Financial Inclusion

1. Introduction

The banking industry has shown tremendous growth in volume and complexity during the last few decades. Despite making significant improvements in all the areas relating to financial viability, profitability and competitiveness, there are concerns that banks have not been able to include vast segment of the population, especially the underprivileged sections of the society, into the fold of basic banking services. Internationally also efforts are being made to study the causes of financial exclusion and designing strategies to ensure financial inclusion of the poor and disadvantaged. The reasons may vary from country to country and hence the strategy could also vary but all out efforts are being made as financial inclusion can truly lift the financial condition and standards of life of the poor and the disadvantaged.

2. What is Financial Inclusion?

Financial inclusion is delivery of banking services at an affordable cost to the vast sections of disadvantaged and low income groups. Unrestrained access to public goods and services is the sine qua non of an open and efficient society. As banking services are in the nature of public good, it is essential that availability of banking and payment services to the entire population without discrimination is the prime objective of the public policy.

3. The scope of financial inclusion 

The scope of financial inclusion can be expanded in two ways.

(a)   through state-driven intervention by way of statutory enactments ( for instance the US example, the Community Reinvestment Act and making it a statutory right to have bank account in France).

(b)   through voluntary effort by the banking community itself for evolving various strategies to bring within the ambit of the banking sector the large strata of society.

When bankers do not give the desired attention to certain areas, the regulators have to step in to remedy the situation. This is the reason why the Reserve Bank of India is placing a lot of emphasis on financial inclusion.

In India the focus of the financial inclusion at present is confined to ensuring a bare minimum access to a savings bank account without frills, to all. Internationally, the financial exclusion has been viewed in a much wider perspective. Having a current account / savings account on its own, is not regarded as an accurate indicator of financial inclusion. There could be multiple levels of financial inclusion and exclusion. At one extreme, it is possible to identify the ‘super-included’, i.e., those customers who are actively and persistently courted by the financial services industry, and who have at their disposal a wide range of financial services and products. At the other extreme, we may have the financially excluded, who are denied access to even the most basic of financial products. In between are those who use the banking services only for deposits and withdrawals of money. But these persons may have only restricted access to the financial system, and may not enjoy the flexibility of access offered to more affluent customers.

4. Consequences of Financial Exclusion

Consequences of financial exclusion will vary depending on the nature and extent of services denied. It may lead to increased travel requirements, higher incidence of crime, general decline in investment, difficulties in gaining access to credit or getting credit from informal sources at exorbitant rates, and increased unemployment, etc.  The small business may suffer due to loss of access to middle class and higher-income consumers, higher cash handling costs, delays in remittances of money.  According to certain researches, financial exclusion can lead to social exclusion.

5. Indian Scenario

Bank nationalization in India marked a paradigm shift in the focus of banking as it was intended to shift the focus from class banking to mass banking. The rationale for creating Regional Rural Banks was also to take the banking services to poor people. 

The branches of commercial banks and the RRBs have increased from 8321 in the year 1969 to 68,282 branches as at the end of March 2005. The average population per branch office has decreased from 64,000 to 16,000 during the same period.

However, there are certain under-banked states such as Bihar, Orissa, Rajasthan, Uttar Pradesh, Chattisgarh, Jharkhand, West Bengal and a large number of North-Eastern states, where the average population per branch office continues to be quite high compared to the national average. As you would be aware, the new branch authorization policy of Reserve Bank encourages banks to open branches in these under banked states and the under banked areas in other states. The new policy also places a lot of emphasis on the efforts made by the Bank to achieve, inter alia, financial inclusion and other policy objectives.  

One of the benchmarks employed to assess the degree of reach of financial services to the population of the country, is the quantum of deposit accounts (current and savings) held as a ratio to the adult population. In the Indian context, taking into account the Census of 2001 (ignoring the incremental growth of population thereafter), the ratio of deposit accounts (data available as on March 31, 2004) to the total adult population was only 59% (details furnished in the table). Within the country, there is a wide variation  across states. For instance, the ratio for the state of Kerala is as high as 89% while Bihar is marked by a low coverage of 33%. In the North Eastern States like Nagaland and Manipur, the coverage was a meager 21% and 27%, respectively.  The Northern Region, comprising the states of Haryana, Chandigarh and Delhi, has a high coverage ratio of 84%. Compared to the developed world, the coverage of our financial services is quite low. For instance, as per a recent survey commissioned by British Bankers' Association, 92 to 94% of the population of UK has either current or savings bank account.

