channel.
ATMs are an effective channel which can not accepting public deposits, and
deliver many of the services frequently Satellite offices are a cost-effective
Post Offices can be appointed as Business
used by a branch customer. However, alternative to branches. These offices
ATMs, in their current form, are not can be established at fixed premises in
suitable for rural areas as the literacy level Business Correspondents can provide villages and are controlled and operated
and transaction ticket amount is too l several services which are not currently from a base branch located at a block
ow. ATMs can, however, be designed to offered by SHGs and MFIs, including: headquarters. All types of banking
meet the needs of rural customers. (i) identification of borrowers and fitment transactions may be conducted at these
For example, ICICI Bank is working with IIT of activities; (ii) collection and preliminary offices. Banks have, however, not used this
Chennai to develop an ATM that has processing of loan applications including channel actively, despite the argument
a biometric fingerprint login, accepts soiled verification of primary information/data; that this channel is relatively less expensive,
notes, and lower value denominations. (iii) creating awareness about savings as it can draw personnel from the main
In addition to modifying the design of the and other products and education and branch and can remain open for just two
machines, banks should also hold discussions advice on managing money and debt days a week. This channel, therefore,
with the RBI to allow an attendant to counseling; (iv) processing and submission is appropriate in blocks and districts
be posted at ATMs. This will enhance the of applications to banks; (v) promotion and which are densely populated. In the urban
usability of ATMs. nurturing Self Help Groups/Joint Liability areas, most Indian banks opt for an
extension counter where the business does because many of those that already exist While this list is not exhaustive, it
not justify a full-fledged branch. Similarly, are unprofitable. Therefore, determining highlights the need for creative solutions
satellite branches can cater to rural areas the right combination of channels is critical that apply the right channel to the
which do not justify a large branch. to improving access in profitable ways. right market and transaction.

Where banks do not find it economical to An innovative approach to improving In South Africa, Capitec has combined
open full-fledged branches of satellite offices, access will consider a combination of convenient branches along transportation
mobile offices may be more appropriate. these channels. For example: routes (for example, train and bus stations,
Mobile offices extend banking facilities and taxi stops). In addition, it has
• Branches and Satellite Branches—
through a well-protected truck or van. The rolled-out debit cards and automatic teller
In addition to providing regular banking
mobile unit visits villages on specified days/ machines across 200 of these branches
operations, providing backend support
hours. The mobile office would be affiliated to stimulate savings among low-income
to manage and audit the operations of
with a branch of the bank, and serve areas earners. Between February and August
business correspondents.
which have a large concentration of villages. 2004, the number of customers jumped from
This will not be dissimilar to the mobile • A low-cost, custom-made ATM— around 18,000 to more than 60,000.
ATMs implemented by some of the Indian Managed by a business correspondent
banks in the urban areas. to bring down the operating cost
and scale the channel. Encouraging Usage
The presence of a banking channel does
Determine the Combination of Channels • An e-kiosk—Managed by a business not guarantee that the rural customer will
There is no one right channel or solution correspondent with internet banking, actually use that channel. In addition
to improve access in rural areas. ATM and POS terminal in relatively to access issues there are usage issues.
Banks have to evaluate the trade-offs large rural areas. To stimulate usage, banks need to improve
between those channels that are most • A business correspondent—Using their product mix, reduce total transaction
convenient to customers and those manual ledgers or POS/Palmtop to act cost, provide convenience, and clearly
that are the most profitable. Banks are not as deposit collector and remitting outline the eligibility criteria for products
comfortable opening new rural branches agent in smaller rural areas. and services (Figure 17, see Page 14).

Multi-Channel Approach to Meet Customer Needs and Ensure Channel Profitability

Busines Internet
Facilitators Satllite/ Banking/Phone
Correspondents Mobile Office Branch ATM Banking/POS

Access Needs
of Rural
Ease of
for Rural
Cost to

Very High High Medium Low Negligible

Source: Diamond analysis.

