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Formal employment remains key to financial inclusion

Salaried professionals have easier access to credit as it is simpler for them to fulfil conditions.

August 25, 2014 12:12:39 am

By Vidya Mahambare & Dipti Saletore

Financial inclusion is a key policy initiative for the government and the Reserve Bank of India. Recently the finance minister is his Budget speech announced a launch of a programme on 15th August this year that will provide all households with banking services. Under the programme at least two bank accounts per household which are eligible for availing credit will be opened.

While this is a welcome step, we believe the biggest boost to financial inclusion will come from a push to higher employment in the formal sector, especially regular, salaried employment. We explore here the reasons behind this inference.

Household debt from commercial banks was nearly Rs 12 trillion as of end-March, 2014, including housing and educational loans. Most of it was accumulated in the last decade and nearly half was taken to buy houses.

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On the face of it, this number appears big, but it is equal to just around 3 per cent of household consumption in the last 10 years. And, if we exclude housing loans since home purchases are not accounted in household consumption, only 1.6 per cent of household spending relied on borrowings from commercial banks.

Clearly, the formal banking system has hardly penetrated Indian homes. Not surprisingly, there is far greater reliance on non-banks and informal sources for loans, which are more expensive and often exploitative.

Diced by states, data show there are significant variations in household debt from formal banking channels, which begs the question, what policies will raise access across the country?


We analysed household debt from the banking system on two parameters: debt per household, which measures debt in absolute terms, and debt as a share of state gross domestic product, which indicates debt as a proportion of income, and which by proxy shows ability to repay loans.

Irrespective of the gauge used, the top four states in terms of household debt burden are Kerala, Karnataka, Tamil Nadu and Maharashtra (per latest data available, which is for fiscal 2010). Haryana ranks fifth on absolute level of debt per household, but in terms of the debt to income ratio, Andhra Pradesh takes that slot.

The top three states have an average debt to income ratio of over 15 per cent, or three times the levels of Bihar, Chhattisgarh and UP.  The average household in Kerala had Rs 45,000 debt in fiscal 2010 – with 55 per cent of it spent on buying homes and 10-12 per cent for vehicle purchases and education. Kerala’s debt to GSDP ratio stood at around 17 per cent. States with a relatively high household debt to GSDP ratio — Maharashtra, Andhra Pradesh, Karnataka, Kerala, Haryana and TN — had per-person income higher than the all-India average. Clearly, increase in household debt levels go hand in hand with higher income. Three stark exceptions among the prosperous states however, were Gujarat, Punjab and Haryana. In Gujarat, household debt as a share of GSDP is one of the lowest among major states, whereas for Punjab, it actually fell in fiscal 2010 compared with 2005.


Why have household borrowings from commercial banks not picked up in Punjab, Gujarat and Haryana in line with rising incomes, and as much as in other prosperous states?

One pointer is the lower proportion of salaried workforce compared with states with a similar level of per-capita income. For example, only around 3-4 lakh people in Gujarat, Punjab and Haryana are employed in IT/ITeS and financial services compared with around 11-12 lakh in Tamil Nadu and Karnataka, and nearly 18 lakh in Maharashtra. In Haryana, despite high per-person income the salaried workforce (Gurgaon, IT/ITeS hub) is low and only likely to have increased after fiscal 2010, the latest year for which household debt data is available.

Salaried professionals have relatively easier access to credit from formal financial institutions  because it’s easier for them to fulfil the conditions and paperwork needed by commercial banks for grant of a loan.

In the case of Gujarat, lower access to formal credit is also partly reflected in its lower financial inclusion score despite higher prosperity levels. In the CRISIL Inclusix score (the CRISIL Inclusix report, January 2014) Gujarat ranks 9th among 16 major states, preceding UP, Rajasthan, MP and West Bengal.

Among the relatively less prosperous states the household debt burden varies. In Orissa, debt to GSDP ratio more than doubled between fiscals 2005 and 2010, and the absolute level of debt per household rose 4 times. In contrast, UP and Bihar saw relatively mild increases in debt per household and a fall in the leverage ratio as bank credit to households lagged behind income growth. None of these states have seen a significant rise in salaried employment that boosts access to credit from  formal banking system.


This suggests the nature of employment — salaried or self-employed — matters a lot in access to formal credit. But then why is it that household debt is high in Kerala, which is not known for high salaried employment? A possibility is that the size of down payment, say on a home loan, will be higher due to high remittance income.

So how can household access to finance be improved?

A push to salaried employment will be critical to further and sustain financial inclusion. The current focus on labour-intensive manufacturing growth, which will create more salaried jobs, will have an unintended welfare implication — raising household access to formal financial institutions. This will give them ability to smoothen consumption over a lifetime by borrowing at a young age when income is inadequate to meet expenditure.


— The authors are respectively, Principal Economist and Senior Economist, CRSIL

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First published on: 25-08-2014 at 12:12:39 am
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