A PROJECT ON RURAL

BANKING

Submitted By: Ravi Pal

Centre Code: 02971
Reg No: 510917520

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 RURAL BANKING

INTRODUCTION:
Rural banking in India started since the
establishment of banking sector in India. Rural
Banks in those days mainly focused upon the agro
sector. Today, commercial banks and Regional rural
banks in India are penetrating every corner of the
country are extending a helping hand in the growth
process of the rural sector in the country.

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BANKS: FUNCTIONING FOR THE
DEVELOPMENT OF RURAL AREAS.

The area of operation of a majority of the RRBs is

limited to a notified area comprising a few districts
in a State.SBI have 30 Regional Rural Banks in India
known as RRBs. The rural banks of SBI are spread
in 13 states extending from Kashmir to Karnataka
and Himachal Pradesh to North East. Apart from
SBI, there are other few banks which functions for
the development of the rural areas in India. Few of
them are as follows.
 Haryana State Cooperative Apex Bank Limited
 NABARD
 Sindhanur Urban Souharda Co-operative Bank
 United Bank of India
 Syndicate Bank
 Co-operative bank

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CO-OPERATIVE BANKS AND
RURAL CREDIT.
The Co-operative bank has a history of almost 100
years. The Co-operative banks are an important
constituent of the Indian Financial System, judging
by the role assigned to them, the expectations they
are supposed to fulfill, their number, and the number
of offices they operate.
Their role in rural financing continues to be
important even today, and their business in the urban
areas also has increased phenomenally in recent
years mainly due to the sharp increase in the number
of primary co-operative banks.
Co-operative Banks in India are registered under the
Co-operative Societies Act. The RBI also regulates
the cooperative bank. They are governed by the
Banking Regulations Act 1949 and Banking Laws
(Co-operative Societies) Act, 1965.

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Co-operative banks in India
finance rural areas under:
 Farming
 Cattle
 Milk
 Hatchery
 Personal finance

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Institutional Arrangements for Rural
Credit (Co-operatives)
 Short Term Co-operatives
 Long Term Co-operative

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7
Primary Agricultural Credit Societies
(PACSs)
An agricultural credit society can be started with 10
or more persons normally belonging to a village or a
group of villages. The value of each share is
generally nominal so as to enable even the poorest
farmer to become a member. The members have
unlimited liability, that is each member is fully
responsible for the entire loss of the society, in the
event of failure. Loans are given for short periods,
normally for the harvest season, for carrying on
agricultural operation, and the rate of interest is
fixed. There are now over 92,000 primary
agricultural credit societies in the country with a
membership of over 100 million.
The primary agricultural credit society was expected
to attract deposits from among the well –to-do
members and non-members of the village and thus
promote thrift and self-help. It should give loans and
advances to needy members mainly out of these
deposits.

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Central Co-operative Banks (CCBs)
The central co-operative banks are located at the
district headquarters or some prominent town of the
district. These banks have a few private individuals
also who provide both finance and management. The
central co-operative banks have three sources of
funds,
 Their own share capital and reserves
 Deposits from the public and
 Loans from the state co-operative banks
Their main function is to lend to primary credit
society apart from that, central cooperative banks
have been undertaking normal commercial banking
business also, such as attracting deposits from the
general public and lending to the needy against
proper securities. There are now 367 central co-
operative banks.

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State Co-operative Banks (SCBs)

The state Co-operative Banks, now 29 in number,

they finance, co-ordinate and control the working of
the central Co-operative Banks in each state. They
serve as the link between the Reserve bank and the
general money market on the one side and the central
co-operative and primary societies on the other.
They obtain their funds mainly from the general
public by way of deposits, loans and advances from
the Reserve Bank and they are own share capital and
reserves.

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COMMERCIAL BANKS AND RURAL CREDIT

The commercial banks at present provide short term

crop loans account for nearly 45 to 47% of the total
loans given and disbursed by the commercial banks.
Term loans for varying periods are given for
purchasing pump sets, tractors and other agricultural
machinery, for construction of wells and tube well,
for development of fruit and garden crops, for
leveling and development of land, for purchase of
ploughs, animals, etc. commercial banks also extend
loans for allied activities viz., for dairying, poultry,
piggery, bee keeping, fisheries and others. These
loans come to 15 to 16%.

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Commercial Banks and Small Farmers

The commercial banks identifying the small farmers

through Small Farmers Development Agencies
(SFDA) set up in various districts and group them
into various categories for credit support so as to
enable them to become bible cultivators. As regard
small cultivators near urban areas and irrigation
facilities, commercial banks can help them to go in
for vegetable cultivation or combine it with small
poultry farming and maintain of one or two milch
cattle.

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IRDP and commercial banks

Since October 1980, the Integrated Rural

Development Programme (IRDP) has been extended
to all the blocks in the country and the commercial
banks have been asked by the government of India to
finance IRDP. The lead banks have to prepare
banking plans and allocate the responsibility of
financing the identified beneficiaries among the
participating banks. Commercial banks have been
asked to finance all economically backward people
identified by government agencies.

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REGIONAL RURAL BANKS AND
RURAL CREDIT
The Narasimham committee on rural credit
recommended the establishment of Regional Rural
Banks (RRBs) on the ground that they would be
much better suited than the commercial banks or co-
operative banks in meeting the needs of rural areas.
Accepting the recommendations of the Narasimham
committee, the government passed the Regional
Rural Banks Act, 1976. The main objective of RRBs
is to provide credit and other facilities particularly to
the small and marginal farmers, agricultural laborers,
artisians and small entrepreneurs and develop
agriculture, trade, commerce, industry and other
productive activities in the rural areas.
The progress of RRBs in the initial stage was quite
rapid. For instance, the Sixth Five-year plan(1980-
85) had envisaged the setting up of 170 RRBs
covering 270 districts by the end of march 1985.The
target was exceeded. There are now 196 RRBs in 23
states of the country with 14,200 branches.

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Structure of regional rural bank

The establishment of the Regional Rural Banks

(RRBs) was initiated in 1975 under the provisions of
the ordinance promulgated on 26.9.1975 and
thereafter Section 3(1) of the RRB Act, 1976. The
issued capital of RRBs is shared by Central
Government, sponsor bank and the State
Government in the proportion of 50%, 35% and 15%
respectively.

• RRBs established with the explicit

objective of:

1. Bridging the credit gap in rural areas.

2. Check the outflow of rural deposits to urban
areas.
3. Reduce regional imbalances and increase rural
employment generation.

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ROLE OF RBI IN RURAL CREDIT
Since it was set up in 1934, RBI has been taking
keen interest in expanding credit to the rural sector.
After NABARD was set up as the apex bank for
agriculture and rural development, RBI has been
taking a series of steps for providing timely and
adequate credit through NABARD.
Scheduled commercial banks excluding foreign
banks have been forced to supplement NABARDs
efforts-through the stipulation that 40percent of net
bank credit should go to the priority sector, out of
which at least 18 percent of net bank credit should
flow to agriculture. Besides, it is mandatory that any
shortfall in fulfilling the 40 percent target or the 18
percent sub-target would have to go to the corpus
Rural Infrastructure Development Fund(RIDF).RBI
has also taken steps in recent years to strengthen
institutional mechanisms such as recapitalisation of
Regional Rural Banks (RRBs) and setting up of local
area banks(LABs).

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Micro-Finance
Micro-finance is a novel approach to "banking with
poor"as they attempt to combine lower transaction
costs and high degree of repayments.The major
thrust of these micro-finance initiatives is through
the setting up of Self Help Groups (SHGs),Non-
Governmental organizations(NGOs),Credit Unions
etc.