Figure 16

With regard to products, rural customers credit limits through credit cards, banks been implemented in urban areas where
have some critical needs, such as can reduce their visits to branches and banks are open from 8:00am to 8:00pm
micro-savings, micro-credit, remittances intervention by a bank officer. This will not or four hours in the morning and four hours
and others which will require banks only reduce the cost of bank operations in the evening.
to develop some innovative offerings. but also reduce the burden of commissions/
To improve the ease of operating an
For micro-savings, banks could develop a bribery at every stage of the process.
account, banks can print signature-ready
flexible savings product with daily deposit
In South Africa, cell phone companies pay-in slips and withdrawal slips, wherein
collection and withdrawal facilities. A
are developing low-cost, cell phone-based the illiterate rural customer is required
business correspondent carrying a manual
banking services using short message only to tick the amount of deposit or
ledger or POS can facilitate such a product.
service technology, often connected to withdrawal and place a thumb impression.
For micro-credit needs, consumption loans
mobile banking. Transactions, which
need to be designed. This is not entirely Finally, to improve customer service,
are being used mainly by poor customers,
different from giving purpose-free personal banks can recruit staff locally. Banking
include balance inquiries, bill payments,
loans and credit cards in urban areas. correspondent channels have been
money transfer, transaction alerts, and
Rather than not offering these loans at successful in some countries because
account servicing.
all, banks should focus on managing credit they recruit local staff who better
risk. For instance, banks may give such The primary convenience needs of understand the local customer.
loans only under the Joint Liability Groups rural customers are bank operating hours,
(JLGs) format. Similarly, for remittances, Prodem in Bolivia is a successful
ease of transaction, and customer service.
banks need to accelerate the remittances example of how banks can increase
between various channels by improving Operating hours need to be tailored to customer usage by improving convenience.
technology and connectivity. better meet the needs of rural customers. Prodem installed ATMs that incorporate
In agricultural communities, for example, biometric fingerprint readers and voice
SafeSave in Bangladesh is an example opening the branch in the morning instructions in three languages. These
of how well-designed financial services and evening would allow farmers and ATMs, along with smart cards, can support
products can quickly become popular daily wage earners to bank without many banking transactions and given
amongst rural populations. SafeSave losing a day’s work or wage. Alternative their convenience, have been popular
has designed savings products which operating hours have, in fact, already with customers.
allow the poor to save on a daily basis,
withdraw as needed at their doorstep,
and access credit products with flexible Improving Usage — Desired Initiatives from Banks
repayment options.
Rural customers are concerned not only Product Cost Convenience Criteria
about the interest rate, but also about • Micro-savings • Interest Rates • Banking Hours • Eligibility for
indirect costs (bribes, commissions, Usage Needs

• Indirect costs
— Bribes
• Ease of deposit
and withdrawal
account opening,
loans, and other
of Rural
etc.) and expenses associated with Customers
• Remittances — Commissions • Friendly bank services
— Documentation officials
banking transactions. While interest expenses
rates of the formal banking system are Usage of
not high, the total transaction cost for
a rural customer is. The government and Bank
• Flexible savings • Differential interest • Flexible working • Define eligibility
account rate based on hours clearly in
RBI can relax rules around interest rates Initiatives to
• Bancassurance credit history • Simpler pay-in vernacular
• E-remittances • Minimal slips and • New credit scoring
for loans less than Rs 200,00015 to allow Usage
• Credit Cards and documentation withdrawal forms models to suit
personal loans • Loan delivery • Employees rural customers
banks to manage the cost of credit risk. • Joint Liability through credit sensitive to local • New methods for
Group based cards culture sharing credit
To reduce indirect costs to the customer, loans • Usage of palmtops information
and POS for deposits
banks have to adopt simpler processes and withdrawals

and documentation, and transparent Note: Usage Needs are Not Exhaustive

and clearly defined norms. By allowing Source: Diamond analysis.

