CAIIB : ELECTIVE – RURAL BANKING

Unit 16- Role of Rural banking-Emerging Trends

• Introduction :
• Since more than 70% live in rural areas, rural development needs to be
prioritized.
• Real effort in rural banking started in 1950’s with All India Rural Credit survey
1954.
• Later on All India Rural Credit review , 1969, introduced social banking along with
Nationalisation Of Banks.
• RBI took initiatives like PSA lending requirements, Lead Bank Scheme, Setting up
RRBs in 1975, Service Area approach in 1989, Self-Help group bank Linkage 1989-
90 , all aimed at providing banking services to masses .
• In spite of impressive gains, structural issues like absence of suitable technology
was a major impediment in financial inclusion.
• The Vision for Financial Inclusion as envisaged by the Committee on Medium
Term Path to Financial Inclusion is that by 2021, over 90 % of hitherto unserved
sections of the society would become stakeholders in economic progress.
 Present scenario of Rural banking
• Rural Areas are served mainly by Commercial banks and RRBs
• Together they achieved remarkable progress by disbursing Rs 287419 crs of credit
as against the target of Rs 280000 crs for 2008-09.
• NSSO 70th Round survey Results :
• At all-India level, institutional and non-institutional sources of credit were almost
identical shares ( Viz, 49% and 51 %)
• Cooperatives are found to have played a more important role in states like,
Maharastra, Gujarat, Kerala and Punjab in providing loans to farmers.
• In most southern sates , commercial banks and RRBs have played a major role in
providing credit to farmers.
• Amongst farmers , 83% of total loans taken by large farmers are from institutional
agencies, while around 60% of marginal farmers loans were from institutional
agencies.
• Farmers in general, and small and marginal farmers in particular, depended
heavily on money lenders.
 Improvement in availability of banking Outlets
• The number of banking outlets in villages went up from 67694 in March 2010 to
586307 in March 2016 after RBI laid a roadmap of spreading services through a mix of Bank
Branches and BCS.
 The BSBDA accounts have increased from 73.45 million in March 2010 to 469 million as on March
2016.
 Under PMJDY alone, 41.88 cr accounts opened on 17-2-21 with approximate balance of Rs
138940 crs.
 The total number of transactions in BC-ICT accounts which were around 26 million in 2010-11
have increased to 826.81 million as on March 2016.
 There were 47.31million small farm sector credit accounts and 11.3 million small non farm sector
credit accounts with outstanding of Rs 5130.7 billion and 1493 billion as on March 2016.
 Distribution of household who took loan- 59% only institutional and 32 % non institutional
sources.
 Among agricultural households owing more than 0.4 hectares,32 % reported to be having Kisan
Credit Cards and had utilized 83% of sanctioned limits.
 On the whole, 23% households reported that they were associated with a micro finance group at
the time of survey.
 Areas of Concern
• 1. Population served :
• Branch expansion brought down population per branch from 82000 in 1969 to 14000 in 1991.
• However upgrading and amalgamation of rural branches caused the population served per rural
branch went up to 17000 in 2007.
• The Committee on financial Inclusion identified 256 districts in 16 states where population per
branch was 19000 and credit gap was estimated to be more than 95%.
• The numb of accounts with credit limit up to Rs 25000 was 62.5 million in 1992 but declined to
38.6 million , accounting for 40.9% in 2007.
• But in sharp contrast, accounts with credit limits between Rs25000 and Rs 2 lacs rose from just
4.3% of total to 45.7 million or 48.4% of the total in 2007.
• 2. High Transaction Costs :
• Commercial banks have high transaction cost in rural areas. It is because of lack of proper
infrastructure, reluctance of staff to work in rural branches and large number of small accounts to
be serviced etc.
 Complex land mortgage procedures, considerable paperwork and multiple visits to the bank
increase the transaction costs to farmers.
3 . Other issues :
•Credit deposit ratio continues to be low in rural areas.
