Goodbye Financial Inclusion, Hello Financial Identity

For those who did not know (but want to) the term ‘financial inclusion’ was coined by former Reserve Bank of India (RBI) governor YV Reddy in 2005. It was over a chance conversation with him a few months ago that I discovered RBI’s original description for this effort was actually ‘financial exclusion’.

In a masterstroke of sorts, Reddy changed the phrase from ‘exclusion’ to ‘inclusion’. And it has stuck since. Seven years on, with some water under the bridge but much more to flow, I wonder if it's a good time to revisit and relook at the term financial inclusion. And whether we could achieve much more by christening it ‘financial identity’.

Before I come to that, what’s happened so far? Since 2005, a host of initiatives have been launched by the Government and the RBI to 'include' more citizens into the financial system, particularly in rural India. The most recent being the Swabhiman initiative in 2011 which set banks a mandatory target of connecting 74,000 villages (with a population of over 2,000) by March 2012.

There is a reason for this and similar efforts globally. World Bank studies (among others) demonstrate clear linkages between improved financial access and higher income levels in countries, through bank branches and deposit accounts. Moreover, these very accounts provide stability within and to the banking system, particularly against crises.

But success has been limited. Total number of villages banked in India is around 107,000 as of June 2011, up from 54,258 as on March 2010. And Swabhiman has taken banking to some 42,079 villages (last available data). Note that the definition of banking is not confined to branches and extends to ‘business correspondents’ and mobile vans.

On the other hand, more than 480,000 villages are still unbanked. In contrast, the China Banking Regulatory Commission said last week (almost with some trepidation) that banking services were still absent in 1,696 remote townships in end-2011. China has around 1 million villages, compared to India’s 600,000.

Its entirely possible that China’s numbers do not quite add up or will invite scepticism. An Asian Development Bank study of October 2007, for instance, says only 36% of Chinese rural households had access to financial services. So the definitions of access to banking services, savings accounts and credit might vary. Or things are really moving fast on ground there.

But that’s besides the point. India faces a twin problem. First, of course is not enough bank accounts opened. Second, even for accounts opened (79 million ‘no-frill’ till mid-2011 with outstanding balances of Rs 5,944 crore) less than 20% are actually used.

You can also do the math to see that there is little money actually sitting in the accounts that are opened. Moreover, the ability to lead a ‘cashless’ existence is limited because there are fewer linkages at the bottom of the pyramid.

Incidentally, there are around 500 million bank accounts in India (that figure is a wildly moving target) presumably attached to around 250 to 300 million individuals. The figure extrapolates from several RBI statements which speak of half the country being banked.

The banking system is wary about inclusion efforts. It feels the investment in account creation at such scale does not pay back. Particularly when the volumes of money moving even in those active accounts is small. Even technology (databases) cost money, banks and insurance companies have told me repeatedly.

Things are changing though. Financial literacy, a pre-condition for inclusion is growing. Intra-country remittances between urban and rural areas are touching new highs. Some estimates put them at hundreds of crores a day now. And the debit card population continues to grow, crossing 200 million now, from a tenth of that a decade ago.

Now, why does financial identity make sense today? For two reasons. First, it makes clear to all concerned that a financial identity is a critical component of an individual’s existence. Remember that a savings bank account is often a proxy or proof of a real identity – “I exist because I have a bank account”.

Second, this identity link will get accentuated as financial transactions form one of the biggest interaction points between the state and citizen. For example, subsidies and benefits will increasingly get converted into cash or cash transfers and delivered through bank accounts.

States like Maharashtra have saved hundreds of crores (since last year) by insisting on transferring student scholarships to bank accounts as opposed to handing out cash. Yes, the money got saved because most of the earlier recipients were ghosts and never existed.

More importantly, a concept of financial identity pushes banks and insurance companies, among others, to create products and services that link to that identity. And of course think differently about the opportunity. Picure a bank or insurance firm setting financial identity targets as opposed to financial inclusion ones.

On the other side, think of a poor farmer or migratory construction worker who could access and then hitch a micro-insurance, micro-pension or even a provident fund account to his or her financial identity, ie a bank account. To be fair, the same could be done even if there was no concept of financial identity. But the opportunity and the incentive to build the `merged ecosystem' may be less. Most of us who have access to the banking system but are saddled with multiple financial identities are also potential beneficiaries, in some sense.

On a related note, the Government itself is exploring bank account number portability, similar to mobile phones. So, I can take the same account I opened to whichever bank I want, presumably wherever. It reinforces the concept of a permanent financial identity.

Creating the linkages themselves is not difficult. Banks already do it within their system, offering a single view of savings, loans and depository accounts. This is despite, in some cases, reporting to multiple regulatory authorites. So you can’t transact your stockbroking account from your banking account but you can sure ‘see’ it.

Now let me be candid and admit that a nomenclature change is not going to cause some magical transformation. There is still the effort of opening physical accounts and the nightmarish efforts involved in the Know Your Customer (KYC) process.

But the Government is making it easier to do so by allowing first, the creation of no-frill accounts and then asking banks to accept National Rural Employment Guarantee Act (NREGA) job cards, Kisan Credit Cards & Aadhaars as proof of identity.

Hundreds of millions of citizens will benefit if they had a financial identity or a single bank account to which they could attach a host of lifelong services. And accelerate the move to a more cashless economy, which has benefits of its own.

Dr Reddy’s move to look at the problem of the unbanked as an opportunity for inclusion as opposed to the challenge of exclusion triggered a fundamental shift in approach. Inclusion to identity seems like logical progression. What would Dr Reddy think of this move ? I’m not sure. But sure intend to ask the next time I run into him.