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Research World, Volume 12, 2015
Online Version


Article S12.2

Seeking Research Objectives to Study Rural Finance

Mrigakshi Das, Subhendu Patnaik
Doctoral Candidates, Xavier University, Bhubaneswar, INDIA
mdas[at]stu.ximb.ac.in

Published Online: September 12, 2015


Note. This report is based on the “Topic Registration Seminar” delivered by Alok Pattanayak, Doctoral Candidate, Xavier Institute of Management, Xavier University, Bhubaneswar, India.

Rural Financial Services

Doctoral candidate Alok Pattanayak began his seminar by discussing the Asian Development Bank’s report on rural finance in India (Asian Development Bank, 2005). As per this report, “India has one of the world’s most extensive formal rural credit systems, with nearly 47,000 bank branches and approximately 100,000 cooperative credit outlets in rural areas” (p. 3). However, the physical outreach of rural credit has not been effective in achieving income expansion and poverty reduction due to several factors like high transaction cost and low population density. Hence, access to financial services is still an issue in rural areas. The higher transaction costs associated with dispersed populations and inadequate infrastructure, along with the particular needs and higher risk factors inherent in agriculture (which is the major occupation in rural India) result in an under-provision of financial services in rural areas. Also, where services are available, these do not always meet the needs of the rural households.

Access to financial markets is important for poor people to take advantage of profitable business opportunities and increase their earnings potential. Although rural contribution to the Indian GDP stands at 40%, the Indian commercial banks’ total credit to rural areas is only 10%. The credit cooperative structure is known to serve the interests of middle and larger farmers. A variety of microfinance institutions working with the poor, though effective, lack scale due to their limited ability to raise resources in the absence of facilitative regulations. The near absence of risk mitigation mechanisms such as insurance for life, health, crops, and assets, commodity derivative contracts to deal with price risks, and limited access to financial services in rural India exacerbates the vulnerability of the poor.

Reduction of Rural Poverty

Based on the literature review, Pattanayak found that the following factors have played a role in reducing poverty in rural India: (a) access to financial services, (b) financial inclusion, (c) effectiveness of rural financial system, and (d) financial literacy.

Access. Lack of access to financial services is considered to be a major constraint to development of the rural sector, particularly increasing investments capability and productive activities. As per the literature, majority of the population in less developed countries have very little or no access to financial services. Moreover, the literature also suggests rural financial institutions are facing several constraints in providing services to the rural poor, such as internal practices and attitudes, and mechanisms for client enhancement. Government initiatives in the creation of multiple state-owned or state-sponsored channels of credit have had a mixed influence on the rural banking sector. The erosion of the repayment ethic and the weakening of the mutual trust between bankers and borrowers have been major negative consequence of linking up poverty alleviation programmes with bank credit.

Financial Inclusion. In simple terms, financial inclusion refers to the availability of banking and financial services to the rural poor at an affordable cost. Financial inclusion includes services such as credit facility, savings account facility, and insurance services (Bhandari, 2009).These services are normally provided by financial institutions. Effective execution of financial inclusion initiatives requires support from the government and it should be supported by an appropriate regulatory framework. Financial inclusion initiatives should be free from political interferences (Dev, 2006). Development of an inclusive financial system is treated as a poverty reduction strategy. However, only growth in the number of bank accounts does not guarantee reduction in poverty (Bhandari, 2009). Poverty alleviation depends on economic growth. Therefore, the effectiveness of a financial system should be assessed in terms of the economic growth stimulated by it (Mor& Ananth, 2007).

Researchers argue that the relationship between availability of financial service and rural poverty could be bidirectional in nature. It implies that financial exclusion increases susceptibility of rural people to fall into the poverty trap which, in turn, produces low demand for financial services (Bhandari, 2009). Rural people need credit and necessary financial services to generate economic activity and earn their livelihood but surprisingly financial inclusion in India is mostly restricted to having saving accounts. This only serves as a precondition but does not guarantee effective financial services. Hence rural people do not get the benefits of an inclusive financial system.

Effectiveness. The Rural Finance Access Survey, 2003 (conducted jointly by the World Bank and the National Council of Applied Economic Research, India) found that 44% of rural households availed financial assistance from informal sources and such loans were subjected to exorbitant rate of interest (48% per annum). The rural financial system has not been effective in reducing the dependence of rural households on traditional sources of credit, such as money lenders, friends, and relatives (Basu, 2005).

Financial Literacy. Financial literacy is an important instrument to raise demand for banking services in India (Bose & Sardana, 2014). Financial literacy is known to generate rational financial behaviour. It stimulates demand for bank accounts as people become aware of available financial services. Financial literacy is expected to facilitate competition in the financial services sector and help in efficient allocation of capital within society (Cole, Sampson, & Zia, 2011).

India requires a financial system that can generate and sustain economic growth. Effective financial inclusion is likely to bring economic benefits to the poor. As per the recommendations of the Vaidyanathan Committee (i.e., Task Force on Revival of Rural Co-operative Credit Institutions, Government of India, which submitted its final report in February 2005), cooperatives in India should be revitalised and should work towards financial inclusion.

Inability of formal financial institutions to meet the specific needs of the poor has enabled informal service providers to fill the vacuum and exploit the rural poor (Ananth & Öncü, 2013). Success of financial inclusion would depend on a number of factors such as measures that expand the scope of the formal banking sector, overcoming pervading information asymmetries, expanding financial literacy, mandating appropriate agencies to lead efforts that expand financial inclusion, and creating a relevant suite of financial products that meet the needs of the financially excluded (Ananth & Öncü, 2013).

Discussion

Finally, the seminar considered the possible research objectives in this field. It was suggested that rural finance cannot be considered in isolation from the broader socioeconomic context. Future research could focus on studying the impact of rural finance on poverty reduction, taking into account the broader contextual factors.

References

Ananth, S., & Öncü, T. S. (2013). Challenges to financial inclusion in India: The case of Andhra Pradesh. Economic and Political Weekly, 48(7), 77-83.

Asian Development Bank. (2005, October). India: Rural finance sector restructuring and development (Volume 1: Executive summary). Retrieved from http://www.adb.org/sites/default/files/project-document/75076/exec-sum.pdf

Basu, P. (2005). A financial system for India's poor. Economic and Political Weekly, 40(37), 4008-4012.

Bose, S., & Sardana, A. (2014). Financial literacy in rural banking: Proposal for an alternate approach. Economic and Political Weekly, 27, 80-85.

Bhandari, A., K. (2009, April). Access to banking services and poverty reduction: A state-wise assessment in India (IZA Discussion Paper No. 4132). Retrieved from http://ftp.iza.org/dp4132.pdf

Cole, S., Sampson, T., & Zia, B. (2011). Prices or knowledge? What drives demand for financial services in emerging markets? The Journal of Finance, 66(6), 1933-1967.

Dev, S., M. (2006). Financial inclusion: Issues and challenges. Economic and Political Weekly, 41, 4310-4313.

Mor, N., & Ananth, B. (2007). Inclusive financial systems: Some design principles and a case study. Economic and Political Weekly, 42(13), 1121-1123.



Suggested Citation: Das, M., & Patnaik, S. (2015). Seeking research objectives to study rural finance. Research World, 12, Article S12.2. Retrieved from http://www1.ximb.ac.in/RW.nsf/pages/S12.2




Copyleft The article may be used freely, for a noncommercial purpose, as long as the original source is properly acknowledged.

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