IMPROVING ACCESS TO FINANCIAL INSTITUTIONS

1. INTRODUCTION:

1.1 BACKGROUND ON INDIAN ECONOMY

The history of the Indian economy encompasses all the struggles the country has gone through in order
to survive against the influences of foreign factors. It is the story of Indian economy which narrates the
evolving of industry from largely comprising of agriculture and trading society to the mixed economy of
manufacturing and service industry. Prior to the intervention by British and Mughals, the Indian
economy was at par with the economies of the develop countries (like: Europe).

During the 18th century, when Mughal Empire ruled the country, India’s agriculture and manufacturing
industry was flourishing. While manufacturing sector produced 1/4th of the world’s total output and the
agriculture sector had undertaken the cultivation of many foreign crops which was traded from various
western traders. During this period, the land was the major source of the national income. Akbar, one of
the many rulers of the Mughal Empire, brought many reforms to improve the efficiency of the
agriculture sector by providing relief on taxation when the weather conditions weren’t good. Even
though there was a constant clash of interest between the notables and emperors, the Mughals did
bring the indian economy to its peak.

The Indian economic condition started to deteriorate when the britishers came into power in 1757
(battle of plassey). Since Bengal had a fertile land and a good economic condition, britishers imposed
heavy taxes on the residents. This revenue was allocated to the british army which helped them conquer
other parts of the india. Eventually, Bengal’s economy ran out their money supplies which lead to
poverty. As Britishers expanded their territory they brough new reforms to exploit the resources of the
country. Firstly, they made the indian economy export raw materials and import manufactured finished
goods. Then eventually they improve the transportation facilities by building better roads and railway
line to further exploit the resources. This caused majority of the indian population to suffer from famine
while remaining illiterate. The assistance of british army during world wars only contributed to the
suffering of the economy. During world war 1 nearly 15 lakh (1.5 million) solders voluntired to assist
british army. At the time of world war 2, indian government was mostly divided. Thinking that they
would be allowed to form an independent government or rewarded by giving freedom to the entire
country, they assisted the british army by sending 20 lakh (2 million) indian tropes. However after seeing
the government of india act 1935 the indian government had lost their faith in the british government.
This gave rise to the various independence movements.

At the time of the independence, the economy was in shambles. The exploitation of resources by the
ruling empires had completely dried out the economy. The output of indian production which as 25%,
out of the total world’s output, was now at 2% only. It is this economic situation that led to the adoption
of five year planning by the government. The first 2 plans were a major success which made the
government believes that the five year plans can revive the economic conditions of the country.
However, after the indo-china and indo-pak wars the economic situation of the country crippled, the
government decided to liberalize the economy for foreign trade.
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
1.2 FINANCIAL SYSTEM

Financial system is a set of complex and closely connected or intermixed institutions, agents, practices,
markets, claims of an economy. It allows the exchange of funds amongst investors, lenders and
borrowers. It also facilitates the transfer of funds from surplus spending units to deficit spending units
(as shown in the diagram below).

Flow of funds (savings)

Seekers of funds
(e.g. - banks,
government, firms)
Supplier of funds
(e.g. - households)
Flow of financial services

Income and financial claims

(Fig -1.1)

Financial system acts as conduit for savers and investors. Financial system utilizes the resources of an
economy to facilitate capital formation through the provision of wide range of financial instruments
complying with the requirements of borrowers and lenders.

According to Levine, financial system also performs five important functions: Facilitate trading, hedging,
diversifying and pooling of risk, Allocation of resources, Monitor managers and exert corporate control,
mobilize savings and facilitate the exchange of goods and services.

Indian financial system not only performs the above mentioned functions, but also channels the savings
of public, private or household sectors and allocates it to those in need. The gross saving of India is
calculated by comprising the savings of public, private and household sectors. According to the national
institution of public finance and policy, saving represent the excess of current income over current
expenditure and is the balancing item on income and outlay accounts of producing enterprises and
households, government administration and other final consumers. The calculation of gross saving of
public, private and household sector is:

1.2.1 PUBLIC SECTOR:

All the government administration, departmental enterprise and non-departmental (like: government
companies, statutory corporations and port trusts) enterprise come under this sector. The gross savings
of government administration and departmental enterprise is defined as the excess of current receipts
over current expenditure. Whereas, the gross savings of the non-departmental enterprise (except the
LIC and issue department of the RBI) is estimated from the analysis of the annual reports of these
companies. In case of banking department of RBI, the gross saving is estimated as the sum of annual
changes in – national agricultural credit fund (long-term operation as well as stabilization), national
industrial credit (long term operation), and depreciation fund. In case of LIC only savings arising out of its
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
general insurance business is considered (life insurance savings is taken into account of household
sector).

