> Posted by Rishabh Khosla and Vikas Raj, Senior Investment Analyst and Senior Investment Officer, Accion Venture Lab
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In May, India’s new government, led by Narendra Modi, was elected in a landslide. Popular frustration with the Congress Party’s increasingly ineffectual 10-year reign, made most visible by persistently low GDP growth, allowed for one of the most lopsided victories in Indian history, and the first time a non-Congress candidate had an outright majority in parliament. Wisely, Modi focused his election campaign rhetoric on economic issues and more efficient governance to revive GDP growth. The markets have reacted positively: the bell-weather BSE stock-index is up 20 percent since the start of the year. Two weeks ago, the government finally proposed a budget for the next year – the first real concrete recommendations for the economy since coming to power two months ago.
India is a key market for financial inclusion investors like Accion Venture Lab because of the size, depth, and strength of its entrepreneurial pool, as well as the persistent lack of financial services for the poor. Despite the huge success of microfinance in India, two-thirds of the working-age population lacks a bank account, mobile payments have yet to take off, and access to credit for small and medium enterprises (SMEs) remains abysmal.
However, there are signs of improvement in the latest budget proposal. First, it suggested the formation of a committee to study and alleviate bottlenecks in financing of SMEs and startups. Despite the fact that the 30 million SMEs in India generate 30 percent of the country’s industrial output, only 5 percent have access to commercial capital. The budget begins to address this issue with a proposal to broaden the definition of SME in order to encourage greater lending from banks, which are given special incentives to lend to “priority sectors” like SME. The 2014 budget also includes a 10,000 crore (~$1.6B) startup fund for new businesses, allocations for a “Startup Village,” and greater connectivity and leadership development programs for aspiring entrepreneurs in minority and rural communities.
At Venture Lab, we are actively looking to invest in innovative non-bank lenders that support SMEs, and are cautiously optimistic about this element of the budget. It is abundantly clear that raising wholesale debt to lend on to SMEs is a major pain point for these organizations, and the government’s statements seem like a positive first step.
Next, on the consumer banking side, the government announced a “Financial Inclusion Mission” to expand banking access to all Indians, particularly those in weaker sections of society, including women, small and marginal farmers, and laborers. This is consistent with recent recommendations from the Reserve Bank of India (RBI) to create free bank accounts for every citizen, which would be biometrically verified through the “Aadhaar” program.
This is an exciting vision, but it does not address a seeming lack of consumer interest in traditional banking products and services: numerous government and non-profit initiatives have focused on opening bank accounts for the poor, which then see little or no use.
Part of the solution is to liberalize the sector and inspire greater experimentation. A great example of this is the recent move to allow microfinance organizations (MFIs) to operate as business correspondents – equivalent to agent banking in which retailers or individuals are distributors for a range of financial services. The government also proposed to introduce uniform standards for customer verification (KYC) that can be used across the financial sector. These kinds of changes could increase competition, lower costs, and allow more innovative models of customer engagement to emerge.
The RBI also announced draft regulation for payments banks and “small banks” which will allow eligible financial institutions, MNOs, retailers, cooperatives, and others to provide remittance, payment, and limited deposit and lending services. There is talk that the Indian Postal Service will be granted a payments bank license. With a wider branch network than the largest Indian bank (the State Bank of India), this reform will enable citizens in remote areas to access and remit money far more easily.
These are great steps forward, but from what we have seen so far, minimum capital requirements for these kinds of entities may be too high to allow real experimentation. The government must work hand-in-hand with the RBI to enable a range of actors to work more effectively and flexibly together, encourage the harmonization of the patchwork of standards, and allow for them to leverage each-others’ expertise and infrastructure to deliver innovative and consumer-centric products to the market.
To accelerate financial inclusion in India, the government will need to continue to partner with the RBI, support successful programs initiated by the Congress (including the vital Aadhaar scheme), and design specific and relevant reforms for both the financial sector and the broader economy. Arun Jaitley, the Finance Minister who presented the budget said, “This is the beginning of our journey, not the end.” As with much in India, the ideas may be strong, but the real challenge is execution.
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