NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Thursday, October 1, 2015

The Reserve Bank of India (RBI) has been steadily reforming India’s financial sector, in addition to achieving notable monetary policy successes. A few weeks back, the RBI granted licenses to 11 payments banks and followed that with licenses to 10 small finance banks.

The background for the broad and deep changes that the RBI’s actions can bring has been explained in two policy reports: Raghuram Rajan’s “A Hundred Small Steps” and Nachiket Mor’s recommendations.

The new licensing will enable mobile payments and a significantly expanded depositor base that will reshape India’s financial sector. The technological innovation and increased competition these measures will unleash may threaten the future of some of India’s listed banks. The new licensees are expected to broaden financial inclusion among India’s previously unbanked population, estimated at 50% of the total. Targeted subsidies that the banks can facilitate will likely prevent over $40 billion (2% of GDP) in leakages, whether through inefficiencies or corruption and otherwise help alleviate poverty. The last-mile connectivity that the payments banks are designed to provide, will remove one of the biggest handicaps hindering India’s unbanked poor.

The Poverty Link

Why are financial inclusion and poverty eradication important? How are they connected? India’s 7% average real annual GDP growth over the last two decades has brought considerable economic prosperity. But that prosperity has not been widely shared. India’s GINI index is lower (better) than comparable countries, but the absolute numbers are alarming. Most Indian metro areas have massive skyscrapers with their associated uber societies, replete with pools and saunas. These isolated pockets of wealth may become untenable if the seas of shanties surrounding them keep expanding. For growth to be sustainable, prosperity needs to be spread more broadly — and especially to those who now live hand-to-mouth.