Kisan(Farmers') Credit Card

Another notable development in recent years is the
introduction of Kisan Credit Cards(KCC) in 1998-
99.The purpose of the Kisan Credit Cards(KCC)
scheme is to facilities short term credit to
farmers.The scheme has gained popularity and its
implementation has been taken up by 27 commercial
banks, 187 RRBs and 334 Central cooperative banks.

Agricultural Insurance
As Agricultural is highly susceptible to risks such as
drought, flood, pests etc.It is necessary to protect the
farmers from natural calamities and ensure their
credit eligibility from the next season. Towards this
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purpose, the Government of India introduced a
comprehensive crop insurance scheme throught the
country in 1985 covering major cereal crops,
oilseeds and pulses. Among commercial crops, seven
crops viz., sugarcane potato, cotton, ginger, onion,
turmeric and chillies are presently covered.

MARKETING OF MUTUAL FUND

UNITS - RRBS
With a view to expanding the scope of business of
RRBs and considering that marketing of Mutual
Fund (MF) units provides a profitable avenue for
banks, it has been decided by RBI on 17th May 2006
to allow Regional Rural Banks (RRBs) to undertake
marketing of units of Mutual Funds, as agents.
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Accordingly, RRBs may, with approval of their
Board of Directors, enter into agreements with
Mutual Funds for marketing their units subject to the
following terms and conditions:

*The bank should only act as an agent of the

customers, forwarding applications of the investors
for purchase / sale of MF units to the Mutual Fund /
Registrar Transfer Agents.

* The purchase of MF units should be at the risk of

customers and without the bank guaranteeing any
assured return.

* The bank should not acquire such units of Mutual

Fund from the secondary market.

* The bank should not buy back units of Mutual

Funds from their customers.

* The bank holding custody of MF units on behalf of

their customers should ensure that its own
investment and investments belonging to their
customers are kept distinct from each other.

* Retailing of units of Mutual Funds may be

confined to some select branches of the bank to
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ensure better control.

* The bank should comply with the extant KYC/

AML guidelines in respect of the applicants.

* The RRBs should put in place adequate and

effective control mechanisms in consultation with
their sponsor banks.

WHAT IS FINANCIAL
EXCLUSIONS?

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21
 WHO ARE FINANCIALLY
EXCLUDED

• Poor
• Socially under-privileged
• Disabled
• Women
• Uneducated
• Ethnic Minorities
• Un-employed

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 Financial inclusion-Definition

“The process of ensuring access to financial

services and timely and adequate credit where
needed by vulnerable group such as weaker
section and low income group at an affordable
cost.”-NABARD

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FINANCIAL INCLUSIONS

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Financial Inclusion-Institutionalization miles stones
since early 1900’s
1904 - Cooperative Societies Act
1954 - Rural Credit Survey committee
1955 - State Bank of India created for rural
penetration
1969 - 19 Commercial Bank Nationalized, All India
rural credit review committee
1970 Lead Bank Scheme –states /districts
1975 Regional Rural Bank – Hybrid banks
1981 6 more commercial banks nationalized
1992 SHG-Bank Linkage Programme
2001 Kishan credit card /Swarojgar Credit card
/Garmin Tatkal Card
2006 committee of financial Inclusion Set up

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 Rural Finance comprise credit, saving and
insurance (or insurance substitutes) in rural
areas, whether provide through formal or
informal mechanisms . The world credit trend to
be associated with enterprise development where
as rural finance also includes saving and
insurance mechanisms used by poor to protect
and stabilized their families and livelihoods
(not just their businesses).

 An understanding of rural finance helps explain

the livelihood strategies and priorities of the
poor.

Rural finance is important to the poor.

 The poorest group spend the highest proportion

of the their income on food –typically more than
60% and sometimes as much as 90% .Under
these circumstances , any drop in earning or any
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additional expenditure has immediate
consequence for family welfare –unless saving
or loan can be accessed

 Financial transactions are therefore an integral

part of the livelihood system of the poor.

 Rural finance consist of informal or formal

sector Example of formal sources of credit
includes: banks, project and contractor farmer
scheme. Reference is often made of micro
credit.

 Micro underlines the small loan size normally

associated with borrowings requirements of the
poor rural populations and micro credit
schemes used specially developed pro-poor
lending methodologies.

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 Rural populations. However, are much more
dependent on informal sources of finance
( including loan from family and friend , the
local moneylender and rotating or
accumulating saving and credit association)

 Rural finance is a set of financial services that

are not limited to credit only. Financial services
in rural finance include: loans. Savings,
investments, guarantee funds, remittance
services, inventory credit , trader finance and
insurance.

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 SOURCE OF RURAL FINANCE

Depending upon the requirement and purpose, the

funds needed by Indian farmers can be categorized
into three types:

Short term loan - 12 to15 months

Medium term loan -3 to 5 years
Long term loan -15 to 20 years

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 SHORT TERM LOAN are issued to the farmer
for the purpose of cultivation or domestics
expenses such buying seeds, manure and fodder
for cattle, etc.

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MEDIUM TERM LOAN are given to farmer to
purchase cattle, agriculture implement and to
make improvement on land.

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LOAG TERM LOAN are given to the farmer to
purchase land, pay of old debt and purchase
useful machinery for long term usage. These
loans are for comparative long period since the
farmers can repay them gradually over a number
of years.

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The two credit sources available to the farmers
institutional and private

Institutional sources consist of the co-operative

and commercial banks including Regional Rural
Banks (RRBS)

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Non institutional or private sources including
money lender traders commission agents and
landlords

Non –institutional sources or private sources of

farms credit refer to credit supplied by money
lender landlords and traders.

 Money lender is often combined with the

farming by the village money lender as they lend
to farmer for both the productive and non
productive purposes charging high rate of
interest.

 They enter larger than actually borrowed sums

through false pretense by obtaining promissory
and give no receipts for repayment and often
deny such repayments.

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They commit many other rogueries and have
been responsible for many of the ills of Indian
agriculture

 Their main interest has been exploit the farmers

and grab their lands.

 Institutional credit has been introduced to stop

such activities of the money lenders

CREDIT DELIVERY MECHINISM

IN RURAL FINANCE: MULTI
AGENCY APPROACH

 In all agriculture development programs

agricultural credit is one of the most crucial
inputs.
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Private money lenders are the major sources for
agricultural finance which is inadequate and
highly expenses and exploitative.

 Since independence, a multi agency approach

consisting of co-operative commercial banks
(RRBS) has been adopted to provide timely
adequate and relatively cheap to farmer this is
known as institutional credit.

 The major objective of the credit policy of the

government of India is to provide increasingly
institutional credit to small and marginal farmer
to enable them to adopt modern technology and
improved agricultural practices and thus

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increases agricultural production and
productivity.

INSTITUTIONAL SOURCES OF
FINANCE

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At present three agency supply institutional
finance .they are:
Co-operatives
Commercial banks
RRBs

The primary agricultural credit societies (PACSs)

provide mainly short term loans, and
Land development banks (LDBs) –these are now
called co-operative agricultural and rural

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development bank (CARDBs) –provide long term
and medium term loans to the agriculture sector.

 Agriculture credit to the farmer and refinancing

to the above mentioned banks is provided by the
National Banks for agriculture and rural
development (NABARD), which is apex
institution for the agriculture credit at the
national level.

