The banking system in India consists of Commercial Banks (CBs), Cooperative banks
and Regional Rural Banks (RRBs) which play a significant role in purveying rural
credit. The distribution of credit underwent a substantial structural transformation
in the post-bank nationalization period mainly due to mandated credit approaches,
especially for CBs. Though much of the credit from the commercial banking sector
was mandated, these banks still hold a sizeable stake in the formal rural credit
market. Although the directed approach succeeded in altering credit allocations,
its impact on viability and sustainability of rural banking left much to be desired.
High appraisal and monitoring costs of well-dispersed loans of different sizes have
often compelled banks to reduce their efforts on these fronts leading to poor credit
penetration and coverage as well as poor recoveries. This issue had been further
compounded due to low staff position in rural branches in the post-Voluntary Retirement
Scheme (VRS) scenario and staff turnover.
Until recently, poor persons applying for microloans in order to improve their selfemployment
opportunities were mostly excluded from the credit market. As a consequence, they
were either unable to be self-employed, or if they had started their own business,
suffered from underfinancing and were not able to expand their business. At a macrolevel,
the lack of financial capital for small and microbusinesses had been a major obstacle
not only in developing, but also in transition economies, and to a smaller extent
in industrialized economies.
The reasons for their exclusion were risks and high transaction costs associated
with microcredit. Persons without collateral were unable to signal their creditworthiness
which inhibited banks from granting their loans by collateral, making them incapable
of accessing their risk. Given that persons running a microbusiness mostly ask for
small size loans, it was not feasible in the usual banking system to substitute
the additional screening and monitoring efforts for collateral. The added cost then
surpassed the potential revenues and thus most institutional lenders using conventional
financial technologies considered the disbursement of microcredits highly inefficient.
Innovations of credit products and delivery systems which would help banks manage
transaction costs relating to appraisal and monitoring, and which cover default
risks and reduce delinquency levels in this niche segment of agriculture credit
have eluded the banking system. Innovations like Self-Help Group (SHG)-Bank linkage
program have brought in tremendous reprieve for the bankers, especially while dealing
with asset-less or ultra poor. Studies by the Agriculture Credit Review Committee
(ACRC) have shown that the phenomenon of overdues is generally neutral to the category
of borrowers financed and the variations in recoveries between different classes
of borrowers were only marginal. Recoveries from the middle categories of borrowers
in rural banking sector continued to cause concern for the bankers. SHGs have been
a successful product for the poor across the nation. However, with the movement
gaining ground, there was a need to develop products for other segments of population
above the poor, but in dire need of credit. These segments also did not have much
physical collateral to offer. Learning from the positive experience of the SHGs
of transferring risk from physical collateral to social collateral, it was thought
that the new product would also use the social collateral to replace the physical
collateral.
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