Concept of Financial Inclusion

Mandira
Sarma, Jesim Pais (2008) in their study went through the
history and stated that financial inclusion started in 1904 and it gained speed
when major commercial banks were nationalized. The Lead bank scheme was
initiated just after the above event. A number of bank branches were introduced
across the length and breadth of the country and even in the areas that were
geographically isolated form the country. However, there is still a lot to be
covered when it comes to the parameter of financial access requiring special
focus and attention. The studies have come up with a glaring fact that lower
levels of financial inclusion or financial exclusion cost for around loss of 1 per
cent to the GDP. The problem of financial exclusion could not have been
discounted and hence RBI treated it on an urgent basis Thus, the RBI concluded
that the financial inclusion is not just a socio-political imperative but also an
economic one and realized the gravity of the problem. The Reserve Bank of
India implemented the same in Mid Term Review of Monetary Policy and
pressed the banks to treat financial inclusion on priority as one of the foremost
objectives.

2.10.1 Defining Financial Inclusion

112
United Nations, (2006) in their study explained financial inclusion as
the timely delivery of financial services to disadvantaged sections of society. IT
basically means two things. Firstly, financial inclusion relates to a customer who
should have a hold on to a rage of financial services from simplest financial
services such as savings to more complicated financial service or a product.
Secondly, financial inclusion implies that the customer should have an access to
different financial service providers ensuring the competitive market spirit. Hence,
financial exclusion would connote the helplessness of the disadvantaged to access
financial services. A number of hindrances result in financial exclusion. These
include geographical barriers limiting the physical access, stringent banking
regulations like lack of identification proof , psychological implying lack of trust
in financial institutions credibility, lack of financial information and knowledge
regarding products and procedures and lower levels of financial wisdom due to
lower levels of income and financial indiscipline.
113
Claessens (2006) concluded that financial inclusion relies a lot on financial access
and access to finance is the availability of an adequate number of financial services
at reasonable costs, where reasonable costs are relative and costs include all
pecuniary and non-pecuniary costs.
Demirguc-Kunt and Levine (2008) defined financial inclusion as the absence of
price and non-price barriers.
Leyshon and Thrift (1995) underlined financial exclusion as those processes
which intend to avert certain social groups and individuals from getting an access
to the formal financial system.
World Bank (2008) in its working paper suggested that access to finance eases the
limitation that external financing puts on to firms expansion process.
Lower access also leads to skewed income differences, poverty, and lower income
growth rates. Therefore, access to finance would lead to an inclusive growth and
developed financial system catering to all groups of people can be considered as a
tool to reduce inequalities and poverty in various nations.
Demirguc-Kunt (2010) suggested that fully functional financial system, poor
individuals, and small enterprises are dependent upon their personal wealth and
internal financial resources to capitalize upon the financial opportunities available
in the financial markets.
RBI Report (2008) came up with many versions of definition in financial inclusion
or financial exclusion. Some of these are mentioned in the table given in the later
section. Most of the definitions are operational in nature and generally focus on
ownership or access to particular financial products and services.
Meadows et al., (2004) advocated that the focus of financial players with respect to
financial products and services narrows down to the mainstream ones. The entire
emphasis should be on the development of affordable financial products and
services for the poor.
Bridgeman (1999) broadened the scope of financial inclusion and included such
financial products like home insurance, short and long-term credit and savings and
money transfer. Further, several other operational improvements have also evolved
from the underlying public policy concerns.
 H.M. Treasury (2004) advocated that people who live on marginal incomes
do not have an access to vailable financial products such as bank accounts and low
cost loans. Such a situation spirals up creating a web and escalates the magnitude
of real costs on them.

ADB(2000) stated that financial inclusion is the availability of a facility of a wide

range of financial services like deposits, loans, payment services, money transfers
and insurance to poor and low-income households and their micro-level
businesses.