 RBI is the central bank of the country plays a

crucial role by giving overall direction to rural
credit and financial support to NABARD for its
operations.

SUPERIORTY OF INSTITUTIONAL
FINANCE

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Weakness and inadequacy of private agencies to
supply credit to farmer aroused the need of
institutional credit private finance for example is
defective because:

It is based on profit motive and therefore it is

always unfair
It is very expensive moneylenders charge very
high rates of interest and it is not related to
productivity of land and
 It does not flow in to the most desirable channel
and it is not available to the needy persons.

The motive of the institutional credit is always

maximizing the farmer income and raise his
productivity.

The rate of interest is relatively low compared to

money lenders and can be different for different
purposes.

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Institutional also make a clear distinction between
short term credit and long term requirement and give
long accordingly.

EVOLUTION OF MULTI –AGENCY

APPROACH IN INDIA

Much was expected of the cooperative credit

movement .as the movement was led by and was
for farmers it was expected to cover all the needs
of the farmers.

 The co-operative were expected to protect the

farmer from the clutches of the money lenders.

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A survey for the year 1950-51 shows that the co-
operative met only 3.3% of the total requirement
of the farmers.

 Then State Bank of India was set up in 1955

after taking over the imperial bank of India to
show special concern for agriculture credit.

 The all rural credit review committee (1969)

recommended that the adoption of multi agency
approach was necessary to the rural sector as
banks and societies alone could not meet the
needs of farmers.

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 SBI’s e-Gram Project in Gujarat

 To provide all banking product /services.

Customers not visit branches personally.

 Target more than 5000 rural ICT kiosks.

 Villagers to start a bank a/c with Rs 50.

Zero balance also be permitted.

MOU with Indian postal department to act as

facilitator for 50 post officers at Surendra nagar
anand and bharuch districts.

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Also signed with Gujarat agro india to market
bank product in 700 out of its 1200 outlets.

 So commercial banks have to play an important

role in the rural sector also.

 This is one of the main reason for the

nationalization of the 14 top commercial banks
in 1969.

Later in 1976 the commercial bank were asked

to set up RRBs to help the small and marginal
farmers and rural artisans.

Thus the multi-agency approach to institutional

credit to agriculture co-operative societies and
co-operative banks commercial banks and RRB
evolved over a number of years.

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 PROBLEMS OF MULTI AGENCY
APPROACH

The problems were:

 There was multiple financing over financing in

some area and under financing due to lack of co
ordination between the agencies in the same
area.

Despite the option of lead bank scheme and

districts credit plan, the different agencies often
fail to formulate and develop meaningful
agriculture programs in given blocks and
districts.

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Despite guidelines issued by RBI, different
agencies adopted different procedures and
policies in the matter of providing loans and
their recovery.

When different agencies had lent loan to the

same person there were some practical problems
in the recovery of loans.

ROLE OF RBI IN RURAL CREDIT

 Since it was set up in 1934, RBI has been taking

keen interest in expending credit to the rural
sector. After NABARD was set up as the apex
blank for agriculture and rural development, RBI
has been taking a series of steps for providing
timely and adequate credit through NABARD.

 Schedule commercial bank excluding foreign

banks have been forced to supplement

46
 NABARD effort through the stipulation that
40% of net banks credit should go the priority
sector out of which at least 18 % of net bank
credit should flow to agriculture.

 Beside it is mandatory that any shortfall in

fulfilling the 40% target or the 18% of the target
would have to go to the corpus Rural
Infrastructure Development Fund(RIDF). RBI
has also taken step in recent year to strengthen
institutional mechanism such as recapitalization
of regional rural bank(RRB’s) and setting up of
local area banks(LAB’s).

MICRO- FINANCE

47
Micro finance is a novel approach to “banking with
poor” as they attempt to combine lower transaction
costs and high degree of repayment. The major trust
of these micro finance initiative is through the
setting up of Self Help Group (SHG’s)
nongovernmental organization (NGO’s), Credit
union etc.

KISAN FARMER’S CREDIT CARD

Another notable development in recent year is the

introduction of Kisan credit card (KCC) in 1998-99.
The purpose of the Kisan credit card (KCC) scheme
is to facilities short term to farmers.
The scheme has been gained popularity and its
implementation has been taken up by 27 commercial
banks 187 RRB and 334 central cooperative banks.

48
 AGRICULTURE INSURANCE

As agriculture is highly susceptible to risk such as

drought floods pests etc. it is necessary to protect the
farmer from natural calamities and ensure their credit
eligibilities from the next season. Towards this
purpose the government of India introduced a
comprehensive crop insurance scheme through the
country in 1985 covering major cereal crops oilseed
49
and pulses. Among commercial crops seven corps
viz., sugarcane potato, cotton, ginger, onion,
turmeric, and chilies are presently covered.

For development of fruit and garden corps,for

leveling and development of land for purchase of
ploughs animals etc.

Commercial bank also extended loans for allied

activities viz. for dairying poultry piggery bee
keeping fisheries and other. These loans comes to 15
to 16%.

50
 COMMERCIAL BANKS AND
SMALL FARMERS

The commercial banks identifying the small farmers

through Small Farmers Development Agencies
(SFDA) set up in various districts and group them
into various categories for credit support so as to
enable them to become bible cultivation. As regards

51
small cultivation near urban area and irrigation
facilities, Commercial bank can help them to go in
for vegetable cultivation or combine it with small
poultry farming and maintaining one of or two
milk cattle.

IRDP AND COMMERCIAL BANK

Since October 1980, the Integrated Rural

Development Programme (IRDP) has been extended
to all the blocks in the country and the commercial

52
banks have been asked by the government of India
to finance IRDP.

The lead bank have to prepare banking plan and

allocate the responsibilities of financing the
identified the beneficiaries among the participating
banks.

Commercial banks have been asked to finance all

economically backward people identified by
government agencies.

COMMERCIAL BANKS ANG

RURAL CREDIT

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The commercial banks at present provide short term
crop loans account for nearly 45 to 47% of the total
loans given and disbursed by the commercial banks.
Terms loans for varying period given for purchasing
pumps sets tractors and other agricultural machinery
for construction of wells and tube well.

DIRECT FINANCING BY
COMMERCIAL BANKS

Commercial banks were expected to vigorously

support the farmer’s in general small cultivators In
particulars.

For obvious reason the nationalized banks

concentrated their attention on cultivation and other
special category farmers such as those engaged in
raising high yielding verities of food grain.

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Term loans for varying period are given for
purchasing pump set tractors and other agricultural
machinery for construction of wells and tube wells
for development of land for the purchase of plough
animals.

INDIRECT FINANCING BY
COMMERCIAL BANKS

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Even though the scope of direct financing by
commercial banks would be limited for some tears to
come. There is a considerable scope for indirect
financing by them.

 Commercial bank fiancé cooperative societies to

enable them to extend their production credit to
the farmers. More especially they provide
finance increasingly to co-operative engaged in
the marketing and processing the agricultural
produce or in activities ancillary to such as dairy
poultry etc.

56
Commercial banks are undertaking indirect
provision of production credit through
production credit through agencies through
engaged in the supply of the marketing or
processing of agricultural produce.

 They extend credit to manufacturing or

distribution firm and agencies and co operative
engaged in the supply of pumps set and other
agricultural machinery on a hire purchase basis
or otherwise.

 They finance the operation of the food

corporation of India the state govt and other in
the procurement storage and distribution of food
gains.

