Rural Credit, Evolution of since 1952

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RURAL CREDIT, EVOLUTION OF SINCE 1952 India's rural credit system is divided into two segments: an unorganized or informal system of moneylenders, traders, and input suppliers; and a formal, organized segment constituted by cooperative banks, regional rural banks, commercial banks, and nonbanking financial companies. In recent years, the move to strengthen formal credit institutions was justified by not only the demands of modern inputs but also usurious moneylending practices that could not otherwise be countered effectively. India's ideological commitment to encouraging a "cooperative commonwealth" also played a role, especially in strengthening cooperative credit institutions at all levels.

Structure of Rural Financial Institutions

Rural credit needs in India are met by an elaborate structure of rural financial institutions (RFIs). The National Bank for Agriculture and Rural Development (NABARD) acts as the apex institution and also as the principal refinancing agency for the RFIs. The Reserve Bank of India, as the principal monetary authority of the country, has retained some powers of regulating and directing agricultural credit, though most of its developmental functions in this area have been ceded to NABARD. Cooperative banks, scheduled commercial banks, and regional rural banks are the three principal rural financial agencies. Numerous state-sponsored institutions and nongovernmental organizations established for development of special sections of the population or particular regions in the country also advance credit to the rural population.

Cooperative banks cater to the short-term as well as long-term requirements of credit in rural and semiurban areas. The short-term credit structure is a three-tier structure, with state-level cooperative banks, or SCBs (numbering 30), at the apex, district-level credit cooperative banks, or DCCBs (numbering 368) constituting the middle tier, and over 98,000 village-level primary societies. Each higher tier largely relies on the lower tier for credit dispersal and, to an extent, on deposit mobilization. State- as well as district-level cooperative institutions also operate, to a limited extent, through their branches. There are 847 branches of the SCBs and over 12,000 branches of the DCCBs. Long-term credit structure is also a tiered structure. There are 20 state-level cooperative agricultural and rural development banks. Some of these banks, mainly in the smaller states, operate directly through their branches. Others, especially those located in the larger states, operate through an intermediary level called primary cooperative agricultural rural development banks, the latter numbering nearly 800, with a branch network of nearly 1,100.

Ninety-eight scheduled commercial banks operate through more than 66,400 branches, of which nearly 32,000 are located in rural areas. The rural and the semi-urban branches of the commercial banks are controlled at the regional level by their regional offices, and the regional offices are coordinated at the zonal level by zonal offices, with the headquarters of the banks responsible for overall control and supervision. The commercial banks have also sponsored, in collaboration with the central and state governments, local district level banks, known as regional rural banks (RRBs). The RRBs number 196, and have a network of over 14,000 branches, which are located preponderantly in rural areas.

There are more than 157,000 credit outlets serving India's rural population of nearly 742 million people. By the end of the financial year (April–March) 2001–2002, the flow of credit for agriculture and allied activities was estimated at 6204.5 billion rupees, of which 4050.9 billion rupees were disbursed as production credit and 2153.6 billion rupees as investment credit. A progressively larger share of ground-level credit in agriculture is accounted for by commercial banks. During the period 1994–1995 to 2001–2002, the share of the commercial banks in the total credit, short term and long term, increased from 44 percent to 54 percent. The share of the cooperatives declined to that extent.

A remarkable feature of the RFIs is their comprehensive coverage of different segments of rural society, including the small and marginal farmers. With the organization of self-help groups of poor farmers and artisans, now numbering over 780,000, and their coordination with the banking institutions, the RFIs now cover a large number of households among the disadvantaged sections of rural society.

Evolution of State Policies

Three distinct phases can be identified in the evolution of the RFIs. The first phase began in 1954, when the recommendations of the Rural Credit Survey Report were largely accepted and efforts made to encourage formal credit institutions, particularly cooperatives. The beginning of the second phase coincided with bank nationalization in 1969, when credit was considered an important instrument of eradicating poverty. The third phase began in 1991, when the RFIs sought to be reformed in consonance with the overall policy of economic reforms.