Stephen P. Sinclair(2001) stated that Financial exclusion means that the people
are not able to access important financial services in a fitting manner. Exclusion
can be due to the result of problems with access, conditions, prices, marketing, or
self-created exclusion as an outcome to negative experiences.

Chant Link and Associates, Australia(2004) explained Financial exclusion is the

outcome which results from lack of access to low cost, fair, and safe financial
products and services from mainstream providers. It further becomes a concern in
the community when it is applied in case of lowere income consumers and those
suffering from financial hardship.

Scottish Government (2005) emphasized upon the Access for individuals to

suitable financial products and services. Further, it stresses on the financial
capability emphasizing capacity, skills, knowledge and understanding to make the
optimum use of those products and services.

Treasury Committee, House of Commons UK(2004) defined financial inclusion

as the Capacity of individuals to access suitable financial products and services.

United Nations (2006b) advocated in their study that a financial sector is sound
when it creates an access to credit for all bankable people and firms, to insurance
for all insurable people and firms and to savings and payments services for
everyone. Inclusive finance does not require that everyone who is eligible use
each of the services, but they should be able to choose to use them if desired.

RBI Report (2008) defined financial inclusion as the process of guaranteeing

access to financial services, handy and adequate credit where needed by
vulnerable groups such as weaker sections and low income groups at an affordable
cost.

World Bank (2008) in their report underlined financial inclusion as Broad access
to financial services which further implies an absence of price and non-price
barriers in the usage of financial services. It is equally difficult to define and
measure because access has many dimensions.

Initiatives for Financial Inclusion in India

RBI (2008) study provided the history and evolution of a sound banking system
developed after independence which insisted upon the planned economic
development through allocation of financial resources and channelize them into
productive sectors. RBI attempted to put an end to financial exclusion by
expanding credit and financial services to a wide range of population and resulting
host of financial institutions have been set up catering to the varying needs of the
society. These new financial insititutions and market players included commercial
banks, urban co-operative banks, development banks, and regional rural banks.
Self-help groups (SHGs) also were initiated to meet and match the financial needs
of the the needy sections of the society. The development strategy has now
evolved and is focused on coming up with a wider variety of financial services
and financial products using the available channels of distribution such as civil
society organisations, post offices, non-government organisations. Further, a
number of specific and tailor made financial innovations took place keeping in
mind the demographic profile of the nation in both rural and urban areas.

The RBI initiatives can be categorized into three major timeline phases. The first
initiative began in late 1960s through the 1980s. The major emphasis was on the
creation of credit to the underserved sections of the society. The second initiative
began in 1990 through March 2005. The attempt was to strenghthen the financial
institutions by bringing financial sector reforms. Several schemes like SHG-bank
linkage programme and Kisan Credit Cards (KCCs) were encouraged for credit
provision to farmers. The final phase began in April 2005. The concept of
financial inclusion was given a major headaway and it was made a major policy
objective. The entire focus was on to create as many accounts as possible and at
the same time the banks were also asked to speed up their branch expansion
programme.
2.11.1 Financial Inclusion in India Key Elements

Leeladhar(2006) underlined financial inclusion as the delivery of financial

services particularly banking services at a relatively low price which culd be
affordable to the vast sections of underprivileged and low income groups.
Unrestricted access to public goods and services has always been a prime feature
of an open and efficient economy. Further, banking services also fall into the
category of public goods and it is imperative that the availability of banking and
other financial services to the entire population is ensured and sustained.

Mohan(2006) suggested that financial exclusion indicates lack of access to

suitable and low-cost financial products and services from mainstream providers
by certain sections of the society. Therefore, Financial exclusion is a major policy
issue as denial of basic financial services can vastly affect the finances and money
management plans of most families in society. This process is self-repeating and
results in social exclusion especially for families with limited financial resources
and limited access to financial products in both rural and urban areas.

Thorat(2006) provided a simpler view of financial inclusion and defined it as a

provision of affordable financial service such as access to payments and
remittance facilities, savings, loans and insurance services by the formal financial
system to the sections of the society who are most vulnerable and are likely to be
financially excluded.

