Banks go on rural overdrive, but profitability a worry

Even as the Reserve Bank of India (RBI) gets ready to issue a new set of banking licences with the hope that some of the new players will help push financial inclusion, existing banks have upped the pace at which they are expanding in rural areas.

In 2012-13, nearly 41% of new branches opened were in tier-5 and tier-6 centres, which are considered ?rural?, provided their population is under 10,000. Of the 7,213 branches opened during the previous fiscal, 2,937 were in tier-5 and tier-6 centres, noted RBI?s recent trend and progress of banking in India report.

As per RBI regulations, each back is required to open atleast a quarter of it’s new branches in unbanked rural areas, defined as rural centres which have no bank branches. The central bank has also asked each bank to have a board-approved plan for financial inclusion in place.

While data show that banks are expanding more rapidly into the hinterlands, rural banking still remains a largely unprofitable line of business.

Global consulting firm McKinsey estimates that the banking system makes a loss of close to $1 (R62 at current exchange rate) per account on an annual basis from each rural branch.

Part of this is because the banks have been unable to do much lending activity through their rural branches ? where most accounts are opened as ?no frills? or basic savings accounts. While over 18.2 core no-frills accounts are currently in existence, only 1.3% of these accounts have started borrowing from banks, estimates Ashvin Parekh, partner at Ernst & Young.

?Right now, rural banking is not viable because the government is pushing it as a social responsibility. People in rural areas withdraw almost the entire amount and still prefer to transact via cash. Banks make money via transaction fees,? said Parekh. The numbers tally will RBI estimates, which suggest that only 2% of no-frills account holders have used the overdraft facility offered with these accounts. At the end of March 2013, only 40 lakh accounts availed the overdraft facility out of 18.2 crore accounts, shows RBI data.

Banks tend to generate more income through lending activity, which adds to their interest income, while other banking services such as savings bank accounts earn fee income for banks, which is far lower than interest income. No wonder then that private sector banks like HDFC Bank are approaching the rural markets with precision, looking to bank areas where the need for financial transactions is greater.

A number of the bank?s rural branches in recent years have been opened in areas where there is high commodity trading activity or in centres which are close to manufacturing hubs, says Ravi Narayanan, HDFC Bank?s head of branch banking for the western region. ?We are looking at centres that have unorganised mandis or wholesale markets and cater to a larger produce chain. They may not be as organised as the APMC yards but still contribute significantly,? said Narayanan. ?We?re also looking at villages which have semi-manufacturing centres,? he added.

HDFC Bank opened 518 branches in 2012-13, out of which 30-35% were in tier-5 and tier-6 centres. According to industry sources, the average cost of setting up a rural branch is about R8-10 lakhs, with each rural branch taking about 2-3 years to break even.

Among the top three private banks, Axis Bank opened 325 branches in 2012-13, with 110 of them in tier-5 and tier-6 centres. At ICICI Bank, 755 were added from March 2012 to September 2013. Of this, 426 are in rural areas, suggesting that more than half the branch additions have come in tier-5 and tier-6 centres.

State Bank of India ? the country largest lender ? agrees that while the cost of doing business in rural areas is similar to that in urban areas, generating profits from these branches remains a difficult task. For SBI, the cost per transaction is roughly R40 for both urban and rural areas.

?Banks are pushing for rural banking as they can fulfill the RBI?s guidelines for financial inclusion while trying to get centres that are more profitable,? said A. Krishna Kumar, managing director and group executive at SBI, which is on average opening 1,000 new branches each year, with 25% of these in unbanked rural areas. While the real estate cost of opening a branch in rural areas may be lower, the cost of servicing and staffing these branches often balances out the lower fixed costs, said bankers. ?The biggest cost for these branches is manpower. Rental costs are generally low and so are cash management costs,? said Narayanan of HDFC Bank.

Government policies have also played a part in making the rural banking business less profitable, particularly for the private banks. Since the government offers a subvention on interest rate for loans less than R3 lakh for farmers via public sector banks, private players find it difficult to lend to this segment.

?Private banks find it difficult to extend credit to farmers when public sector banks can offer loans at 7%. The subvention stops us from growing rural banking,? said Thampy Kurian, head of rural banking and financial inclusion at Federal Bank. The RBI, however, remains hopeful that banks will move into rural areas more aggressively in the coming years. The central bank has set a target of covering all unbanked villages over the next three years. In September, RBI governor Raghuram Rajan set up a committee headed by Nachiket Mor to frame a fresh blueprint for financial inclusion in India.