Lead Bank Scheme needs to contextualise recent changes instead of tinkering

– Prof. M. S. Sriram
IIM Bangalore

The draft circular makes changes in the coordination structure, with subcommittees for inclusion and literacy; agriculture; micro, small, and medium enterprises (MSMEs); and payment systems

When the Reserve Bank of India (RBI) released the new (draft) circular for the lead-bank scheme (LBS), several newspapers carried reports about the proposal to closely monitor credit/deposit (C/D) ratios in rural branches. However, a bit of digging into the past indicates that these are not new concerns but were part of the master circular issued in April last year.

The concerns articulated in the RBI circular do not have any fundamental changes; they continue to be:

• Expanding banks’ presence in unbanked rural areas, making banking services universally accessible;
• Better deployment of credit based on a block-level identification of opportunities;
• Coordination with states and their developmental imperatives.

Apart from tinkering with the coordination mechanism by introducing multiple subcommittees, the draft circular was not particularly newsworthy. Now that the circular is in the news, it is worth examining the relevance of the LBS in current times.

The previous review was in August 2009, when a high-powered committee chaired by Usha Thorat examined the issue. The conditions have significantly changed since then. The growth of the microfinance sector has made loans available to women across geographies, sometimes even leading to pockets of over-lending.

Additionally, the branch licensing policy mandates that 25 per cent of new branches be in unbanked locations, the Jan Dhan Yojana has brought households into the banking system, small finance banks (SFBs) have been licensed, and the banking sector, including private banks, has consistently met priority-sector lending (PSL) targets.

The circular outlines two key objectives of the LBS:

• The first objective of “enhancing the flow of credit to priority sectors for achieving inclusive growth” is adequately addressed;
• The second objective — “deepening financial inclusion through improved access and usage of financial services” — needs attention.

The draft circular makes changes in the coordination structure, with subcommittees for inclusion and literacy; agriculture; micro, small, and medium enterprises (MSMEs); and payment systems. Even here, the tone of the circular focuses more on credit planning and disbursement rather than adapting to the evolving financial ecosystem.

The contextual framework of the LBS was rooted in pushing credit to excluded sections of society and required district-level credit committees and annual block- and district-level credit plans. Banks also had a clear service area. Most of these have now been breached.

• The concept of a service area no longer exists, and with interconnected banking, even the idea of a home branch is becoming irrelevant.
• Many players in the credit market — microfinance institutions, gold-loan companies, and non-banking finance companies (NBFCs) — are dispensing credit while not being authorised to take deposits.
• The changes in the PSL architecture have incentivised lending to underserved areas by giving additional weights to underbanked districts, and with the tradability of PSL obligations through PSL certificates, there is a discovery of opportunity sets.
• The RBI has reduced priority-sector obligations for SFBs from 75 per cent to 60 per cent of adjusted net bank credit. It has also reduced the threshold for qualifying assets to 60 per cent for NBFC-MFIs (microfinance institutions). Both these indicate the RBI’s movement away from hard regulation to respecting the market forces.

In this context, the lead bank continuing to look at credit plans and monitor C/D ratios of banks makes limited sense. MFIs and other players have been lending in districts where the C/D ratio is low, without needing permission to take deposits.

The priorities of financial inclusion in the current context are different.

First, there is a need to focus on savings-led inclusion. With the Jan Dhan Yojana and the architecture of business correspondents, bank accounts are nearly universal. However, there has been no concerted effort to encourage savings among the poor through safe and accessible options. The belief that the poor cannot save is misplaced; saving is fundamentally about managing cash flows, something they often do effectively.

Second, while digital payments are now widespread, accounts remain tied to devices. The focus should be on enabling each account holder to transact independently using their own personal device.

Third, and most importantly, is consumer protection. Financial literacy is often bundled with inclusion, but the real need is for strong customer rights, protection mechanisms, and meaningful education. Teaching concepts like compound interest is of little value if people lack real financial choices.

The nomenclature of a “lead bank” itself is now outdated. In the current environment, the structure of the state-level bankers’ committee needs to be reimagined, and financial-sector data should be integrated into a broader coordination framework.

Institutions such as cooperatives, chit funds, pawnbrokers, and moneylenders — all regulated by state legislation — should be brought into this framework. The RBI should work with state governments to establish state-level financial-sector development and regulatory authorities that can ensure registration, collect data, and coordinate regulation.

This model has worked for urban cooperative banks and can be expanded to include other state-level financial actors.

There is a need for a new high-powered committee with updated terms of reference that reflect developments over the past 15 years. We have had enough tinkering.

Source: Business Standard