How India's Financial Inclusion Infrastructure Failed During the Pandemic

Despite the fact that India's financial inclusion infrastructure has a complex mix of self-help groups and small private banks offering credit to the poor, it has failed to deliver during the pandemic.

When the pandemic struck, policymakers and prominent economists across the world called for financial infrastructures to be strengthened. They argued this would support the efficient channeling of relief through cash transfers or cheap loans. India was no exception to the optimistic discourse. Proposed relief for the poor relied heavily on financial inclusion infrastructure, coming in the form of targeted transfers to bank accounts, increased credit to women’s savings groups, and moratoria on micro-loans.

However, having studied household financial practices and debt in rural India over many years, we had serious doubts. One year into the pandemic, it is clear that our fears were well-founded. In India, financial inclusion infrastructures have proven to be a tool for revenue capture rather than distribution.

Financial inclusion in India: From self-help groups to global finance  

Financial inclusion is considered “a key enabler to reducing poverty and boosting prosperity” by the World Bank. The idea of financial inclusion started out with microcredit. Its founding promise was to end poverty by empowering the poor to start small businesses. This grew to a broader promise: to offer everyone, regardless of income, a set of banking services and to enable the poor to “make the best use of their money”. Further, it is purported to strengthen their citizenship through the effective delivery of cash transfers.

Also read: Financial Inclusion in Liberalised India – a Ringside View

In India, civil society organisations first created microcredit programmes in the 1980s, and for-profit global institutions entered by the early 2000s. Today, India probably offers the most ambitious financial inclusion infrastructure in the world, with a complex mix of self-help groups (SHGs) and small private banks that offer credit to the poor, and a variety of public programmes.

 self-help group

Representational image of self-help group. Photo: Twitter.

In 2020, India’s microcredit portfolio was estimated at Rs 1.08 lakh crore, 80% of which was held by for-profit entities. The number of adults with a bank account almost doubled over a few years to include more than four-fifths of the population.

Channeling cash transfers through financial infrastructure: A false promise

The Central government’s relief package included cash transfers of Rs 500 to women’s Jan Dhan bank accounts for three months, and a further one-off Rs 1,000 to senior citizens, handicapped individuals and widows. Not only were these amounts strikingly low, at under one-tenth of development economists’ recommendations, but most of that relief came from existing budgets, and much of it missed its target.

To receive funds, households had to include at least one female member with a Jan Dhan bank account. These accounts are a key part of the Central government’s flagship PMJDY. But it has been estimated that only 57% of poor Indian households hold such an account.

As part of a two-year research study funded by the UK’s Global Challenges Research Fund, we studied three villages in Tamil Nadu during the six-month lockdown period and carried out a quasi-exhaustive survey. None of our interviewees had received a cash transfer from the Central government. Yet most of them, including women, held a non-Jan Dhan bank account that they had opened under other state programmes. This shows the lack of coordination between federal and state programmes, and the clear prioritisation of political interests over people’s wellbeing.

Others had been disqualified because their bank accounts weren’t linked to their Aadhaar number, or because they hadn’t completed their KYC (Know Your Customer) update with their bank. And even if they had received a transfer, accessing the banks or ATMs would have been very challenging owing to the distance, curbs on movement, entry restrictions and long queues – all the more so for women.

Also read: Direct, Conditional Cash Transfers Will Help Blunt COVID-19’s Economic Blows

Despite claims to the contrary, technology has not eradicated manipulation and fraud, as the Tamil Nadu PMKSNY (Pradhan Mantri Kisan Samman Nidhi) farming subsidy scandal has shown. Collusion among private computer center owners, cooperative society leaders, and agriculture department officials resulted in the diversion of funds earmarked for farmers to other accounts. Out of over 80,000 beneficiaries, it seems that only 4% were genuinely eligible . In the Cuddalore district alone, the sum misappropriated is estimated at Rs 80 crore.

Self-help group credit for the wealthiest

The relief package also promised to double the maximum credit limit for women’s self-help groups from Rs 10 to Rs 20 lakh.  The claim was that 63 lakh SHGs and seven crore poor households would benefit. In fact, an RBI working committee (UK Sinha committee) had proposed this change in 2019, arguing that it was justified purely in terms of adjusting for inflation. Furthermore, though the scheme’s benefits are presented as reaching all SHGs, most groups are not even eligible for the previous upper limit – the average value of SHG loans is 1.3 lakh rupees – so even if loan values increased, they would not receive Rs 20 lakh. And in any event, this change was not implemented.

The Tamil Nadu government issued a small pool of funds to state-level SHG federations, this was used to grant loans ranging from Rs 20,000 to Rs 50,000 to a handful of women amongst hundreds of members in each village panchayat. These loans were issued on favourable terms, repayments only began three months after the loan was issued, and the monthly interest rate was under one percent. The beneficiaries were the wealthiest.

Our field observations indicate that these funds were mostly taken by group leaders and others whose incomes had not been severely impacted by the pandemic, mostly from upper classes and upper castes.  The selection was based on perceived ability to repay. Many Dalit women had returned from migration sites because of the lockdown and depended on irregular and poorly-paid local agriculture coolie work. They were denied on the grounds that they would be unable to service the loans. This illustrates the limitations of a credit-based solution for vulnerable households at a time of a crisis.

