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Mainstream, Vol XLVI, No 25

Commercial Banking for the Rural Sector : Some Suggestions

Sunday 8 June 2008, by Anil Kumar Jain



After the adoption of the New Economic Policy in 1991, the Indian economy is becoming more and more mature with the passage of time on account of structural changes undertaken in different sectors and areas. The GDP growth rate has been much higher than the neo-Hindu rate growth and it has averaged over eight per cent during the past three years. While there has been acceleration in the industrial sector, especially manufacturing and services sector, and the country is graduating from a low-income regime to a middle income regime, there has been deceleration in agricultural growth, which reflects as a broad-based slowdown in the productivity growth. Some of the poorest and most populous States have fallen behind. The commercialisation of agriculture, as also technology intensification has resulted in creation of substantial surplus labour in the agriculture sector. As a result, as per the results of the Economic Census 2005, employment growth in the non-farm sector is much lower and average employment itself has declined during the 1990s as comparted to the 1980s.

While growth is important, it is also imperative that growth becomes more inclusive because if certain regions, sectors or groups of people are denied economic opportunities for long periods, the spread and sustainability of growth itself is threatened. Hence, growth, to be inclusive, must take into account the betterment of every section of society. Hence, it is imperative to ensure that higher growth is also more inclusive. In the Draft Approach Paper to the Eleventh Five Year Plan, the Planning Commission has emphasised the need for faster and greater inclusive growth during the Eleventh Plan period. The banking sector, as the most important financial intermediary to mobilise the savings leading to increased investments, facilitating growth would, thus, play the most crucial role in attaining the stipulated economic objectives through expansion of the coverage of banking services by reaching the vast unbanked and underbanked population of the country.

Historical Perspective

ADOPTION of a policy of social control over banks in 1967 and the nationalisation of 14 major scheduled commercial banks in 1969 have provedto be two major turning-points in the history of commercial banks in India. When the banks were nationalised in 1969, the primary focus was on social banking. government thought that it was necessary to ‘control the heights of the economy and to meet progressively, and serve better, the needs of development of the economy in conformity with national policy and objectives’. The setting up of Regional Rural Banks in 1975 and nationalisation of another five banks in 1980 further revealed the concern of the government towards meeting the credit requirements of agriculturists.

Farmers in India have had to face a number of problems, one of them being great difficulty in getting credit because of the peculiar nature of agricultural credit. The element of uncertainty is greater in agriculture as compared to other sectors because even today a considerably high proportion of Indian agriculture is dependent on the vagaries of the monsoon. The agriculturalists (borrowers) want credit at relatively low rates of interest but the lender desires to charge a higher rate of interest to cover the risk of uncertainty. Therefore, one of the important objectives of the nationalisation of 14 major commercial banks in India, among others, was to make a provision of adequate credit for agriculture and the agricultural sector was included in the category of priority sectors. On the recommendations of a Committee of Bankers, the Lead Bank Scheme was introduced and throughout the seventies targets were set for commercial banks to open up branches in rural and semi-urban areas. In the years that followed, banks reached the targets and, in some cases, even surpassed them. The total direct and indirect finance by the public sector banks to agriculture increased from Rs 162 crores in June 1969 to Rs 3881 crores in June 1981 (24 times) and the number of accounts increased from 1.7 lakhs of 96.99 lakhs. (Table 1). The number of branches in rural areas also increased from 1833 branches in 1969 to 17,656 branches in 1981 (over nine times) and that in semi-urban areas from 3342 branches to 8471 branches during the same period. This policy of target fixation continued in future years also. Consequently, the number of accounts, advances to the agricultural sector, as also the number of banks offices in rural and semi-urban areas increased.

In the meantime, the Working Group on Rural Banks (Chairman M. Narasimham) recommended in 1975 the setting up of Regional Rural Banks, as part of a multi-agency approach to rural credit. Accordingly, scheduled commercial banks’ total advances (direct and indirect) further increased to Rs 16,750 crores in 1990-91 and the number of scheduled commercial banks’ offices increased to 35,206 in rural areas and to 11,344 in semi-urban areas by 1991.

The Economic Reforms launched by the Indian Government in 1991 were designed to accelerate the overall growth and help India realise its full productive potential. Structural reforms were undertaken in industry, trade, foreign investment, fiscal front and various policy initiatives were undertaken in the area of agriculture. The basic objective behind all such reforms was to improve efficiency by encouraging competitiveness in the economy. These reforms were supported by reforms in the financial sector, including the banking system which has the prime responsibility for mobilising and allocating financial resources. Accordingly, reforms in the banking sector in the post-1991 era have been largely influenced by the recommendations of the Report of the Committee on Financial System 1991 (Chairman M. Narasimham). The first phase of reforms focused mainly on enabling and strengthening measures. During the second phase of reforms, based on the recommendations of the Committee on Banking Sector Reforms 1998 (Chairman M. Narasimham), greater stress has been placed on structural measures and improvement in standards of disclosure and levels of transparency so as to align Indian standards with the best international practices.

