1. Impact of financial liberalization on
rural banking
Mehak Malik
Hans Raj College

3. What is Financial Liberalization?
• Reduction of any sort of regulations on the
financial industry of a given country.
• Broadly defined: Financial system is the
lending system.
• Financial Liberalization means lessening
restrictions on various type of lending
institutions and instruments.

4. 1969-1975: The Era Of Social and
Development Banking
• Nationalization of India’s 14 major commercial
banks.
• This phase coincided with GREEN
REVOLUTION.
• Objective: To gain access to new
liquidity, particularly among rich farmers in
the countryside.

5. 1969-1975: The Era Of Social and
Development Banking
OBJECTIVES OF SOCIAL BANKING:
To provide banking services in previously
unbanked or under-banked rural areas.
Provide substantial credit to specific
activities, including agriculture and cottage
industries.
To provide credit to certain disadvantaged
groups such as Dalit and Scheduled Tribe
Households.

6. 1969-1975: The Era Of Social and
Development Banking
IMPACT OF SOCIAL BANKING:
 Entailed a radical shift from prevalent practice in
the objective and functioning of commercial
banks.
 Prior to 1969, countryside was not considered
the problem of commercial banks.
 Multi-institutional approach to credit provision in
the countryside became policy.
 Commercial Banks, Regional Rural Banks and
cooperative institutions established wide
geographical and functional reach.

7. Regional Rural Banks
• Created on the recommendations by a
working group on commercial credit, called
‘Narsimham Committee’ in 1975.
• Intended to “combine the cooperatives’ local
feel and familiarity with the business acumen
of commercial banks”.
• Targets were set on expansion of rural
branches.

8. Priority Sector Lending
• Social banking was also marked with setting up of
guidelines for the sectoral allocation of credit.
• A target of 40 per cent of advances for the
“priority sectors,” namely agriculture and allied
activities, and small-scale and cottage industries
was set for commercial banks.
• Advances to the countryside increased
substantially, although biased in respect of
regions and classes.

9. Second Phase: Late 1970s-1991
• Self employment generation by means of
loans-cum-subsidy schemes were used as an
employment strategy targeted at the rural
poor.
• Period of ‘directed credit’, during which credit
was directed towards ‘the weaker sections’.
• New Scheme: Integrated Rural Development
Program (IRDP)

10. IRDP: Integrated Rural Development
Program
• Started in 1978-79 as a pilot project.
• Objective: Creation of productive income-bearing
assets among the poor through allocation of
subsidized credit.
• Lead to significant transfer of funds to the rural
poor, however, failed to create long-term income-
bearing assets in the hands of rural poor.
• Reasons for failure include misidentification of
beneficiaries, small loan size leading to purchase
of low quality assets, etc.

11. Second Phase: Late 1970s-1991
• Expansion and consolidation of the
institutional infrastructure of rural banking
• Unprecedented growth of commercial banking
in terms of both geographical spread and
functional reach.

12. Liberalization: Post-1991 Period
Policy objectives of this phase:
 Setting up a vibrant and competitive financial system to
sustain the ongoing reforms in the real economy’s
structural aspects.
 Redistributive objectives to be fulfilled via fiscal
instruments rather than credit system instruments.
 Interest rates to be deregulated.
 Capital adequacy norms to be changed (to compete with
banks globally)
 Branch licensing policy to be revoked.
 Creation of new institutional structure that is “market
driven and based on profitability”.

13. Record of Progress of Rural Banking
• Contraction in rural banking in general and in
priority sector lending and preferential lending
in particular.
Growth of Scheduled Commercial
Banks in Rural Areas
80
60
Share of rural
40 bank offices in
20 total bank
0 offices
1967 1972 1990 1998

14. Deposit Mobilisation in Rural Areas
18
16
14
12
10
Rural Deposits as a
8 proportion of Total
6 Deposits
4
2
0
1972 1980 1990 Post 1991

15. Credit Starvation
• Shortage of credit for all purposes, including
productive investment in agricultural and non-
agricultural activity.
Priority Sector Lending
50
40
30 Share of
20 priority sector
10 in total credit
0 outstanding

16. Declining share of formal debt

17. Declining share of formal debt

18. Reversal of Policy Objectives
• Extending the reach of rural credit.
• Providing cheap and timely credit to rural
households.
• Overcoming historical problems of imperfect
and fragmented rural credit markets
• Displacing the informal sector from its
powerful position in rural credit.

19. Miracle Cure: Micro Finance and Self
Help Groups
• The Task Force on Supportive and Regulatory
Framework for Micro-Finance in India defined
micro-finance as:
“ The provision of thrift, credit
and other financial services and
products of very small amounts
to the poor in rural, semi-urban
and urban areas enabling them
to raise their income levels
and improve living standards.”

20. Miracle Cure: Micro Finance and Self
Help Groups
Features of Micro-Credit:
 Very small loans
 No collateral
 Borrowers from among the rural and urban poor
 Loans for income generation through market-based
self-employment
 Formation of borrower groups (group lending), and
 Privatization over disbursement and the determination
of the terms and conditions attached to each loan.
(through the mechanism of NGO control)

21. Miracle Cure: Micro Finance and Self
Help Groups
Heralded as ONLY major policy instrument to
fill the gap left by the formal sector.
Were viewed to rectify the two major
weaknesses of the banking system:
 Transaction Costs
 Better performance in respect of recovery of
loans.

22. Was there a miracle?
• Administrative costs of NGOs were high and
relatively higher than those of commercial banks.
(Ramachandran and Swaminathan,2002)
• NGOs cannot match the economies of scale of a
comprehensive system of banking.
• Moreover, the costs of administration of
controlled micro-credit have actually risen when
NGO activity is scaled up.
8.6% of liabilities in 1988 to 18.1% in 1992.

23. Limitations: Micro Finance and Self
Help Groups
• A system based on quick repayment of very
small loans does not allow for funds to go into
income-bearing activities that have a
significant gestation period.
• High interest rates (24 to 36%)
• High repayments dependent on high
transaction costs.
• Exclusion of the poorest and perpetuation of
existing class hierarchies by groups.

24. Limitations: Micro Finance and Self
Help Groups
• Though scale of bank finance through SHGs
has expanded rapidly; from less than 10,000 in
1996-97 to 10 lakhs in 2004; not as
widespread as it is in Bangladesh.
• ANDHRA PRADESH:
o Had more than 50% of the SHGs in the
country by 2002.
o Only 0.6% of total bank credit was chanelled
to SHGs.

25. What banks can offer?
• Advantages of scale
• Reach
• Specialized training to their employees in
development banking.
• Better placed to coordinate with development
administrations, local governments and SHGs.
• Wide range of financial services.

26. Way Ahead
• Revisiting the policy of Social and development
banking ?
• Restoring geographical and functional reach of
public sector banking.
• Reinstating differential interest rate policies
• Reintroduction of special loans-cum-subsidy
schemes.
• Reinforcing priority sector norms and instead of
alternatives such as investment in RIDF
bonds, penalties must be imposed on any failure
of banks to meet these public interest targets.