 Commercial banks increasingly subscribing to

the debenture of the central and development
57
 banks and also extend advances to the letter.
This enable land development banks to expand
their medium and long term advances to the
farmer for the purpose of land development.

PROBLEMS OF COMMERCIAL
BANKS IN RURAL CREDIT

In the field of financing agriculture the problem

concern quantitative and coverage aspect
The RRB have been under serve financial strain on
account of higher transaction cost involved in
handling of a large no of small size loan account and
some what lower interest income as a result of
confessional rates of interest on small size loan.

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 REGIONAL RURAL BANKS

 Rural banking of India started since

establishment of banking sector in india.Rural
banks those mainly focused upon the agro sector.
Regional rural bank in India penetrated every
corner of the country and extended a helping
hand in the growth process of the country.

59
 WEAKNESSESS OF RRBS

NARSIMHAM COMMITTEE (1991)

ON RRBS

60
SERVICE AREA APPROACH (SSA)

Public sector bank adopted a new strategy for

lending on the basis of a study on the impact of
blank credit in the rural sector viz., ‘sevice area
approach’ under which each semi urban and rural
branch of commercial banks was assigned a specific
area comprising a cluster of villages with in which it
would operate adopting a planned approach. It was
to avoid duplication of efforts and scattered lending
over wider areas.

61
The implementation was:

Identification of service area.

Survey of service area for accessing the potential

for lending.

Preparation of credit plans on annual basis.

 Coordination on continuing basis, and

A continuous system of monitoring the

implementation plan.

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Some of the advantages claimed of SSA are as
follows:
 Attention to the development of the service
area for each branch.

 Avoidance of duplication of efforts.

Organized and planned lending.

 Easier and effective monitoring of the end ise

of credit.

 Assessment of its impact on production level.

63
The problem during implementation of SAA were
with respect to:

Allocation of villagers

Organizational issue

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FUTURE OF RURAL BANKING IN
INDIA
The Reserve Bank of India has a mandate to be
closely involved in matters relating to rural
credit and banking by virtue of the provisions of
Section 54 of the RBI Act. The major initiative
in pursuance of this mandate was taken with
sponsoring of All-India Rural Credit Survey in
1951-52. This study made agency-wise estimates of
rural indebtedness and observed that
cooperation has failed but it must succeed. The
Report of the Committee on Directions is still
considered a classic on the subject, and two of the
four members were, incidentally, from Andhra
Pradesh. This is the origin of the policy of extending
formal credit through institutions while
viewing local, traditional and informal agencies as
usurious. In the first stage, therefore, efforts
were concentrated on developing and strengthening
cooperative credit structures. The Reserve
Bank of India has also been making financial
contributions to the cooperative institutions
65
through evolving institutional arrangements,
especially for refinancing of credit to agriculture.

While enacting the State Bank of India Act in 1955,

the objective was stated to be the extension
of banking facilities on a large scale, more
particularly, in rural and semi-urban areas. SBI,
therefore, became an important instrument of
extending rural credit to supplement the efforts of
cooperative institutions. In 1969, 14 major
commercial banks were nationalised and the
objective, inter alia, was "to control the heights of
economy". The nationalised banks thus
became important instruments for advancement of
rural banking in addition to cooperatives and
State Bank of India. The next step to supplement the
efforts of cooperatives and commercial
banks was the establishment of Regional Rural
Banks in 1975 in different states with equity
participation from commercial banks, Central and
State Governments.
By 1982, to consolidate the various arrangements
made by the RBI to promote/ supervise
institutions and channel credit to rural areas,
NABARD was established. Though several efforts

66
were made to increase the flow of institutional credit
for agricultural and rural lending, there

were mismatches in credit and production. Field

studies conducted to determine the reason,
revealed that it was due to absence of effective local
level planning. It was felt that with the
establishment of large network of branches, a system
could be adopted to assign specific areas to
each bank branch in which it can concentrate on
focussed lending and contribute to the
development of the area. With a view to
implementing this approach, RBI introduced a
scheme
of "Service Area Approach" for commercial banks.
To further supplement the institutional
mechanism, the concept of Local Area Banks was
taken up in 1996-97 and in-principle approval
has been given for 8 Local Area Banks.
As regards cost of credit, for most of the period, the
administered interest rate regime was
applicable for bank lending and this included
concessional terms for priority sector. Currently,
all interest rates on bank advances including in rural
areas are deregulated and there is no link
67
between priority sector and interest rate, though
there are some regulations on interest rates by

size of advance i.e. below Rs. 2 lakh in respect of

commercial banks.
As regards policy measures to enhance flow of credit
to rural areas, apart from availability of
credit lines from the Reserve Bank of India, the
concept of priority sector was evolved to ensure
directed credit. Currently, the stipulation is that
domestic commercial banks should extend credit
to the extent of 40 per cent of the total net bank
credit to priority sector as a whole, of which 18
per cent should be specifically for agriculture. Out of
the target of 18 per cent for agriculture, at
least 13.5 per cent should be by way of direct loans
to agriculture and remaining could be in the
form of indirect loans.
Where a bank fails to fulfil its commitment towards
priority sector lending, it is currently
required to contribute to Rural Infrastructure
Development Fund set up by NABARD. NABARD
in turn provides these funds to State Governments
and state owned corporations to enable them
to complete various types of rural infrastructure
projects.
68
It is pertinent to recognise that there are a large
number of credit linked programmes sponsored

by the Government for direct assault on poverty. In

programmes relating to self-employment and
women welfare, the multiplicity of programmes has
been reduced by having a comprehensive
and consolidated programme named Swaranjayanti
Gram Swarojgar Yojna.
The financial sector reforms, which were introduced
from 1991 onwards were aimed at
transforming the credit institutions into
organisationally strong, financially viable and
operationally efficient units. The measures
introduced include reduction in budgetary support
and concessionality of resources, preparation of
Development Action Plans and signing of
Memoranda of Understanding with the major
controllers, and introduction of prudential norms
relating to income recognition and asset
classification for RRBs and cooperative banks. The
lending rates for these institutions have also been
deregulated. Other measures of liberalisation
include allowing non-target group financing for
RRBs, direct financing for SCBs and CCBs, and

69
liberalisation in investment policies and non-fund
business.

