The Mor Committee on “Comprehensive Financial Services for Small Businesses and Low-Income Households” submitted its report in record time. The elaborate report is comprehensive – it has the large aspirational ideas and replete with technical and micro details. The report will no doubt generate a lot of debate and also hopefully lay the foundation for the future financial institution architecture to deal with the inclusion of those that are currently outside the formal financial system.

The Committee’s six vision statements are apt and address the current problems in financial inclusion. The four design principles – Systemic Stability, Balance Sheet Transparency, Institutional Neutrality, and Responsibility Towards the Customer – are well thought out and will provide a sound basis to test any new policy or strategy or change from existing policy/strategy.

Several positive suggestions have emerged. These include:

  1. Licensing of new categories of banks with lower entry requirements, making priority sector lending (PSL) portfolios tradable through a variety of instruments;
  2. Allowing non-bank financial companies (NBFCs) to be business correspondents (BCs);
  3. Pricing freedom for banks on farm loans;
  4. Reorienting the focus of the National Bank for Agriculture And Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), National Housing Bank (NHB), etc., towards facilitation of other financial sector institutions;
  5. Universal reporting of loans to credit bureaus; and
  6. Setting up a registry of financial institutions that the public can access to verify the antecedents are all positive suggestions.

In addition, the strong links with Aadhaar’s unique identification number, improving the interface of white label ATMs with banks, withdrawal of tax on securitization transactions, freedom to banks and BCs to agree on risk sharing, introducing a small loan guarantee facility with NABARD for farm loans etc., address current problems in a way that will alter the business practices and improve efficiencies all around. The suggestion to address data needs through quarterly reporting and periodic surveys on access to finance are also very appropriate.

However, there are also a number of issues that arise. The short time limit given for realizing the vision statements could present a problem. The idea that these are achievable in less than two years seems more idealistic than realistic.  Secondly, by repetitively referring to “low cost”, “reasonable pricing”, “affordable pricing” etc., the Committee has moved away from its design principle of institutional neutrality. At the retail level, small, niche institutions with higher base cost only can deal with small ticket products. By requiring reasonable costs, this type of institutions is excluded even before they start.

On certain larger issues, the committee could have dived deeper. The suggestion to increase priority sector lending from 40% to 50% of adjusted net bank credit (ANBC) will not have been an easy recommendation to make. But the relevance of PSL and specifically the continuation of the 18% requirement for agriculture – which makes a contribution of about 12% to gross domestic product (GDP) – should be questioned.

The discourse on the credit to GDP ratio is interesting. While a higher credit to GDP ratio might be in the best interests of growth in the medium term, a very high rate has negative implications. Very high credit to GDP ratio contains the seed of asset bubbles, as credit availability boosts asset prices all around. Secondly, adequate domestic financial savings levels should be established before large-scale credit expansion can take place. Econometric modeling of required savings rate might well show that a huge effort will be required in the Indian context to achieve higher domestic household savings rates required to drive high credit to GDP ratio.

The continuation of NPA based portfolio assessment is an anachronism in the current context. All financial institutions should use portfolio at risk as the first choice tool for measuring risk in their loan assets. If MFIs can successfully use the same, banks should be able to adopt the same.

Comments on the current regulatory stance – that regulatory bandwidth will determine the financial architecture – are conspicuous by their absence. While useful suggestions were made on how to use other proxies for supervision, a forthright statement that for a country of India’s size, a large supervision machinery may not be inappropriate (and indeed may be essential) would have a gone a long way in goading the Reserve Bank of India (RBI) to re-examine its regulation function. Currently, we require the regulator not only regulate but also to develop the financial sector and make it the prime mover of the economy – including for low income and vulnerable people.

The challenges in regulation are yet to come. Going by the Committee’s report, a number of new institutional types have to be licensed,  their market conduct supervised, customer protection mechanisms expanded and sharpened to provide comfort to the new clients, systemic issues to be addressed and a much larger number of financial institutions have to be brought under supervision for periodic assessment of solvency, sustainability, and probity. The preparatory work of designing the entry requirements, eligibility criteria for promoters of new institutions, developing a regulatory and supervisory framework, hiring and capacity building of staff to handle the expanded number of institutions and putting in place a sound off-site surveillance mechanism are tasks that will demand considerable energy and time. Once the preparatory work is complete, the ongoing monitoring and surveillance will be rigorous and take up a considerable amount of the central bank’s time in the initial years. A significant part of the challenge will be the change in mindset required of the regulator with regards to the new institutional types and their relevance for financial inclusion. We cannot avoid facing the challenges before they arise by limiting the institutional architecture.

India’s current efforts at financial inclusion perpetuate poor quality service to low-income people; they should expand choices. The Mor Committee has created a basis for expanding choices – the regulator should actively pursue this line of thinking, to enable other existing institutions and possibly new ones, to offer services to the people excluded by the current formal financial service infrastructure.

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