Reddy(2007) defined financial inclusion as the process which consists of

providing each household with basic financial services particularly banking
services.

Dr. C. Rangarajan, (2008) underlined financial inclusion as the process of

ensuring access to financial services and timely and adequate credit where needed
by vulnerable groups such as weaker sections and low income groups at an
affordable cost to achieve financial inclusion.

Leeladhar, (2005) advocated that inspite of all drastic improvements in the

banking system influencing the major parameters of financial viability,
profitability and competitiveness, there are still major issues and concerns related
to the banks who have not been able to reach vast sections of the society
especially the underprivileged sections of the society.
 In 2003, the RBI introduced a major policy programme of financial
inclusion emphasizing upon the availability of financial services to the needy
people. The major focus was on to ensuring the access to finance for all and this
major policy initiative brought a radical change in the way banks used to function.
The Committee on financial inclusion in 2008 (Rangarajan committee) concluded
that financial inclusion of the excluded sections is important for accelerating and
sustaining the growth trajectory. The committee initiated multi-dimensional
strategies including setting up of National mission on financial inclusion, RRBs
and Cooperatives, and by Business Facilitator and Business Correspondents
Model on a vast scale.
K. A. Shreenivasan, P. Vaijayanthi, Kaundinya Narsimha (2013) discussed in
their study that non-access to credit sources and banking products and services is a
major hurdle which denies the poor and the needy to take an advantage of the
financial product or a financial service.

Aghion and Bolton, (1997) in their empirical analysis observed that improved
access to financial resources is a major policy decision in favour of poor people
and it would help to provide a much needed impetus to the growth process.
Further, it would reduce income inequality and poverty.

International studies (World Bank Policy Research Working Paper 3338 2004;
Clarke, Colin and Heng-fu, 2006) observed that the income of the poorest
quintile grows faster than the average per capita GDP in countries with better
developed financial intermediaries. These studies also endorse the influence of
financial marketplayers on economic growth measured by GDP per capita and
productivity per capita in terms of private credit (Levine, Loayza, Beck, and
Thorsten, 2000).

Credit is at top priority for poor households and financial services are both needed
by the small firms and the poor households. All this depends upon financial
marketplayers and intermediaries for providing access to good savings, payment
services and insurance (World Bank Policy Research Report, 2008).

The Economist (2012) in their report highlighted that financial exclusion has
become a major global concern. According to the World Bank estimates, in some
countries, fewer than 10 per cent of people have access to financial services of any
kind. Similar conditions exist in developed nations as well. The growing challenge
is to ensure the access and availability of financial resources including financial
products and financial services. The glaring figure of financial exclusion can be
gauged by the fact that almost Two thirds of the adult population in developing
countries or 2.7 billion people are denied the access to basic formal financial
services, such as savings or checking accounts.

According to World Bank (2010) report empirical results indicated that in

the largest share of the unbanked live in Sub-Saharan Africa (12% banked) and
South Asia (24% banked). East Asia, Middle East and North Africa, Latin
America and Eastern Europe and Central Asia are also low-access regions with
less than 50% of their population banked. Among the unbanked population, a
large proportion lives on less than $5 dollars a day. The report established that
financial inclusion needs to optimize the work done by financial services
providers so as to deliver financial services beyond what is delivered by the
conventional set up. The same would require commitment from a wide range of
banking and non-banking financial institutions, including commercial banks and
microfinance institutions.

