Institutional innovation is just as important as technological innovation; so while JAM is important, focus on reforming PSBs.
Financial inclusion is an important aspect of financial development. Uneven and narrow financial development can hamper overall economic progress, whereas a broad and vibrant financial sector can lubricate the engine of growth. Financial inclusion can also be an important catalyst for promoting equity and poverty reduction. The concept itself probably brings to mind microfinance, but there is much more to financial inclusion. The baseline is, in fact, innovations that allow even the less well-off to store money and send and receive payments. Saving and transaction accounts are a gateway to other financial services, including various forms of credit and insurance.
Indian policy-makers have conceptualised financial inclusion in terms of a three-part strategy based on using digital technologies: JAM, standing for Jan Dhan (banking), Aadhaar (biometric identity) and Mobile (transactions). For example, biometric identity cards have reduced corruption in welfare programmes, economised on expenditures and even had some positive impacts on outcomes. The JAM framework for policy innovation has the potential to avoid a common problem in policymaking in India, of broad and shallow interventions. But there is scope for thinking about and implementing financial inclusion in greater depth as well as breadth.
Recently, I surveyed some of the recent research on financial inclusion, focusing on recent studies for India sponsored by the International Growth Centre (IGC). Several interesting results are emerging from these studies. Shawn Cole and his co-authors show that commercial bank loan officers can be more efficient if provided with better designed incentives. Erica Field and her co-authors find that properly incentivised loan agents working for SEWA Bank (the oldest women’s bank in the world) improved access to loans and integration of women into the labour market. Since India has already made a push to expand bank accounts and the number of banks, these studies suggest that the next phase of promoting financial inclusion in this sphere should be paying attention to the structure of such organisations, including the incentives provided to employees and overall organisational culture.
Small farmers are an important target group for financial inclusion. They are vulnerable to weather shocks and other production uncertainties, and often at the mercy of powerful intermediaries. They do receive government help in the form of government promoted loans, which sometimes have repayment waived. But poor targeting and other political distortions suggest that the current situation in India is grossly suboptimal. An experiment by Pushkar Maitra and co-authors shows that enlisting local trader agents in lending decisions can improve outcomes. Another experiment, by Sandip Mitra and co-authors, gives indirect evidence that better targeting of credit to small farmers might also help them in getting better prices for their output. Most importantly for Indian small farmers, there is mounting evidence that agricultural insurance can be designed to be both affordable and beneficial for production and welfare. Recent research by Ahmed Mushfiq Mubarak and Mark Rosenzweig, and by Sarthak Gaurav and co-authors provides examples of effective design of such insurance.
Health insurance, mortgages, and financial literacy are other aspects of financial inclusion where research progress is being made that can guide Indian policy-making. But perhaps the most important area of financial inclusion is small firm finance, at one level up from traditional microfinance. An IGC project by Rajesh SN Raj and Kunal Sen show that finance constraints play an important role in firm transition from family-labour-only firms to small firms that use hired labour, but even more so for the growth of the latter beyond six workers. They also find that that existing government assistance programs, such as loans, training, and marketing, do not help these firms transition and grow. Employment creation through the growth of India’s myriad small firms seems like an essential part of generating job-friendly and inclusive growth, and Raj and Sen’s research strongly suggests that policy-making to support this goal needs a fundamental re-evaluation.
In an earlier column, I discussed the need for a big push in enhancing working capital finance for small and medium firms in India. Digital platforms and digital technology in general have an important role to play in helping overcome information asymmetries, reducing transaction costs, matching borrowers and lenders, monitoring loans, and so on. But technological innovation by itself will not be enough. Recent research suggests that institutional innovation is also necessary, including in the private sector (promoting transparency and competition) and the public sector (achieving more effective regulation and targeting). Recent research indicates that details matter, and that there can be many variations across markets, products and target segments in the successful design of financial products and services so that they work for a greater proportion of the population than has been served so far.
As in many other areas of Indian economic policy-making, the big picture is that policymakers need to understand the lessons of academic experiments and analyses of administrative data. And researchers need to communicate these lessons so that non-specialists can grasp them. Academics also need to monitor the impact of their research on policy-making and implementation, and reiterate or refine their messages as often as they can, to keep policy-makers on track. This process may now be developing in India, at a critical juncture for the economy.