1.2.2 PRIVATE CORPORATION SECTOR:

All non-government, non-financial/ financial corporation enterprises and corporative institutions comes
under this sector. For the non-government non-financial companies the gross savings has been taken as
the equivalent to retained earnings (excluding non-operating surplus/deficit). On the other hand,
savings of private commercial banks are estimated as addition to reserve funds.

1.2.3 HOUSEHOLD SECTOR: -

In addition to individuals, this sector also includes all non-government, non-corporate enterprise and
non-profit institutions. Since data on direct household savings (current income – current expenditure) is
not available, the residual method is opted by taking the sum of the investments in various financial
instruments. Thus, the Gross Domestic Savings is calculated as GDP less final consumption expenditure
(total consumption including public, private and household sector).
1

(Fig – 1.2)

1
Retrieved from https://data.worldbank.org/indicator/NY.GDS.TOTL.ZS?contextual=default&locations=IN
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
The fig -1.2 represents the data taken by world bank which shows that after government of India’s
decision to nationalize 14 largest commercial banks in 1969 the level of Gross Savings started improving
and after the liberalization on trade the Gross Savings increased rapidly.

India’s gross domestic savings (GDS) as a percentage of Gross Domestic Product (GDP) has remained
above 30 per cent since 2005. It is projected that national savings in India will reach US$ 1,272 billion by
2019. Over 95 per cent of household savings in India are invested in bank deposits and only 5 per cent in
other financial asset classes

Central Statistics Organization (CSO) and International Monetary Fund (IMF) and it is expected to be one
of the top three economic powers of the world over the next 10-15 years. India’s GDP is estimated to
have increased 6.6 per cent in 2017-18 and is expected to grow 7.3 per cent in 2018-19

The economic growth has a direct relationship with financial system. In a small or local area the financial
system comprises of lenders and borrowers. However, at the global scale the financial system consists of
financial markets in which the short and long term financial instruments are bought and sold which
represent economic resources. Hence, a smooth financial system enables the efficient allocation and
increases in the productivity of the economic resources which results in the development of capital
markets. A developed capital market would act as a conduit for financing the entrepreneurs setting up
their plants. Here capital formation can help boost the capital markets and therefore becomes an
integral part of economic development. It involves three activities:

a. Savings: when resources are set aside for the utilization of other activities.
b. Finance: when available resources are obtained by investors or government for the purpose of
capital formation.
c. Investment: when resources are allocated for the production of capital goods.

The level of capital formation in a country is directly related to the intensity and efficiency with which
these activities are undertaken. The financial system helps not only in allocation of small chunks of
money from large scattered masses into productive business opportunities but also grows the value of
real savings overtime.

Another role that the financial system plays in development of an economy is of banks. According to
Schumpeter banks not only act as an intermediary in the process of financial system but it also provides
credits to the aspiring entrepreneurs. Therefore, banks act as the providers of purchasing power in the
economy.
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
2. INDIAN FINANCIAL SYSTEM

The financial system in india has been divided into two major categories:
formal or organizaed system
informal or unorganized system

The formal sector consists of organized institutions forming a regulated system. Whereas, the informal
sector constitutes unorganized non-institutional entities forming an unorganized system.

2.1. The formal sector is comprised of:

2.1.1. Financial institutions: In general, these are those entities which are in business of accepting
deposits; giving credits or loans, exchange currencies and broker investment securities. However
not every financial institutions provides all of these services. Some institutions may provide
loans and broker services while others may only provide broker services. However, according to
the Reserve bank of India the financial institutions are those non-banking entities which carry
out its business activities similar to that of a bank. The financial institutions include following
entities:

a. Banking sector: this sector is comprised of scheduled and non-scheduled banks. Most of the
banks fall under the category of scheduled banks (such as: public and private sector banks,
foreign banks and regional rural banks).
b. Non-banking financial institutions: these are those institutions which are engaged in banking
activities but have certain restrictions, such as- they can’t accept demand deposit, they can’t be
a part of payment and settlement system and hence can’t issue cheques. They can however,
perform issuance of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or other
marketable securities2.
c. Mutual fund companies: A Mutual fund can be defined as a trust that pools the savings of
investors who share a common financial goal. The money collected from the investors is then
invested in securities that are spread over a wide cross section of industries and sectors, which
reduces the risk of the portfolio.
d. Insurance and housing finance: these companies are an another form of non-banking financial
institutions which are primarily engaged in the business of financing an individual for either
acquiring a property or providing coverage in case of accidental damage.

