Tamal Bandyopadhyay: Getting banks to rural India

Outsourcing in core banking must be allowed in rural India if banking is to spread.

Close to a million bank employees went on a one-day strike last week. Among the issues that the striking employees were protesting was outsourcing. The unionised employees do not want the banks to outsource some of the activities which they traditionally do. In the normal course, commercial banks outsource certain pockets of activities like applications processing (for loans and credit cards), document processing, investment management, marketing and research, supervision of loans, data processing and back office related activities besides maintenance, security and movement of cash from one branch to another or to ATMs.

Going by the RBI rules, banks cannot outsource core banking activities. However, if the government and the RBI want the banks to cover the un-banked rural India, banks must be allowed to outsource core banking work. Otherwise, no bank will spread its wings to the rural pockets as this will not justify the cost of operation. Apart from the fact that smaller loans carry a higher transaction cost, banks incur huge wage costs as there is no wage differential between employees working in metro pockets like Greater Kailash in Delhi or Warden Road in Mumbai and the remote villages in Uttar Pradesh and Bihar.

In March 2004, there were 66,970 branches across India. Close to 50 per cent of these branches (32,080) were in rural India, 15,018 branches were located in semi-urban India, 10,990 were in urban locations and another 8,882 in four metros. Since there is no system of differential salary packages (except for the city compensatory allowance component) between rural and urban India, banks incur a much higher cost-return ratio for every rural employee as the returns are much lower in rural areas. "Ideally, we should be given freedom to pay a lower salary to the employees stationed at villages as their cost of living is much lower. If we cannot do so, allow us to employ direct sales agents to conduct business," says the CEO of a public sector bank who has been studiously adhering to the RBI's mantra of financial inclusion.

Primary school teachers and even local provision stores owners run post offices in villages. They keep envelopes and stamps at their homes and shops and sell them. Banks, of course, cannot follow this model since depositors' money is involved. So, banks need to have a branch with a vault and security, but surely the employees can be outsourced. A few new private sector banks are experimenting with a new model by setting up Internet kiosks run by local school dropouts. For all practical purposes, they run as banks minus the direct cash transactions.

The Monetary Authority of Singapore allows outsourcing of application processing, back office management (electronic funds transfer and payroll processing), custody operations, loan negotiations and processing, collection of bad loans, document processing and information system management and maintenance. It also allows third-party appointment for portfolio management, cash management, manpower management including staff training and development, marketing and research and real estate administration.

However, it does not allow the outsourcing of clearing and settlement arrangements between clearing and settlement institutions and their members, correspondent banking services, sale of insurance policies by agents or brokers, statutory audit and independent audit assessments, among other things.

Similarly, the Hong Kong Monetary Authority allows outsourcing of data processing, customer-related services (call centres) and back office-related activities. Banking entities in Hong Kong are, however, subject to a common law ensuring confidentiality to their customers. The general principle under common law is that customer data should be kept confidential and not divulged to any person without the customer's consent.

The RBI does not allow banks to outsource core management functions like corporate planning, organisation, management and control and decision-making functions like determining compliance with the know your customer (KYC) norms for opening deposit accounts, according sanction for loans and management of investment portfolio.

The RBI has also made it clear that the outsourcing arrangements should not affect the rights of a customer vis-a-vis the bank. Going by the norms, banks are required to put in place a comprehensive outsourcing policy, approved by their boards and the senior management of banks will be responsible for evaluating the risks of all existing and prospective outsourcing, based on the framework approved by the board. The evaluation process must include strategic risk, reputation risk, compliance risk and operational risk. It has also suggested formation of code of conduct for the direct sales agents (DSAs) and recovery agents.

DSAs have been instrumental in driving the phenomenal retail loan growth in urban India. It is high time, the experiment was replicated in rural India. The State Bank of India is running a pilot project, employing DSAs in unbanked Uttaranchal. If the project succeeds, other banks will follow the DSA model for banking in rural India. If the banking regulator has reservations about such activities as they are part of core banking, then the finance ministry should allow banks to follow a differential salary model. Employment of low-cost white-collar staff to bring in un-banked India under the fold of banking is as important as giving performance-linked incentives to CEOs and senior bank executives.