Private lenders: Financial security first

Microfinance institutions (MFIs), with their self-proclaimed social mission, could have helped the poor by immediately issuing cheap emergency loans to help them cope with the massive fall in income. But this was not the case. Although most of the 78 MFIs interviewed as part of an industry-sponsored study in April 2020 said that they were keen to provide emergency credit, only two said they had the funds to offer it. Owing to their dependence on risk-averse (global, domestic and public) capital, microcredit providers found themselves severely lacking in liquidity, and unable to fulfil their claimed mission.

The Central government’s moratorium on loan repayments offered significant short-term relief. Unfortunately, many MFIs, whose own survival was doubtless under threat, ignored the moratorium and began to harass borrowers to repay as soon as staff could reach the villages. Some managed to assert their right to postpone repayment, standing collectively against the pressure. Even when successful, since interest continued to be charged throughout the moratorium period, delays made their loans much more expensive in the long run. Some chose to pay, either because they believed untrue threats of impact to their credit rating, or to avoid the extra interest costs. Borrowers who had received a digital loan linked to a bank account had no choice, as the repayments were deducted directly from their deposits.

As with higher-profile campaigns in Punjab and Assam, local leaders and unions have taken up demands to cancel debt, or at least additional interest. So far, they have had no success. When the moratorium was lifted last September borrowers had no choice but to repay. This was ensured by the new formidable weapon of credit scoring, accessible to formal lenders. A single overdue loan means a borrower is denied loans from all MFIs and banks. Repeated late payments result in a lower rating. Whereas previously loans officers had to resort to tactics that included individual threats, social pressure, intimidation and shaming, they now have a technology-based mechanism that does the work for them. Borrowers who attempted to resist repayment in order to negotiate reduced interest for the pandemic payment, conceded when they realised they would not receive a loan from any source until they had repaid. Since juggling debt is an inescapable part of household coping mechanisms, women cannot afford to be blacklisted.

Many households were simply unable to make repayments, however, and default rates rose sharply. While delinquency rates are usually strikingly low –between 1 and 2% – they were estimated at 10-15% last December. Among those who managed to pay, we observed in rural Tamil Nadu that this often came at the price of many, sometimes tragic, sacrifices whose impact is still difficult to estimate. These include reduced food consumption leading to malnutrition, a loss of assets (jewels, vessels, land, homes) and means of production (land, livestock, trees, bullock carts, vehicles), and eroded social capital when relatives are called upon to help with repayment. It has led to depression, rape, and sometimes suicide, as has been observed in other parts of India.

Microfinance, which lends without securities to women at the bottom of the pyramid, is intrinsically strong. Credit: Peter Haden/Flickr CC BY 2.0

Representative image. Photo: Peter Haden/Flickr CC BY 2.0

In early 2021, before the second wave arrived and while the economy seemed to be stabilising, MFIs started lending again. They pressured existing borrowers, still struggling with reduced incomes and unable to pay dues, to take out new loans. MFIs deducted outstanding balances and paid out the remaining sum, but required borrowers to immediately begin repaying the whole loan. This left poor women further in debt, while ensuring that MFI portfolios seemed more robust, with lower non-performing assets, evidence of lending activity, and higher-value asset accounts.

Also read: Additional 230 Million Indians Fell Below Poverty Line Due to the Pandemic: Study

Ultimately, the pandemic episode shows how the financial sustainability of lenders takes precedence over that of borrowers, despite the microcredit sector being largely dependent on public funding. In 2019, private funding for Indian MFIs was only 38%. Public support from soft loans is continuing with the pandemic, especially for the largest MFIs since they can show an investment grade rating.

The flaws of a debt economy 

Like any crisis, the pandemic has revealed the flaws of an accumulation regime that was already in existence. Beyond a model based on the circulation of labour, which was brutally exposed with the first lockdown, the pre-pandemic accumulation model was also based on a race for consumer debt, including amongst the poorest.

According to Reserve Bank of India data, household consumer debt rose threefold from 2012 to 2020. Microlevel data show that this debt boom was not just an urban middle-class phenomenon. Long before the pandemic, consumer debt of the rural working poor was increasing much faster than income or wealth. This debt was most often used to for living costs and sometimes to attempt to build a better life, whether by improving housing, educating children or paying for a good marriage. Debt is not necessarily bad if it can support investment. However, here it serves mostly as a substitute both for wages that are far beyond subsistence levels and for largely inadequate social protection. Thus, the core of the problem is not a model privileging private lenders that it is exploitative by design – and yet publicly subsidised. It also is a regime of accumulation that is incapable of ensuring the social reproduction of households, as a result of both the failure of private capital to provide subsistence wages, and an inefficient state unable to provide real social protection.

In the context of the pandemic, relief that came in the form of credit, especially from for-profit institutions, rather than substantive support from the state was simply an extension of this longer trend. Data from the first quarter of 2021 shows a significant additional increase in household debt. We have shown how problematic this is and argue that rather what was needed was adequate and effectively channeled state relief as well as regulation to ensure that lenders did not exploit already vulnerable households at this time.

Isabelle Guérin is Senior Research Fellow at the National French Research Institute on Sustainable Development. Nithya Joseph and G. Venkatasubramanian are respectively Post-Doctoral and Research Fellows at the French Institute of Pondicherry.