2.1.2. Financial markets: It can be defined as any market where trading of financial securities and
derivatives occurs. This market can be divided into two types namely:

2
https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
Capital market: it is a market where the trading of long term securities (i.e., securities having a maturity
date of more than one year) occurs.
Money market: it is a market where the trading of short term securities (i.e., securities having a maturity
date of less than one year) occurs.

However, both the capital and the money market can be sub divided into two categories:
Primary market: These are those markets which deal with the issuance of new securities.
Secondary markets: In these markets, the existing securities are traded.
Both the capital and money market help in the sale and purchase of securities which finances a business
and increases its productivity.

2.1.3. Financial instruments: It is a general term used to describe a monetary asset. Depending on the
type of instrument the owner is entitled to either a part ownership of an entity (usually a
corporation) or payment of the interest in return of the principal amount equal to the face value
of the financial instrument, these instruments are known as stocks or bonds respectively. These
instruments can be of long term (longer than one year) or short-term (shorter than one year)
and are traded in both primary and secondary markets.

2.1.4. Financial services: these are those institutions or companies that are primarily engaged in the
activities of managing money which includes underwriting, leasing, portfolio and wealth
management etc. These activities are usually performed by entities like merchant banks,
investment banks, insurance companies, credit unions, etc.
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
On the other hand, the informal sector of the Indian financial system is comprised of small money
lenders and land lords. This sector is neither taxed nor monitored by any form of government. Unlike
the formal sector the informal sector is not managed by any authorized entity which makes it easier for
the entities in this sector to exploit their workers.

The regulation of the formal sector is done by different authorities which monitors the different sections
of the formal sector. The regulatory structure of the indian financial system can be explained through
fig. 2.2.

(Fig. 2.2)

Fig. 2.2 shows that there are 5 major authorizes which regulates the different aspects of the financial
markets of India. The function of these entities can be explained in following way:

The Reserve bank of India (RBI) not only regulates and monitors government securities and foreign
exchange reserves but it also monitors banking and non-banking entities. The banking entities include:

a. Commercial banks: These banks consists - public banks (like: SBI, PNB, bank of India), private
banks (like: ICICI, AXIS bank, HDFC bank), foreign banks (HSBC, standard and chartered, Ba
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
rclays) and regional rural banks (like: Andhra Pragathi Grameena Bank, Punjab Gramin
Bank, etc.).
b. Co-operative banks: These banks are classified into urban and rural co-operative banks
c. Financial institutions: These institutions (according to RBI) consist – IDFC, IFCI, NABARD, EXIM
banks etc.
d. Non-banking financial institutions

The Securities exchange board of India (SEBI) regulates the securities market of India. It maintains a
stable, smooth functioning, secure and efficient investment market by the enforcement of effective
regulation in Indian securities market, Whereas, Insurance regulatory and development authority (IRDA)
regulates both life and general insurance industries in India and Pension fund regulatory development
authority (PFRDA) monitors and regulates the entire pension related schemes or initiatives taken by
government of India.

The Government of India (GOI) in fig 2.2 is representing the Ministry of finance. The Ministry of finance
has Ministry of consumer affairs which deals with the forward market commission (FMC). The Forward
market commission regulates the prices or rates of commodity exchange through commodity brokers.

3. CURRENT SCENARIO:

The nationalization of 14 large commercial banks in 1969 led to the entry of private sector banks in India
which created a competitive environment for the banks to develop and grow. Since then, Indian banking
sector has taken a huge leap and grown into a gargantuan industry regulating not only the financial
aspect of the consumers but also the financial markets of a national as well as global economy. The
Indian banking system consists of 27 public sector banks, 22 private sector banks, 44 foreign banks, 56
regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks, in addition to
cooperative credit institutions.

According to India brand equity foundation’s (IBEF) report, value of public sector bank assets has
increased to US$ 1.52 trillion in FY17 from US$ 1.34 billion in FY16 and total banking sector assets have
increased at a CAGR of 8.83 per cent to US$ 2.202 trillion during FY13–17. While the assets of the
banking industries are growing rapidly the Credit off-take has been surging ahead over the past decade,
aided by strong economic growth, rising disposable incomes, increasing consumerism & easier access to
credit. As of Q3 FY18, total credit extended surged to US$ 1,288.1 billion and credit to non-food
industries increased by 9.53 per cent reaching US$ 1,120.42 billion in January 2018 from US$ 1,022.98
billion during the previous financial year.