6. Steps towards financial inclusion

In the context of initiatives taken for extending banking services to the small man, the mode of financial sector development until 1980’s was characterized by

·         a hugely expanded bank branch and cooperative network and new organizational forms like RRBs;

·         a greater focus on credit rather than other financial services like savings and insurance, although the banks and cooperatives did provide deposit facilities;

·         lending targets directed at a range of ‘priority sectors’ such as agriculture, weaker sections of the population, etc;

·         interest rate ceilings;

·         significant government subsidies channeled through the banks and cooperatives, as well as through related government programmes;

·         a dominant perspective that finance for rural and poor people was a social obligation and not a potential business opportunity.

It is absolutely beyond any doubt that the financial access to masses has significantly improved in the last three and a half decades. But the basic question is, has that been good enough. As I mentioned earlier, the quantum of deposit accounts (current and savings) held as a ratio to the adult population has not been uniformly encouraging. There is a tremendous scope for financial coverage if we have to improve the standards of life of those deprived people.

With a view to enhancing the financial inclusion, as a proactive measure, the  RBI in its Annual Policy Statement for the year 2005-06, while recognizing the concerns in regard to the banking practices that tend to exclude rather than attract vast sections of population, urged banks to review their existing practices to align them with the objective of financial inclusion. In the Mid Term Review of the Policy (2005-06),  RBI exhorted the banks, with a view to achieving greater financial inclusion, to make available a basic banking  ‘no frills’ account either with nil or very minimum balances as well as charges that would make such accounts accessible to vast sections of the population. The nature and number of transactions in such accounts would be restricted and made known to customers in advance in a transparent manner. All banks are urged to give wide publicity to the facility of such no frills account so as to ensure greater financial inclusion.

Further, in order to ensure that persons belonging to low income group both in urban and rural areas do not face difficulty in opening the bank accounts due to the procedural hassles, the KYC procedure for opening accounts has been simplified for those persons who intend to keep balances not exceeding rupees fifty thousand (Rs. 50,000/-) in all their accounts taken together and the total credit in all the accounts taken together is not expected to exceed rupees one lakh (Rs.1,00,000/-) in a year. 

7. The Way Forward

The banks should come out of inhibited feeling that very aggressive competition policy and social inclusion are mutually exclusive. As demonstrated elsewhere, the mass banking with no-frills etc. can become a win-win situation for both. Basically banking services need to be “marketed” to connect with large population segments and these may be justifiable promotional costs. The opportunities are plenty.

·               In the context of India becoming one of the largest micro finance markets in the world especially in the growth of women’s savings and credit groups (SHGs) and the sustaining success of such institutions which has been demonstrated by the success of SEWA bank in Gujarat, low cost banking is not necessarily an unviable venture/proposition. 

·               The IBA may explore the possibility of a survey about the coverage in respect of financial inclusion keeping in view the geographical spread of the banks and extent of financial services available to the population so as to assess the constraints in extension of financial services to hitherto unbanked sections and for initiating appropriate policy measures.

·               It may be useful for banks to consider franchising with other segments of financial sector such as cooperatives, RRBs etc. so as to extend the scope of financial inclusion with minimal intermediation cost.

·               Since large sections of low income groups transactions are related to deposits and withdrawals, with a view to containing transaction costs, 'simple to use' cash dispensing and collecting machines akin to ATMs, with operating instructions and commands in vernacular would greatly facilitate financial inclusion of the semi urban and rural populace.

In this regard, it is worthwhile to emulate the example of ‘e-Choupal’ project brought forth through private sector initiative.

8. Conclusion 

It is becoming increasingly apparent that addressing financial exclusion will require a holistic approach on the part of the banks in creating awareness about financial products, education, and advice on money management, debt counseling, savings and affordable credit. The banks would have to evolve specific strategies to expand the outreach of their services in order to promote financial inclusion. One of the ways in which this can be achieved in a cost-effective manner is through forging linkages with microfinance institutions and local communities. Banks should give wide publicity to the facility of no frills account. Technology can be a very valuable tool in providing access to banking products in remote areas. ATMs cash dispensing machines can be modified suitably to make them user friendly for people who are illiterate, less educated or do not know English.

To sum up, banks need to redesign their business strategies to incorporate specific plans to promote financial inclusion of low income group treating it both a business opportunity as well as a corporate social responsibility. They have to make use of all available resources including technology and expertise available with them as well as the MFIs and NGOs.

It may appear in the first instance that  taking banking to the sections constituting “the bottom of the pyramid”, may not be profitable but it should always be remembered that even the relatively low margins on high volumes can be a very profitable proposition. Financial inclusion can emerge as commercial profitable business. Only the banks should be prepared to think outside the box!

Contributed by :- Bharadwaj M - MBA(A) 

Some Important Financial Terms

Time Value of Money 

The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. For example, assuming a 5% interest rate, Rs.100 invested today will be worth Rs.105 in one year (Rs.100 multiplied by 1.05). Conversely, Rs.100 received one year from now is only worth Rs.95.24 today (Rs.100 divided by 1.05), assuming a 5% interest rate.

Discounting

The act of determining the present value of future cash flows. Because money is subject to inflation and has the ability to earn interest, one dollar today is worth more than one dollar tomorrow. Discounting, then, is the act of determining how much less tomorrow dollar is is worth.

Compounding

A process whereby the value of an investment increases exponentially over time due to compound interest.

Retained earnings

The percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under Shareholders equity on the balance sheet. The formula calculates retained earnings by adding net income to (or subtracting any net losses from) beginning retained earnings and subtracting any dividends paid to shareholders:

Retained Earnings (RE) = Beginning RE + Net Income - Dividends

Also known as the "retention ratio" or "retained surplus".

In most cases, companies retain their earnings in order to invest them into areas where 

the company can create growth opportunities, such as buying new machinery or spending the money on more research and development. Should a net loss be greater than beginning retained earnings, retained earnings can become negative, creating a deficit. The retained earnings general ledger account is adjusted every time a journal entry is made to an income or expense account.

Cost of capital

The required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity. The cost of capital determines how a company can raise money (through a stock issue, borrowing, or a mix of the two). This is the rate of return that a firm would receive if it invested in a different vehicle with similar risk.

BASIC TERMS RELATING TO PRIMARY ISSUE OF SHARES

IPOs are seen as one of the most lucrative options of investing in the current market scenario. Few of the recent IPOs have given good listing gains to the investors.   But before you share your hard earned money with the promoters of the company, it is very important to get a basic understanding about the various technical terms, abbreviations and jargons used in the primary market ( call it the IPO market). This is an attempt to explain in brief some of the key terms, without making any reference to the various sections and clauses governing the primary market.

 1.     IPO : IPO stands for Initial Public Offer. An IPO is the first sale of shares of a company to the general public. The promoters of the company, after complying with the various guidelines of SEBI (Securities and Exchange Board of India) and of The Companies Act, ask the public at large to subscribe to their shares so that they can generate capital and utilize the same for expanding their business. A successful IPO can raise a substantially huge amount of capital.

 2.       FPO : FPO stands for Follow-on Public Offer. Once a company comes with an IPO , it gets listed on the stock exchanges. After a certain period of time, if the company again intends to raise capital from the general public, then it again comes with a public issue which is called an FPO (Follow-on Public Offer ). It is a supplementary issue made by a company once it is listed and established on the stock exchange. In short, the first public issue of a company is an IPO, and any further  public issue of the same company is called an FPO. For example, Shipping Corporaton of India (SCI), a listed company, is again coming up with a public issue which will be its FPO ( i.e. a second public issue)

 3.       Listing : Once the issue gets subscribed and the shares are allotted, they are listed on a recognized stock exchange e.g. BSE, NSE etc. Listing means that company has adhered to the terms and conditions of the stock exchange and its shares are now a part of the list of shares which can be traded on the stock exchange. Post listing, any investor can sell the shares, allotted at the time of the issue, in the secondary market.

 4.       Bid-cum-Application Form : For applying in any public issue, each investor must fill a standard form providing all the relevant details like Name, PAN, Demat ID, Bank account details, Bid price, Number of shares applied etc. Such a form is called a Bid-cum-Application form. It can be submitted through the offline or online mode. An investor must ensure that all the relevant details are filled correctly to avoid rejection of application and to ensure smooth allotment of securities.

