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Reinventing Banking

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The editor has commented on the ideas put forward by the deputy governor of Reserve Bank on financial inclusion. To recognise the errors of official thinking about financial inclusion — which itself is a cliché designed to prevent reflection — is the first step towards finding a solution. To recognise that a solution is already there, and that there have always been financial services for the poor, gives us a base from which to start working out another solution. The question is, why does the government want to jettison the centuries-old solution and find another? The answer given by the government for over a hundred years is that the traditional moneylender is an exploiter: that he charges extremely high interest rates, and harasses those who do not repay on time.

The modern version of the moneylender is the bank; and it has been the dream of government types to replace the moneylender by the bank. After they nationalised banks in 1971, they had the means to realise their dream. For forty years they have been whipping government banks to go and serve villagers; but banks have doggedly resisted. The rural spread of banks remains poor.

Meanwhile, others tried other solutions. They are basically of three sorts. One is microfinance institutions — institutions that give small loans to start some sort of business. The idea is twofold: that the loans should make the poor less poor, and should generate activities which enable their servicing and repayment. The second is self-help groups. There the idea is that if a self-help group fails to service a loan, it would not get another loan, and all its members would suffer. The pressure of the group would prevent individual members from defaulting, and if they did, other members would pay for them. A third is the chit fund, where members pay in the same amount every month, and each gets the accumulated amount when his turn comes.

None of these institutional innovations meets the problem of the quintessential poor Indian: that she does not belong naturally to a self-help group, and that he wants loans for uses, such as ceremonies and weddings, that bring no income. And government types are not interested in solving their problems because of their preconceptions, that no one should borrow except for productive purposes, and that cooperation is good.

What the poor Indian needs is not a do-good institution, but a bank. He should be able to park his spare savings in it, and he should be able to borrow from it. But it has to be different from the banks that exist in India. It would be present in villages, it would give small loans; hence its working would be more labour-intensive, and its wages would have to be lower than those of the present banks with their unionised labour forces. And it would give loans without asking questions about the purpose. If a client wants to give his daughter a dowry, it is his business; the bank has no business asking him questions. If it gives consumption loans, it would be taking greater risks; in other words, it would incur more bad debts than current banks. So it would have to charge higher interest rates. In other words, it would be more like the moneylender than like a government bank: it would have lower costs, and it would be more entrepreneurial.
If it is going to be like a moneylender, why have it? What is wrong with the moneylender? Nothing; but because the government has been so hostile towards him, he has remained primitive. The moneylender can be modernised; he can be made more efficient and customer-friendly. In the new incarnation, he would really become a bank, but there would be no controls on the interest rates he charges, and the only control on his costs would come from competition.
So what we need is thousands of small rural banks free from the heavyhanded regulation that the Reserve Bank specialises in. But as the long history of banks shows, they do need some regulation; otherwise, many people would open banks, take deposits and run away with them. How is that to be prevented? What kind of regulation would ensure safety of thousands of small banks?

What we need is hundreds of small regulators. But there can be no competition amongst regulators; otherwise there would be a race to the bottom. So let there be a regulator for every district. Every bank in the district would have to pay him a small tax in proportion of its deposits. He would set prudential regulations, and audit the banks frequently. We have plenty of small-scale industry in this country; let us now try out small-scale regulation.
The author is Consultant Editor of Businessworld.

(This story was published in Businessworld Issue Dated 18-04-2011)