The discussion paper issued by the Reserve Bank of India to evolve guidelines for issuing new banking licences sets out to do one thing and ends up doing mostly something else. It begins by saying that the exercise has been initiated in order to take banking where it has not yet reached, to make it more inclusive, but conducts the discussion that follows in general terms. It weighs the criteria for granting licences for some more of the general run of banks — the sort that we already have in plenty. Then, at the end, it briefly returns to the idea of inclusion. In between is discussed issues like minimum capital requirement, promoters’ contribution, diversification of holdings, allowable level of foreign shareholding and whether industrial houses and non-banking financial companies (NBFCs) should be allowed to promote banks or not.
The fact is, there are enough banks to cater to the needs of the middle and upper classes living mostly in urban areas. Some more of the same will not promote financial inclusion. We need a new kind of animal whose chosen domain is the bottom of the pyramid and whose advance prototype by all accounts is the successful microfinance institution. Interestingly, some of these are quite well-run, employ modern management techniques and processes, and use a fair amount of information technology. As a result, they have been able to reduce the cost per transaction — the key requirement for handling low-value transactions in large volumes — and have, therefore, been growing very fast and profitably too.
But this is not enough. If only they could attract low-cost deposits the way large banks do (now they borrow at over 10 per cent from banks to onlend to the poor), that is become deposit-takers, then they could become hugely more viable and be able to offer their products far cheaper than the 20 per cent plus rates currently obtaining. The regulatory issue is what kind of business model they can have so that they become low-risk businesses, a must because all deposits have to be guaranteed by the state. What have large business houses, NBFCs that finance trucks or existing foreign banks to do in this space? The space they aspire to be in or know is conventional banking, with some banks probing the edges of the space where the leading microfinance institutions are now solidly placed.
The discussion paper examines at length regulatory practices in important developed countries where financial inclusion has already happened. There is no mention of what innovation is taking place in Latin America or South Asia, notably Bangladesh. If Grameen Bank is able to offer higher interest rates than conventional banks and attract substantial middle-class deposits, or if microfinance delivering banking in Pakistan is allowed to maintain lower statutory liquidity ratios than the rest, then what can we learn from them? This is the kind of discussion that would be meaningful if financial inclusion is genuinely desired and is not being used to initiate a process through which the finance ministry really wants to oblige an industrial house here or a class of foreign banks there.
If you assume that lending to the poor is more risky and thus set higher capital adequacy and reserve requirements, then banks doing business mostly with them will be disadvantaged. Ultimately, successful regulation is not a matter of mechanistically applying this ratio or that but all about having your ears close to the ground and quickly acting when something undesirable is afoot. If you do not know or do not want to know what a Harshad Mehta is up to, then, of course, there will be a scam. And the market will always be ahead in devising new tricks.
Regulation is also about allowing only the right kind of people into the space — conducting a proper due diligence of intending promoters. As every banker knows, the security of a small business loan is not in the collateral offered but in determining whether the borrower is a decent fellow and whether his business is viable. Then, after granting the loan, continued health of the account lies in keeping a close watch on what is happening. Roughly the same holds for the regulator allowing the creation of vehicles that promote financial inclusion. At the operational level, you have to visit your borrower every so often to make sure he has not quietly sold off his cycle-rickshaw financed with your loan to pay off a moneylender’s debt. Those who are worried about new-generation, hard-driving microfinance institutions say that their meteoric growth rate cannot go hand in hand with keeping track of the customer.
Microfinance is fascinating because it represents a contradiction. The leading microfinance institutions, which are incorporated as NBFCs, are very modern operations which have established the fact that lending small amounts to the poor is quite safe. Under normal conditions, their non-performing asset levels are lower than that of commercial banks. But it is also true that the poor are more vulnerable to external shocks than the better off. An illness, flood or drought can take a family back to destitution and no Vikram Akula in the world can stop it. Once that happens, you have to write off and start again. Shocks and calamities will not allow shareholder returns to be maximised all the time. Regulatory genius lies in being able to understand this space and identify promoters who have sound business sense but are not in it entirely for money. Bits of Bill Gates, Warren Buffet and Muhammad Yunus rolled into one!