 5.       Price Band : A price band is the range of price within which an investor can place his bid for the securities. The price mentioned by the investor in the bid-cum-application form can neither be less than the lower limit of the price band nor can it exceed the upper limit of the price band. For example, In the recent IPO of Coal India, the price band was Rs. 225-245 per share, which means that an investor can bid only within the range of Rs. 225 to Rs. 245

 6.       Floor Price : In a price band, the lowest price is called the floor price, below which a bid cannot be placed. In the above example Rs. 225 is the floor price of the Coal India IPO

 7.       Cap Price : Cap price is the upper ceiling limit in a price band beyond which a bid cannot be placed. Again, taking the same example of Coal India, Rs. 245 is the Cap price, beyond which you cannot place the bid.

 8.       Minimum order quantity : Minimum Order Quantity is the minimum number of shares which the investor has to apply for in a public issue. For example, in the case of Coal India’s IPO, the minimum order quantity was 25, i.e. an investor has to bid for atleast 25 shares.

 9.       Market Lot : If an investor wants to bid for shares which are more than the minimum order quantity, then he can do so by bidding in multiples of a certain number of shares which is known as the Market Lot. By continuing the above example, if an investor wants to apply for more than 25 shares of Coal India, then bids can be made in multiples of 25 shares, which is the market lot size in case of the Coal India issue. Thus, applications can be made for 25, 50, 75 …….number of shares until the maximum subscription limit is reached. In case of Coal India, the minimum order quantity and market lot size, both were 25 shares.

 10.   Maximum Subscription Limit for Retail Investors : Maximum Subscription Limit for Retail Investors is the maximum amount of investment which can be made though a single bid-cum-application form, or simply speaking, by a single individual, in a public issue. Previously, retail investors were allowed to make an application of a maximum of Rs. 1,00,000, but now SEBI has increased this limit to Rs. 2,00,000. Any application by an retail investor which exceeds Rs. 2,00,000 becomes an application by a High Net Worth Individual (HNI), thus disabling the investor to enjoy the benefits of discount which are offered in some big ticket IPOs to the retail investors.

 11.   Cut Off Price : In book building issues, the issuer company specifies a price band within which the bids are made. The actual issue price can be any price above the floor price and within the price band. This issue price is called the Cut Off Price. This price is determined after considering the demand for the stock by the investors. Investors, in order to get allotments in big ticket public issues, bid at the cut off price, conveying their intention that they are willing to pay any price for the stock within the price band, at the end of the book building process.

 12.   ASBA (Application Supported by Blocked Amounts) : ASBA is an alternative mode of making payments in public issues whereby the application money stays in the bank account of the investor until the allotment is made. Only that much amount of funds are debited to the investor’s bank account for which the allotment is made and the rest of the blocked amount is released. In case the application is made using the ASBA facility, the need for refunds is completely obviated. For example : if an investor makes an application for Rs. 2,00,000 , then in the earlier system, he was required to pay the entire sum of Rs. 2,00,000 upfront, either through a cheque or net-banking and then if shares worth Rs. 1,50,000 are only allotted, then Rs. 50,000 used to get refunded. Under the ASBA mechanism, the investor just need to keep Rs. 2,00,000 in his bank account and at the time of allotment only Rs. 1,50,000 would be debited to his account thus releasing the left over blocked amount of Rs. 50,000 and also doing away with the cumbersome task of issuing refunds.

 13.   Book Building Process : Book Building is one of the methods of carrying out a public issue, the other being the Fixed Price method. Under the Book Building method, the price at which securities will be offered is not known to the investor. The investor is allowed to bid in a given price range called the price band, and then, after the bids are closed & looking at the demand for the shares at various price levels within the price band, the final issue price is decided by the Merchant Bankers or BRLMs. This process leads to a better price and demand discovery. It is called the “Book Building Process” because during the entire issue period, the book for the offer remains open and keeps building up with the bids collected from investors.

 14.   BRLM (Book Running Lead Manager) : BRLM are those financial intermediaries which are involved in the IPO process right from the very first stage and play a vital role in preparation & submission of prospectus, price fixation, application processing, allotment and listing. Names of such BRLMs are printed at the bottom of the bid-cum-application form

e.g. Karvy Securities, Kotak Mahindra, SBI Capital, Enam Securities etc. are some of the well known BRLMs

Posted By
CA Rachana Phadke