Factors Affecting Access to Financial Services

According to RBI (2008) report there are a number of factors which affect the
process of financial inclusion. These are:

1) Gender issues: The financial inclusion is limited for women who do not have
an access to a financial resource in general.
2) Age factor: Most of the financial products and services are derived
considering the middle age people and they fail to cater to the needs of the
young and old sections of the society.
3) Legal identity: Lack of documentation substantiating legal identities like
identity cards, birth certificates or written records make it difficult for women,
economic and political refugees, and migrants from getting financial products
and services.
4) Limited literacy: Low levels of financial acumen and financial knowledge
including concepts of basic financial mathematics and financial skills create a
hindrance for financial product and service.
5) Place of living: Factors such as density of population, geographical distances,
lack of transportation, also affect the availability and access to a financial
product or a service.
6) Psychological and cultural barriers: Lack of trust and confidence in banks
create a situation where people create self-exclusion. This usually is the case in
low income groups.
7) Social security payments: The lack of social security payments such as
subsidies creates a higher level of financial exclusion.
8) Bank charges: A high level of financial charge reduce the attractiveness of a
banking product or a financial service. These charges create a lot more burden
on the overall benefit provided by the financial product or a service.
9) Terms and conditions: The terms and conditions along with procedures while
buying a financial product or a service are plenty in place which create
unnecessary hassle in using the financial product and financial service.
a. Level of income: The lower levels of income with people quite often
reduce the access to a financial product. The amount of money at a
disposal of a person is limited and can be put only to a few priorities.
This defeats the purpose of financial inclusion emphasizing upon
creation of a tailored financial product for the poor people.
10) Type of occupation: Most banks fail to evaluate the credit worth of individuals
resulting which they fail to grant loans and advances to a host of needy people
and unorganized businesses.
11) Attractiveness of the product: The financial product or service such as a
savings accounts, credit product, payment services and insurance) and how
their availability is marketed are crucial in financial inclusion.

The Financial Action Task Force (FATF), (2011) in their report concluded
that the main obstacles to financial inclusion can be summarized as follows:
A. Supply side

1) Outreach: low density areas and low income populations are not
attractive for the provision of financial services and are not
financially sustainable under traditional banking business strategies
and corresponding regulatory requirements
2) Regulation: frameworks are not always adapted to local contexts
3) Business strategies: mostly with high fixed costs
4) Providers: limited number and types of financial service providers
 5) Services: non-adapted products and services for low income
populations and the informal economy

B. Demand side
1) Irregular income

2) Frequent micro-transactions

3) Lack of trust in formal banking institutions

4) Literacy level, lack of awareness and/or knowledge/understanding of

financial products
5) Cultural obstacles (e.g., gender and cultural values).

Building Inclusive Financial Sectors

A report by United Nations (2006) stated that most nations need to design suitable
strategies for increasing availability of financial services for all the segments of
the population. These nations should therefore take into account the existing
financial situation before they convert their plans into policies and procedures.
However, such an effort would require the support and coordination of every other
stakeholder including governments, financial institutions and development
partners. Further, it also stresses that every other stakeholder needs to pay
considerable attention on financial inclusion over a longer period.

Asia Multi-Stakeholder Dialogue (2005) concluded that there is a huge

unsaturated demand for financial by the poor families and small businesses. The
underserved sections include those who are living on below subsistence levels and
living in sparsely populated regions and the groups lacking legal identity.

Nature, Causes and Consequences of Financial Exclusion

Nature and Causes:

Sinclair (2001) indicated that the nature and forms of exclusion and the
factors responsible for it are varied and, thus, no single factor could explain the
phenomenon. So the principal barriers in the expansion of financial services are
often identified as physical access, high charges, and penalties, conditions attached
to
products which make them inappropriate or complicated and perceptions of
financial service institutions which are thought to be unwelcoming to low income
people.
101
Kempson et al. (2000) analysed in their report the range of physical and
geographical barriers to financial inclusion factors that can contribute to financial
exclusion for different products and individuals under certain circumstances.
There are a number of dimensions or forms of financial exclusion that have
been identified. The critical dimensions of financial exclusion include: (i) access
exclusion- restriction of access through the process of risk management (by
financial services providers); (ii) condition exclusion - conditions attached to
financial products which make them inappropriate for the needs of some segments
of population; (iii) price exclusion- some people can only gain access to financial
products at prices they cannot afford; (iv) marketing exclusion - some people are
effectively excluded by targeted marketing and sales; and (v) self-exclusion -
people decide not to opt for a financial product because of the fear of refusal to
access by the service providers. However, in many countries, many non-poor
individuals, micro, small and medium entrepreneurs also have difficulty in
accessing financial services. The most conspicuous dimension is that many of the
low- income segments of the population do not have access to even the very basic
financial services. Even amongst those who have access to finance, most are
underserved in terms of quality and quantity of products and services. Significant
proportion of low-income households is dependent on unsustainable, subsidy-
dependent and poorly performing institutions (Chart-VII.2) (Kempson and
Whyley, 1999; Kempson et al., 2000; Connolly and Hajaj, 2001).

