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Formal Financial Outreach in Rural India
The conventional wisdom is that opening up new branches is the best way to extend outreach of the formal financial sector to rural areas. Using a survey data set, this paper challenges the conventional view by concluding that relatively resource-rich rural households from distant locations availed multiple loans from formal lenders rather than the households located closer to them as often believed.
The author expresses his indebtedness to Samar K Datta and Arnab K Laha for their valuable suggestions leading to the enrichment of this paper.
He acknowledges the doctoral fellowship and dissertation support grant extended by the Indian Institute of Management, Ahmedabad (IIMA) to him. He is also grateful to Samar K Datta for making available the data set used by the study. The author has also benefited from the comments and suggestions of the participants of the India Finance Conference 2019 (jointly with IIMA) in Ahmedabad.
To date, the focus of the literature on financial development has been on two strands. The first strand of inquiry revolves around identifying the determinants of access to financial services from formal institutions. The second strand of empirical investigation evaluates the impact of access to the formal financial sector. Formal financial institutions include both public and private commercial banks, regional rural banks,1 village cooperatives, and their higher tier bodies. However, it is increasingly being accepted by policymakers that access to financial services differs significantly from the outreach of financial services. An economic agent with access to financial sources may not fully utilise these sources due to the high transaction cost involved in doing so (Sriram 2007). While access is defined as the likelihood of receiving the financial service of one’s choice, outreach indicates the extent of usage of the financial service by a household (Beck et al 2007).
Outreach was traditionally measured by the ratio of private sector credit to the gross domestic product (GDP). In contrast, Beck et al (2007) proposed additional measures of outreach that include per capita loan accounts and per capita deposit accounts. They surveyed regulatory bodies spread over 99 countries to present country-wise indicators of financial outreach. In another study, Beck et al (2008) consolidated the country-wise barriers to financial sector outreach. Barriers across 62 countries were captured under three broad categories, namely physical access, affordability, and eligibility. Physical access represents locations of branches; affordability includes the minimum balance required to open a savings account or the minimum amount of loan extended by the formal lender and processing fees paid to avail a financial product; and eligibility exhibits the number of documents one needs to submit along with the application. They found that government-owned as well as small-sized banks imposed a higher barrier on customers and limited the outreach of the formal financial sector. Beck et al (2007, 2008) argued that these macro indicators closely reflect harder-to-collect household micro-level data on formal financial sector outreach. Noted exception includes Brewer et al (2014) who explored the choice between single and multiple lenders among the Kansas farms and found that risky farms are more likely to carry banking relationship with multiple lenders to avail loan at the lowest possible cost.
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