These measures have contributed to many RRBs

turning around and becoming more vibrant
institutions. In the case of cooperative banks, there is
greater awareness of the problems of
officialisation and politicisation and initiatives in this
regard include legislative actions on
cooperative banks in Andhra Pradesh.
Recently, several policy initiatives have been taken
to advance rural banking. These includ
additional capital contribution to NABARD by the
RBI and the Government of India,
recapitalisation and restructuring of RRBs,
simplification of lending procedures as per the Gupta
Committee recommendations, preparation of a
special credit plans by public sector banks and
launching of Kisan Credit Cards. Finally, a scheme
linking self-help groups with banks has been
launched under the aegis of NABARD to augment
the resources of micro credit institutions. A
Committee has gone into various measures for
developing micro credit, and has submitted its
report, which is under the consideration of the RBI.
In respect of cooperatives, a Task Force
70
under the chairmanship of my esteemed and
affectionate colleague Shri Jagdish Capoor, Deputy
Governor has been constituted to review the status
and make recommendations for improvement.
Undeniably, these initiatives have enabled a very
wide network of rural financial institutions,
development of banking culture, penetration of
formal credit to rural areas and a counter to the
dominance of moneylenders. These initiatives have
also financed modernisation of rural
economies and implementation of anti-poverty and
self-employment programmes. However, for
the purpose of focussing on the future, generalisation
on some concerns regarding the current
approach to rural credit and banking would be
appropriate.
Firstly, the cooperative banks have different layers
and many of them have significantly large
non-performing assets (NPAs). Many cooperatives
are undercapitalised. The public sector
banking system also exhibits NPAs, and some of
them have so far been provided with
recapitalised funds. The RRBs also exhibit NPAs
and these have been recapitalised from the
71
Government of India so far, which would imply a
total recapitalisation of double the amount
provided by Government of India.
Secondly, according to the All-India Debt and
Investment Survey, 1991-92, the share of debt to
institutional agencies in the case of rural households
has increased marginally from 61.2 per cent
to 64 per cent between 1981 and 1991. However, it
must be noted that this figure relates to debt
outstanding and the overall share of the institutional
credit in the total debt market is likely to be
smaller than what this figure indicates.
Thirdly, the cost of financial intermediation by the
various rural financial institutions is
considered to be on the high side. The difference
between the cost of resources made available to
NABARD by Reserve Bank of India and the
commercial rates of interest at which the
cooperative banks lend for agriculture in the
deregulated interest rate regime is also considered
to be on the high side.
Fourthly, empirical studies indicate that institutional
credit is more likely to be available for well
to do among the rural community.
72
Fifthly, empirical studies also indicate that relatively
backward regions have less access to
institutional credit than others do.
Sixthly, the non-availability of timely credit and the
cumbersome procedures for obtaining credit
are also attributed to the functioning of the financial
institutions, though this is equally valid for
rural and urban banking.
Finally in regard to Government sponsored schemes,
there has been overlap in accountability in
as much as the beneficiaries are identified on a joint
basis. Banks have been indicating that
NPAs are proportionately more due to this
overlapping.
An important development in the formal segment of
the rural financial markets is the growing
significance of non-banking financial companies, in
particular, in hire purchase and leasing
operations. They also finance traders of agricultural
inputs and output. The NBFCs have only
recently been brought under the regulatory regime of
RBI. While their importance is recognised
in financing diversified rural agriculture, its extent
and scope of operations has not been
73
adequately researched.
Dynamics of Rural Economy
Problems, prospects and solutions to many of the
issues mentioned have been researched and
debated, primarily with a view to strengthening,
revamping or re-orienting rural financial
institutions. However, there is merit in viewing the
problems of rural credit and rural banking in
a wider context. In this regard, it will be useful to
recognise some dynamics of rural economy.
First, services sector is getting increasing importance
in the rural areas also -from coffee shops to
cable television operators. Assessing and meeting of
credit needs of this sector is important.
Second, the integration between rural and urban
areas has increased significantly, with the result,
mobility of labour, capital, products and even credit
between the two is increasing.
Third, commercialisation of agriculture, particularly
the increasing role of cash crops like cotton
has resulted in substantial role for suppliers' and
buyers' credit. Thus, fertiliser and pesticide are
supplied to farmers on credit, often on deferred
payment basis. In such deferred payment
74
arrangements, credit terms are built into price and
hence it is difficult to isolate terms. Similarly,
the commission-agents advance money towards
purchase of output from farmers, which amounts
to providing credit and includes an element of
forward trading. These arrangements are often
entered into on a voluntary basis. The present
banking system does not generally encourage
financing the transactions of this nature. However, a
few non-banking financial companies do
provide indirect finance for such purpose.
Fourth, compared to cereal production, other food
items, including poultry and fish are growing
at a faster pace. In other words, rural agriculture is
getting increasingly diversified in terms of
products and processes.
Fifth, in areas where commercialisation of
agriculture has reached significant levels, the
traditional landlord-based tenancy is replaced with
commercial-based tenancy. Where intensive
cultivation of cash crops such as cotton is called for,
this has become quite common. However,
the present credit and banking procedures do not
cater to the working capital needs of such
commercial based tenancy relationship.
75
Sixth, given the diversified activities, and large work
force in rural areas, there is increasing
recourse to multiple occupations to earn a decent
livelihood. For example, a small farmer is also
a petty trader and may also be a satellite based cable
television operator in the village. The end48
use specification and monitoring of credit is more
difficult in such circumstances.
Seventh, to the extent employment and indeed
incomes could be seasonal, especially for
agricultural labour, there is reason to seek and obtain
consumption loans. Such assurance is
possible with prosperity in rural employment.
Present arrangements in formal credit markets are
inadequate to meet such requirements.
Eighth, while there is significant commercialisation
and diversification of rural economies,
progress is very uneven in different parts of the
country. So, there are still many areas, where
exploitation of tribals by money lenders or of
agricultural labourers by landlord-money lenders,
still persists. Norms and procedures of credit,
therefore, need to be different to meet varying
circumstances.

76
Ninth, from the data on credit deposit ratios, it is
clear that the banking system is a conduit for

net transfer of financial savings from rural to non-

rural sectors. On the other hand, a major part
of informal markets would be local and hence
savings would be locally deployed, within the
rural areas.

Rural Credit Markets : New Realities

As mentioned earlier in the approach to rural

banking, the basic thrust of our policy has been to
promote institutional credit and eliminate or ignore
informal finance. However, in reality, while
formal credit has expanded its share, informal
finance continues to be significant. The idea of
promotion of Self-Help Groups and micro financing
is an indirect admission of necessity of
informal finance. The future of rural banking cannot
be appreciated without fully understanding
both formal and informal rural credit markets,
especially their linkages. Since in the earlier
sections, organisation and functioning of the formal
credit system in the rural areas has been

77
explained, in this section nature of informal markets
and the linkages will be explored.

The informal financial market which is legal but

officially unrecorded comprises unregulated
financial activities i.e., outside the orbit of officially
regulated financial intermediaries. In the
informal financial transactions, one could treat
borrowing and lending among friends and
relatives as occasional and not part of such an
informal market. Consequently, there are three
broad types of informal financial transactions, viz.,
well-defined group, tied-lending/borrowing;
and untied lending/borrowing activities. In the
literature on well-defined groups, there are three
broad types namely Rotating Savings and Credit
Associations (ROSCA); Accumulated Savings
and Credit Associations (ASCRA) and hybrid forms
of both. There are some variations under
each category. Basic characteristics of these groups
are that they are voluntary in nature, usually
among equals, with little or no outside support or
interference. Often, members have some
special bonds based on religion, caste, status,
neighbourhood, etc. In brief, there is no patronclient

78
framework. In essence, therefore, these arrangements
among well-defined groups, though
important, should not in my view be included in the
concept of informal financial markets. In the

recent past, there have been efforts to provide a

bridge between formal financial markets and
these well-defined groups in the form of ‘micro-
finance' initiatives. However, these initiatives do
not constitute marketisation of activities of well-
defined groups. Thus, the informal financial
markets are those which are outside the orbit of
officially regulated institutions. These informal
debt transactions may involve tied debt transactions
and untied debt transactions.
The general approach, at least at the policy level, to
informal market whether tied or untied, has
not been positive since informal debt market has
been historically equated with either landlord or
moneylender. The transactions are considered to be
expensive, especially in view of what is held
to be of usurious nature of interest rates. It is
considered to be financing unproductive
expenditures since consumption needs are financed.
Sometimes, it is said that there are often
unequal and exploitative arrangements, say, between
the landlord and the tenant or the
79
agricultural labourer. Finally, it is held that, since
these are unregulated, they are prima facie not
desirable.