United Nations (2006b) report emphasized that exclusion may also have
resulted from a variety of structural factors such as unavailability of products
suiting their requirements, stringent documentation and collateral requirements
and increased competition in financial services. There has also been particular
emphasis on socio- cultural factors that matter for an individual to access
financial services.

Ashvin Parekh, D. S. Rawat (2011) 103 in their report analysed the

global situation the following table depicts a comparison of the state of
financial exclusion among some regions/countries across the world. It considers
FI as ownership and ignores the levels of activity in savings accounts. The
state of exclusion will surely

become worse if the real rate of inclusion, which measures usage frequency, is also
taken into account.
108
Dr. Reena Agrawal(2011) indicated that Financial exclusion is a serious
concern among SC,ST,OBC and women households as well as small businesses,
mainly located in semi-urban and rural areas. The main Consequences of financial
exclusion being financially excluded the absence of access to bank accounts and
other saving opportunities result in lack of savings, low investments and lack of
financial planning, then it becomes difficult in gaining access to credit getting
credit from informal sources at exorbitant rates results in increased unemployment
due to lack of self employment opportunities as well as higher incidence of
crime etc. Therefore, 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, lots of reliance on private money lenders for small credits.
He concluded that financial exclusion not only widens the Rich-Poor divide , it
also leads to Social Exclusion.

109
According RBI (2008) it is emphasized that the Financial Exclusion is broadly
defined as the lack of access by certain segments of the society (SC, ST, OBC, and
women) to suitable, low-cost, fair, and safe financial products and services from
mainstream providers. Thus the essence of financial inclusion is to ensure that a
range of appropriate financial services is available at affordable price to every
individual and access those services. In reality, the Reserve Bank of India found
that the main reasons for financial exclusion, from the demand side are lack of
awareness, low income, poverty and illiteracy; and from the supply side it is the
distance from branch, branch timings, cumbersome documentation and
procedures, unsuitable products, language, staff attitudes, etc. The RBI found that
due to all these procedural hassles people feel it easier to take money from
informal credit sources, in spite of, high cost of credit. It results in compromised
standard of living and higher costs. Informal credit increased exposure to
unethical and unregulated providers and vulnerability to uninsured risks. The RBI
 concluded that financial inclusion does not mean merely opening of saving bank
account but signifies creation of awareness about the financial products,
education, and advice on money management, offering debt counseling, etc. by
banks. Every society should ensure easy access to public goods. Therefore,
banking service being a public good should also be aimed at providing service to
the entire population.
2.13 Overcoming barriers to financial inclusion
129
Sarma and Pais,(2008) study indicated how to overcome barriers to
financial inclusion in India. So Financial inclusion is the process that will ensures
the ease of access to finance, market and resources must keep in availability and
usage of the formal financial system for all members of an economy. Financial
inclusion has three dimensions: accessibility, availability, and usage. Therefore,
the empirical findings strengthen the argument that financial exclusion is
important as a policy objective to overcome financial exclusion.

130
K.G. Karmakar, G.D. Banerjee and N.P. Mohapatra(2011) in their book on
Towards Financial Inclusion in India discussed in the depth way that there are
Structural Challenges: these are: