(i) Title of submission:
(ii) Name of the author:
36th SKOCH Summit 2014
Delivering to an Aspirational India
20th, 21st & 22nd June, Delhi, India
Differentiated Banks and Financial Inclusion
Dr. R Ramakrishnan
Chief Consultant and Independent Researcher)
Classic Consultants, Salem
(iii) Mailing address:
5/7 Padmavathy Colony,
Near Thigaraja Polytechnic, Salem 636 005
(iv) E-mail address of Author: ramakrish54@gmail.com or ramakrish54@yahoo.com
(v) Phone number(s) Mobile
919952669656 Landline: +91427-4040492
Dr Ramakrishnan Ramachandran, a baby bloomer did his PhD in Corporate
Social Responsibility and has been associated in founding 3 B schools in rural Tier 2/3
cities in India.
After working in the Government of India in the Cabinet Secretariat and Indian
High Commission Seychelles for 22 years, he worked in the manufacturing and IT
sector for the next 8 years and has also done consultancy works in the field of Quality
for small and medium industries in India. He joined academics on s full time basis in
2005 to pursue his passion –teaching as the founder director of three B Schools in
India.
Author of books ranging from Total Quality management to Environmental
Science to Ethics, Ramakrishnan Ramachandran has presented over 30 papers on
various management topics. He is continuing his research work on various topics
ranging from Mentoring to Marketing as he tries to give shape to the future managers of
India. He can be contacted at Cell No. +919952669656 and ramakrish54@gmail.com
His current post doctoral research interests are Social Responsibility,
Educational Reforms, CRM, TQM, Gender Studies, Financial Inclusion, Development
Studies, etc. His research papers can be accessed at SSRN Author page:
http://ssrn.com/author=646193
Page 1 of 16
Differentiated Banks and Financial Inclusion
Full paper
Business is the most important engine of economic change. It brings
employment, goods, revenues, knowledge and skills development. Local entrepreneurs,
microenterprises and small and medium enterprises (SMEs) form the backbone of
global economic activity.
It is quite difficult to envision a strong economy without a good financial system.
Sustainable economic growth requires that, all sections of the society are included and
participate in the growth process.
Financial inclusion bringing more people into the formal financial system by
giving individuals tools to cope with everyday needs and increases the likelihood of their
access to education, health services and employment.
Bank plays an important role in the economic development of a country. It is a
financial institution that accepts deposits and uses the same into lending activities either
directly or through capital markets. Bank connects customers who have capital deficits
to those customers with capital surpluses.
Jaffe and Levonian (2001) argue that the demand for banking services varies
across economies and is dependent on economic, demographic and geographic
features of each country
Banks contribute to the economy of the country by
 Facilitating for monetary policy
 Promoting capital formation
 Encouraging innovation
 Monetization
 Influencing economic activity
According to RBI Since 1991, the size of the Indian economy in terms of GDP at
market prices has increased by almost fifteen times, whereas the household financial
savings have expanded by sixteen times and the gross domestic savings by almost
seventeen times during the same period.
Page 2 of 16
Despite significant progress, one aspect of banking in India that requires deeper
analysis is the still inadequate coverage of the banking and financial sectors. It is
instructive that even with 157 [26 Public Sector Banks, 7 New Private Sector Banks, 13
Old Private Sector Banks, 43 Foreign Banks, 4 Local Area Banks (LABs), 64 RRBs]
domestic banks operating in the country, just about 40 per cent of the adults have
formal bank accounts.
Studies on the relationship between financial structures for the economic growth
of a country have been inconclusive. Depending upon the structure and needs of an
economy, the country’s banking system should be dynamic and competitive to cater to
the diverse needs of the economy.
According to Reid (2010), some financial structures may be better suited to
growth at certain stages of development but they may be less well suited in other
circumstances. An appropriate or optimal banking structure is one, which evolves in
such a way that it accommodates the changing requirements of various constituents of
the economy.
Over the last two decades post reform, the reach of banking has widened
significantly to include relatively under-banked regions, particularly in rural areas.
Commercial bank credit as per cent of GDP picked up steadily from 5.8 per cent in 1951
to 56.5 per cent by 2012. The population per bank branch came down from 64,000 in
1969 to 12,300 in 2012 (RBI, 2013).
Resilience of the Indian banking system has improved over the years. It was
able to withstand adverse economic and financial conditions from time to time. It is
estimated that rural India had only 7 branches per 1, 00,000 adults in 2011 compared to
most of the developed and even BRICS economies having over 40 branches.
The Indian banking sector is yet to meet the desired banking penetration and
inclusion. Hence there is a need for the reorientation of the present structure of the
banks to further increase its capacity to serve the economy better.
Since the Indian economy is dynamic, the banking system needs to be flexible
and competitive in the emerging milieu. An approach that balances flexibility with
Page 3 of 16
effective oversight may be an unexceptionable principle to inform potential steps and
requisite changes.
The existing banking structure in India can be depicted as under:
Existing Banking Structure in India as on March 31, 2013
Commerci Public Sector Banks (26)
State Bank of India
al Banks
Associate Banks(5)
Nationalized Banks(19)
Other Public Sector Bank(1)
Private Sector Banks (20)
Old Private Sector Banks(13)
New Private Sector Banks(7)
Foreign Banks (43)
Branch mode of presence (331
branches)
Regional Rural Banks (64)
Limited area of operation
Local Area Banks (4)
Limited area of operation
Cooperativ Urban Cooperative Banks Multi-State
Urban
Cooperative
e Banks
(1,606)
Banks(43)
Single State Urban Cooperative
Banks(1563)
Rural Cooperatives (93,551)
Short Term (92,834)
State Cooperative Banks(31)
District
Central
Cooperative
Banks(371)
Primary
Agricultural
operative
Societies(92,432)
Long Term (717)
State Cooperative Agriculture and
Rural Development Banks(20)
Primary Cooperative Agriculture and
Rural Development Banks(697)
Source Reserve Bank of India
Available data indicate that the cooperatives, commercial banks, and other
formal financial sector programmes in rural areas have not displaced informal sources
of credit altogether as 43 per cent of rural households continue to rely on informal
finance in 2002, when the last All India Debt and Investment Survey was undertaken
The RBI-constituted Nachiket Mor Committee for financial inclusion first mooted
the idea of having differentiated banks in the country. The panel's suggestions include
specialised payment banks, retail banks, wholesale banks, infrastructure banks etc
Page 4 of 16
The committee came up with two broad designs for the banking system in the
country — the Horizontally Differentiated Banking System (HDBS) and the Vertically
Differentiated Banking System (VDBS) based on the functional building blocks of
payments, deposits and credit.
In HDBS design while all configurations are deposit-taking, the variations
between them are on account of
 the ways in which they originate risks and transmit them throughout the
system; and
 their size and focus — whether regional or sectoral.
The HDBS has six design categories — national bank with branches; national
bank with agents; regional bank; national — consumer bank; national-wholesale bank;
and national- infrastructure bank.
The rational for VDBS is usually linked to niche capabilities such as credit underwriting for specialised business segments or network management in the case of
payments.
On one hand, the horizontal component is introduced to make explicit branching
decisions across different geographical markets. It is done by considering that banks
compete spatially through the opening of branches in several geographical markets.
On the other hand, vertical differentiation is considered to cope with the
heterogeneity of bank types. It is introduced by allowing consumers’ preferences to
depend on the type of the banking institution they are dealing with by considering that
the relevant interest rate for customers’ decisions is the sum of the explicit interest rate
and the implicit interest rate. These two types of product differentiation can be related in
an easy way to deregulation. The differentiation could be a result of deregulation and/or
of strategies adopted for facing the new environment that deregulation carried out.
By applying the fact that differentiating the product is one way to escape from
competitive pressures (concept well known in the industrial organization theory) to the
banking industry, we can see that product differentiation would allow banks to gain
higher prices for their services.
There has been a long standing debate on whether large banks with their
financial strength and resources and ability for greater reach are better vehicles for
Page 5 of 16
financial inclusion than the small banks with limitations in these aspects but having
‘local feel’ and cultural synergy with the local population.
Most big banks are urban-centric. Their DNA is to cater to large borrowers and
large savers. It results in more visible profit with lesser manpower and infrastructure.
Their reach can go up to small towns or large villages in the threshold of graduating to
small towns.
Country‐level studies show that small, regional and local banks may perform very
differently from large banks. Greater access to local information, greater commitment to
local prosperity, differences in costs and risk management, and competition policy could
explain the specific influence of such type of banks on local economic development.
Small banks play a very important role in the supply of credit to small business
units, small farmers and other unorganized sector entities. They need only a small
capital base, less infrastructure, staff and low operational expenses and can improve
penetration of banking sector to unbanked areas and mobilize resources. They may
develop core competence through relationship banking in financing agriculture, SMEs
industries, in a particular geographical area, and, thereby, able to serve their credit
needs better. They would be able to explore business potential more tailored to the
socio economic background in the area of operation and extend banking services to the
people in that area.
While small banks have the potential for financial inclusion, performance of the
small banks in India (LABs, RRBs and UCBs) has been unsatisfactory. There are
fundamental weaknesses inherent in the business model of small banks, such as,
narrow capital base, restrictive geographical jurisdiction, lack of diversification in source
of funds and the concentration risk. They lack economies of scale and scope, cannot
finance big investments like infrastructure, vulnerable to shocks from the local economy
and hence require higher level of capital to risk weighted assets ratio (CRAR) etc
The United States has got a banking structure comprising both big banking
institutions, hand in hand, with small community banks focusing on specific
geographical areas. Small community banks form a very important segment of the US
banking system, though they account for a very small share of the total banking assets
of the country. These banks are closely tied to the local communities and focus on
Page 6 of 16
mainly ‘relationship banking’. The Office of the Controller of the Currency (OCC), an
independent bureau within the United States Department of the Treasury established by
the National Currency Act of1863, inter alia, serves to charter not only national banks
but also special purpose or narrow focus banks such as credit card banks, trust banks,
community development banks, cash management banks and banker’s bank
In Singapore, there are five types of bank licences — full bank, qualifying full
bank (QFB), wholesale bank (WB), offshore bank, and representative bank. A full bank
conducts a whole range of banking business for retail and corporate clients, but foreign
banks in Singapore are restricted when it comes to branch expansion and expansion of
ATMs.
The QFB is for foreign banks in Singapore where it allows them to have
additional branches or off-premise ATMs and share ATMs amongst themselves.
Wholesale banking licence, permits a bank to only have one place of business in
Singapore and cannot operate savings accounts and Singapore-dollar fixed deposits of
less than $250,000.
The offshore bank licence allows banks to operate mainly in the Asian dollar
market, foreign exchange and wholesale banking with non-residents. The offshore bank
shall not operate savings accounts or accept fixed deposits denominated in Singapore
dollars. Finally, the representative office licence prevents banks from conducting regular
banking operations, but promotes business and correspondent banking business
between their home offices and the region.
Hong Kong has a three-tier banking system based on licensed, restricted licence,
and deposit taking companies. Licensed banks may operate current and savings
accounts, and accept deposits of any size and maturity from the public and pay or
collect cheques drawn by or paid in by customers while restricted licence banks are
principally engaged in merchant banking and capital market activities
. Restricted licence banks may only take deposits of any maturity of HKD
500,000 and above. Deposit-taking companies are mostly owned by, or otherwise
associated with, banks. These companies engage in a range of specialised activities,
including consumer finance and securities business. They may take deposits of HKD
100,000 or above with an original term of maturity of at least three months.
Page 7 of 16
In Indonesia, the banking system is multifarious, with simultaneous existence of
commercial banks in big cities, branches of provincial banks in small towns, the Unit
Desa (village banks) of Bank Rakyat Indonesia (BRI), the local small banks, cooperative
banks and private rural banks.
In January 2013, Indonesia migrated to multiple licensing policy from the single
license policy. Under the new plan, licenses will be issued based on the “capital
condition” of banks, and only those institutions with hearty capital reserves will be
eligible for the multiple licenses permitting multiple activities. To promote capital
strengthening in the banking sector, banks will be categorized according to the amount
of their core capital.
Some of the advantages of a differentiated licensing regime are:
 There are diverse opportunities in the banking and financial landscape
reflecting significant macro-economic growth potential in India and
differentiated licensing could enable unlocking potential of these
opportunities
as
it
encourages
niche
banking
by
facilitating
specialisation thereby reducing potential non-optimal use of resources.
 Very large ticket, long term infrastructure lending requires risk
management expertise that goes beyond traditional credit appraisals at
banks. There is significant space for specialized entities in risk
assessment and structuring of infrastructure finance.
 Very
low
ticket
unsecured
credit
requires
risk
management
methodology and cost control that is not easy in business model of
conventional banks.
 Gaps in SME finance can be filled with asset based lending, operating
leases, and factoring.
 Issues of conflict of interest when a bank performs multiple functions
would not arise, where differentiated licences are issued.
 Risk management systems and structure for regulatory compliance
could be customised according to the banking type.
Page 8 of 16
 Customised application of supervisory resources according to the
banking type could result in greater optimisation of such scarce
resources.
 Core competency could be better harnessed leading to enhanced
productivity in terms of reduced intermediation cost, better price
discovery and improved allocative efficiency.
Some of the disadvantages could be
 Given the extent of financial exclusion in India, such a regime would be
a path away from carrying banking to masses particularly if large
number of banks were to opt for this.
 Priority sector lending could be impacted as specialised institutions
may not have to meet the extant targets for such lending, which is
otherwise applicable to all commercial banks.
 Many niche-banking models typically depend on inter-bank liquidity,
and whole sale funding which is a potential source of risk and
vulnerability in a crunch situation.
 Unlike specialised banks, banks engaging in various kinds of activities
will find it easier to cross subsidise across various sectors and
optimum
utilization of
resources
and
therefore
ensure
better
profitability of banks.
 Specialized banks may be prone to high concentration risk as their
business would be focused on a particular area.
A high proportion of socially and economically underprivileged sections of society
in India are concentrated in the informal economic activities. This sector holds
importance due to growing inter-linkages between informal and formal economic
activities.
Fostering a speedy and inclusive growth warrants special attention to informal
economy as well. Sustaining high levels of growth is, therefore, also intertwined with
demand of those engaged in informal economy, and addressing the needs of the sector
in terms of credit, skills, technology, marketing and infrastructure.
Page 9 of 16
Currently, the wholesale banking space in India is occupied mostly by foreign
banks and the new generation private sector banks. According to Mckinsey (2011),
wholesale banking revenues, which in India account for close to 30 percent of total
banking revenues, are expected to more than double, from roughly $16 billion in fiscal
2010 to $35 to $40 billion by 2015.
It is widely recognized that banks providing services to retail customers have
different skill sets and risk profiles as compared to banks which deal with some specific
clientele like large corporate clients, infrastructure firms, etc.
For a wholesale bank dealing with corporate clients only, it becomes a costly
adjunct to maintain a limited retail banking presence. Moreover it becomes difficult for
such a bank to meet the obligations for doing inclusive banking.
The Nachiket Mor panel points out the present status of the banking reach.
 Estimates suggest close to 90% of small businesses have no links with
formal financial institutions
 About 60% of the rural and urban population do not even have a
functional bank account
 Bank-credit to GDP ratio in the country, as a whole, is a modest 70%
 In Bihar, bank-credit to GDP ratio is even lower, at 16%
 Savings as a proportion to GDP has fallen from 36.8% in 2007-08 to
30.8% in 2011-12
 Financial savings of households have declined from 11.6% of GDP in
2007-’08 to 8% in 2011-’12
 Against only 30 million fixed line subscribers, telecommunications
companies, now, have over 870 million mobile phone subscribers, of
whom over 350 million are based in rural areas
 While the urban number of mobile subscribers stabilised, rural number
continues to grow at an annualised rate of 10 percent.
From a historical perspective, the move towards universal banking has been on
account of perceived economies of scale and scope leading to increased economic
efficiency even though the evidence on the importance and significance of economies of
scale and scope has been mixed. Their emergence therefore also has partly been on
Page 10 of 16
account of regulatory considerations which liberalised the range of activities for banks
based on a broad consensus that banks which offered a full range of finance services
would be able to provide the largest economic benefits in a rapidly growing economy.
Diversification of business lines, innovations in risk management, and market
base pricing of risks were seen as effective counters to the risks associated with the
rapid expansion of large universal banks.
Universal banking may suffer conflict of interest between commercial and
investment banking operations and by combining depository institution activity with
other types of financial services, they may open new channels of contagion thereby
increasing systemic risk. The universal banks may derive power to suppress competing
institutions and market and thereby reduce the benefits of competition.
Currently, India has a universal banking system wherein lenders serve all the
needs. The Committee, while laying down its vision statement for financial inclusion and
deepening, has suggested providing a universal bank account to all Indians above the
age of eighteen years and has recommended a Vertically Differentiated Banking
System with Payments Banks for Deposits & Payments and Wholesale Banks for credit
outreach with relaxed entry point norms of Rs 50 crore.
First Tier
International
Banks
Second Tier
National
Banks
Indicative Re-orientation of Banking Structure in India
i) Three or four very
• Possible mergers of Associate Banks with
large banks
SBI.
• Voluntary merger of a few large Public
ii) Foreign Banks in
Sector Banks having significant overseas
India
presence.
• Organic and in-organic growth of one or two
large Private Sector Banks.
Note: These will lead to formation of large
banks. The issue of competition among them
in particular and in the banking system in
general will have to be kept in view.
• Branches of Foreign Banks in India.
i) Public Sector Banks
• Voluntary merger of banks both in the Public
ii) New Private Sector
and Private Sector.