Serious efforts to revamp the rural credit system began with the publication, in 1954, of the Report of the Rural Credit Survey (RCS) sponsored by the Reserve Bank of India. The recommendations of the RCS made a profound impact on the rural credit structure. State policy was directed to provide a comprehensive and viable alternative to nonformal credit agencies such as moneylenders and traders. Among the formal credit institutions, it emphasized the importance of cooperatives. The RCS was aware of the weaknesses of the cooperative movement, but considered it the best organizational form to meet the requirements of the rural population. It inspired the now famous slogan "cooperation has failed, but cooperation must succeed." The committee was equally eager to make cooperatives financially viable, suggesting large-sized credit cooperatives, and rejecting the "one village, one society" norm.

An equally important recommendation of the RCS was state partnership in the cooperative structure at all levels. Two funds were created in the Reserve Bank of India: the National Agricultural Credit (Long-Term Operations) Fund for advancing loans to the state governments to subscribe to the cooperative institutions and to assist land mortgage banks; and a National Agricultural (Stabilization) Fund to help cooperatives convert short-term loans of members to medium-term loans during periods of natural calamity. Some attention was also given to bringing commercial banks into the rural credit arena. The RCS's recommendation of nationalization of the Imperial Bank of India, enjoining the new State Bank of India to open a large number of branches in rural areas, heralded the entry of commercial banks as important players on the rural credit scene.

Some of these recommendations generated heated controversy. There were serious reservations in a section of cooperators, and also in some government quarters, but, by and large, the recommendations were accepted and were acted upon. Reforms in the credit institutions resulted, though not to the extent expected, in the desired direction, that is, the substitution of the formal sector in place of the informal sector. The proportion of credit from the formal sector increased from 3 percent in 1952 to nearly 30 percent in 1969. Similarly, the land mortgage banks, which had mainly financed redemption of old loans, changed into institutions for long-term funding for productive purposes. However, the major objective of strengthening cooperatives was not achieved. Neither the large-size cooperatives nor the state partnership helped in rejuvenating the credit cooperatives.

Meanwhile, the deepening agricultural crisis of the 1950s and the early 1960s led to greater attention being given to raising agricultural productivity, first by concentrating on a few potentially favorable districts under the Intensive Agricultural District Programme, popularly known as the Package Programme, and later, by spreading this program to a large area. The approach was based on the application of a package of modern inputs and improved practices. To implement such packages, the producers, obviously, needed credit. As efforts to develop agriculture intensified, the need for a higher scale of credit became obvious. The era of exclusive reliance on cooperatives was over, and a multiagency approach to rural credit was initiated. The Agricultural Review Committee noted the need for a multiagency approach in its report in 1969, coinciding with the nationalization of fourteen major commercial banks, a measure that completely changed the character of the banking industry in India. Prime Minister Indira Gandhi felt threatened by her political opponents and had to garner support form the general public with the slogan "garibi hatao" (eradicate poverty). Subsequently, six more banks were added to this list of banks obliged to lend 40 percent of their advances to "priority" sectors, 18 percent of which were in agriculture. The banks were compelled to open branches in the rural areas. They came to be heavily involved in funding the beneficiaries of the poverty alleviation programs, such as the Integrated Rural Development Programme. Other measures in the same direction included the lead bank plan, under which the principal commercial bank operating in a district was given responsibility for coordinating the efforts of all the banks of the area for funding rural development and poverty alleviation.

These measures had an important bearing on the rural credit system. First and foremost was the extension of the credit delivery system to every part of the country. The number of credit outlets of commercial banks in the rural and semi-urban areas, for example, witnessed a phenomenal increase, from 8,262 in 1969–1970 to 60,220 by 1990–1991. The regional imbalances in the number of credit outlets did continue, however, the northeastern states receiving a much smaller number of credit outlets than some of the more advanced states. The absence of proper infrastructure of roads and communications did not inhibit the spread of formal credit institutions in rural areas. In coverage of India's rural population, the objectives of bank nationalization were thus largely fulfilled. Major weaknesses also crept in, reflected in a growing share of overdue and nonperforming assets (NPAs). By the beginning of the 1990s, the percentage of recovery to demand had fallen to 41 percent in the case of RRBs, 54 percent for commercial banks, and 57 percent for primary cooperative societies. The accumulated NPA crippled the financial health of the RFIs.

Since the beginning of the 1990s, the pace of economic reforms, that is, measures to liberalize the domestic economy and to achieve greater integration with the global economy, were accelerated. As a part of these reforms, far-reaching changes were introduced in the financial sector. These included:

  • freeing larger resources of the commercial banks, which had previously been preempted by the government as cash reserve ratio and statutory liquidity ratio;
  • interest rate deregulation;
  • introduction of prudential norms with increase in capital adequacy ratio, risk weighting of assets, stricter norms for income recognition and asset classification;
  • adequate provisioning for nonproductive assets, adherence to prudential norms, especially in income recognition, provisioning for sticky accounts and capital adequacy; and
  • transparency in financial dealings.

The reforms were accompanied with many structural, legal, and procedural changes. Sick regional rural banks, as well as a few commercial banks, that had the potential for revival were recapitalized, after promising to stick to the norms suggested by the Reserve Bank of India and NABARD. A Multi-State Cooperative Act was passed by Parliament to free part of the cooperative credit system from the stranglehold of state bureaucracies.

Major initiatives were taken during the postreform period to bring down the transaction costs in rural lending and to extend the reach of the RFIs to the poor. One of these is the organization and development of self-help groups of poor people, and connecting them to the banking system. Nearly 800,000 groups, each comprising ten to twenty poor households, generally headed by women, have already been organized. They have encouraged savings among the members, reduced the transaction costs of the lending institutions, and ensured a high (more than 80%) rate of recovery. The self-help group movement of India is the largest, and arguably the most successful, micro-credit program of its kind. Another innovative measure is the introduction of the Kisan (Farmers') Credit Card, which enables cardholders timely and flexible availability of credit.

Another important change that took place during this period was the creation of a Rural Infrastructure Development Fund (RIDF). It was observed that very few commercial banks were able to fulfill the mandatory requirement of advancing 18 percent of their total lending to agriculture. At the same time, there was a crying need to invest in rural infrastructure to strengthen the production base of agriculture. A fund was created, to which the banks had to contribute to cover the shortfall. The Expert Committee on Rural Credit recommended the introduction of an element of penalty in terms of lower interest rates on the amount falling short of the mandatory requirement for advances to agriculture, deposited in RIDF.

Almost every medium-sized village in the country now has a credit outlet, cooperative or commercial. A substantial part of agricultural operations are financed by financial institutions. There is a wide variety of products offered to borrowers. At the same time, there are many unresolved issues. The most important are the organizational problems facing the cooperative sector. As a delivery system, it is in a state of disarray. A large number of DCCBs are defunct, and the malady has spread to the state-level institutions. The long-term credit agencies, known as agricultural and rural development cooperative banks, are in a worse plight. Duality of control and supervision, by the registrars of the Cooperative Societies in the states and by the Reserve Bank of India and NABARD in the central government, has not helped matters. The role of the apex and secondary institutions in strengthening the primary units is proving ineffective. The ground level institutions, the cooperative credit societies, are proving to be high-cost credit-dispensing outlets, rather than genuine cooperatives of the members.

Regional rural banks have failed to prove themselves as low-cost, rural-oriented credit institutions, and have largely become deposit-mobilizing institutions for their sponsoring banks. Their cost for dispersing credit is high, and their reach is limited. Their present status and performance do not inspire much confidence. The commercial banks are reluctant to expand their lending to the agricultural sector beyond the statutory requirements, and even there, they fail by a substantial margin. Newer agencies—non-banking financial institutions, local area banks, input suppliers, and a few non-governmental organizations—are now coming into the picture.

At the policy level, the main debatable issue is the mandatory lending targets, for the priority sector in general, and agriculture in particular. As agricultural production is becoming diversified to more value-added products and enterprises, it is becoming much more expensive and capital intensive. If India's small farm sector, which accounts for not only a large number of holdings but also a progressively increasing area of cultivated land, is to participate in this second "Green Revolution," access to timely and low-cost credit will be required. Credit has an important developmental role in a poor country like India. The challenge before the country is to adapt its vast credit system to meet the legitimate demands of the population in India's vast rural areas, without impairing the viability of its financial institutions.

Vijay Vyas

See alsoBank and Non-bank Supervision ; Banking Sector Reform since 1991 ; Development of Commercial Banking 1950–1990 ; Non-banking Financial Institutions, Growth of


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