While it is true that the policy environment during the nineties has been dominated by the liberalisation of the banking sector, greater concern with prudential norms for banks, risk management, etc. and most of the efforts have been concentrated in the urban and metropolitan centres, it is also true that priority sector lending, including agriculture, has also continued to grow. The total number of bank accounts in the agricultural sector with public sector banks have increased from 198 lakhs in 1995 to 253 lakhs in 2007 and the total outstanding advances for agriculture have increased from Rs 23,328 crores in March 1995 to Rs 2,05,091 crores in March 2007 (direct finance from Rs 20,562 crores to Rs 1,46,941 crores and indirect finance from Rs 20,766 crores to Rs 58,150 crores. The government has laid emphasis on agricultural credit in the post-1991 period also because agricultural credit, by promoting agricultural and related business, plays an important role in poverty alleviation and creation of employment. Keeping this in view, the Reserve Bank of India had advised the public sector banks to prepare Special Agricultural Credit Plans (SACP) in 1994-95. The SACP mechanism was also made applicable to the private sector banks in 2005-06. The disbursements by the public sector banks to agriculture under SACP have increased from Rs 25,654 crores in 2000-01 to Rs 1,22,215 crores in 2006-07.1 The private sector banks also made disbursements under SACP of Rs 31,1999 crores in 2005-06 and Rs 18,819 crores in 2006-07.

Keeping the importance of agricultural credit in mind the Tenth Five Year Plan envisaged a substantial increase in credit flow to agriculture from a level of Rs 2,29,956 crores achieved during the Ninth Five Plan to a level of Rs 7,36,570 crores during the Tenth Five Year Plan.

Under the government’s policy, all domestic banks (including private banks) and foreign banks are required to provide 40 per cent and 32 per cent respectively, of their net banking credit to the priority sector. From Table 3, it would be clear that both public and private sector banks had achieved their overall target for priority sector lending in March 2006. However, the public sector banks fell short of the target of 40 per cent by 0.4 percentage points by March 2007 whereas the private sector banks had achieved their overall target. Foreign banks had also advanced 33.4 per cent loans to the priority sector, as against target of 32 per cent, as on last Friday of March 2007.

In recent years, two innovations, namely, micro- finance and Kisan Credit Card (KCC) Scheme, have emerged as the major policy tools to address the problems associated with the distributional aspects of rural credit. Today micro-finance, the Self-Help Group-Bank Linkage Programme (introduced in 1992), has emerged on the major micro-finance programme. At the end of March 2007, 29.24 lakh SHGs were linked to banks covering a total flow of credit of Rs 18,040 crores. Similarly, the Kisan Credit Card (KCC) Scheme was introduced in 1998-99 to provide adequate and timely credit support to the farmers in a flexible, hassle-free and cost-effective manner. Hence the KCC Scheme has become very popular and by the end of March 2007, 26.6 million KCCs have been issued by the public sector banks, with limits amounting to Rs 94,712 crores.

Critical Appraisal

WHILE it is true that since 1991, the policy environment has been dominated by the liberalisation of the banking sector and greater concern for prudential norms for banks and risk management, most of these efforts have been concentrated in the urban and metropolitan centres and very little change has effectively come in the rural areas. Even today, majority of the rural branches are running in losses, the deposit mobilisation is not up to the desired level, there are problems in granting advances etc. In their anxiety to reach the target of 40 per cent to the priority sectors, banks have gone in for indiscriminate lending. There have been external pressures on the banking sector to lend to weaker sections. What is still worse, much of the priority sector lending has to be at a low concessional rate of interest. Despite these pressures, the total priority sector lending by public sector banks has come down from 43.6 per cent in March 2004 to 39.6 per cent in March 2007 and lending by the private sector banks from 47.3 per cent to 42.7 per cent during the same period (Table 3).

Another trend witnessed since 1991 is that scheduled banks are opening more and more branches in semi-urban, urban and metropolitan centres and the number of rural branches are going down. From Table 2 it would be clear that while the total bank offices have increased from 60,220 at the end of June 1991 to 71,781 offices in June 2007, the number of bank offices in the rural areas has gone down from 35,206 offices in 1991 to 30,633 offices in 2007.