•Money lenders still dominate in credit disbursement
•Cost of credit from banks are higher for agriculture than for the private corporate sector.
•Many of the public sector banks are averse to rural credit and consequently their lending is
inadequate.
• Most of the private sector banks and foreign banks also have very poor track record of
extending rural credit.
Credit Delivery system in rural areas is not able to cope up with the rising demand.
Micro finance is yet to be popularized in many states.
Cooperative credit systems and RRBs have to perform better.
There is need to educate farmers about the benefits of farm loans.
Future of Inclusive banking
• 1. Definition of financial inclusion :
• In the Indian context, Financial inclusion has been described as the provision of affordable
financial services to people who have hitherto excluded .
• Deepening and widening the reach of the financial system is crucial for increasing growth rate and
for equitable distribution.
• The causes of financial exclusion leading to low credit in rural areas are :
• i)High perception of risk
• ii) High operating costs
• Iii) Vast geographical area
• Iv) Lack of rural infrastructure
• V) Lack of awareness of financial products
• Vi) Cumbersome procedures for getting loans
• Vii) Staffing of human resources
• Viii) Lack of effective regulation to regulate money lenders
 RBI POLICY INITIATIVES AND PROGRESS IN FINANCIAL
INCLUSION
• RBI has adopted a bank-led model for achieving financial inclusion and removed all regulatory
bottlenecks in achieving greater financial inclusion in the country.
• Advised all banks to open BSBD accounts with minimum common facilities such as no minimum
balance, deposit and withdrawal of cash at branch and ATMs, providing ATMs etc,
• Relaxed and simplified KYC norms for balances < Rs 50000 and annual credits, Rs 1 lac.
• Simplified branch authorization policy wherein SCBs are permitted to open branches in Tier2 to 6
centres without any permission from RBI.
• Compulsory requirement of opening at least 25% branches in unbanked centres
• Opening of low cost branches for effective cash management, documentation and redressal of
grievances.
• Public and private banks had been advised to submit board approved 3 year plan for Financial
Inclusion starting from April 2010.
• In June 2012, guidelines on Financial Literacy Centres revised wherein all rural branches should
scale up financial literacy efforts including outdoor camps at least once in a month through
provision of two essentials-Financial literacy and Financial access.
• Recent measures:
• Licensing of new banks :
• The present round of licensing new banks is essentially aimed at giving further fillip to financial inclusion in
the country.
• Innovative business models aimed at furthering financial inclusion would be looked into while processing
applications for new bank license.
• The RBI has put up a discussion paper in August 2013 on Banking Structure for public comments. One of the
main issues relates to “ Differentiated Banking Licenses “. The subject of licensing small banks and financial
inclusion has been discussed therein.
• In this context, it needs to be mentioned that Urban Co=op banks, RRBs, and Local area banks numbering
1606, 64 and 4respectively are in fact small finance banks.
• These apart there is a 3 tier Co-operative structure with State Central Co-op Banks at the apex level, District
Central Cooperatives at the intermediary level and Primary Agricultural Credit Societies at the grass root
level.
• Further we have around 12225 NBFCs as on march 2013, which can be construed as semi banks .
• Progress in financial Inclusion :
• Since the launch of Financial Inclusion Plans, there is substantial progress with opening of new banking
outlets, deployment of BCs, opening of BSBD accounts, Grant of credit through KCCs and GCCsetc.
• *******************
Unit 17 – Transaction Costs and Risk cost
• 1.0 Introduction
• Lending cost comprises transaction and risk costs.
• Transaction costs include cost required for deposit mobilization, cost of servicing accounts,
recovery and all other banking operations.
• One of the biggest impediments in rural credit is high overdues and attendant bad debts.
• The Agricultural Review Committee has defined risk costs in terms of either loans written off or
provision made for bad debts.
• 2.0 Transaction Costs :
• In financial markets, this cost refers to the resources required to transfer one unit of currency
from the bank which collects deposits to a borrower and to recover that unit of currency at a later
date with some interest charges.
• The costs incurred by all participants- banks, financial intermediaries and borrowers in a loan
transaction , constitute total transaction costs.
• 2.1 Bank Transaction Costs :
• Banks incur cost while raising funds such as cost of deposit mobilization, interest paid and the
cost of the loan delivered.
• The cost of lending is the cost associated with identification of borrowers, loan processing and
disbursement of loans .
• 2.2 Borrower transaction Costs :
• The 3 major constituents of borrower transaction costs are :
• A) Cost of loan negotiation , receipt and payment which include expenditure relating to travel and incidental
expenses
• B) Documentation expenses which are incurred by the borrower in getting necessary certificates from village
authorities and NOC from other banks.
• C) Opportunity cost of time spent in negotiating loan which is estimated by average wage cost.
• 2.3 Transaction costs :
• The major components of loan transaction costs include :
 Identification of borrower and collection of loan application
 Pre sanction visits and document verification
 Loan appraisal, sanction, disbursement and maintaining books
 Post sanction visit, follow- up and recoveries.
 Other misc costs
 Transaction costs influence both lenders and borrowers behaviour.
 The Loan demand equation shows that loan amount is determined by various factors such as cost of
borrowing, interest rates, and financial strength of borrower.
 The Transaction cost equation shows that they are determined by size of the loan, interest rates, type of
bank, value of asset owned by borrower etc,.
• 2.4 Reducing Transaction Costs :
• The transaction Cost in different Rural Financial Institutions estimated by ACRC are as under :
• PACs=5.4 DCCB: 1.51 PCARDB : 3.39 RRB +6.90 SCARDB =1.35
• Commercial banks –Rural =4.21 Semi-urban = 4.02
• Institutions can reduce cost by increasing level of business and by improving systems and
processes.
• The improvement may be in the following areas :
 Reduction in time in processing proposals
 Better pre sanction appraisal
 Simplifying loan processing system and documentation procedures
 Devising cost efficient loan follow up and supervision system.
 Consider intermediation by NGOs/SHGs to reduce cost in loan processing .
 Viability of banking institutions is also a function of volume of operations
 Viability is mainly related to business related factors such as low level of deposits, and
unbalanced mix, low level of advances, and inefficient management of cash and bank balances
 So any strategy to make rural banking viable should address these business issues and not
transaction costs alone.
•3. Risk costs :
•Risk cost is a premium which lenders charge all borrowers to compensate for default .
•Risk cost depends upon the default rate which in turn depend upon the risk reducing mechanisms such as credit rationing, use of
collateral, smaller and shorter period loans etc,
•Risk Premium is measured by Rp = (D/1-D) (1+a+f) where Rp is risk premium, D is default rate , a is the loan admn cost and f is the
opportunity cost of funds.
•Default risk can be calculated using the formula , R=P( FP+OCF+TC) RP , where FP is full principal, OCF is opportunity cost, TC is
transaction cost, Rp is principal repaid and P principal and interest in last 3 years.
•The 3 categories of risk are :
•i) Subsidy risk – dependence on subsidy threatens their longevity as there is the risk of variation in future.
•Ii) Covariant Risk : It arises when many households in one area are adversely affected by a single factor like drought, epidemic etc.
•Iii) Default risk : The risk can be minimized by joint liability mechanisms, providing incentives and carefully monitoring
performance.
•3.1 Risk cost- present status :
•The most glaring manifestation of risk is poor credit portfolio which leads to bad debts.
•ACRC has estimated an approximate risk of 1% for various RFIs
•There is also wilful default by borrowers who refuse to pay though having means to pay.
•Lenders can reschedule loans, provide additional credit , alter loan size etc to reduce risk.
• 3.2 Measures to reduce risks :
• Clients should be carefully selected and screened.
• Forming of groups can offset lack of information.
• Alternative forms of collateral like joint liability to be accepted.
• Loan size should be carefully evaluated
• Loan terms should meet all genuine needs of clients and be flexible and convenient.
• The effective rate of interest must be clearly shown to the clients and should be rewarded for
timely payment.
• Staff should be given incentive for high loan collection performance.
• Diversification of loans in relation to clients, lines of activity, loan maturities and location should
be considered.
• Services of recovery agents may be utilized for better recovery.
• There should be robust MIS system to monitor performance of accounts.

*************************
 Unit 18 – Financing poor as bankable opportunities
• 1.0 Micro-Finance :
• Microfinance is the provision of thrift, credit and other financial services and products to the poor in rural,
semi-urban and urban areas to enable them to raise their income levels.
• The beginning of the micro finance program can be traced back to SHG-bank Linkage program ( SBLP) as pilot
project in 1992by NABARD & RBI.
• NABARD & SIDBI have taken several initiatives over the years to give a fillip to Micro Finance.
• 1.1 Micro credit delivery models :
• Innovative programs to help the poor were designed by various countries. A few are discussed below :
• i) Grameen Bank :
• Grameen Bank works on the assumption that even the poorest of the poor can manage their own financial
affairs and development given suitable conditions.
• Ii) South American rural/village banks :
• Each rural bank unit has 10 to 35 members , usually mothers. They are given small loans to expand their
business and are also offered incentives to save. These banks operate in areas where normal banks do not
operate.
• Iii) Bank Rakyat Indonesia :
• The bank provides small loans and borrowers can avail only one loan at a time.
• Iv )Bancosol, Bolivia :
• Bank provides working capital loans to groups of three or more persons engaged in similar activities which
formally join and guarantee to meet the bank’s obligations.
• 1.2 SHG-n Bank Linkage Program (SBLP)
• A SHG is a small homogeneous group of 10 to 20 people who join together to address common issues.
• Voluntary thrift activities are undertaken on a regular basis by the group and their pooled savings are used to
make interest bearing loans among the group members.
• Once the group is stabilized, it gets linked to banks and financial services from banks.
• As on 31-3-2009, the number of SHGs maintaining bank accounts were 6.1 millions with total savings of
Rs5546 crores.
• The recovery percentage of bank loans to SHGs at higher level with recovery rate of 80 to 90% for public
sector banks and 95% for private sector banks
• SBLP has emerged as one of the world’s largest movement of organizing poor, having more than one crore
SHGs and with banks credit facilities amounting to more than Rs 1 lac crores.
• Highlights of SBLP as on 31 march 20 Are :
 i) 102.43 lakh SHGs are linked to about 12.4 crore poor households.
 Ii) 2.29 lakhs SHGs were added during 2019-20.
 Iii) Saving bank balance of SHGs went up to Rs 26.15 thousand crs from Rs 23.32 thousand cr as on 31 march
2019.
 Iv ) SHGs have credit outstanding of Rs1.08 lakh cr with formal lending institutions.
• V) The NPA level was 4.92% compared to 5.19% as on March 2019.
• Vi ) NABARD continued support to partner agencies , NGOs, DCCBs, farmers clubs , SHG
federations etc for promoting and nurturing SHGs .
• Project E- Shakti :
• E- Shakti, the project of digitization of SHGs, by providing end to end solution for creating a
secured, access controlled database of SHGs and their members, with customized reports was
rolled out during the year 2015.
• It has introduced standard books of account in the digital platform, bringing transparency and
regularity in the operations and record keeping of SHGs in a secured online portal.
• As on March 20, data pertaining to 6.54 lac SHGs involving membership of 72 lakh members in
more than 98000 villages has been on boarded to the E-Shakti portal.
• It has resulted in increased credit flow to SHGs.
• 1.3 Micro Credit Institutions :
• Micro- credit programs are conducted primarily by NABARD in agriculture and SIDBI in industry,
services and businesses .
• RBI defines NBFC- MFI as a non deposit taking NBFC licensed under Section 25 of Companies Act
• Micro finance institutions exist in India as NGOs registered as soceities or trusts or as NBFCs
• Commercial banks, RRBs, Co-operative Soceities and other large lenders have provided refinance
facility to MFIs.
• 1.3.1 Salient features of micro finance :
 Borrowers are from low income group
 Loans are for small amount –micro loans
 Short duration loans
 Loans are offered without collaterals
 High frequency of repayment
 Loans are generally taken for income generation purpose .
 Micro finance institutions serve as a supplement to banks .
 They offer micro credit and other financial services like savings, insurance, support to start own
businesses etc,.
 The borrower receives all the services in his doorstep and in most cases with a convenient
repayment schedule.
 But all these come with higher cost compared to banks and some people claim it is too high.
1.3.2 Qualifying asset criteria :
 Taking into consideration the important role played by MFIs in delivering credit to those in
bottom of the pyramid, it was decided to increase the household income criteria from Rs 1 lakh in
rural areas and Rs 1.6 lakhs in semi-urban/ urban areas to Rs 1.25 lakhs and rs 2lakhs respectively.
 Further limit on indebtedness of borrower has increased from Rs 1lakh to Rs 1.25 Lakhs,
• 1.3.3 Sa- dhan report Fy2019-20 :
• India’s microfinance industry registered jump of 31% in its portfolio to Rs 2.36 lakh cr for 2019-20
and expects to post moderate growth of 15% in current year.
• The outstanding loan as on March 20, stood at Rs 236427 cr. Of the total portfolio, 32 % is from
NBFC-MFIs while banks and small finance banks contributed 59 %.
• The YOY growth for NBFC-MFI;s was 38%, 24% for banks and 34%forSFBs.
• 2. Role Of NABARD;
• 2.1 NABARD as micro-finance facilitator :
• NABARD extended 100% refinance to banks.
• Seminars, workshops, training programs were conducted in the whole country on a regular basis.
• All the partner agencies in which NGOs being prominent with other financial institutions, farmers’
club etc, have a crucial role in promoting micro finance institutions.
• 2.2 Refinance to banks :
• NABARD provides long term refinance to eligible NBFCs; MFIs and SFBs under pre sanction as well
as Automatic Refinance facility, against investment credit extended by them to agriculture, allied
activities, rural housing , nonfarm activities etc.
• During2019-20, NABARD extended Rs 9956 crore as refinance to NBFCs, MFIs and SFBs
• 2.3 Development of SHG/JLGs
• Financial Inclusion fund and Women self Help Group development Fund were utilized for various micro
finance related activities such as formation of SHG/JLG , training and capacity building of stakeholders,
livelihood promotion etc.
• 2.4 Support for training and capacity building :
• NABARD gave due recognition to training and capacity building of various stakeholders such as bankers,
NGOS, Govt officials, SHG federations and trainers.
• During 2019-20 3592 training programs were conducted covering 1.53 lakh participants.
• 2.5 Support to partner agencies for promotion and nurturing SHGs:
• NABARD extended grant support to NGOs, SHG Federations, NGO-MFIs , Farmers Clubs, Individual Rural
Volunteers ( IRVs) etc for promotion, nurturing and credit linkage of SHGs with Banks .
• 2.6 Financing JLGs :
• During 2019-20, 41.80lakh JLGs were promoted and financed by banks.
• Apart from 100 % refinancing , NABARD extended support for awareness creation and capacity building to all
stakeholders.
• 2.7 Livelihood and Enterprise Development programs ( LEDP):
• LEDPs was initiated on pilot basis in Dec 2015 to create sustainable livelihood among SHG members ,
training for skill building , refresher training and backward-forward linkages.
• 237 LEDP involving 25577 members were conducted during2019-20.
• 2.8 Scheme for promotion of women SHG in backward districts :
• The scheme for promotion of women SHGs in 150 backward districts spread across 29 states is
being implemented with support from Govt.
• Anchor NGOs work for promotion and credit linkage of SHGs
• Under the project 2.11 lakhs of women SHGs have been savings linked and 1.29 lakhs of them
were credit linked as on March 20.
• 3.0 Role of SIDBI :
• SIDBI foundation for Micro Credit (SFMC) was launched in Jan 99 to channel funds to the poor.
• SFMC is the apex wholesaler for micro finance in India providing a complete range of financial and
non financial services to retail MFIs.
• MFIs are provided annual need based assistance .
• One of the unique features is the capacity building support provided to MFIs to expand their
operations and efficiency.
• SIDBI developed an electronic portal for information dissemination sharing within the sector and
development of MIS software to MFIs.
• Other initiatives are creation of gender and environmental awareness, promoting innovations and
action research.
• Seven dedicated microfinance branches have been opened by SIDBI at Lucknow, Chennai,
Hyderabad, Bangalore, Kolkatta, Bhubvaneswar and Guwahati.
•3.1 Code of Conduct Assessment ( COCA) :
•SIDBI has developed a Code of conduct Assessment tool to assess the extent of adherence to common code of conduct by MFIs during the
period of assessment.
•3.2 Portfolio Risk Fund :
•Since it becomes difficult for MFI s and NGOs to pay the security deposit of 10% for multiple loans
Govt decided to provide funds to Micro Finance program of SIDBI .
The funds so provided to SIDBI by Govt is called Portfolio Risk Fund.
Out of 10% security deposit required by SIDBI towards loan, the share of MFIs/NGOs would be 2.5% of loan and balance 7,5% would be
adjusted from funds provided by Govt.
When the loan is recovered fully, the Govt contribution of 7.5% of loan and interest earned thereon would be rotated and used for future
loans.
3.3 India Micro Finance Equity Fund :
To ease the liquidity situation , GOI stepped in with creation of Rs 100 cr Fund ( IMEF) in Union Budget 2011-12 operated through SIDBI.
The assistance under the fund is expected to help MFIs to leverage more debt funds from banks and financial institutions.
As on Sept 2017, 65 MFIs were committed assistance under the fund amounting to Rs 195.50 cr.
As per the impact assessment study conducted by SIDBI, the IMEF fund attributed for a high and positive impact on the MFIs in terms of
building their overall sustainability.
There was a remarkable improvement in performance of MFIs in the area of outreach and lending practices and operational efficiency.
• 4.0 Initiatives by RBI and Govt :
• RBI and Govt have announced a number of regulations and developments supporting financial
inclusion and MFIs.
• While the continuation of priority sector status continues, the permissible debt levels per
borrower has been increased to Rs 1 lakh.( From 50000 earlier)
• RBI has given in principle approval for setting up 10 SFBs.
• RBI has announced the annual household income limit of rural borrowers to take loans from MFIs
to Rs 1 lakh from Rs60000 earlier.
• In the case of Semi-urban and urban the income limit raised from Rs 1.2 lakh to Rs 1.6 Lakhs.
• At the policy level , Govt launched MUDRA which would be refinancing micro- enterprise
financing.
• The Pradhan Mantri Jeevan Jyoti Bhima Yojana(PMJJY) and Atal Pension Yojana expand the
financial instruments for MFIs to offer to their clientele.
• The Indian micro-finance sector reported an overall growth of 23% in first half of Fy 2015-16 with
overall market siz nearing 1.1 trillion as on Sept 2015.
• Significantly, even after impressive growth during last 3 years, the untapped potential remains
large.
• According to ICRA estimates, the potential size of micro –finance and SHGs is as large as Rs 2.8 -
3.4 trillion at penetration levels of 50-70% and ticket size of Rs 60000 per household.