RBI Governor Raghuram Rajan made an important observation about the limits to which financial inclusion can be “pushed”. Speaking at an IMF event in Lima on October 8, Rajan talked about how, beyond a point, financial inclusion, especially one led by a drive to make easy credit available for the poor and hitherto unbanked, can actually have a negative impact on the financial stability of the whole system. Rajan’s cautionary words come at time when India is seeing a massive campaign for financial inclusion in the form of the Jan Dhan Yojana, under which over 18.5 crore new bank accounts have been opened in the past one year. Each of these accounts comes with an overdraft facility of Rs 5,000 once the account remains active for six months. Although not speaking specifically about India, Rajan said “…my sense is that, beyond a certain point, push becomes actually negative because you bring in people who aren’t able to absorb credit.” This ties in with Rajan’s analysis of what went wrong during the subprime crisis in US, which eventually led to a full-blown global financial crisis in 2008. The flip side of pushing financial inclusion is the supervisory capacity of the banks and lending institutions. There is evidence already that because of relaxed KYC norms, there is considerable duplication in the newly granted bank accounts.
The extensive research on financial inclusion is clear about two things. One, it is an effective tool for raising economic growth and reducing inequality. It is for this reason that it figures prominently in the post-2015 goals set by the United Nations. Two, research also points to how too much push can hurt financial stability. The crisis in India’s microfinance sector around 2010 was a direct result of lax supervision and excessive lending to people who had no ability to invest the loans productively and repay.
At one level, banks can be blamed for perversely competing with each other to loan out big sums to people who cannot repay. But the larger problem, as Rajan pointed out in his book Faultlines, is the political economy of credit-led financial inclusion. Policymakers use cheap credit as a way to enhance the short-term consumption of voters, while ignoring investment in the real economy. Is something similar happening now in India? Rajan did not venture into any specifics. But it is clear that the government’s efforts towards financial inclusion will not work in the long term unless there is adequate investment in the real sectors of the economy.