Further, as the priority sector loans have been of small amounts, the public sector banks not been able to adequately monitor the distribution, follow-up and recovery of loans, resulting in squeezing of profitability and increase in non-performing assets. Non-Performing Assets (NPAs) of the end of March 2006 were 54.07 per cent for the public sector banks, as against 29.17 per cent for the private sector banks.2 The official compulsions of keeping a high proportion of their deposits in liquid form and subsidisation of credit added fuel to fire. Over the years, there has been growth in staff, resulting in increased operating expenses—although in the recent past this ratio has gone down on account of compulsions of increased competition from private sector and foreign banks. Moreover, very few programmes focused on micro-enterprises or encouraged diversification away from agriculture. This led to a focus merely on geographical expansion of the rural areas, where the banks’ branches offered credit in sizes which were too large to be made use of by the very poor. These practices led to a high default.


ENHANCING the growth rate in agriculture to 4.1 per cent, as envisaged in the Approach Paper to the Eleventh Five Year Plan, and improving its robustness would require substantial investment in irrigation and water management technologies, diversification and boosting productivity of different crops through improved seeds and plant-care practices. The move towards inclusive growth is a big challenge for the financial system of the country, including commercial banks. Banks would need to adopt an innovative, customer-friendly approach to increase their effective reach so that the share of organised finance increases. A participatory and partnership-based model for financial inclusion, coupled with community-linked financial initiatives is the need of the hour. In the near future customer-friendly products, delivery channels, relationship banking, dependency on IT systems and competitive pricing would be the driving forces. Banks will to move to a high-tech banking. The Internet would be the engine of the banking revolution in the decades to come and e-commerce would be its fuel. Therefore, the key to survival of banks in future will be the retention of customer loyalty by providing value-added services tailored to their needs.

First, traditionally banks have viewed rural areas as a segment purely in need of upliftment. This was based on the underlying philosophy of a social obligation. However, the future lies with those who see the poor as their customers, namely, financial inclusion. By ‘financial inclusion’ is meant the provision by the financial system, of financial products and services at an affordable price, to those who have been financially excluded. As banking services are in the nature of a public utility service, it is essential that banking and payment services are provided to the entire population without discrimination. The harsh reality is that the spread of banking facilities in India is uneven, with a substantial portion of the households, especially in the rural areas, still outside the coverage of the formal banking system. Almost 40 per cent of the adult population of the country is unable to access mainstream financial products.3 The Reserve Bank of India has recently adopted a decentralised approach in this regard with close involvement of State Governments and banks and has used multiple channels to expand the outreach of banks. It is important to mention that the Union Bank has launched a new initiative called ‘Village Knowledge Centres’. Here, technology is used to help the farmer improve his productivity. The Bank’s staff at these village knowledge centres act as relationship managers, liaising between local authorities and farmers, facilitating the opening of accounts and ensuring that credit is provided to the needy. Such examples need to be followed by other banks.

Secondly, commercial banks should change their marketing concept. Under the new concept of marketing, the task of management should not so much be skill in making the customer do what suits the rest of the business, as to be skilful in conceiving and making business do what suits the interest of the customers.

Thirdly, stress should be laid on deposit mobilisation from the agricultural sector itself to finance its own credit requirements. Such a move will entail two steps—curtailment of unproductive expenditure and deposit of savings by the agriculturists in banks. It is common knowledge that villagers spend huge sums on unproductive social ceremonies, drinking, litigation, etc. Their outlook needs to be changed with the help of banking staff and utilising the services of the mass media. Villagers must be convinced that money spent on such social obligations is a waste and they themselves would gain in the long run if they would save and invest. The services of officers and staff of the community development projects may also be utilised for this purpose.

Fourthly, the more important aspect of the whole drive is the deposit of savings by the agriculturist in the banks. Vast sums of money are lying idle even today in rural areas. We think that, in spite of different agencies engaged in providing agricultural finance, the village moneylender continues to be a necessary evil. These moneylenders have great influence on the villagers. To mobilise the savings of the villagers, the services of these moneylenders—both professional and agricultural—can be utilised. The nationalised banks may appoint them as their agents. The banks should then ask them to encourage the villagers to deposit their money in the banks and approach the banks for loans through them. The banks may give them a sort of del credere commission, depending upon the quantum of business done by them, as is done in the case of agents of the Life Insurance Corporation, General Insurance Corporation, National Savings Organisation, etc. Such a step would help in mobilising savings. The appointment of moneylenders as agents has an added advantage. These moneylenders have been living in villages for a long time and are, therefore, accustomed to the rural way of life. They know the local language and can, therefore, mix well with the villagers.4 This is not the case with the qualified, educated and sophisticated bank staff. Many a time, superiority complex on the part of the bank employees drives away the villagers. As a corollary to this, it is also suggested that, as far as possible, the staff to be deputed in the rural branches, should be drawn from the villages or semi-urban areas themselves and better living conditions be assured for the bank employees.

