How much do rural bank branches cost the financial sector?

For every loan of Rs, 10,000 made through a Public Sector Bank rural branch, it costs them about Rs. 4150. The same number for a Private Sector Bank rural branch is about Rs. 3210. Little wonder then that rural branch expansion meets with so much resistance.

In a new working paper, my colleagues Deepti George and Anand Sahasranaman develop a framework to compare costs of rural credit delivery across five dominant channels: PSB lending through its rural branch, PSB lending through a Self-Help Group (SHG), PSB lending through a Micro Finance Institution, Private Bank lending through its branch and Private Bank lending through a Micro Finance Institution. Importantly, they look at costs comprehensively including a) cost of debt b) cost of equity c) transaction costs and d) loan loss provisions.

The magnitude and spread of these numbers is quite stunning.  Channel-wise costs and losses (assuming lending at 12%) look as follows:

Why does any of this matter? From a policy perspective, if the outcome of rural credit expansion is deemed important, shouldn’t these just be viewed as welfare increasing costs just like other subsidies?

What is important to note here is that the same Rs. 10,000 loan to the rural customer has very different costs of delivery across various channels. By prescribing that bank branches ought to be the dominant delivery channel, the financial sector gets saddled with steeply higher costs without any proportionate welfare gain. As the authors note, flexibility to the bank in choosing the lowest cost channel has the potential to achieve the outcome of rural credit delivery with far lower costs. After all, shouldn’t policy making be more about outcomes and less about instrumentality?