rural borrowers to use their approved Figure 17

Uncertain eligibility criteria traditionally are not denied credit. This can be achieved CECAM in Madagascar and Prizma in
have been a barrier to usage. The process through proper credit scoring systems Bosnia present two examples where
and guidelines to apply for loans are that assess credit risk of farmers and innovative methods in developing credit
neither clear nor concrete. Rural customers others who have irregular cash flows, and products and credit methods helped
are never certain what is required to processes and systems which allow banks to include the poor in their clientele.
apply for a loan or whether they qualify for to share information. Most importantly, CECAM developed credit products where
a certain product. In order to encourage developing and enforcing clearly defined the repayment of loans matches the
consumption banks need to clearly rules and educating the customers will cash flows of the borrower, and Prizma
define the loan qualification criteria in the help them to see the merits of the formal developed customized credit score
local language. In addition, banks should banking system. models which help it keep track of
ensure that otherwise qualified candidates customers’ credit histories.

Conclusion There are 185 million bankable adults Reserve Bank of India and the commercial
in rural India who are unbanked because banks. In addition, partnerships between
of access and usage issues. This presents banks and business correspondents, and
a significant opportunity for commercial collaboration amongst banks is critical.
banks. However, to reach this market and Furthermore, banks should tailor their
subsequently build an inclusive financial product and service mix to meet rural
system, there must be a coordinated needs, and adapt their delivery models
and concerted effort by the three key to ensure commercial viabiility of their
stakeholders: the Government of India, the rural banking operations.

End Notes

1. World Bank 2005

2. Reserve Bank of India 2005


4. National Sample Survey Organization (NSSO), Household Consumer Expenditure in India (2004)

5. Census 2001

6. Access to and Usage of Financial Services, World Bank 2003

7. RFAS, 2003, World Bank & NCAER

8. Reserve Bank of India,

9. Access to Financial Services by Stijin Claessens, World Bank 2005

10. Rutherford Stuart, “The Poor and their Money,” January 2000


12. RFAS 2003, World Bank

13. Bharat Nirman is a four year business plan of the Government of India to improve rural infrastructure

14. National Sample Survey Organization (NSSO) 2003

15. At present interest rates on loans less than Rs 200,000 are regulated.

About the Firm Diamond (NASDAQ: DTPI) is a premier global management consulting firm that helps
leading organizations develop and implement growth strategies, improve operations,
and capitalize on technology. Mobilizing multidisciplinary teams from our highly
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achieve sustainable business advantage. Diamond is headquartered in Chicago, with
offices in Washington, D.C., New York, Hartford, London and Mumbai. To learn more,

About the Authors Vinod Nair is a Partner at Diamond and leads the firm’s India practice. He has worked
with clients in India, Europe, the Middle East, U.S. and South Africa on a range of
strategic and operational issues. Vinod has focused on issues such as successful market
entry strategies, proposition development and marketing planning, analytical marketing
techniques to improve customer lifetime values, and operational improvement efforts
to reduce costs and streamline processes. His clients include leading corporations in the
telecommunications, financial services, media, automotive and manufacturing sectors.
In financial services, he has worked with retail banks and credit card issuers on defining
new payment solutions and exploring partnerships between retail banks and mobile
operators. He has also advised leading private equity houses on potential transactions
in Europe and in India.

Andrew Sofield is a Manager in Diamond’s Financial Services practice. Andy has experience
in retail financial services’ organization, product, marketing and communication strategy,
process and policy reengineering, competitive analysis, and operations management.
He has also worked as a strategy, operations, and change management consultant in
the telecommunications, health care and product sectors. Throughout his consulting career
Andy has gained extensive international experience, having lived, worked, or travelled
in more than 50 countries on six continents. His most recent international initiative has
been helping open Diamond’s office in Mumbai, India.

Vijay Mulbagal is a Senior Associate in Diamond’s Financial Services practice. Vijay

has nine years of experience working in commercial banking in India. He has worked
across multiple segments, including retail banking, operations, trade services, microfinance
and corporate banking, in both domestic and multinational banks. He has significant
experience in client relationship management, due diligence, structured problems analysis,
and project management.

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