Yet, the fact remains that informal debt markets do

prevail, and studies have shown that in some
areas in our country, they account for 70 to 80 per
cent of debt transactions. Studies have also
shown that many poor people have no access to
institutional credit. The arrangements in
informal debt markets are said to be flexible, and
sometimes have in-built risk sharing
arrangements. These credit arrangements do provide
for smoothening of consumption and
production requirements. Transaction costs in terms
of certainty, timeliness, procedural
requirements, number of trips, etc. are somewhat
negligible although there may be hidden costs
in tied lending. Moreover, while formal markets tend
to cater to less risky borrowings, informal
markets provide for the more risky borrowings and
thus serve a purpose. Finally, it has been
stated in the literature that financial repression like
directed credit, high reserve ratios, interest
rate ceilings, branch licensing, etc. make informal
financial markets relatively attractive and
popular.
80
Perhaps, one way of reconciling the conflicting
views on usefulness of informal credit is to

recognise some emerging realities of both formal and

informal markets. This would also help a
rethink on approaches to rural credit and rural
banking.
First, it is no longer the case that the money lender
and informal financing are always
synonymous, in view of the dynamics of rural
economy already described involving suppliers
credit, buyers credit and credit for services sector.
Second, informal markets are less significant now
than before, and have to face competition or at
least accept benchmarking of formal credit. The
concept of monopoly of moneylender in rural
areas is not true in many areas now.
Third, when informal financial market is linked to
socially undesirable activities, there is
certainly a cause for concern though the available
evidence shows that such a link is more a
metropolitan or urban phenomenon rather than a
rural one.
Fourth, bank credit is really not severely restricted to
what can be officially determined as

81
productive, since most of the credit-card financing
by the banks is, in fact, financing of
consumption and at interest rates comparable to
those prevailing in the rural informal debt

markets. In other words, it is no longer unethical for

banks to finance consumption credit
through the credit card route. Credit card business,
so far, is an essentially urban phenomenon.
Hence, the financing of consumption by informal
markets in rural areas cannot be frowned upon
when it is being done by banks through their credit
card business.
Fifth, the real extent of informal markets is grossly
understated in any survey that views data on
outstanding debt since the turnover of debt is
admittedly much lower for public institutions than
for private lending. The turnover-differential is on
account of several factors, including
preference for short term finance and better
recovery-performance in informal markets.
Sixth, the social significance of informal credit is
more than its proportion in financial terms
since the poorer sections draw far larger amounts
from informal than formal markets.
Seventh, a significant part of informal market is
through leasing, hire purchase, deferred
82
payment, etc. with finance often provided by
NBFCs. The informal market is providing a range

of financial products, which the formal banking

system is not able to.
Eighth, studies have demonstrated that expansion of
literacy and education tends to increase the
access of rural folk to formal credit, reduce the
informal transaction costs in dealings with formal
credit institutions and improves their resistance to
malpractices attributable to landlord or
moneylender. The exploitative nature of informal
markets is more pronounced in tribal or less
developed areas while productive nature of informal
markets is more pronounced in prosperous
villages. Indeed, one can argue that in many areas,
the formal credit structure has provided a
positive institutional alternative to the moneylenders
and thus marginalising his role in providing
credit to rural masses.

Linkages in Rural Debt Markets

Having recognised that one cannot wish away

informal markets, some tentative generalisations

83
on the relative roles of formal and informal markets
and on the linkages between them would

also be necessary to capture the emerging but

complex realities. Such generalisations are
possible on the basis of empirical studies.
First, the formal credit has a tendency to flow more
easily to agriculturally developed regions
and to relatively larger farmers leaving the backward
regions and small farmers to be largely
served by the informal market. This phenomenon is
generally explained by four factors viz.,
poor-resource endowment features of the borrower,
poor personal factors (education, social
contact etc), underdevelopment of a region and
higher transaction costs.
Second, as per empirical studies, transaction costs
associated with formal credit include fees for
procuring necessary certificates (open), travel and
related expenses including loss of wages etc.,
and informal or unofficial commissions (hidden).
The transaction costs vary with type of credit
agency involved, the type of borrower and farm-size.
Third, uncertainties and delays usually associated
with formal credit can also be treated as
additions to the transaction costs.
84
Fourth, the true cost of borrowing from the formal
credit system is thus higher than nominal cost

if the above informal transaction costs are also

included. To the extent some transaction costs are
fixed, the effective cost of borrowings for smaller
loans tends to be relatively higher than for a
larger loan.
Fifth, there are usually hidden costs or concealed
interest rates in respect of informal credit also,
which have to be added to the nominal costs to arrive
at the true cost. These hidden costs
generally relate to tied lending, tied to land, labour,
input or output. The tied advance in respect
of labour is particularly relevant for migratory
labour. The hidden costs are usually in the form
of undervaluation of labour and output of borrowers
and overvaluation of inputs supplied by
lender.
Sixth, the choice between formal and informal credit
depends on both the access and relative true
costs. Thus, recourse to informal credit, admittedly
at far higher nominal costs, is to be explained
partly in terms of effective costs and the extent of
supply of formal credit.

85
Seventh, in assessing relative roles, both supply and
demand side bottlenecks of formal credit

need to be appreciated. The former relate to asset-

based lending policies and complex formalities
and procedures, while the latter relate to poor
endowment, lower education and social-contact,
usually caste-based in backward regions. Viewed
differently, a larger role for informal credit
may arise due to low level of commercialisation and
monopoly power of moneylender; and it
may also arise due to high level of
commercialisation of agriculture when supply from
formal
channel cannot match significant demand for credit.
Eighth, it is also necessary to recognise that, to the
extent informal markets tend to lend to
borrowers who are relatively less creditworthy, risk-
premium is bound to be higher. This would
also get reflected in higher nominal interest rates in
informal markets and indeed higher true
cost, though it may not be so high if it is net of risk
premium.
It is clear that the critical issue in respect of informal
credit is the manner in which the linkages

86
among the participants in the market operate and
result in varying degrees of hidden costs. It is
possible to make some exploratory postulates here.
First, trader-lenders are likely to provide

most of production - credit, while farmer-lender or

moneylender is likely to provide most of
consumption - credit. It is, of course, possible that
some individuals combine the functions of
farmer, trader and moneylender. Second, informal
markets are unlikely to finance credit for
investment purposes, given the time preference.
Third, the levels of education are likely to
reduce the scope for gross overvaluation or
undervaluation in linked-transactions. Fourth, the
inter-linked transactions among parties with equal
bargaining power are likely to minimise the
hidden costs. Fifth, from the supply side, farmer-
lenders may tend to be associated with land and
labour market linkages while trader-lender is likely
to be associated with input-output markets.
On the demand side, agricultural labour may be
associated with land and labour markets while
the farmer-cultivator with input-output linkages. In
the process, it is likely that a farmer would
be a borrower from a trader and a lender to
agricultural labour, a common phenomenon in
87
villages. It will, therefore, be over simplification to
divide the rural population into lenders and
borrowers or exploiters and exploited. Sixth,
similarly it is necessary to appreciate the role of

linkages in credit-risk-mitigation. In fact, the risk

reducing element of linkages are not built into
formal credit-channels. Incidentally to the extent the
transaction costs are front loaded in respect
of formal credit, there is no incentive to repay while
the true costs of informal credit are spread
out. Seventh, in terms of bargaining power among
the class of borrowers, the agricultural labour
and migratory labour appear to be weakest except in
agriculturally prosperous areas wher
labour-shortage is acute to cater to agricultural and
other operations. Similarly, the differential in
bargaining power between large and small borrowers
is similar to that between large corporates
and small-industrialists in urban areas.
In brief, the linkages between formal and informal
markets are complex, contextual and
dynamic. The two markets appear to compete with
and also supplement each other.