Banks
• To encourage foreign banks to have
iii) Subsidiaries of
subsidiary mode of presence in India.
Foreign Banks
• To grant differentiated licences for
incorporated in India
specialized banks.
iv) Specialized banks
Page 11 of 16
Third Tier
Regional
Banks
i) Old Private Sector
Banks
ii) Regional Rural Banks
iii) Multi-State Urban
Cooperative Banks
• To carry forward the process of
consolidation of the Regional Rural Banks.
• Conversion of a few well managed,
financially sound Multi-State Urban
Cooperative Banks into commercial banks
Fourth Tier
Local Banks
i) Local Area
Banks/small banks
ii) Single-State Urban
Cooperative Banks
State Cooperative
Banks
iii) District Central
Cooperative Banks
• Well managed and financially sound UCBs
would have opportunities to convert into
commercial banks
• Well managed and financially sound
LABs/small banks would have opportunities
to expand their area of operations.
• Rural cooperatives to be made financially
sound to serve the local needs.
Source Reserve Bank of India
The most controversial part of the Nachiket Mor is its suggestion that each Indian
above the age of 18 years must have a full-service, safe and secure electronic bank
account by January 2016. Aadhaar Card issued under the UDAI scheme should be
sufficient to open his account. And, he should reach his banking centre within 15
minutes of walk. Those, who know India’s rural hinterland, easily realize how gigantic
this task is as we have not yet been able to issue voter identity cards to our citizens in
spite of our efforts in the last 21 years.
According to Rajan and Zingales (1998), it is the financial system’s overall level
of development that matters for growth rather than the nature of financial structure.
So far we have been talking of financial inclusion. But have we really walked the
talk? Let us look at some live examples
If we look at the NPA of the banks we can see that the main culprits are the Big
Corporates while the SMEs simply starve for want of capital. Similarly we can see that
the rich benefit with their loans waived while the poor are not been able to even start a
banking account
It is known fact that rich is able to get loans faster than the poor who needs them
the most. It is easier to get a loan for 20 Lakhs from any national bank as educational
loan for studies abroad while it is very difficult to get
Page 12 of 16
a loan of Rs 50000 or I Lakh for
the poor student for his graduation studies. It is much easier to get a housing loan of 1
crore but very difficult to get a loan of Rs 5 Lakhs
For banking services through internet is almost free within the same bank and in
some cases with all banks. RTGS with a minimum of Rs 2 Lakhs, one need to pay Rs
25 to 50 as service charges which can be done comfortably in from ones lap tap. But a
poor person who wants to send Rs 500 today to his family in Bihar or Orissa from
Chennai has to spend more than Rs 50/For paying Rs 100/- as fees for getting identity card a student have to pay Rs
30/- as commission for Bank Draft or Pay order in the Indian Bank just outside the
Alagappa university.
Loss occurs when Loans are not paid. The basic problem is that loans are
waived off for political reasons. This has to be stopped.
Accountability has to be
established at all levels
The All India Bank Employees Association (AIBEA) has released the details of
406 bad loan accounts with public sector banks. These 406 loans account for nonperforming assets (NPAs) worth Rs 70,300 crore.
“The total NPA in public-sector banks till September, 2013, was Rs 2.36 Lakh
crore. The bad loans restructured and shown as good loans amount to another Rs 3.25
Lakh crore. The NPAs registered by all public sector banks in March 2008 was Rs
39,000 crore. The bad loans constituted by the top four defaulters in public sector banks
is around Rs 23,000 crore and the bad loans in top-30 bad loan accounts in 24 banks is
Rs 70,300 crore. Fresh bad loans in public sector banks in the last seven years are Rs
4.95 Lakh crore.
According to AIBEA, bad loans written off in the past 13 years come to the tune
of Rs 2.04 Lakh crore. Profits transferred and adjusted for provisions toward bad loans
from 2008 to 2013 was Rs 1.40 Lakh crore. The bad loans in 172 corporate accounts of
Rs 100 crore or above was Rs 37,000 crore, it added.
Political as well as corporate nexus seems to be the reason behind the increase
in NPAs. We have wonderful ideas but when it comes to implementation we falter. The
Know your Customer (KYC) of the banks have become “Knock out your customer”
when it is applied to the poor.
Page 13 of 16
But all said and done banking on the poor is a viable option in India as there are
huge mass at the bottom of the pyramid. There are enormous unmet potential lying in
the rural areas for financial institutions. If financial institutions could successfully tap this
potential there would be a win-win‟ situation for institutions and people.
********************
Page 14 of 16
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