I begin by looking at exactly the opposite of financial inclusion, i.e., financial exclusion. Broadly defined, financial exclusion signifies the lack of access by certain segments of the society to appropriate, low-cost, fair and safe financial products and services from mainstream providers. Financial exclusion is thus a key policy concern, because the options for operating a household budget, or a micro/small enterprise, without mainstream financial services can often be expensive. This process becomes self-reinforcing and can often be an important factor in social exclusion, especially for communities with limited access to financial products, particularly in rural areas.
Two major factors have often been cited as the consequences of financial exclusion. First, it complicates day-to-day cash flow management – being financially excluded means households, and micro and small enterprises deal entirely in cash and are susceptible to irregular cash flows. Second, lack of financial planning and security in the absence of access to bank accounts and other saving opportunities for people in the unorganised sector limit their options for providing for themselves for their old age. From the macroeconomic standpoint, being without formal savings can be problematic in two respects. First, people who save by informal means rarely benefit from the interest rate and tax advantages that people using formal methods of savings enjoy. Second, informal saving channels are much less secure than formal saving facilities. Those who can afford it least suffer the highest risk. The resultant lack of savings and saving avenues means recourse to non-formal lenders, like money lenders. This, in turn, could lead to two adverse consequences – a) exposure to higher interest rates charged by formal lenders; and b) the inability of customers to service the loans or to repay them. As loans from non-formal lenders are often secured against the borrower’s property, this raises the problem of inter-linkage between two apparently separate markets. Judged in this specific context, financial exclusion is a serious concern among low-income households, mainly located in rural areas.
Once access to financial institutions improves, inclusion affords several benefits to the consumer, regulator and the economy alike. Establishment of an account relationship can pave the way for the customer to avail the benefits of a variety of financial products, which are not only standardised, but are also provided by institutions that are regulated and supervised by credible regulators, and are hence safer. The bank accounts can also be used for multiple purposes, such as, making small value remittances at low cost and making purchases on credit. Furthermore, the regulator benefits, as the audit trail is available and transactions are conducted transparently in a medium that can be monitored. The economy benefits, as greater financial resources become transparently available for efficient intermediation and allocation, for uses that have the highest returns. In other words, the single gateway of a banking account can be used for several purposes and represents a beneficial situation for all the economic units in the country.
In addition, I would like to flag an important perspective. Improvements in rural infrastructure in terms of availability of electricity, improvement in connectivity through provision of rural roads and telecommunications, and construction of warehouses, are expected to lead to better overall supply chain management, enhance productivity of physical resources in the rural areas and greater addition in agriculture. These developments would lead to much greater demand for banking activity in rural areas. The two-fold implications of these developments for the banking sector are apparent. First, with higher financing needs of such new activities vis-a-vis traditional ones, the overall financing intensity of agriculture is likely to experience a manifold rise. Second, along with growth in rural infrastructure, there is also likely to be an increase in rural non-farm activities, such as repair activities, education, housing, restaurants and medical services. These activities, both traditional and emerging ventures, would be available for financing by the banking sector.
Thus, as the economy begins to grow rapidly, the rate of financial intermediation is expected to increase further. In other words, the banking system will be expected to increasingly provide larger quantum of funds to existing and emerging enterprises. And without adequate deposit growth, however, credit expansion might not be sustainable over the medium-term, without putting immense pressure on real interest rates and impacting the overall stability of the financial system.
Typically, countries with low levels of income inequality tend to have lower levels of financial exclusion, while high levels of exclusion are associated with the least equal ones. In Sweden, for example, lower than two per cent of adults did not have an account in 2000 and in Germany, the figure was around three per cent (Kempson, 2006). In comparison, less than four per cent of adults in Canada and five per cent in Belgium, lacked a bank account (Buckland et al, 2005). Countries with high levels of inequality record higher levels of banking exclusion. To illustrate, in Portugal, about 17 per cent of the adult population had no account of any kind in 2000 (Kempson, 2006).
The policy responses to such exclusion have been varied (Box 1). In Sweden, for example, banks cannot refuse to open a saving or deposit account under Section 2 of the Banking Business Act of 1987; in France, Article 58 of the Banking Act, 1984 recognised the principle of the right to a bank account; in the US, federal government introduced the Community Reinvestment Act in 1997, partly in response to concerns about bank branch closures in low-income neighbourhoods. Under this legislation, federal bank regulatory agencies rate banks on their efforts to serve low-income communities. These early legislations were designed to ensure access to a deposit account but did not spell out the nature of banking services that should be on offer. Refinements in this area have actually taken place in the latter half of the 1990s, resulting partly from a wider concern regarding social exclusion (Caskey et al, 2006, Kempson et al, 2000). It may, thus, be noted that financial inclusion is a concern even in developed countries and legislative or regulatory measure to achieve it are a common feature.