As the demand for the loans by service, agricultural, real estate, corporate and retail industries grow,
the competition amongst banks in the industry grows even higher. The concept of FINTECH (financial
technology) has revolutionized the banking industry. According to Financial Stability Board (FSB), of the
BIS, “FinTech is technologically enabled financial innovation that could result in new business models,
applications, processes, or products with an associated material effect on financial markets and
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
institutions and the provision of financial services”. Basically, financial technology is any innovation in
financial sector which improves the facilitation of financial services. In order get a sense of broad
contribution of FINTECH in different areas of financial industry we can divide the major FINTECH
innovations into 5 main groups.

PAYMENT,
CLEARING AND
SETTLEMENT

DATA
ANALYTICS AND MARKET
RISK PROVISIONING
MANAGEMENT
MAJOR
FINTECH
INNOVATIONS

DEPOSITS,
INVESTMENT LENDING AND
MANAGEMENT CAPITAL
RAISING

3.1. PAYMENT, CLEARING AND SETTLEMENT:

In this, the financial technology improves the speed and efficiency of payments, clearing and settlement.
It also reduces the cost of carrying out the financial services and makes it easily available for the
consumer to access their bank accounts. Some of the innovations in the area of payment, clearing and
settlement in financial markets are:

3.1.1. Mobile and web based applications:

These applications allow a user’s mobile to act as their credit/debit cards. E.g.: Apple, Samsung
or Android pay. There are also new mobile payments apps built on new payment infrastructure
which facilitates smooth and fast transactions like; M-pesa or immediate payment services
(IMPS). The government of India has also taken initiatives through Bharat bill payment systems
to encourage E payment systems.
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
3.1.2. Digital currencies:

It is a form of currency which are only in digital form, i.e. they don’t have any physical or
tangible form. These currencies are not necessarily attached to fiat currencies which means that
they can be traded in exchange of any commodity equal to the value of these currencies. The
digital currencies are also known as crypto-currencies due to their use in cryptographic
techniques. E.g.: Bitcoin, Ethereum, Ripple, Litecoin etc.

3.1.3. Distributed ledgers technology:

Distributed ledger technologies (DLT) provide complete and secure transaction records, updated
and verified by users, removing the need for a central authority. These technologies allow for
direct peer-to peer transactions, which might offer benefits, in terms of efficiency and security,
over existing technological solutions. The major benefits of adopting this technology are
reduced cost; faster settlement time; reduction in counterparty risk; reduced need for third
party intermediation; reduced collateral demand and latency; better fraud prevention; greater
resiliency; simplification of reporting, data collection, and systemic risk monitoring; increased
interconnectedness; and privacy.

3.1.4. Block chain technology:

Block chain is a distributed ledger in which transactions (e.g. involving digital currencies or
securities) are stored as blocks (groups of transactions that are performed around the same
point in time) on computers that are connected to the network. The ledger grows as the chain of
blocks increases in size. Each new block of transactions has to be verified by the network before
it can be added to the chain. This means that each computer connected to the network has full
information about the transactions in the network. The block chain secures the transactions and
keeps the users anonymous. Currently, this technology is majorly applied in Bitcoin.

3.2. Deposits, lending and capital raising services:

The financial technology has changed the way banks act as the intermediaries for general public
for either accepting deposits, granting loans or acting as a broker of securities. Exmaples of
FINTECH innovations under this area are:

3.2.1. Peer-to-Peer (P2P) lending:

Peer-to-peer (P2P) lenders connect lenders and borrowers, using advanced technologies to
speed up loan acceptance. These technologies are designed to increase the efficiency and
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
reduce the time involved in access to credit. P2P may involve simple matching, deposit taking, or
management of a collective investment scheme. Since P2P lending companies operate entirely
online, they can run with lower overhead and provide services more cheaply than traditional
financial institutions. As a result, lenders often earn higher returns compared to savings and
investment products offered by banks, while borrowers can borrow money at lower interest
rates.

3.2.2 Crowd funding:

It is the concept where a small amount of capital is collected from different individuals through
a social media platform in order to finance a new business venture. The platform matches
borrowers / issuers with savers/investors. Platform providers offer a range of information about
the potential borrowers/issuers, ranging from credit ratings (for most peer-to-peer loan
arrangements) to business model to verification of information and Anti-money laundering
checks of firms that want to raise equity capital.

3.3. Market provisioning services:

The financial technology innovations in this sector have led to smooth dissemination of
information in the market.

3.3.1. Smart contracts:

Smart contracts are computer protocols that can self-execute, self-enforce, self-verify, and self-
constrain the performance of a contract. It verifies the credibility of the transaction without
needing a third party. This technology has already been applied and used with the trade of
Ethereums.

3.3.2. E-aggregators:

These refer to the websites, computer programmes or an organization that pools the
information from different sources in order to provide a platform for consumers to compare and
analyze different financial products such as standardized insurance, mortgages, and deposit
account products. They can also be firms that provide services that allow users to aggregate and
analyze their data on their payment patterns, across separate accounts and products (example-
Yodlee). They can also aggregate a special type of information for different users (e.g: poll
aggregators, Review aggregators).

3.3.3. Cloud computing:

Cloud-based IT services can deliver internet-based access to a shared pool of computing

resources that can be quickly and easily deployed. It provides a shared data center to a user so
that they can run their business without needing any personal servers.

3.3.4. Artificial intelligence (AI) & Robotics:

IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
Banks use artificial intelligence in order to analyze and compare huge chunks of data in a short
period of time. Some of the top multinational banks (such as: JPMorgan Chase, PNC financial
services, CITI bank, Wells Fargo) have heavily invested in this technology which uses algorithms
to analyze data.

3.4. Investment management services:

The FINTECH has given a competitive edge to many companies in investment and wealth
management. Some of the FINTECH applications used in this sector are mentioned below:

3.4.1. Robo-advisors:

These refer to the computer programmes or algorithms designed to assess a user’s financial
data and give investment advice. The Robo-advisor digital platforms are automated and require
little to no human intervention.

3.4.2. E-Trading:

Electronic/Scripless/paperless trading is the online trading of financial securities and financial

derivatives. It has enabled a pickup of automated trading in the most liquid market segments.
Innovative trading venues and protocols, reinforced by changes in the nature of intermediation,
have proliferated, and new market participants have emerged. This, in turn, has had
implications for the process of price discovery and for market liquidity. It could also lead market
structures to evolve from over-the-counter to a structure where all-to-all transactions can take
place.

4. IMPACT OF FINTECH IN INDIAN FINANCIAL SYSTEM AND ITS FUTURE IMPLICATIONS:

Though the concept of FINTECH has just emerged in India, the foreign companies and institutions have
raised the level of competition so much that the banks are adopting these technologies and applying
them in their services at a faster pace. Banks have now realized that eventually most of the financial
services of retail banks will be performed by the computer programmes and algorithms as it would
significantly reduce the cost of operations thereby limiting the function of retail banks only for customer
interactions and building customer relationships.

According to the forbs, millennial in America are losing their interest in banks as they don’t find any
difference between their bank and other banks. They want new and improved technology which should
be equipped for handling their investments. In my opinion there is no reason why they shouldn’t shift
towards automated financial services as they are more cost effective and give more precise analysis
compared to the analysis done by professionals. This could be one of the reasons why most of the
children who inherit their money, immediately fire their parents’ financial advisors.
IMPROVING ACCESS TO FINANCIAL INSTITUTIONS
Most of the large banks in America have noticed this recent trend and they have started to acquire the
FINTECH applications in order to gain a competitive edge. In India, most of the private sector banks
(especially NBFCs engaged in home loans or insurance) have also started to use the FINTECH
applications to find potential customers or to assess the credit worthiness of the individuals. The
Government of India has also taken some initiative in order to encourage digital transactions amongst
individuals of the economy. The government has made some relaxation on KYC norms, eliminated the
mandatory two-authentication for each digital wallet transaction and Aadhar initiative. The launch of
unified payment interface (UPI) system by national payment corporation of India (NPCI) and Bharat bill
payment system (BBPS) have had a huge impact on digital transactions.

5. SUGGESTION:

In order to improve the access to banking facilities, the government can focus on providing full digital
facilities and high speed internet connections in semi-urban areas or cities in hilly areas (like: new tehri,
Dehradun, Mussoori) for the efficient allocation of the resources.

The government can also make new privacy laws in order to make the digital transactions more secure
and transparent. The European Union has passed a new privacy law, known as “General Data Protection
Regulation” (GDPR), according to which the users will have full control over their data and gives them
the right to even delete their data from company servers under certain conditions. In 2018, a similar
privacy code known as the Indian privacy code 2018 has been made. In my opinion the bill is certainly
highly inflexible and would make it very hard for foreign companies who are looking to enter in the
Indian economy. Therefore, the government can add the certain aspect of the privacy code (like: right to
access and right to object) while excluding some aspects (like: right to restriction of processing). In my
opinion, the reason for not including these laws is because through data collection and analysis the
companies usually access the behaviors of buyers in an economy. The deletion of data could hinder the
company’s abilities to access the preferences of the consumers. Furthermore culprits can use these laws
and find loopholes in order to get out of legal actions.