Technology and Rural Banking

88
We should recognise that the role of banks, which is
central to formal credit in rural areas, is fast

changing. Many non-banks are providing avenues

for savers and funds for investment purposes.
Banks themselves are undertaking non-traditional
activities. Banks are also becoming what are
called universal banks and are already providing a
range of financial services such as
investments, merchant banking and even insurance
products. Similarly, non banks are also
undertaking bank like activities. At present in India,
these are mostly confined to urban areas, but
they will sooner than later spread to rural areas.
Another development relates to the gradual
undermining of the importance of branches of banks.
The emergence of new technology allows access to
banking and banking services without
physical direct recourse to the bank premise by the
customer. The concept of Automated Teller
Machines (ATMs) is the best example. At present,
ATMs are city oriented in our country. It is
inevitable that ATMs will be widely used, in semi-
urban and rural areas.
The technology-led process is leading us to what has
been described as virtual banking. The

89
benefits of such virtual banking services are
manifold. Firstly, it confers the advantage of lower

cost of handling a transaction. Secondly, the

increased speed of response to customer
requirements under virtual banking vis-à-vis branch
banking can enhance customer satisfaction.
Thirdly, the lower cost of operating branch network
along with reduced staff costs leads to cost
efficiency. Fourthly, it allows the possibility of
improved quality and an enlarged range of
services being available to the customer more rapidly
and accurately at his convenience. It may
not be possible to deny these facilities to rural areas
in our country since, if banks do not provide
them, some non-banks will do it.
Another development relates to the increasing
popularity of credit cards, which are bound to
reach rural areas. Many Public Sector Banks are
already in credit card business. In fact, multipurpose
cards could be a facility that IT could usher in for
rural population. The potential can be
illustrated with SMART cards. SMART cards –
which are basically cards using computer
circuits in them thereby making them ‘intelligent' –
would serve as multipurpose cards. SMART
90
cards are essentially a technologically improved
version of credit and debit cards and could be

used also as ATM cards. They could be used for

credit facilities at different locations by the
holders. SMART cards could also be used for
personal identification and incidentally for
monitoring credit usage.
For the spread of virtual-banking and SMART cards
to rural areas, it is essential that electric
power and telecom connectivity are continuous and
supplies do not drop especially during the
hours when a bank's transactional activity is at
relatively high levels. The banks could, under
such assured supply conditions acquire the required
banking software and also put in place the
necessary networking for providing anywhere
banking facilities in rural and semi-urban areas
also.
Like banks in other parts of the world, Indian banks
will have to get interested in providing
diversified range of financial products and services
along with those that they are already
providing, by using technological advances. As the
level of education in rural areas rises and

91
affluence spreads, customers will start seeking
efficient, quicker and low cost services. As the

financial system diversifies and other types of

financial intermediaries become active, in rural
areas, savers would turn towards mutual funds or the
savers themselves decide to deploy part of
their financial surpluses into equities and debentures
as also other fixed income securities. The
bulk of bank deposits in the rural areas are currently
longer term deposits and as these come
down, there would be a distinct shortening of the
average maturity structure of bank deposits
with an increase in asset liability mismatches. The
spreads that the banks now enjoy will
progressively shrink making it more difficult for
them to survive. As more and more
intermediaries enter rural areas with greater level of
technology, traditional banking business
will come under pressure. In order to face the
competitive pressures being exerted by the
recently set up market savvy banks, banks which
have extensive branch network in most of the
existing and potential rich rural and semi-urban areas
may have to provide such services.

92
Issues

It is clear that significant progress has been made,

since independence, in expanding bank
branches and banking habits in the rural areas,
through a variety of institutional innovations. An
impressive segment of rural economy has been
brought into the ambit of formal financial
intermediation, mainly through the public sector
banking system, and to some extent, through
cooperatives and RRBs. The future of banking in
rural areas would, however, depend on several
factors that have been described, namely, how the
current concerns are addressed taking into
account the dynamics of transformation in rural
economies, the new realities in credit markets,
the linkages between formal and informal markets,
and the impact of financial as well as
technological progress on the systems of financial
intermediation.
Consequently, public policy will have to address
several issues to ensure a sound and efficient

93
banking system in the service of rural areas. The
more important of such issues relate to the

approach, institutions, supply, cost, and related

policies

Approach

In the past, the major instruments of public policy

were cooperatives and public-sector banking
system. However, with the diversification of
ownership of public sector banks and the overall
thrust of financial-sector reform, a review of
institutional arrangements, mainly in the
incentiveframework
for credit-delivery appears necessary. Similarly, in
the area of cooperatives also, a
reduced role for Government including in providing
refinance is being advocated. This desirable
approach would also need a review of institutional
arrangements, in particular in delayering and
debureaucratising the cooperatives.
Further, there are new institutions and new forms of
financial intermediation that are emerging –
be it mutual funds or more important for rural areas,
non-banking financial companies. Any
94
approach to rural-development should consider
capturing, at least the activities of non-banking

financial companies as part of formal rural financial

markets.
Moreover, in many parts of the country, growth of
literacy and diversification of the economy
have brought about new characteristics and linkages
between formal and informal financial
markets in rural areas. The latter does play a
significant part in rural economy. Hence, the two
markets should be treated as competing and co-
existing, and in fact the policy should seek to
utilise informal markets also for public interest. A
small beginning has been made in this
direction, through initiatives on micro finance. A
policy of analysing and monitoring of rural
financial markets as a whole is critical for the future
and devoting attention only to banks and
cooperatives may not suffice. I would hasten to add
that a policy-focus on informal markets does
not at all imply extending regulation to informal
markets. In fact, the Report of Task Force on
micro-finance of NABARD (1999) has
recommended extending regulatory framework for
micro-finance institutions, and in my view this
recommendation is fraught with difficulties.
95
Funding by banks and regulated NBFCs of micro-
finance institutions should be encouraged and

guidelines provided, but regulation of micro-finance

institutions may not be prima facie wise.
In any case, research and micro studies
encompassing both formal and informal segments
would
help the policy makers appreciate relative roles and
linkages in rural financial markets as a
whole. In other words, policy analysis should
perhaps consider expanding its attention from rural
banking to rural financial markets.
Enhancing effective supply of credit in such rural
financial markets would be a logical objective
of policy, thus enlarging the current attention to
include both directly disbursed credit by the
banking or cooperative sectors and indirect supply.
Similarly, reducing the true cost of creditavailability
to rural areas would be yet another objective,
expanding the attention of policy to
include both nominal cost of credit from banking or
cooperative sector and true cost in formal
and informal markets. In an increasingly deregulated
environment, this objective would imply
attention to competitive efficiency involving
procedural-simplification also, in respect of banks
96
and cooperatives.

Finally, the approach may expand from delivery of

credit to rural areas to making available
financial services and products to savers, investors
and consumers in the rural areas. In other
words, it should be recognised that rural financial
markets comprise both depositors or savers
and borrowers or investors.