Fifthly, there is need for a reorientation in the credit policy of banks. Priority sector lendings should be restricted only to the core sector. Banks should provide credit not merely on the basis of collateral security such as land and buildings but they should also advance loans to the agriculturists after assessing the ‘absorptive capacity’ and the increase in productivity that is feasible with the help of such loans. Crops should also be accepted on a loan of security. To assess the ‘absorptive capacity’ of the farmers commercial banks should maintain a staff of agricultural experts.

Sixthly, the commercial banks should also provide credit to the agriculturists on the basis of ‘joint guarantee’ given by the village panchayat or by a few well-known farmers of the village. The acceptance of such a basis will greatly help the farmers, particularly small farmers, in securing loans from commercial banks. This will also result in more purposeful advent of the commercial banks in the rural sector and will bring them into relationship with cooperative institutions. It will also ensure a fair understanding between them and encourage commercial banks to operate on the principle of collective service for a collective need.

Seventhly, one problem experienced by banks is that, many a time, villagers divert the loans from productive to unproductive uses. This needs to be stopped and it needs to be ensured that the credit is used for the purposes for which it is meant. Banks may think in terms of advancing credit to agriculturists in the form of agricultural inputs. While giving credit to farmers in the form of agricultural inputs, it should be ensured that inputs are supplied in adequate quantities and in time and complementary and supplementary facilities are also available.

Finally, it needs to be remembered that stray attempts would not solve the problem of agricultural credit. The credit system as a whole—government, commercial and cooperative—must be so knit together that it does not suffer either from a gap or an overlap. It is only then that the real fruits of credit facilities will be enjoyed by the country at large in the form of agricultural development which still the key to India’s prosperity in future.


1. RBI, Annual Report, 2006-07, p. 143.
2. RBI, Trend and Progress of Banking in India, 2005-06, p. 300.
3. RBI, Annual Report, 2006-07, p. 138.
4. Anil Kumar Jain, ‘New Scheme of Deposit Mobilisation’, Mainstream, January 30, 1971, pp. 17-18.

Table 1 : Advances to the Priority Sector by Public Sector Banks
S. Sector Number of Accounts (in lakhs) Amount oustanding (Rs. crore)
No. June June March March March March June June March March March March
1969 1981 1995 2005 2006 2007@ 1969 1981 1995 2005 2006 2007@
1. Agriculture 1.7 96.99 198.42 201.71 237.98 253.00 162 3881 23328 109917 155220 205091
(5.4) (16.2) (14.1) (15.3) (15.3) (15.6)
(i)Direct 1.6 84.96 194.12 194.94 220.79 235.00 40 2955 20562 83038 112126 146941
Finance (1.3) (12.3) (12.4) (11.6) (11.0) (11.2)
(ii)Indirect 0.1 12.03 4.30 6.77 17.19 18.00 122 926 2766 26879 43093 58150
Finance (4.0) (3.9) (1.7) (3.7) (4.2) (4.4)
2. Small-scale 0.5 8.44 28.84 13.95 17.29 20.00 257 3351 25636 67800 82434 104703
Industry (8.5) (14.0) (15.5) (9.5) (8.1) (8.0)
3. Other 0.4 30.56 107.84 98.08 103.13 102.00 22 1629 11838 125114 163756 201023
Priority (0.7) (6.8) (7.2) (17.4) (16.1) (15.3)
4. Totalpriority 2.6 135.99 335.10 313.74 358.40 391.00 441 8861 60802 307046 409748 521180
sector (14.6) (37.0) (36.8) (42.8) (40.3) (39.6)
5. Net bank - - - - - - 3016 23950 165377 717419 1017656 1317705

@ provisional
Source: 1. Report on Trend and Progress of Banking in India (different years)
2. Economic Survey (different years)

Table 2 : Distribution of Scheduled Commercial Banks’ Offices (as on 30th June)
Year 1969 1975 1981 1986 1991 1996 2001 2002 2003 2004 2005 2006 2007@

@ provisional
Source: 1. Report on Trend and Progress of Banking in India (different years)
2. RBI Handbook of Statistics on Indian Economy (different years)

Table 3 : Priority Sector lending by Public and Private Sector Banks (By end March)]
Public Sector Banks (by end March) Priority sector advances (a+b+c) of which: a)Agriculture b) Small Scale Industries c) Other priority sectors

@ provisional
Note: Figure in the brackets represent percentage to net bank credit for the respective groups

Source: RBI, Report on Trend and Progress of Banking in India (different years)

Dr Anil Kumar Jain is a Professor of Economics, Banaras Hindu University, Varanasi.

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