Indian banking network forms the backbone of the Indian economy. The banking sector in the country plays a significant role in molding the direction in which the economy proceeds. This is primarily because of the fact that more than 40% of the gross financial savings of the people in the country is with the banks. They also provide several banking services other than savings to the people, like purchase of securities, mutual funds etc. One of the major services provided by banks is the supply of loanable funds into the market to enhance investments and the credit requirements of the businesses.
Money lending has been a prominent economic activity since the time of the early nation states. Though the ancient economic thought in general and the religious institutions in particular, opposed the extraction of usury from loanable funds, it still thrived as a major source of money for traders and merchant classes. By the emergence of modern day banking institutions in the latter periods of renaissance. Today, it is a major source of income for the banks as well as a source of capital for investments.
The entire process of lending activity involves a lot of risk and majority of these risks emerge out of the problem of information asymmetry. Information asymmetry in the banking sector can be defined as the imbalances and imperfections that arise out of the situations where the economic stakeholders involved in a financial activity fails to reveal the complete information. For example, there is always an imbalance in terms of the information available for the parties of a loan transaction. While the borrower enjoys an advantage of knowing the exact use and returns on the credit she received, the lender might be in the dark if the borrower hide such information from her. Thus, the lender or the bank often will have to depend upon the probabilistic estimates of loan repayment, than going with the actual information and facts, which are beyond her capacity to access and retrieve.
One of the reasons as to why financial inclusion remains low in India’s rural areas, even after a popular digitization drive by the government, is due to this fact that the formal banking sector finds it too difficult to operate in rural areas. As bank employees mostly don’t work in their native places, they are not aware of the credit repayment abilities of the borrowers to the extent a local money lender knows. As a result, formal banks prefer to abstain from operating in distant, rural spaces– money lenders thrive in these areas. It also shuts the window for the rural households to access cheap and reliable loanable funds.
The reason why this issue of information asymmetries becomes important in the present context is due to the fact that the rural India is still struggling with the lack of supply of adequate banking services. Many households are under pressure from petty money lenders, who often threaten the rural farming community for possible failures in repayment of loans. Similarly, rural households save a lot of their surplus in the form of gold or cash reserves, and thus leaving the possibility of any yield from the money that they save.
A good way to tackle this crisis would be the localization of banking activities to cater the needs of rural communities. This doesn’t mean the mere extension of the banking facilities into the local areas, but making the banking network adaptive to the rural conditions. A good example would be the success story of Grameen Bank, the brain child of Muhammad Yunus, which brought a financial revolution in Bangladesh by availing credits to even those marginalized sections of the society. Instead of providing individual loans, he created a peer-network or group of borrowers to whom the funds were finally disbursed. This ensured that the individuals will have the incentive not only to payback their own loans, but also persuade others in the same group for repayment. In this way, the repayment rate of the loans issued by Grameen Bank stood at 98% whereas other traditional banks could only recover 65-70% of the loans that they disbursed. Though the ‘Grameen’ way of loan disbursement is not viable for large borrowers, it is the ideal way of supplying loans to the underprivileged sections of the society. This will also keep the menace of debt trap and unwilful defaults, which are quite common in the rural areas.
It is high time; poverty must be eradicated from the country. When we speak of India as a developed country, it should also mean an ‘inclusive development’ where no one is left behind. As Mohammed Yunus once said, “The only place where poverty should be is in museums”.
– Contributed by Jiss Palelil
Picture Credits: ‘Rural Women Receiving Loans’ from http://www.iodonna.it/