Institutions
Among the institutions involved in rural credit,
cooperatives have a special place in the RBI.
There is full appreciation of the problems and efforts
are underway to workout a package for
revival and may be, rebirth of rural cooperative
banks by a Committee headed by Deputy
Governor Shri Jagdish Capoor. The Committee
would naturally address issues relating to legal
framework, and incurring costs of addressing
problems related to overhang of the past. In
addition, the Committee, I trust, would consider
desirability of cooperative banks' foray into
non-fund-based activities, such as fee-based
financial services on behalf of mutual funds or
97
insurance-products. The cooperatives could, in fact
help, retail Treasury Bills and Government
Securities in rural areas. Diversified financial
products will be increasingly demanded and
supplied in the rural areas, and co-operatives should
not be left out of this trend of providing
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multiple-products through a single window. This
would also imply, going beyond the somewhat
closed loop of preferred financial relations within
cooperative system into a multiple contacts
between cooperative banks and other financial
intermediaries, largely utilising technological
improvement.
Commercial banks are being reformed in accordance
with recommenations of the Narasimham
Committee. The RRBs are being recapitalised. These
efforts in regard to banks would
presumably recognise the trends in providing
financial services to enable them to exercise
necessary flexibility and dynamism that is warranted
by fast changing world. Similarly, the
future role of NABARD could be addressed because
the organisational setup, funding and

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activities will have to reflect the basic logic of
financial sector reform viz. changing roles of

owner, regulator, refinancing, subsidised credit,

government-funding and cooperatives.

Enhancing Effective Supply

Some analysts argue that supply-led strategy in
regard to rural credit has not been successful,
since institutional spread and directed-lending have
not had the desired impact. While accepting
that demand has to play its role, and real-demand
also implies negotiating strength of the
borrower in respect of financial institutions, it will be
inappropriate to conclude that supply
should necessarily follow demand. Mere presence of
rural credit institutions, does not amount to
availability of supply. Similarly, mere prescriptions
of priority lending would not ensure supply.
For example, prescription of priority-sector lending
relates to percentage of credit outstanding
rather than advances. Further, there is no reward for
overshooting the target and undershooting is
not really penalised since amounts of shortfall need
to be placed in a fund administered by

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NABARD with a totally risk-free return of 11.5
percent for a five-year advance. These funds are

actually lent to State Governments, thus to an extent

replacing rural credit to agriculture with
credit to State Government for rural development.
While as a transient measure during a period
conspicuous for incomplete projects, such an
arrangement was justifiable, this should not
become a permanent feature as it would have
obviously perverse effects. The coverage of
definition of priority sector also leads to some
difference between apparent supply and effective
supply. Thus, the base for calculating priority sector
excludes commercial banks' investments,
which are expanding rapidly. The procedural
bottlenecks resulting in delayed supply also, in
some ways, amount to erosion of effective supply.
At the same time, there may be some effective
supplies which are not reckoned for supply under
priority-sector. There may be funds channeled by
banks to rural area through urban-branches or
through other intermediaries such as NBFCs.
There is perhaps a case for some research and studies
on policy of directed lending so that we

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could improve on the incentive and policy
framework to enhance effective supply. For
example,

the definition and coverage of priority sector for

agriculture could be revisited and lending to
agriculture by banks through NBFC's could be
considered for inclusion in priority-sector, as has
been done to ensure flow of credit to truck operators.
Yet another area in effective supply relates to
lending by banks under government sponsored
programmes, which has significant non-commercial
considerations. Several issues relating to
both supply and accountability arise due to
involvement of both Government and banks. A more
transparent approach, for example, by separately
accounting for them as policy-induced lending
would help isolate and monitor this supply, apart
from isolating the non-performing assets on
this account in the balance sheets of banks.
An important bottleneck in the delivery of credit has
been the negligible use of bill-discounting
for services sector. Current policies and procedures
restrict this instrument to goods. It has been
decided by the RBI to constitute a Committee to
explore ways by which bank finance can be
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made available to service sector. The Committee,
with representation from public, private sector

and foreign banks also is expected to study

international experience, our policies and procedures
and make recommendations in two months. This
important step recognises that about half of our
Gross Domestic Product is in services sector and
would also help flow of bank finance to the
growing services sector in rural areas.

Reducing True Cost

The major reasons for the true cost of credit from
rural financial institutions being higher than
nominal costs are mainly scarcity of supply and
transaction costs. Enhancing effective supply
would be an important strategy of reducing the true
cost. Encouraging competition would be yet
another strategy. A review of procedural
requirements, such as eliminating mandatory forms
and
replacing them with locally determined procedures,
could also be considered. All non-verified
documentation could, for instance, be replaced with
self-declaration by the borrower. Repeated
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visits and consequent transaction costs can be
avoided by several procedural simplifications -

going beyond Gupta Committee recommendation. In

particular, growth of information
technology and its application in banking would
warrant a thorough review of products,
procedures and linkages among rural financial
institutions.
Arbitrage in financial markets is inevitable and
prevalence of such operations cannot be ignored.
Arbitrage between formal and informal markets, and
between production loans and consumption
needs is also common. Thus, keeping the true cost
artificially low in formal markets, the rural
financial institutions would encourage arbitrage and
erode the clear potential for profit. Indeed,
an appropriate strategy may be to reduce the
difference between nominal and true cost and
ensure that true cost reflects market conditions,
including premium for credit risk.
As already mentioned, provision of diverse financial
products and services in the rural areas
would enhance income to banks and help reduce the
admittedly large spreads in interest rates.
Thus, among the efforts to reduce nominal and true
costs of credit in rural areas would be
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provision of multiplicity of financial services by
rural financial institutions, taking advantage of
developments in technology and financial markets.

Related Policies
There is increasing recognition that, the spread of
literacy and generation of growth impulses in
the rural sector would be very significant factors in
enhancing effective supply and reducing true
cost of rural credit. More specifically, the desired
spread of technology and trickledown of urban
financial products to rural areas would require
concerted action in four areas. First and foremost,
insurance, especially of crops, should penetrate the
rural areas to mitigate the risks to both
farmer and lender. The lack of penetration of
insurance is perhaps an important reason for
lenders seeking tied and other risk-mitigation
arrangements through informal markets. Second,
there should be assured supply of electric power so
that functioning of systems is not disrupted.
Third, telecommunication network needs to be
dependable and financial sector needs to ensure a
network. We, in the RBI, have already launched
INFINET. Fourth, the institutional and

104
regulatory framework should enable rural financial
institutions to operate in diverse financial
products and services. We, in the RBI are currently
engaged in a number of initiatives and
studies. We hope to continue the process, and focus
on rural credit, as mandated by the RBI Act.
We would seek advice and guidance in this
endeavour.

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 CONCLUSION
RRBs' performance in respect of some important
indicators was certainly better than that of
commercial banks or even cooperatives. RRBs have
also performed better in terms of providing loans to
small and retail traders and petty non-farm rural
activities. In recent years, they have taken a leading
role in financing Self-Help Groups (SHGs) and other
micro-credit institutions and linking such groups
with the formal credit sector.
RRBs should really be strengthened and provided
with more resources with which they can undertake
more of these important activities. And most
certainly they should be kept apart from a profit-
oriented corporate motivation that would reduce
their capacity to provide much needed financial
services to the rural areas, including to agriculture.
Ideally, the best use of the resources raised by RRBs
through deposits would be through extensive cross-
subsidisation. This, in turn, really requires an apex
body that would cover and oversee all the RRBs,
106
something like a National Rural Bank of India
(NRBI).
The number of rural branches should be increased
rather than reduced; they should be encouraged to
develop more sophisticated methods of credit
delivery to meet the changing needs of farming; and
most of all, there should be greater coordination
between district planning authorities, panchayati raj
institutions and the banks operating in rural areas.
Only then will the RRBs fulfill the promise that is so
essential for rural development.

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THANK YOU

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