Refresh the approach to growth, equity

Agricultural credit continues to be subsidised through an interest subvention scheme instead of converting these subsidies into cash transfers to farmers

The Reserve Bank of India’s (RBI’s) Committee on Comprehensive Access to Financial Services (2013) had set modest targets. Ten years on, considerable progress has been made on the payments front, but on other targets, there has been limited progress. These include access to credit (minimum 50 per cent credit-to-district-GDP); savings and investment products with reasonable returns (65 per cent); and insurance and risk management instruments (80 per cent).
 
At 50 per cent, the overall credit-to-GDP ratio remains unchanged from 2013; in China and Thailand, it has reached 180 per cent and 160 per cent, respectively. Not only is this inadequate, but since it is also highly unevenly distributed across the country (with interior districts in most parts of the country reporting ratios under 20 per cent), it acts as a critical impediment to growth, equity, and transmission of monetary policy.
 
While there is a continuing need to make banks safer by sharply increasing the levels of capitalisation in universal banks (including small-finance banks) and reducing their direct engagement in high-risk activities, there is no prudential case for imposing capital requirements on non-bank finance companies (NBFCs) until they get to a size that exceeds, say, Rs 50,000 crore.
 
As first recommended by the Narasimham Committee, they can partner with banks and aggressively take on the responsibility of serving the periphery and the higher risk of failure associated with breaking new ground. There continues to be a violation of “risk ordinality” in the pricing of loans, with low-risk, low-income borrowers continuing to be charged very high rates, driven in large part by the differentials in regulatory treatment and the “pancaking of capital” in the channels through which they are able to obtain their financing.
 
Agricultural credit continues to be subsidised through an interest subvention scheme instead of converting these and other agricultural subsidies to direct cash transfers to farmers. This limits the growth of financing to agriculture, dampens its signalling role, and low-risk instruments such as post-harvest financing through warehouse receipts remain underdeveloped.

 
To rapidly grow project finance, gaps on the wholesale banking front also need to be urgently addressed. Access to low-cost retail deposits should not easily be given to domestic and international new entrants. They should instead be required to function as wholesale-investment banks without the added responsibility of building branch networks and serving priority sectors.
 
Enabling such an approach would also allow the larger NBFCs to transition to a wholesale-consumer banking structure with access to “lender of last resort” facilities, without the concerns relating to “self-dealing” associated with corporate ownership being triggered. A wholesale-payment bank licence to clearing houses, as in the Eurozone and UK, would let them clear payments instantaneously, allowing them to support reduced contract sizes and access direct crisis support from the RBI.
 
Farmers are still denied access to tools such as “put options” on commodity prices on an over-the-counter basis because of continuing prohibitions on participation by banks, despite their having significant agricultural exposure. Continued regulatory impediments on the smooth linkages between zero-balance bank accounts and money-market mutual funds, so that banks can continue to benefit from low-cost deposits and the onerous requirements associated with consumer entry into mutual funds and insurance, have biased the financial system against the interests of low-income depositors and investors.
 
While Financial Action Task Force guidelines encourage countries to apply a risk-based approach towards identity-related documents and to focus instead on the operation of the account, our mechanical and exclusive focus on identity verification at the time of account opening has only served to deny access. To support the growth and equity aspirations of the economy with enhanced systemic stability, we urgently need to renew our commitment to these goals, and carefully examine and remove the barriers to them.

The writer is a former director of the Central Board of the RBI, and head of the Committee on Comprehensive Financial Services for Small Businesses and Low-income Households (2013)